UNITED
STATES
 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 28, 2008
 
 OR
 
 o
              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)   (Zip Code)
 
 (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 o
 
 Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting
company.  See the definitions of “large accelerated filer,”
“accelerated filer” and “smaller reporting company” in Rule 12b-2 of the
Exchange Act.:
 Large
      accelerated filer
                  o
                  Accelerated
      filer
                  oNon-accelerated
      filer
                  o
                  Smaller
      reporting
company
                  x
 
 Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of Exchange Act). Yes  o  No x
 
 At
February 10, 2009, there were 12,359,990 shares of Class A Common Stock
outstanding and 1,763,321 shares of Class B Common Stock
outstanding.
  
  SPORT CHALET,
INC.
 
 Table of
Contents to Form 10-Q
 
 PART I –
FINANCIAL INFORMATION
 
 PageItem
      1.
                Financial
      Statements
                3Item
      2.
                Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
                14Item
      3.
                Quantitative
      and Qualitative Disclosures About Market Risk
                27Item
      4T.
                Controls
      and Procedures
                27PART
      II – OTHER INFORMATIONItem
      1.
                Legal
      Proceedings
                29Item
      1A.
                Risk
      Factors
                30Item
      2.
                Unregistered
      Sales of Equity Securities and Use of Proceeds
                32Item
      3.
                Defaults
      Upon Senior Securities
                32Item
      4.
                Submission
      of Matters to a Vote of Security Holders
                32Item
      5.
                Other
      Information
                32Item
      6.
                Exhibits
                33
  2
  PART
I – FINANCIAL INFORMATION
 
 Item
1.  Financial
Statements.
 
 SPORT
CHALET, INC.
 
 CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS
 (UNAUDITED)
 
 Three
      months ended
                  
                  
                  Nine
      months endedDecember
      28, 2008
                  
                  
                  December
      30, 2007
                  
                  
                  December
      28, 2008
                  
                  
                  December
      30, 2007(in
      thousands, except per share amounts)Net
      sales
                  
                  $
                  104,562
                  
                  
                  $
                  116,558
                  
                  
                  $
                  288,139
                  
                  
                  $
                  305,781Cost
      of goods sold, buying and occupancy costs
                  
                  
                  81,237
                  
                  
                  
                  81,310
                  
                  
                  
                  216,510
                  
                  
                  
                  214,671Gross
      profit
                  
                  
                  23,325
                  
                  
                  
                  35,248
                  
                  
                  
                  71,629
                  
                  
                  
                  91,110Selling,
      general and administrative expenses
                  
                  
                  29,107
                  
                  
                  
                  30,546
                  
                  
                  
                  83,582
                  
                  
                  
                  79,069Impairment
      charge
                  
                  
                  10,730
                  
                  
                  
                  2,077
                  
                  
                  
                  10,730
                  
                  
                  
                  2,077Depreciation
      and amortization
                  
                  
                  3,700
                  
                  
                  
                  3,279
                  
                  
                  
                  10,967
                  
                  
                  
                  9,767(Loss)
      income from operations
                  
                  
                  (20,212
                  )
                  
                  
                  (654
                  )
                  
                  
                  (33,650
                  )
                  
                  
                  197Interest
      expense
                  
                  
                  571
                  
                  
                  
                  490
                  
                  
                  
                  1,650
                  
                  
                  
                  1,206Loss
      before taxes
                  
                  
                  (20,783
                  )
                  
                  
                  (1,144
                  )
                  
                  
                  (35,300
                  )
                  
                  
                  (1,009
                  )Income
      tax provision (benefit)
                  
                  
                  11,593
                  
                  
                  
                  (462
                  )
                  
                  
                  5,823
                  
                  
                  
                  (402
                  )Net
      loss
                  
                  $
                  (32,376
                  )
                  
                  $
                  (682
                  )
                  
                  $
                  (41,123
                  )
                  
                  $
                  (607
                  )Loss
      per share:Basic
                  
                  $
                  (2.29
                  )
                  
                  $
                  (0.05
                  )
                  
                  $
                  (2.91
                  )
                  
                  $
                  (0.04
                  )Diluted
                  
                  $
                  (2.29
                  )
                  
                  $
                  (0.05
                  )
                  
                  $
                  (2.91
                  )
                  
                  $
                  (0.04
                  )Weighted
      average number of common shares outstanding:Basic
                  
                  
                  14,123
                  
                  
                  
                  14,087
                  
                  
                  
                  14,123
                  
                  
                  
                  14,060Diluted
                  
                  
                  14,123
                  
                  
                  
                  14,087
                  
                  
                  
                  14,123
                  
                  
                  
                  14,060
 
 See
accompanying notes.
  3
  SPORT
CHALET, INC.
 
 CONDENSED
CONSOLIDATED BALANCE SHEETS
 
 December
      28,
                                
                                
                                March
      30,2008
                                
                                
                                2008(Unaudited)(in
      thousands, except share amounts)AssetsCurrent
      assets:Cash
      and cash equivalents
                                
                                $
                                12,992
                                
                                
                                $
                                3,894Accounts
      receivable, net
                                
                                
                                3,312
                                
                                
                                
                                1,359Merchandise
      inventories
                                
                                
                                108,618
                                
                                
                                
                                86,145Prepaid
      expenses and other current assets
                                
                                
                                2,455
                                
                                
                                
                                6,170Income
      tax receivable
                                
                                
                                1,364
                                
                                
                                
                                1,405Deferred
      income taxes
                                
                                
                                -
                                
                                
                                
                                3,349Total
      current assets
                                
                                
                                128,741
                                
                                
                                
                                102,322Fixed
      assets, net
                                
                                
                                59,147
                                
                                
                                
                                66,619Deferred
      income taxes
                                
                                
                                -
                                
                                
                                
                                2,374Total
      assets
                                
                                $
                                187,888
                                
                                
                                $
                                171,315Liabilities
      and stockholders' equityCurrent
      liabilities:Accounts
      payable
                                
                                $
                                37,422
                                
                                
                                $
                                28,035Loan
      payable to bank
                                
                                
                                55,204
                                
                                
                                
                                17,216Salaries
      and wages payable
                                
                                
                                3,527
                                
                                
                                
                                4,620Other
      accrued expenses
                                
                                
                                22,972
                                
                                
                                
                                13,254Total
      current liabilities
                                
                                
                                119,125
                                
                                
                                
                                63,125Deferred
      rent
                                
                                
                                25,629
                                
                                
                                
                                24,221Commitments
      and contingenciesStockholders’
      equity:Preferred
      stock, $.01 par value:Authorized
      shares - 2,000,000 Issued and outstanding shares – none
                                
                                
                                -
                                
                                
                                
                                -Class
      A Common Stock, $.01 par value:Authorized
      shares - 46,000,000 Issued and outstanding shares – 12,359,990 at December
      28, 2008 and March 30, 2008
                                
                                
                                124
                                
                                
                                
                                124Class
      B Common Stock, $.01 par value:Authorized
      shares - 2,000,000 Issued and outstanding shares – 1,763,321 at December
      28, 2008 and March 30, 2008
                                
                                
                                18
                                
                                
                                
                                18Additional
      paid-in capital
                                
                                
                                34,382
                                
                                
                                
                                34,094Retained
      earnings
                                
                                
                                8,610
                                
                                
                                
                                49,733Total
      stockholders’ equity
                                
                                
                                43,134
                                
                                
                                
                                83,969Total
      liabilities and stockholders’ equity
                                
                                $
                                187,888
                                
                                
                                $
                                171,315
 
 See
accompanying notes.
  4
  SPORT
CHALET, INC.
 
 CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS
 (UNAUDITED)
 
 Nine
      months endedDecember
      28, 2008
                  
                  
                  December
      30, 2007(in
      thousands)Operating
      activitiesNet
      loss
                  
                  $
                  (41,123
                  )
                  
                  $
                  (607
                  )Adjustments
      to reconcile net loss to net cash provided by operating
      activities:Depreciation
      and amortization
                  
                  
                  10,967
                  
                  
                  
                  9,767Impairment
      charge
                  
                  
                  10,730
                  
                  
                  
                  2,077Loss
      on disposal of equipment
                  
                  
                  179
                  
                  
                  
                  64Share-based
      compensation
                  
                  
                  278
                  
                  
                  
                  188Deferred
      income taxes
                  
                  
                  5,723
                  
                  
                  
                  1,649Changes
      in operating assets and liabilities:Accounts
      receivable
                  
                  
                  (1,953
                  )
                  
                  
                  3,368Merchandise
      inventories
                  
                  
                  (22,473
                  )
                  
                  
                  (19,076
                  )Prepaid
      expenses and other current assets
                  
                  
                  3,715
                  
                  
                  
                  (597
                  )Income
      tax receivable
                  
                  
                  41
                  
                  
                  
                  (2,375
                  )Accounts
      payable
                  
                  
                  9,387
                  
                  
                  
                  9,400Salaries
      and wages payable
                  
                  
                  (1,093
                  )
                  
                  
                  (1,364
                  )Other
      accrued expenses
                  
                  
                  9,718
                  
                  
                  
                  7,160Deferred
      rent
                  
                  
                  1,408
                  
                  
                  
                  1,131Net
      cash (used in) provided by operating activities
                  
                  
                  (14,496
                  )
                  
                  
                  10,785Investing
      activitiesPurchase
      of fixed assets
                  
                  
                  (14,404
                  )
                  
                  
                  (17,834
                  )Net
      cash used in investing activities
                  
                  
                  (14,404
                  )
                  
                  
                  (17,834
                  )Financing
      activitiesProceeds
      from bank borrowing
                  
                  
                  222,419
                  
                  
                  
                  91,221Repayments
      of bank borrowing
                  
                  
                  (184,431
                  )
                  
                  
                  (80,998
                  )Proceeds
      from exercise of stock options
                  
                  
                  -
                  
                  
                  
                  320Tax
      benefit on employee stock options
                  
                  
                  10
                  
                  
                  
                  300Net
      cash provided by financing activities
                  
                  
                  37,998
                  
                  
                  
                  10,843Increase
      in cash and cash equivalents
                  
                  
                  9,098
                  
                  
                  
                  3,794Cash
      and cash equivalents at beginning of period
                  
                  
                  3,894
                  
                  
                  
                  3,841Cash
      and cash equivalents at end of period
                  
                  $
                  12,992
                  
                  
                  $
                  7,635Supplemental
      Disclosure of Cash Flow InformationCash
      paid during the period for:Income
      taxes
                  
                  $
                  -
                  
                  
                  $
                  -Interest
                  
                  
                  1,129
                  
                  
                  
                  1,072
 
 See
accompanying notes.
  5
  SPORT
CHALET, INC.
 
 NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (UNAUDITED)
 
 1.
              Basis
      of Presentation
 
 The accompanying condensed consolidated
balance sheet as of March 30,  2008, which has been derived from
audited financial statements, and the unaudited interim condensed 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
accompanying condensed consolidated financial statements should be read in
conjunction with the audited consolidated financial statements included in the
Company’s Annual Report on Form 10-K for the fiscal year ended March 30,
2008.  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.
              Liquidity
 
 Our
primary capital requirements are for inventory, store expansion, relocation and
remodeling.  Historically, cash from operations, credit terms from
vendors and bank borrowing have met our liquidity needs.  Same store
sales for the past six quarters from the second quarter of fiscal 2008 to the
third quarter of fiscal 2009 are +2.2%, -6.9%, -8.8%, -11.1%, -6.7% and -15.4%,
respectively.  More recently, for our fourth quarter through February
8, 2009 we have experienced a 21% decline in same store sales.  In the
event this decline were to continue, we may have insufficient working capital to
continue to operate our business as it has been operated, or at
all.
 
 In our
efforts to reduce operating expenses and improve liquidity, we have reviewed all
of our store leases and are obtaining rent reductions and lease modifications
from our landlords.  Additionally, we are evaluating our operating
expenses, such as store labor, corporate overhead and advertising, and have
commenced implementing cost reductions.  No assurance can be given
that we will be successful in reducing operating expenses and controlling costs
in an amount sufficient to improve our financial
performance.  Moreover, no assurance can be given that by reducing
operating expenses and controlling costs we will return to
profitability.  Any failure to successfully reduce an adequate amount
of operating expenses and control costs could constrain our ability to continue
to operate our business.  If cash generated by operations does not
result in a sufficient level of unused borrowing capacity, our current
operations could be constrained by our ability to obtain funds under the terms
of our revolving credit facility.  In such a case, we would need to
seek other financing alternatives with our bank or other
sources.  Additional financing may not be available at terms
acceptable to us, or at all.  Failure to obtain financing in such
circumstances may require us to significantly curtail our
operations.
  6
  The
amount we can borrow under our credit facility with Bank of America, N.A. (the
“Lender”) is limited to a percentage of the value of eligible inventory, minus
certain reserves.  A significant decrease in eligible inventory due to
the aging of inventory, an unfavorable inventory appraisal or other factors,
could have an adverse effect on our borrowing capabilities under our credit
facility, which may adversely affect the adequacy of our working capital In
January 2009, the Lender commissioned a third party appraiser to update the
calculation of the “net orderly liquidation value” as defined in the agreement,
and this valuation may impact the amount that we will be able to continue to
borrow and pay bills as they become due.  In the likely event of an
unfavorable inventory appraisal, we would need to further reduce our operating
costs and seek alternative funding, the nature and source of which has not been
identified and may not be available on acceptable terms, or at
all.  If we are unable to implement either or both of these steps, our
operations would be materially and adversely impacted.
 
 3.
              Change
      in Inventory Valuation Method
 
 In connection with the implementation
of a new financial and merchandising system, effective March 31, 2008, we have
changed the inventory valuation method from the first-in, first-out “FIFO” basis
determined by the retail method of accounting to a weighted-average cost basis,
using the retail method.  We have accounted for the change in
accounting principle prospectively, in accordance with Statement of Financial
Accounting Standards (“SFAS”) No.154, “Accounting Changes and Error
Corrections.”  The cumulative effect of this change is not
determinable as we do not have the ability to recalculate average cost for prior
periods.  We are beginning fiscal 2009 with the FIFO costs as used for
the ending fiscal 2008 inventory valuation; going forward these amounts will be
updated as new purchases are made.  We do not anticipate this change
will have a material effect on our results of operations, and we chose this
method based on our new system capabilities.
 
 4.
              Income
      Taxes
 
 In
accordance with SFAS No. 109, "Accounting for Income Taxes," we evaluate
whether a valuation allowance should be established against our net deferred tax
assets based on the consideration of all available evidence using a "more likely
than not" standard.  Significant weight is given to evidence that can
be objectively verified.  The determination to record a valuation
allowance is based on the recent history of cumulative losses and losses
expected in the near future.  In conducting our analysis, we utilize a
consistent approach which considers our current year loss, including an
assessment of the degree to which any losses are driven by items that are
unusual in nature and incurred to improve future profitability.  In
addition, we review changes in near-term market conditions and any other factors
arising during the period which may impact our future operating
results.
 
 As a
result of our analysis, we determined that a full valuation allowance against
our net deferred tax assets in the third quarter of fiscal 2009 was
required.  We will not record income tax benefits in the consolidated
financial statements until it is determined that it is more likely than not that
we will generate sufficient taxable income to realize our deferred income tax
assets.  As of December 28, 2008, our net deferred tax assets and
related valuation allowance totaled $19.8 million.
  7
  The
following table summarizes the components of the provision for income
taxes:
 
 Three
      months ended
                  
                  
                  Nine
      months endedDecember
      28, 2008
                  
                  
                  December
      30, 2007
                  
                  
                  December
      28, 2008
                  
                  
                  December
      30, 2007(in
      thousands)Federal:Current
                  
                  $
                  3,866
                  
                  
                  $
                  (3,112
                  )
                  
                  $
                  (32
                  )
                  
                  $
                  (2,376
                  )Deferred
                  
                  
                  4,157
                  
                  
                  
                  2,845
                  
                  
                  
                  3,565
                  
                  
                  
                  2,156Total
      Federal
                  
                  
                  8,023
                  
                  
                  
                  (267
                  )
                  
                  
                  3,533
                  
                  
                  
                  (220
                  )State:Current
                  
                  
                  1,127
                  
                  
                  
                  55
                  
                  
                  
                  83
                  
                  
                  
                  325Deferred
                  
                  
                  2,443
                  
                  
                  
                  (250
                  )
                  
                  
                  2,207
                  
                  
                  
                  (507
                  )Total
      State
                  
                  
                  3,570
                  
                  
                  
                  (195
                  )
                  
                  
                  2,290
                  
                  
                  
                  (182
                  )Provision
      (benefit) for income taxes
                  
                  $
                  11,593
                  
                  
                  $
                  (462
                  )
                  
                  $
                  5,823
                  
                  
                  $
                  (402
                  )
 
 Deferred
income taxes reflect the net tax effects of temporary differences between the
carrying amounts of assets and liabilities for financial reporting purposes and
the amounts used for income tax purposes.  The following table
summarizes the tax effect of temporary differences that give rise to deferred
income taxes:
 
 December
      28, 2008
                  
                  
                  March
      30, 2008Current
                  
                  
                  Non-Current
                  
                  
                  Current
                  
                  
                  Non-Current(in
      thousands)Deferred
      tax assets:Fixed
      assets
                  
                  $
                  -
                  
                  
                  $
                  4,716
                  
                  
                  $
                  -
                  
                  
                  $
                  1,181Uniform
      cost capitalization
                  
                  
                  609
                  
                  
                  
                  -
                  
                  
                  
                  510
                  
                  
                  
                  -Inventory
      reserves
                  
                  
                  996
                  
                  
                  
                  -
                  
                  
                  
                  1,235
                  
                  
                  
                  -Accrued
      vacation
                  
                  
                  524
                  
                  
                  
                  -
                  
                  
                  
                  467
                  
                  
                  
                  -Bonus
      accrual
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  101
                  
                  
                  
                  -Self-insurance
      accruals
                  
                  
                  569
                  
                  
                  
                  -
                  
                  
                  
                  539
                  
                  
                  
                  -Allowance
      for bad debt and sales returns
                  
                  
                  617
                  
                  
                  
                  -
                  
                  
                  
                  300
                  
                  
                  
                  -State
      income taxes
                  
                  
                  (694
                  )
                  
                  
                  -
                  
                  
                  
                  (26
                  )
                  
                  
                  -Deferred
      rent
                  
                  
                  -
                  
                  
                  
                  1,561
                  
                  
                  
                  -
                  
                  
                  
                  1,193Net
      operating loss carryforward
                  
                  
                  -
                  
                  
                  
                  10,314
                  
                  
                  
                  -
                  
                  
                  
                  -Other
                  
                  
                  567
                  
                  
                  
                  -
                  
                  
                  
                  223
                  
                  
                  
                  -Total
      deferred tax assets before valuation allowance
                  
                  
                  3,188
                  
                  
                  
                  16,591
                  
                  
                  
                  3,349
                  
                  
                  
                  2,374Valuation
      allowance
                  
                  
                  (3,188
                  )
                  
                  
                  (16,591
                  )
                  
                  
                  -
                  
                  
                  
                  -Total
      deferred tax assets
                  
                  $
                  -
                  
                  
                  $
                  -
                  
                  
                  $
                  3,349
                  
                  
                  $
                  2,374
 
 As part of the economic stimulus
package, on January 29, 2009 a House bill which includes a provision that would
extend the net operating loss carryback period from two to five years was
approved.  In the event this bill becomes a law, we believe we could
obtain an income tax refund of up to $10.0 million.
  8
  The
following table summarizes a reconciliation of the income tax provision computed
using the Federal statutory income tax rate:
 
 Three
      months ended
                        
                        
                        Nine
      months endedDecember
      28, 2008
                        
                        
                        December
      30, 2007
                        
                        
                        December
      28, 2008
                        
                        
                        December
      30, 2007(in
      thousands)Statutory rate, 34%
      applied to incomebefore taxes
                        
                        $
                        (7,066
                        )
                        
                        $
                        (390
                        )
                        
                        $
                        (12,002
                        )
                        
                        $
                        (343
                        )State
      taxes, net of federal tax effect
                        
                        
                        (1,213
                        )
                        
                        
                        (66
                        )
                        
                        
                        (2,060
                        )
                        
                        
                        (58
                        )Deferred
      tax valuation allowance
                        
                        
                        19,779
                        
                        
                        
                        -
                        
                        
                        
                        19,779
                        
                        
                        
                        -Other,
      net
                        
                        
                        93
                        
                        
                        
                        (6
                        )
                        
                        
                        106
                        
                        
                        
                        1Provision
      (benefit) for income taxes
                        
                        $
                        11,593
                        
                        
                        $
                        (462
                        )
                        
                        $
                        5,823
                        
                        
                        $
                        (400
                        )
 
 We
adopted the provisions of Financial Accounting Standards Board (“FASB”)
Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN
48”), an interpretation of FASB Statement No. 109 (“SFAS 109”), on April 2,
2007.  When applicable, we recognize interest and penalties related to
uncertain tax positions in income tax expense.  The tax year ending
March 30, 2008 remains open to examination by the Internal Revenue
Service.  The tax years ending March 31, 2004 to March 30, 2008 remain
open to examination by the state of California.  The tax years ending
March 31, 2006 to March 30, 2008 remain open to examination by the state of
Arizona.  The tax year ending March 30, 2008 remains open to
examination by the state of Utah.
 
 5.
              Loss
      per Share
 
 Loss per
share, basic, is computed based on the weighted average number of common shares
outstanding for the period.  Loss 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 of the
numerators and denominators of the basic and diluted loss per share computations
are set forth below:
 
 Three
      months ended
                  
                  
                  Nine
      months endedDecember
      28, 2008
                  
                  
                  December
      30, 2007
                  
                  
                  December
      28, 2008
                  
                  
                  December
      30, 2007(in
      thousands, except per share amounts)Net
      loss
                  
                  $
                  (32,376
                  )
                  
                  $
                  (682
                  )
                  
                  $
                  (41,123
                  )
                  
                  $
                  (607
                  )Weighted
      average number of common shares:Basic
                  
                  
                  14,123
                  
                  
                  
                  14,087
                  
                  
                  
                  14,123
                  
                  
                  
                  14,060Effect
      of dilutive securities-stock options
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Diluted
                  
                  
                  14,123
                  
                  
                  
                  14,087
                  
                  
                  
                  14,123
                  
                  
                  
                  14,060Class
      A and Class B Loss per share:Basic
                  
                  $
                  (2.29
                  )
                  
                  $
                  (0.05
                  )
                  
                  $
                  (2.91
                  )
                  
                  $
                  (0.04
                  )Effect
      of dilutive securities-stock options
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Diluted
                  
                  $
                  (2.29
                  )
                  
                  $
                  (0.05
                  )
                  
                  $
                  (2.91
                  )
                  
                  $
                  (0.04
                  )
 
 An aggregate of 1,949,105 options for
the three and nine months ended December 28, 2008 and an aggregate of 943,404
and 729,975 options for the three and nine months ended December 30, 2007,
respectively, are excluded from the computation of diluted loss per share as
their effect would have been anti-dilutive.
  9
  6.
              Loan
      Payable to Bank
 
 In June
2008, we negotiated a new credit facility with our Lender, which provides for
advances up to $45.0 million, increasing to $70.0 million, for the period
September 1, through December 31, each year, and up to a $10.0 million maximum
in authorized letters of credit.  The amount we may borrow under this
credit facility is limited to a percentage of the value of eligible inventory,
minus certain reserves.  Interest accrues at the Lender’s prime rate
plus an applicable margin up to 0.50% based on our fixed charge coverage ratio
(3.75% at December 28, 2008) or at our option we can fix the rate for a period
of time at LIBOR plus an applicable margin (1.50% up to 2.50% based on our fixed
charge coverage ratio).  In addition, there is an unused commitment
fee of 0.25% per year, based on a weighted average formula, a one-time,
non-refundable commitment fee of $350,000 and an early termination fee of 1.50%
in year one, 0.75% in year two and 0.25% in year three which is waived if the
loan is refinanced by the Lender or any of its affiliates.  This
credit facility expires in June 2012.  Our obligation to the Lender is
presently secured by a first priority lien on substantially all of our non-real
estate assets, and should availability fall below certain prescribed limits we
would be subject to a covenant that we maintain a minimum cash flow coverage
ratio of 1:1.  We do not now meet this minimum ratio.  While
our cash flow coverage ratio is less than 1:1, we must avoid availability
falling below the prescribed limits in order to comply with our covenants under
the credit facility.
 
 On
January 9, 2009, we entered into a First Amendment to Amended and Restated Loan
and Security Agreement and Limited Forbearance Agreement (the "First Amendment")
dated as of December 28, 2008, with the Lender under the Amended and Restated
Loan and Security Agreement, as amended, dated as of June 20, 2008 (the "Loan
Agreement").
 
 Under the
First Amendment, (i), the Lender has agreed to forbear from exercising its
rights in respect of the Event of Default described below under the Loan
Agreement, (ii) we may not select a LIBOR-based interest rate under the Loan
Agreement, and (iii) the Lender agreed to permit an overadvance in the amount of
$1.5 million until January 13, 2009.  As of December 31, 2008, an
event of default had occurred under the Loan Agreement due to our failure to
maintain a "Fixed Charge Coverage Ratio" (as defined in the Loan Agreement) of
not less than 1.00 to 1.00 (the "Event of Default").  On December 28,
2008, availability under the Loan Agreement was less than $10.5 million, thereby
requiring the testing of the Fixed Charge Coverage Ratio.  The
forbearance period under the First Amendment ended on January 31,
2009.  We acknowledged, among other things, that we had no defenses,
claims or set-offs to the obligations under the Loan Agreement and provided the
Lender a general release of claims.
 
 Also on
January 9, 2009, we entered into a letter agreement (the "Turnaround Letter
Agreement") with the Lender in which, as an inducement to the Lender to enter
into the First Amendment, we agreed to engage a certified turnaround
professional on or before January 12, 2009 and for a minimum term of 90
days.  On January 9, 2009, we engaged FTI Consulting, to prepare cash
flow and operating budgets to be presented periodically to the Board of
Directors of the Company and to the Lender in accordance with the Turnaround
Letter Agreement.
 
 On
January 29, 2009, we entered into a Second Amendment to Amended and Restated
Loan and Security Agreement and Limited Forbearance Agreement (the “Second
Amendment”) with the Lender under the Loan Agreement.  Under the
Second Amendment, the Lender has agreed to extend the period during which it
will forbear from exercising its rights in respect of certain defaults under the
Loan Agreement from January 31, 2009 until the earlier to occur of any further
default under the Loan Agreement or March 2, 2009.  There can be no
assurance that there will not be another event of default or that the Lender
will extend the forbearance period beyond March 2,
2009.   Additional financing may not be available at terms
acceptable to us, or at all.  Failure to obtain financing in such
circumstances may require us to significantly curtail our
operations.
  10





In
January 2009, the Lender commissioned a third party appraiser to update the
calculation of the “net orderly liquidation value” as defined in the agreement,
and this valuation may impact the amount that we will be able to continue to
borrow and pay bills as they become due.  In the likely event of an
unfavorable inventory appraisal, we would need to further reduce our operating
costs and seek alternative funding, the nature and source of which has not been
identified and may not be available on acceptable terms, or at
all.  If we are unable to implement either or both of these steps, our
operations would be materially and adversely impacted.





7.
            Share-based
      Compensation





Total
share-based compensation expense and the related income tax benefit recognized
for the three months and nine months ended December 28, 2008 and December 30,
2007:





Three months ended
                  
                  
                  Nine months endedDecember 28, 2008
                  
                  
                  December 30, 2007
                  
                  
                  December 28, 2008
                  
                  
                  December 30, 2007(in
      thousands)Compensation
      expense
                  
                  $
                  88
                  
                  
                  $
                  44
                  
                  
                  $
                  278
                  
                  
                  $
                  188Income
      tax benefit
                  
                  $
                  -
                  
                  
                  $
                  18
                  
                  
                  $
                  -
                  
                  
                  $
                  75





The fair value of each option granted
is estimated on the date of grant using the Black-Scholes option-valuation
model.  The Black-Scholes option valuation 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.  For the three months and nine
months ended December 28, 2008 and December 30, 2007 the following weighted
average assumptions were used to estimate the fair value for stock options
granted in that period:





Three months ended
                  
                  
                  Nine months endedDecember 28, 2008
                  
                  
                  December 30, 2007
                  
                  
                  December 28, 2008
                  
                  
                  December 30, 2007Risk-free
      interest rate
                  
                  
                  3
                  %
                  
                  
                  5
                  %
                  
                  
                  3
                  %
                  
                  
                  5
                  %Expected
      volatility
                  
                  
                  44.7
                  %
                  
                  
                  36.6
                  %
                  
                  
                  38.8
                  %
                  
                  
                  36.6
                  %Expected
      dividend yield
                  
                  
                  0
                  %
                  
                  
                  0
                  %
                  
                  
                  0
                  %
                  
                  
                  0
                  %Expected
      life in years
                  
                  
                  7.5
                  
                  
                  
                  7.5
                  
                  
                  
                  7.5
                  
                  
                  
                  7.5


11


The
following table sets forth information concerning stock option activity for the
nine months ended December 28, 2008:




Options
                                          
                                          
                                          Weighted
                                            Average
                                            Exercise Price
                                          
                                          Weighted-
                                            Average
                                            Remaining
                                            Contractual
                                            Term (Years)
                                          
                                          
                                          Aggregate
                                            Intrinsic Value
                                            (in 000's)Outstanding
      as of March 30, 2008
                                          
                                          
                                          1,432,055
                                          
                                          
                                          $
                                          5.28Granted
                                          
                                          
                                          538,150
                                          
                                          
                                          
                                          4.77Exercised
                                          
                                          
                                          -Forfeited
      or expired
                                          
                                          
                                          (21,100
                                          )
                                          
                                          
                                          7.38Outstanding
      as of December 28, 2008
                                          
                                          
                                          1,949,105
                                          
                                          
                                          $
                                          5.09
                                          
                                          5.6
                                          
                                          $
                                          -




The
aggregate intrinsic value in the table above is based on the Company’s closing
stock price of $0.45 and $0.50 for Class A and Class B, respectively, as of the
last trading day of the period ended December 28, 2008.





8.
            Impairment
      of Long-Lived Assets





A
non-cash impairment charge of $10.7 million and $2.1 million was recorded in the
three and nine months ended December 28, 2008 and December 30, 2007, related to
eleven and two stores, respectively, with significantly lower than expected
sales volume and based on recent trends are not expected to obtain sufficient
cash flow over their remaining lease terms to support the net book value of
their leasehold improvements and fixtures.  The existence of the
impairment was assessed by calculating the net cash flow of each individual
store on an undiscounted basis and comparing it to the net book value of the
individual store.  The actual impairment charge was measured
by determining the fair value of the store's assets, calculated based on
the discounted net cash flow of the store over the remaining lease term, and
comparing it to the book value.





9.
            Recently
      Issued Accounting Pronouncements





The following is a list of recently
issued accounting pronouncements, none of which have had or are expected to have
a material impact on our results of operations, cash flows or financial
position.





In
September 2006, the FASB issued SFAS No. 157, “Fair Value
Measurements.”  SFAS No. 157 defines fair value, establishes a
framework for measuring fair value in generally accepted accounting principles
and expands disclosures about fair value measurements.  SFAS No. 157
applies under other accounting pronouncements that require or permit fair value
measurements, the FASB having previously concluded in those accounting
pronouncements that fair value is the relevant measurement
attribute.  Accordingly, SFAS No. 157 does not require any new
fair value measurements.  There are numerous previously issued
statements dealing with fair values that are amended by SFAS No. 157. SFAS
No. 157 is effective for financial statements issued for fiscal years
beginning after November 15, 2007. In February 2008, the FASB issued
Staff Position (“FSP”) FAS 157-1, “Application of FASB Statement No. 157 to
FASB Statement No. 13 and Other Accounting Pronouncements That Address Fair
Value Measurements for Purposes of Lease Classification or Measurement under
Statement 13,” which scopes out leasing transactions accounted for under SFAS
No. 13, “Accounting for Leases.” In February 2008, FSP FAS 157-2,
“Effective Date of FASB Statement No. 157,” was issued, which delays the
effective date of SFAS No. 157 to fiscal years and interim periods within
those fiscal years beginning after November 15, 2008 for nonfinancial
assets and nonfinancial liabilities, except for items that are recognized or
disclosed at fair value in the financial statements on a recurring basis (at
least annually).  In October 2008, FSP FAS 157-3, “Determining
the Fair Value of a Financial Asset When the Market for That Asset Is Not
Active” was issued.  FSP FAS 157-3 clarifies the application of SFAS
No. 157, in determining the fair value of a financial asset when the market
for that financial asset is not active.  FSP FAS 157-3 became
effective upon issuance and includes prior periods for which financial
statements have not been issued. The adoption of the applicable provisions of
SFAS No. 157 at the beginning of fiscal 2009 has not had a material impact
on our financial condition.  We do not expect the adoption of the
remaining provisions of SFAS No. 157 to have a material impact on our results of
operations, cash flows, or financial position.


12





In
February 2007, the FASB issued SFAS No. 159, “The Fair Value Option
for Financial Assets and Financial Liabilities.”  SFAS No. 159
permits companies to choose to measure many financial instruments and certain
other items at fair value.  The objective is to improve financial
reporting by providing companies with the opportunity to mitigate volatility in
reported earnings caused by measuring related assets and liabilities differently
without having to apply complex hedge accounting provisions.  SFAS
No. 159 is effective for fiscal years beginning after November 15,
2007.  We have adopted SFAS No. 159 at the beginning of fiscal
2009 but elected not to apply the Fair Value Option of SFAS
No. 159.





In
December 2007, the FASB issued SFAS No. 141(R), “Business Combinations” (“FAS
141(R)”), to replace FAS 141, “Business Combinations.”  FAS 141(R)
requires use of the acquisition method of accounting, defines the acquirer,
establishes the acquisition date and broadens the scope to all transactions and
other events in which one entity obtains control over one or more other
businesses.  This statement is effective for financial statements
issued for fiscal years beginning on or after December 15, 2008 with earlier
adoption prohibited.  While we do not expect the adoption of FAS
141(R) to have a material impact to our consolidated financial statements for
transactions completed prior to December 31, 2008, the impact of the accounting
change could be material for business combinations which may be consummated
subsequent thereto.





In
December 2007, the FASB issued SFAS No. 160, “Non controlling Interests in
Consolidated Financial Statements — an amendment of ARB No. 51” (“FAS
160”).  FAS 160 establishes accounting and reporting standards for the
non-controlling interest in a subsidiary and for the retained interest and gain
or loss when a subsidiary is deconsolidated.  This statement is
effective for financial statements issued for fiscal years beginning on or after
December 15, 2008 with earlier adoption prohibited.  We currently do
not have any non-controlling interests or deconsolidated subsidiaries and
therefore FAS 160 will not have any impact on our consolidated financial
statements.





In May
2008, the FASB issued SFAS No. 162, “Hierarchy of Generally Accepted Accounting
Principles” (“SFAS 162”). This statement is intended to improve financial
reporting by identifying a consistent framework, or hierarchy, for selecting
accounting principles to be used in preparing financial statements of
nongovernmental entities that are presented in conformity with
GAAP.  This statement will be effective 60 days following the U.S.
Securities and Exchange Commission’s approval of the Public Company Accounting
Oversight Board amendment to AU Section 411, “The Meaning of Present Fairly in
Conformity with Generally Accepted Accounting Principles.”  We believe
that FAS 162 will have no effect on our financial statements.


13





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





This Quarterly Report on Form 10-Q
contains statements that 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.  These
forward-looking statements are made pursuant to the safe harbor provisions of
the Private Securities Litigation Reform Act of 1995.  These
forward-looking statements include statements relating to trends in, or
representing management’s beliefs about, our future strategies, operations and
financial results, as well as other statements including words such as
“believe,” “anticipate,” “expect,” “estimate,” “predict,” “intend,” “plan,”
“project,” “will,” “could,” “may,” “might” or any variations of such words or
other words with similar meanings.  Forward-looking statements are
made based upon management’s current expectations and beliefs concerning trends
and future developments and their potential effects on the
Company.  Prospective investors are cautioned that they should not
place undue reliance on forward-looking statements as predictions of actual
results.  These statements are not guarantees of future performance
and involve risks and uncertainties that are difficult to
predict.  Further, certain forward-looking statements are based upon
assumptions as to future events that may not prove to be
accurate.  Actual results may differ materially from those suggested
by forward-looking statements as a result of risks and uncertainties which are
discussed in further detail under “- Factors That May Affect Future Results” and
“Risk Factors.”  We do not assume, and specifically disclaim, any
obligation to update any forward-looking statements, which speak only as of the
date made.





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





We are a leading operator of 55 full
service specialty sporting goods stores in California, Nevada, Arizona and
Utah.  In 1959, Norbert Olberz, our founder (the “Founder”), purchased
a small ski and tennis shop in La Cañada, California.  A focus on
providing quality merchandise with outstanding customer service was the
foundation of Norbert’s vision.  We continue this tradition and are
focused on growth through a number of initiatives, including: continuing new
store development; remodeling stores to conform to our prototype; and improving
information systems to increase product flow-through, improve in-stock positions
and optimize merchandise and specialty services assortment.  Our
prototype store is 42,000 square feet in size and showcases every merchandise
and service category with the feel of a specialty shop all contained under one
roof.





Our
comparative store sales growth had been positive for the four fiscal years prior
to fiscal 2008.  Comparative store sales declined 4.5% for fiscal 2008
and declined further in the first three quarters of fiscal 2009 as we continue
to confront a difficult macro-economic environment, which began with weak
housing trends and high gasoline prices in our core markets and continued with
the financial and credit crisis.  As a result of the reduction in same
store sales for the first nine months of fiscal 2009 and the opening of new
stores which have not reached maturity, we incurred a net loss of $41.1 million,
or $2.91 per diluted share, compared to a net loss of $607,000, or $0.04 per
diluted share, for the first nine months of fiscal 2008.  Same store
sales for the past six quarters from the second quarter of fiscal 2008 to the
third quarter of fiscal 2009 are +2.2%, -6.9%, -8.8%, -11.1%, -6.7% and -15.4%,
respectively.  More recently, for our fourth quarter through February
8, 2009 we have experienced a 21% decline in same store sales.  In the
event this decline were to continue, we may have insufficient working capital to
continue to operate our business as it has been operated, or at
all.


14





In our
efforts to reduce operating expenses and improve liquidity, we have reviewed all
of our store leases and are obtaining rent reductions and lease modifications
from our landlords.  Additionally, we are evaluating our operating
expenses, such as store labor, corporate overhead and advertising, and have
commenced implementing cost reductions.  No assurance can be given
that we will be successful in reducing operating expenses and controlling costs
in an amount sufficient to improve our financial
performance.  Moreover, no assurance can be given that by reducing
operating expenses and controlling costs we will return to
profitability.  Any failure to successfully reduce an adequate amount
of operating expenses and control costs could constrain our ability to continue
to operate our business.  If cash generated by operations does not
result in a sufficient level of unused borrowing capacity, our current
operations could be constrained by our ability to obtain funds under the terms
of our revolving credit facility.  In such a case, we would need to
seek other financing alternatives with our bank or other
sources.  Additional financing may not be available at terms
acceptable to us, or at all.  Failure to obtain financing in such
circumstances may require us to significantly curtail our
operations.  See “Risk Factors - A downturn in the economy has
affected consumer purchases of discretionary items, reducing our net
sales.  If the decline were to continue, we may not have sufficient
working capital to continue.” in Item 1A “Risk Factors.”





A
non-cash impairment charge of $10.7 million and $2.1 million was recorded in the
three and nine months ended December 28, 2008 and December 30, 2007, related to
eleven and two stores, respectively, with significantly lower than expected
sales volume and based on recent trends are not expected to obtain sufficient
cash flow over their remaining lease terms to support the net book value of
their leasehold improvements and fixtures.  The existence of the
impairment was assessed by calculating the net cash flow of each individual
store on an undiscounted basis and comparing it to the net book value of the
individual store.  The actual impairment charge was measured
by determining the fair value of the store's assets, calculated based on
the discounted net cash flow of the store over the remaining lease term, and
comparing it to the book value.





Our growth had historically focused on
Southern California; but since 2001 we have expanded our scope to all of
California, Nevada, Arizona and Utah as suitable locations are
found.  We opened seven stores in fiscal year 2008, 17 stores in the
last three years and 25 in the last five years.  For the first nine
months of fiscal year 2009, we opened four new stores and relocated one store,
but currently do not anticipate opening new stores or entering into new lease
commitments in the near future.





The terms
comparable store sales or same store sales are used interchangeably and are
considered a key performance measurement.  The sales of a store are
first included in the comparable store sales calculation in the quarter
following its twelfth full month of operation.


15


Results
of Operations





Three
Months Ended December 28, 2008 Compared to December 30, 2007





The
following table sets forth statements of operations data and relative
percentages of net sales for the three months ended December 28, 2008 compared
to three months ended December 30, 2007 (dollar amounts in thousands, except per
share amounts):





Three months endedDecember 28, 2008
                
                
                December 30, 2007
                
                
                Dollar
                  Change
                
                
                Percentage
                  ChangeAmount
                
                
                Percent
                
                
                Amount
                
                
                PercentNet
      sales
                
                $
                104,562
                
                
                
                100.0
                %
                
                $
                116,558
                
                
                
                100.0
                %
                
                $
                (11,996
                )
                
                
                (10.3
                )%Gross
      profit
                
                
                23,325
                
                
                
                22.3
                %
                
                
                35,248
                
                
                
                30.2
                %
                
                
                (11,923
                )
                
                
                (33.8
                )%Selling,
      general and administrative expenses
                
                
                29,107
                
                
                
                27.8
                %
                
                
                30,546
                
                
                
                26.2
                %
                
                
                (1,439
                )
                
                
                (4.7
                )%Impairment
      charge
                
                
                10,730
                
                
                
                10.3
                %
                
                
                2,077
                
                
                
                1.8
                %
                
                
                8,653
                
                
                
                416.6
                %Depreciation
      and amortization
                
                
                3,700
                
                
                
                3.5
                %
                
                
                3,279
                
                
                
                2.8
                %
                
                
                421
                
                
                
                12.8
                %Loss
      from operations
                
                
                (20,212
                )
                
                
                (19.3
                )%
                
                
                (654
                )
                
                
                (0.6
                )%
                
                
                (19,558
                )
                
                
                *Interest
      expense
                
                
                571
                
                
                
                0.5
                %
                
                
                490
                
                
                
                0.4
                %
                
                
                81
                
                
                
                16.5
                %Loss
      before taxes
                
                
                (20,783
                )
                
                
                (19.9
                )%
                
                
                (1,144
                )
                
                
                (1.0
                )%
                
                
                (19,639
                )
                
                
                *Income
      tax provision (benefit)
                
                
                11,593
                
                
                
                11.1
                %
                
                
                (462
                )
                
                
                (0.4
                )%
                
                
                12,055
                
                
                
                *Net
      loss
                
                
                (32,376
                )
                
                
                (31.0
                )%
                
                
                (682
                )
                
                
                (0.6
                )%
                
                
                (31,694
                )
                
                
                *Class
      A and Class B Loss per share:Basic
                
                $
                (2.29
                )
                
                
                
                
                
                $
                (0.05
                )
                
                
                
                
                
                $
                (2.24
                )
                
                
                *Diluted
                
                $
                (2.29
                )
                
                
                
                
                
                $
                (0.05
                )
                
                
                
                
                
                $
                (2.24
                )
                
                
                *





*Percentage
change not meaningful.





Sales decreased $12.0 million, or
10.3%, to $104.6 millionfor the three months ended
December 28, 2008 from $116.6 million for the same period last
year.  Sales from eight new stores, not included in the same store
sales calculation, resulted in a $4.7 million increase in sales, or
4.1%.  This increase was offset by a same store sales decrease of
$17.1 million, or 15.4%, and a sales reduction of $0.5 million due to an
increase in the use of our customer loyalty program, Action Pass, which requires
sales be reduced as points are earned.  The positive impact on sales
by reducing prices was offset by worsening macro-economic conditions as well as
unseasonably warm weather in our core markets.





Gross profit decreased $11.9 million,
or 33.8%, primarily as a result of the sales decrease, an additional $5.8
million in markdowns primarily used to stimulate the demand for inventory and a
$0.8 million increase in rent from new stores.  As a percent of sales,
gross profit decreased 790 basis points to 22.3% from 30.2%.  The
decrease is primarily the result of increased markdowns, rent as a percent of
sales in newer stores which take time to reach their desired operating
efficiency and the increased use of Action Pass.





Selling,
general and administrative expenses decreased $1.4 million, or 4.7%, as expenses
related to additional stores of $0.8 million were offset from expense reductions
of $2.2 million.  Expense reduction initiatives include $1.9 million
in labor savings from stores, corporate office overhead and the distribution
center.  Additional savings in all other areas such as supplies and
maintenance of $1.0 million were partially offset by an increase in professional
fees of $0.7 million. As a percent of sales, SG&A increased to 27.8% from
26.2%, primarily from the decrease in comparable store sales, the expenses
associated with new stores, which take time to reach their desired operating
efficiency, and an increase in professional fees.


16


A
non-cash impairment charge of $10.7 million was recorded in the three months
ended December 28, 2008 related to eleven stores with significantly lower than
expected sales volume and based on recent trends are not expected to obtain
sufficient cash flow over their remaining lease terms to support the net book
value of their leasehold improvements and fixtures.  The existence of
the impairment was assessed by calculating the net cash flow of each individual
store on an undiscounted basis and comparing it to the net book value of the
individual store.  The actual impairment charge was measured
by determining the fair value of the store's assets, calculated based on
the discounted net cash flow of the store over the remaining lease term, and
comparing it to the book value.





A tax
provision of $11.5 million was recorded for the three months ended December 28,
2008 as there was no valuation allowance on the net deferred tax assets of $11.5
million at September 28, 2008.  Based largely on the magnitude of this
quarter’s loss, the cumulative losses to date, the near term outlook and other
available objective evidence, management concluded that a valuation allowance
equal to all of the net deferred tax assets, $19.8 million, should be recorded
as the Company’s ability to return to profitability during the loss carryforward
period does not meet the “more likely than not” standard.





Primarily
as a result of the reduction in same store sales, the opening of new stores, the
impairment charge and the income tax valuation allowance, we incurred a net loss
of $32.4 million, or $2.29 per diluted share for three months ended December 28,
2008.  Excluding the non-cash impairment charge and the affect of the
valuation allowance in the third quarter of fiscal 2009 as well as a non-cash
impairment charge of $2.1 million pre-tax, or $0.09 per diluted share, recorded
in the third quarter of the prior fiscal year, net loss was $10.1 million, or
$0.71 per diluted share, compared to net income of $0.6 million, or $0.04 per
diluted share for third quarter of last year.





Nine
Months Ended December 28, 2008 Compared to December 30, 2007





The
following table sets forth statements of operations data and relative
percentages of net sales for the nine months ended December 28, 2008 compared to
nine months ended December 30, 2007 (dollar amounts in thousands, except per
share amounts):


17





Nine months endedDecember 28, 2008
                
                
                December 30, 2007
                
                
                Dollar
                  Change
                
                
                Percentage
                  ChangeAmount
                
                
                Percent
                
                
                Amount
                
                
                PercentNet
      sales
                
                $
                288,139
                
                
                
                100.0
                %
                
                $
                305,781
                
                
                
                100.0
                %
                
                $
                (17,642
                )
                
                
                (5.8
                )%Gross
      profit
                
                
                71,629
                
                
                
                24.9
                %
                
                
                91,110
                
                
                
                29.8
                %
                
                
                (19,481
                )
                
                
                (21.4
                )%Selling,
      general and administrative expenses
                
                
                83,582
                
                
                
                29.0
                %
                
                
                79,069
                
                
                
                25.9
                %
                
                
                4,513
                
                
                
                5.7
                %Impairment
      charge
                
                
                10,730
                
                
                
                3.7
                %
                
                
                2,077
                
                
                
                0.7
                %
                
                
                8,653
                
                
                
                416.6
                %Depreciation
      and amortization
                
                
                10,967
                
                
                
                3.8
                %
                
                
                9,767
                
                
                
                3.2
                %
                
                
                1,200
                
                
                
                12.3
                %(Loss)
      income from operations
                
                
                (33,650
                )
                
                
                (11.7
                )%
                
                
                197
                
                
                
                0.1
                %
                
                
                (33,847
                )
                
                
                *Interest
      expense
                
                
                1,650
                
                
                
                0.6
                %
                
                
                1,206
                
                
                
                0.4
                %
                
                
                444
                
                
                
                36.8
                %Loss
      before taxes
                
                
                (35,300
                )
                
                
                (12.3
                )%
                
                
                (1,009
                )
                
                
                (0.3
                )%
                
                
                (34,291
                )
                
                
                *Income
      tax provision (benefit)
                
                
                5,823
                
                
                
                2.0
                %
                
                
                (402
                )
                
                
                (0.1
                )%
                
                
                6,225
                
                
                
                *Net
      loss
                
                
                (41,123
                )
                
                
                (14.3
                )%
                
                
                (607
                )
                
                
                (0.2
                )%
                
                
                (40,516
                )
                
                
                *Class
      A and Class B Loss per share:Basic
                
                $
                (2.91
                )
                
                
                
                
                
                $
                (0.04
                )
                
                
                
                
                
                $
                (2.87
                )
                
                
                *Diluted
                
                $
                (2.91
                )
                
                
                
                
                
                $
                (0.04
                )
                
                
                
                
                
                $
                (2.87
                )
                
                
                *





*Percentage
change not meaningful.





Sales decreased $17.6 million, or 5.8%,
to $288.1 millionfor
the nine months ended December 28, 2008 from $305.8 million for the same period
last year.  Sales from eleven new stores, not included in the same
store sales calculation, resulted in a $15.1 million increase in sales, or
5.0%.  This increase was offset by a same store sales decrease of
$31.5 million, or 11.1%, and a sales reduction of $1.8 million due to an
increase in the use of our customer loyalty program, Action Pass, which requires
sales be reduced as points are earned.  The positive impact on sales
by reducing prices was offset by worsening macro-economic
conditions.





Gross profit decreased $19.5 million,
or 21.4%, primarily as a result of the sales decrease, an additional $7.0
million in markdowns primarily used to stimulate the demand for inventory and a
$4.7 million increase in rent from new stores.  As a percent of sales,
gross profit decreased 490 basis points to 24.9% from 29.8%.  The
decrease is primarily the result of increased markdowns, rent as a percent of
sales in newer stores which take time to reach their desired operating
efficiency and the increased use of Action Pass.





Selling,
general and administrative expenses increased $4.5 million, or 5.7%, primarily
due to $3.9 million from expenses related to additional stores, $1.8 million for
increased professional fees primarily related to new system implementation
support and training as well as professional fees incurred in obtaining our new
bank credit facility partially offset by labor savings of $1.4
million.  As a percent of sales, SG&A increased to 29.0% from
25.9%, primarily from the decrease in comparable store sales, the expenses
associated with new stores, which take time to reach their desired operating
efficiency, and an increase in professional fees.





A
non-cash impairment charge of $10.7 million was recorded in the nine months
ended December 28, 2008 related to eleven stores with significantly lower than
expected sales volume and based on recent trends are not expected to obtain
sufficient cash flow over their remaining lease terms to support the net book
value of their leasehold improvements and fixtures.  The existence of
the impairment was assessed by calculating the net cash flow of each individual
store on an undiscounted basis and comparing it to the net book value of the
individual store.  The actual impairment charge was measured
by determining the fair value of the store's assets, calculated based on
the discounted net cash flow of the store over the remaining lease term, and
comparing it to the book value.


18


Interest
expense increased $0.4 million primarily due to a $0.4 million closing fee for
the amended and restated bank credit facility, partially offset by lower
interest rates on higher average outstanding debt.





A tax
provision of $5.8 million was recorded for the nine months ended December 28,
2008 as there was no valuation allowance on the net deferred tax assets of $5.8
million at March 30, 2008.  Based largely on the magnitude of this
quarter’s loss, the cumulative losses to date, the near term outlook and other
available objective evidence, management concluded that a valuation allowance
equal to all of the net deferred tax assets, $19.8 million, should be recorded
as the Company’s ability to return to profitability during the loss carryforward
period does not meet the “more likely than not” standard.





Primarily
as a result of the reduction in same store sales, the opening of new stores, the
impairment charge and the income tax valuation allowance, we incurred a net loss
of $41.1 million, or $2.91 per diluted share for the nine months ended December
28, 2008.  Excluding the non-cash impairment charge and the affect of
the valuation allowance as well as a non-cash impairment charge of $2.1 million
pre-tax, or $0.09 per diluted share, recorded in the prior fiscal year, net loss
was $24.6 million, or $1.74 per diluted share, compared to net income of $0.7
million, or $0.05 per diluted share for the same period last year.





Liquidity
and Capital Resources





Our primary capital requirements are
for inventory, store expansion, relocation and
remodeling.  Historically, cash from operations, credit terms from
vendors and bank borrowing have met our liquidity needs.  Same store
sales for the past six quarters from the second quarter of fiscal 2008 to the
third quarter of fiscal 2009 are +2.2%, -6.9%, -8.8%, -11.1%, -6.7% and -15.4%,
respectively.  More recently, for our fourth quarter through February
8, 2009 we have experienced a 21% decline in same store sales.  In the
event this decline were to continue, we may have insufficient working capital to
continue to operate our business as it has been operated, or at
all.





In our efforts to reduce operating
expenses and improve liquidity, we have reviewed all of our store leases and are
obtaining rent reductions and lease modifications from our
landlords.  Additionally, we are evaluating our operating expenses,
such as store labor, corporate overhead and advertising, and have commenced
implementing cost reductions.  No assurance can be given that we will
be successful in reducing operating expenses and controlling costs in an amount
sufficient to improve our financial performance.  Moreover, no
assurance can be given that by reducing operating expenses and controlling costs
we will return to profitability.  Any failure to successfully reduce
an adequate amount of operating expenses and control costs could constrain our
ability to continue to operate our business.  If cash generated by
operations does not result in a sufficient level of unused borrowing capacity,
our current operations could be constrained by our ability to obtain funds under
the terms of our revolving credit facility.  In such a case, we would
need to seek other financing alternatives with our bank or other
sources.   Additional financing may not be available at terms
acceptable to us, or at all.  Failure to obtain financing in such
circumstances may require us to significantly curtail our
operations.  See “Risk Factors - A downturn in the economy has
affected consumer purchases of discretionary items, reducing our net
sales.  If the decline were to continue, we may not have sufficient
working capital to continue.” in Item 1A “Risk Factors.”


19


Net cash
used in or provided by operating activities has generally been the result of net
income or loss, adjusted for depreciation and amortization, and changes in
inventory along with related accounts payable.  The following table
shows the more significant items for the nine months ended December 28, 2008 and
December 30, 2007:





Nine months endedDecember 28, 2008
                    
                    
                    December 30, 2007(in
      thousands)Net
      loss
                    
                    $
                    (41,123
                    )
                    
                    $
                    (607
                    )Depreciation
      and amortization
                    
                    
                    10,967
                    
                    
                    
                    9,767Impairment
      charge
                    
                    
                    10,730
                    
                    
                    
                    2,077Deferred
      income taxes
                    
                    
                    5,723
                    
                    
                    
                    1,649Accounts
      receivable
                    
                    
                    (1,953
                    )
                    
                    
                    3,368Merchandise
      inventories
                    
                    
                    (22,473
                    )
                    
                    
                    (19,076
                    )Accounts
      payable
                    
                    
                    9,387
                    
                    
                    
                    9,400Prepaid
      expenses and other current assets
                    
                    
                    3,715
                    
                    
                    
                    (597
                    )Other
      accrued expenses
                    
                    
                    9,718
                    
                    
                    
                    7,160Deferred
      rent
                    
                    
                    1,408
                    
                    
                    
                    1,131Other
                    
                    
                    (595
                    )
                    
                    
                    (3,487
                    )Net
      cash (used in) provided by operating activities
                    
                    $
                    (14,496
                    )
                    
                    $
                    10,785





Typically, inventory levels increase
from year to year due to the addition of new stores, while improvements in
inventory management decrease inventory required for each
store.  Average inventory per store decreased 3.2% to $1.97 million
from $2.04 million at the end of the third quarter of fiscal 2009 and fiscal
2008, respectively, in spite of the significant decrease in sales as compared to
our plan.  The increase of $22.5 million in the nine months ended
December 28, 2008 and the increase of $19.1 million in the nine months ended
December 30, 2007 was primarily due to the seasonal build up of inventory and
the addition of four new stores and seven new stores, respectively.





Historically,
accounts payable increases as inventory increases.  However, the
timing of vendor payments or receipt of merchandise near the end of the period
influences this relationship.





Significant changes in accounts
receivable are from the timing of payments due from landlords for tenant
improvements.  For the nine months ended December 28, 2008, the amount
due is $1.4 million which is also the reason for the increase in deferred
rent.





Other accrued expenses include sales
taxes which are generally due the following month.  As a result of the
seasonal increase in sales, and therefore the sales tax collected, during the
holiday period, other accrued expenses increase during the nine months ended
December 28, 2008 and December 30, 2007.


20


A tax provision of $5.8 million was
recorded for the nine months ended December 28, 2008 as there was no valuation
allowance on the net deferred tax assets of $5.8 million at March 30,
2008.  Based largely on the magnitude of this quarter’s loss, the
cumulative losses to date, the near term outlook and other available objective
evidence, management concluded that a valuation allowance equal to all of the
net deferred tax assets, $19.8 million, should be recorded as the Company’s
ability to return to profitability during the loss carryforward period does not
meet the “more likely than not” standard.  The net deferred assets
include $10.3 million in net operating losses which can be carried forward for a
period of 20 years under current regulations.  As part of the economic
stimulus package, on January 29, 2009 a House bill which includes a provision
that would extend the net operating loss carryback period from two to five years
was approved.  In the event this bill becomes a law, we believe we
could obtain an income tax refund of up to $10.0 million.





Prepaid expenses and other current
assets provided $3.7 million in cash for the nine months ended December 28, 2008
due to the timing of lease payments, normally paid just prior to the end of the
period.  In the third quarter of fiscal 2009, the payments were made
shortly after the end of the period.





Net cash used in investing activities
is primarily for capital expenditures as shown below:





Nine months endedDecember 28, 2008
                    
                    
                    December 30, 2007(in
      thousands)New
      stores
                    
                    $
                    9,511
                    
                    
                    $
                    9,366Remodels/Relocations
                    
                    
                    2,972
                    
                    
                    
                    1,865Existing
      stores
                    
                    
                    460
                    
                    
                    
                    1,394Information
      systems
                    
                    
                    1,407
                    
                    
                    
                    5,101Other
                    
                    
                    54
                    
                    
                    
                    108Total
                    
                    $
                    14,404
                    
                    
                    $
                    17,834





We opened four new stores and relocated
one store in the nine months ended December 28, 2008 compared to seven new
stores in the same period last year.  The costs to open new stores can
vary significantly depending on the terms of the lease.  Two of the
stores opened in fiscal 2009 were significantly more expensive to open than our
historical average as they are in highly desirable locations.  We
currently do not anticipate opening new stores or entering into new lease
commitments in the near future.





Forecasted
capital expenditures for the remainder of fiscal 2009 are expected to be nominal
as all nonessential projects have been curtailed.





Net cash
provided by financing activities reflects advances and repayments of borrowings
under our revolving credit facility.  The outstanding balance as of
December 28, 2008 is $55.2 million compared to $17.2 million at the end of
fiscal 2008.  The increase is primarily the result of funding new and
relocated stores in addition to cash used in operations.


21


In June
2008, we negotiated a new credit facility with our existing lender, Bank of
America, N.A. (the “Lender”) which provides for advances up to $45.0 million,
increasing to $70.0 million, for the period September 1, through December 31,
each year, and up to a $10.0 million maximum in authorized letters of
credit.  The amount we may borrow under this credit facility is
limited to a percentage of the value of eligible inventory, minus certain
reserves.  Interest accrues at the Lender’s prime rate plus an
applicable margin up to 0.50% based on our fixed charge coverage ratio (3.75% at
December 28, 2008) or at our option we can fix the rate for a period of time at
LIBOR plus an applicable margin (1.50% up to 2.50% based on our fixed charge
coverage ratio).  In addition, there is an unused commitment fee of
0.25% per year, based on a weighted average formula, a one-time, non-refundable
commitment fee of $350,000 and an early termination fee of 1.50% in year one,
0.75% in year two and 0.25% in year three which is waived if the loan is
refinanced by the Lender or any of its affiliates.  This credit
facility expires in June 2012.  Our obligation to the Lender is
presently secured by a first priority lien on substantially all of our non-real
estate assets, and should availability fall below certain prescribed limits we
would be subject to a covenant that we maintain a minimum cash flow coverage
ratio of 1:1.  We do not now meet this minimum ratio.  While
our cash flow coverage ratio is less than 1:1, we must avoid availability
falling below the prescribed limits in order to comply with our covenants under
the credit facility.





On
January 9, 2009, we entered into a First Amendment to Amended and Restated Loan
and Security Agreement and Limited Forbearance Agreement (the "First Amendment")
dated as of December 28, 2008, with the Lender under the Amended and Restated
Loan and Security Agreement, as amended, dated as of June 20, 2008 (the "Loan
Agreement").





Under the
First Amendment, (i), the Lender has agreed to forbear from exercising its
rights in respect of the Event of Default described below under the Loan
Agreement, (ii) we may not select a LIBOR-based interest rate under the Loan
Agreement, and (iii) the Lender agreed to permit an overadvance in the amount of
$1.5 million until January 13, 2009.  As of December 31, 2008, an
event of default had occurred under the Loan Agreement due to our failure to
maintain a "Fixed Charge Coverage Ratio" (as defined in the Loan Agreement) of
not less than 1.00 to 1.00 (the "Event of Default").  On December 28,
2008, availability under the Loan Agreement was less than $10.5 million, thereby
requiring the testing of the Fixed Charge Coverage Ratio.  The
forbearance period under the First Amendment ended on January 31,
2009.  We acknowledged, among other things, that we had no defenses,
claims or set-offs to the obligations under the Loan Agreement and provided the
Lender a general release of claims.





Also on
January 9, 2009, we entered into a letter agreement (the "Turnaround Letter
Agreement") with the Lender in which, as an inducement to the Lender to enter
into the First Amendment, we agreed to engage a certified turnaround
professional on or before January 12, 2009 and for a minimum term of 90
days.  On January 9, 2009, we engaged FTI Consulting, to prepare cash
flow and operating budgets to be presented periodically to the Board of
Directors of the Company and to the Lender in accordance with the Turnaround
Letter Agreement.





On
January 29, 2009, we entered into a Second Amendment to Amended and Restated
Loan and Security Agreement and Limited Forbearance Agreement (the “Second
Amendment”) with the Lender under the Loan Agreement.  Under the
Second Amendment, the Lender has agreed to extend the period during which it
will forbear from exercising its rights in respect of certain defaults under the
Loan Agreement from January 31, 2009 until the earlier to occur of any further
default under the Loan Agreement or March 2, 2009.  There can be no
assurance that there will not be another event of default or that the Lender
will extend the forbearance period beyond March 2,
2009.   Additional financing may not be available at terms
acceptable to us, or at all.  Failure to obtain financing in such
circumstances may require us to significantly curtail our
operations.


22


The
amount we can borrow under our credit facility with the Lender is limited to a
percentage of the value of eligible inventory, minus certain
reserves.  A significant decrease in eligible inventory due to the
aging of inventory, an unfavorable inventory appraisal or other factors, could
have an adverse effect on our borrowing capabilities under our credit facility,
which may adversely affect the adequacy of our working capital.  In
January 2009, the Lender commissioned a third party appraiser to update the
calculation of the “net orderly liquidation value” as defined in the agreement,
and this valuation may impact the amount that we will be able to continue to
borrow and pay bills as they become due.  In the likely event of an
unfavorable inventory appraisal, we would need to further reduce our operating
costs and seek alternative funding, the nature and source of which has not been
identified and may not be available on acceptable terms, or at
all.  If we are unable to implement either or both of these steps, our
operations would be materially and adversely impacted.





Our off-balance sheet contractual
obligations and commitments relate to operating lease obligations, employment
contracts and letters of credit which are excluded from the balance sheet in
accordance with generally accepted accounting principles.





The
following table summarizes such obligations as of December 28,
2008:





Payment
      due by periodLess than
                          
                          
                          
                          
                          
                          
                          
                          
                          More thanTotal
                          
                          
                          1
      year
                          
                          
                          2-3
      year
                          
                          
                          4-5
      year
                          
                          
                          5
      years(in
      thousands)Contractual
      ObligationsOperating
      Leases (a)
                          
                          $
                          273,428
                          
                          
                          $
                          37,842
                          
                          
                          $
                          70,986
                          
                          
                          $
                          63,139
                          
                          
                          $
                          101,461Employment
      Contracts
                          
                          
                          806
                          
                          
                          
                          170
                          
                          
                          
                          339
                          
                          
                          
                          297
                          
                          
                          
                          -Total
      Contractual Obligations
                          
                          $
                          274,234
                          
                          
                          $
                          38,012
                          
                          
                          $
                          71,325
                          
                          
                          $
                          63,436
                          
                          
                          $
                          101,461





(a)
Amounts include the direct lease obligations.  Other obligations
required by the lease agreements such as contingent rent based on sales, common
area maintenance, property taxes and insurance are not fixed amounts and are
therefore not included.  The amount of the excluded expenses are; $9.6
million, $8.5 million and $7.2 million for the fiscal years 2008, 2007 and 2006,
respectively.





We lease
all of our existing store locations.  The leases for most of the
existing stores are for approximately ten-year terms with multiple option
periods under non-cancelable operating leases with scheduled rent
increases.  The leases provide for contingent rent based upon a
percentage of sales in excess of specified minimums.  If there are any
free rent periods, they are accounted for on a straight line basis over the
lease term, beginning on the date of initial possession, which is generally when
we enter the space and begin the construction build-out.  The amount
of the excess of straight line rent expense over scheduled payments is recorded
as a deferred rent liability.  Construction allowances and other such
lease incentives are recorded as deferred credits, and are amortized on a
straight line basis as a reduction of rent expense over the lease
term.





Generally,
our purchase obligations are cancelable 45 days prior to shipment from our
vendors.  Letters of credit amounting to approximately $1.8 million
relating to workers’ compensation insurance were outstanding as of December 28,
2008 and expire within one year.





No cash
dividends have been declared on Class A Common Stock and Class B Common Stock as
we intend to retain earnings for use in the operation of our business and,
therefore, do not anticipate paying any cash dividends in the foreseeable
future.


23


Critical
Accounting Policies and Use of Estimates





In
preparing our consolidated financial statements we are required to make
estimates and judgments which affect the results of our operations and the
reported value of assets and liabilities.  Actual results may differ
from these estimates.  As discussed in “Item 7 - Management’s
Discussion and Analysis of Financial Condition and Results of Operations”
section of the Company’s Annual Report on Form 10-K for the fiscal year ended
March 30, 2008, we consider our policies on inventory valuation, revenue
recognition, gift card redemption, self insurance reserves, impairment of
long-lived assets, accounting for income taxes, estimation of net deferred
income tax asset valuation allowance and stock-based compensation to be the most
critical in understanding the significant estimates and judgments that are
involved in preparing our consolidated financial statements.





In connection with the implementation
of a new financial and merchandising system, effective March 31, 2008, we have
changed the inventory valuation method from the first-in, first-out “FIFO” basis
determined by the retail method of accounting to a weighted-average cost basis,
using the retail method.  We have accounted for the change in
accounting principle prospectively, in accordance with Statement of Financial
Accounting Standards (“SFAS”) No.154, “Accounting Changes and Error
Corrections.”  The cumulative effect of this change is not
determinable as we do not have the ability to recalculate average cost for prior
periods.  We are beginning fiscal 2009 with the FIFO costs as used for
the ending fiscal 2008 inventory valuation; going forward these amounts will be
updated as new purchases are made.  We do not anticipate this change
will have a material effect on our results of operations, and we chose this
method based on our new system capabilities.





Based largely on the magnitude of this
quarter’s loss, the cumulative losses to date, the near term outlook and other
available objective evidence, management concluded that a valuation allowance
equal to all of the net deferred tax assets, $19.8 million, should be recorded
as the Company’s ability to return to profitability during the loss carryforward
period does not meet the “more likely than not” standard.  The net
deferred assets include $10.3 million in net operating losses which can be
carried forward for a period of 20 years under current
regulations.  As part of the economic stimulus package, on January 29,
2009 a House bill which includes a provision that would extend the net operating
loss carryback period from two to five years was approved.  In the
event this bill becomes a law, we believe we could obtain an income tax refund
of up to $10.0 million.





Factors
That May Affect Future Results





Our short-term and long-term success is
subject to many factors that are beyond our control.  Stockholders and
prospective stockholders in the Company should carefully consider the following
risk factors, in addition to the information contained elsewhere in this
Report.  This Report on Form 10-Q contains forward-looking statements,
which are subject to a variety of risks and uncertainties.  Our actual
results could differ materially from those anticipated in these forward-looking
statements as a result of various factors including, but are not limited to,
those set forth below.





For a more detailed discussion of these
factors, see the “Risk Factors” discussion in Item 1A of the Company’s most
recent Annual Report on Form 10-K. The forward-looking statements included in
this Quarterly Report on Form 10-Q are made only as of the date of this report,
and the Company undertakes no obligation to update the forward-looking
statements to reflect subsequent events or circumstances.


24


Risks Related To Our
Business:





·
            If
      cash generated by operations does not result in a sufficient level of
      unused borrowing capacity, our current operations could be constrained by
      our ability to obtain funds under the terms of our revolving credit
      facility.  In such a case, we would need to seek other financing
      alternatives with our bank or other sources.   Additional
      financing may not be available at terms acceptable to us, or at
      all.  Failure to obtain financing in such circumstances may
      require us to significantly curtail our
  operations.





·
            No
      assurance can be given that we will be successful in reducing operating
      expenses and controlling costs in an amount sufficient to improve our
      financial performance.





·
            A
      downturn in the economy has affected consumer purchases of discretionary
      items, reducing our net sales.





·
            The
      covenants in our revolving credit facility may limit future borrowings to
      fund our operations.





·
            No
      assurance can be given that our Board of Directors will be successful in
      its evaluation of strategic
alternatives.





·
            Intense
      competition in the sporting goods industry could limit our growth and
      reduce our profitability.





·
            Our
      future growth will be dependent on the availability of additional
      financing.





·
            Because
      our stores are concentrated in the western portion of the United States,
      we are subject to regional risks.





·
            If
      we are unable to predict or react to changes in consumer demand, we may
      lose customers and our sales may
decline.





·
            Implementing
      Section 404 of the Sarbanes-Oxley Act of 2002 will be expensive,
      time-consuming and require significant management attention, and may not
      be successful.





·
                Failure
      to protect the integrity and security of our customers’ information could
      expose us to litigation and materially damage our standing with our
      customers.





·
            If
      we are unable to successfully implement our controlled growth strategy or
      manage our growing business, our future operating results could
      suffer.





·
            Our
      ability to expand our business will be dependent upon our ability to meet
      challenges in new and existing
markets.


25


·
            Failure
      to maintain an online presence that mirrors our customers’ in-store
      experience could adversely impact net
sales.





·
            If
      we lose key management or are unable to attract and retain talent, our
      operating results could suffer.





·
            Seasonal
      fluctuations in the sales of sporting goods could cause our annual
      operating results to suffer.





·
            Our
      quarterly operating results may fluctuate substantially, which may
      adversely affect our business.





·
              Declines
      in the effectiveness of marketing could cause our operating results to
      suffer.





·
            Problems
      with our information systems could disrupt our operations and negatively
      impact our financial results.





·
            We
      are controlled by our Founder and management, whose interests may differ
      from other stockholders.





·
            The
      price of our Class A Common Stock and Class B Common Stock may be
      volatile.





·
            Provisions
      in the Company's charter documents could discourage a takeover that
      stockholders may consider
favorable.





·
              We
      may be subject to periodic litigation that may adversely affect our
      business and financial
performance.





·
            Changes
      in accounting standards and subjective assumptions, estimates and
      judgments related to complex accounting matters could significantly affect
      our financial results.





·
            Terrorist
      attacks or acts of war may harm our
business.





·
            We
      rely on one distribution center and any disruption could reduce our
      sales.





·
            We
      may pursue strategic acquisitions, which could have an adverse impact on
      our business.





·
            Our
      comparable store sales will fluctuate and may not be a meaningful
      indicator of future performance.





·
            Global
      warming could cause erosion of both our winter and summer seasonal
      businesses over a long-term
basis.


26


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
4T.  Controls and
Procedures.





Disclosure 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
concluded that, as a result of the material weakness described below, the
Company’s disclosure controls and procedures are not effective, as of the end of
the period covered by this report, to provide reasonable assurance that
information required to be disclosed in this report is:





·
            recorded,
      processed, summarized and reported within the time period specified in the
      Securities and Exchange Commission’s rules and forms;
  and





·
            accumulated
      and communicated to our management, including our principal executive and
      principal financial officer, to allow timely decisions regarding required
      disclosure.





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,
mistakes or intentional circumvention of the established processes.





In
October 2006, we selected an enterprise resource management system (the "ERP
System") from SAP to replace our existing merchandise and financial information
systems.  Over the next 18  months, we were in the process
of implementing this system, including testing the system in a controlled
environment,  training our personnel in the use of the system and
documenting and testing the control environment in preparation for compliance
with Section 404 of the Sarbanes-Oxley Act of 2002.  Our planned
“go-live” date for the new system was October 1, 2007.  However, we
encountered delays in, among other things, integrating the ERP System with our
existing "best of breed" merchandise planning system.  As a result of
such delays we elected to postpone implementation of the ERP System until after
the end of the fiscal year ended March 30, 2008 as we did not believe it
would be prudent to implement the new system so close to our fiscal
year-end.  We implemented the ERP System on March 31,
2008.


27


Pursuant
to Section 404 of the Sarbanes-Oxley Act of 2002, our management is required to
assess the effectiveness of our internal control over financial reporting as of
the end of each fiscal year beginning with fiscal 2008.  We have made
a substantial investment to ensure that the ERP System will provide effective
internal control over financial reporting, and we have evaluated our controls
that are not intended to change with the implementation of the ERP
System.  Because we initially anticipated that the “go-live” date of
the ERP System would be prior to March 30, 2008, we did not, however, fully
evaluate the effectiveness of the existing controls that were to be replaced by
the ERP System.  With the delay in implementing the ERP System, we did
not have sufficient time to fully document, test and remediate (where
applicable) those controls that we previously planned to replace prior to March
30, 2008.  As a result, we believe our inability to fully test the
legacy system or the ERP System as required by Section 404 results in a material
weakness in our internal control over financial reporting.





We have
assessed the risk of financial misstatements in this Quarterly Report on Form
10-Q that might result from the existing information system, including a review
of compensating controls.  Based on our review, we believe that the
information contained in this periodic report fairly presents, in all material
respects, the financial condition and results of operations of the Company as
of, and for, the periods presented in such report.





Since
implementing our ERP System, we have substantially completed documenting our
internal controls and are testing the effectiveness of these
controls.  To date, we have not found any material
weakness.  However, we are unable to conclude at this time whether or
not these controls are effective at preventing or detecting a material
misstatement in our financial reporting.





Notwithstanding
the foregoing, there can be no assurance that we will be successful in
documenting, testing or remediating (where applicable) the ERP System before the
end of fiscal 2009 or at all, that we will not discover material weaknesses in
our internal control over financial reporting, or that we will be able to
remediate any such weakness.  Furthermore, if we discover 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.  See "Item
2.  Factors That May Affect Future Results - Implementing Section 404
of the Sarbanes-Oxley Act of 2002 will be expensive, time-consuming and require
significant management attention, and may not be successful."





Changes
in Internal Control Over Financial Reporting





There
were no changes in the Company's internal controls over financial reporting,
identified by 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.


28


PART
II – OTHER INFORMATION





Item 1.Legal
Proceedings.





On April 10, 2008, we were served
with a complaint filed in the California Superior Court in the County of San
Diego, entitled Cole v. Sport Chalet, Inc., Case
No. 37-2008-00081675-CU-BT-CTL, alleging violations of the California Civil
Code and Business & Professions Code, as well as invasion of
privacy.   This complaint was brought as a purported class action on
behalf of persons who made purchases at our stores in California using credit
cards and were requested to provide their zip codes. The plaintiff alleges,
among other things, that customers making purchases with credit cards at our
stores in California were improperly requested to provide their zip code at the
time of such purchases. The plaintiff seeks, on behalf of the class members,
statutory penalties, actual damages, punitive damages, disgorgement of
profits, injunctive relief to require us to discontinue the allegedly
improper conduct, and attorneys’ fees and costs.  On December 16,
2008, the parties agreed on the core terms of a classwide settlement of this
case.  We are now in the process of documenting the settlement. 
Thereafter, the settlement will require court approval.  If the
settlement is concluded and approved, it should not have a material adverse
impact on our financial condition.  If the settlement is not concluded
and approved, we intend to continue to defend the suit
vigorously.  We are not able to evaluate the likelihood of an
unfavorable outcome or to estimate a range of potential loss in the event of an
unfavorable outcome at the present time. If resolved unfavorably to us, this
litigation could have a material adverse effect on our financial condition, and
any required change in our business practices, as well as the costs of defending
this litigation, could have a negative impact on our results of
operations.





By letter dated May 14, 2008, an
attorney for a former employee has asserted claims for sexual harassment by a
former supervisor during the former employee’s one year of
employment.  The former employee alleges being subjected to verbal and
physical harassment.  The former employee is seeking compensatory
damages and punitive damages, attorneys' fees and costs. The former employee has
recently requested to submit her claims to arbitration.  We have just
begun a review of the allegations, and we are not able to evaluate the
likelihood of an unfavorable outcome nor can we estimate a range of potential
loss in the event of an unfavorable outcome at the present time.  If
resolved unfavorably to us, this litigation could have a material adverse effect
on our financial condition.





From time to time, 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 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.


29




Item
1A.  Risk
Factors.





There have been material changes to the
risk factors disclosed in our Annual Report on Form 10-K for the year ended
March 30, 2008 (the “Annual Report”).  Our short- and long-term
success is subject to many factors that are beyond our
control.  Stockholders and prospective stockholders in the Company
should consider carefully the risk factors set forth below, as well as the risk
factors set forth in the Annual Report.  Additional risks and
uncertainties not currently known to us or that we currently deem to be
immaterial also may materially adversely affect our business, financial
condition and/or operating results.





A
downturn in the economy has affected consumer purchases of discretionary items,
reducing our net sales.  If this decline were to continue, we may not
have sufficient working capital to continue.





The
retail industry historically has been subject to substantial cyclical
variations. The merchandise sold by us is generally a discretionary expense for
our customers.  The current downturn in the general economy and
uncertainties regarding future economic prospects that affect consumer spending
habits are having, and are likely to continue for some time to have, a
materially adverse effect on our results of operations.  Same store
sales for the past six quarters from the second quarter of fiscal 2008 to the
third quarter of fiscal 2009 are +2.2%, -6.9%, -8.8%, -11.1%, -6.7% and -15.4%,
respectively.  More recently, for our fourth quarter through February
8, 2009 we have experienced a 21% decline in same store sales.  In the
event this decline were to continue, we may have insufficient working capital to
continue to operate our business as it has been operated, or at
all.





If cash
generated by operations does not result in a sufficient level of unused
borrowing capacity, our current operations could be constrained by our ability
to obtain funds under the terms of our revolving credit facility.  In
such a case, we would need to seek other financing alternatives with our bank or
other sources.  Additional financing may not be available at terms
acceptable to us, or at all.  Failure to obtain financing in such
circumstances may require us to significantly curtail our
operations.





No
assurance can be given that we will be successful in reducing operating expenses
and controlling costs in an amount sufficient to improve our financial
performance.





In our
efforts to reduce operating expenses and improve liquidity, we have reviewed all
of our store leases and are obtaining rent reductions and lease modifications
from our landlords.  Additionally, we are evaluating our operating
expenses, such as store labor, corporate overhead and advertising, and have
commenced implementing cost reductions.  Moreover, no assurance can be
given that by reducing operating expenses and controlling costs we will return
to profitability.  Any failure to successfully reduce an adequate
amount of operating expenses and control costs could constrain our ability to
continue to operate our business.


30


The
covenants in our revolving credit facility may limit future borrowings to fund
our operations.





In June
2008, we negotiated a new credit facility with our existing lender, Bank of
America, N.A. (the “Lender”) which provides for advances up to $45.0 million,
increasing to $70.0 million, for the period September 1, through December 31,
each year, and up to a $10.0 million maximum in authorized letters of
credit.  The amount we may borrow under this credit facility is
limited to a percentage of the value of eligible inventory, minus certain
reserves.  Interest accrues at the Lender’s prime rate plus an
applicable margin up to 0.50% based on our fixed charge coverage ratio (3.75% at
December 28, 2008) or at our option we can fix the rate for a period of time at
LIBOR plus an applicable margin (1.50% up to 2.50% based on our fixed charge
coverage ratio).  In addition, there is an unused commitment fee of
0.25% per year, based on a weighted average formula, a one-time, non-refundable
commitment fee of $350,000 and an early termination fee of 1.50% in year one,
0.75% in year two and 0.25% in year three which is waived if the loan is
refinanced by the Lender or any of its affiliates.  This credit
facility expires in June 2012.  Our obligation to the Lender is
presently secured by a first priority lien on substantially all of our non-real
estate assets, and should availability fall below certain prescribed limits we
would be subject to a covenant that we maintain a minimum cash flow coverage
ratio of 1:1.  We do not now meet this minimum ratio.  While
our cash flow coverage ratio is less than 1:1, we must avoid availability
falling below the prescribed limits in order to comply with our covenants under
the credit facility.





On
January 9, 2009, we entered into a First Amendment to Amended and Restated Loan
and Security Agreement and Limited Forbearance Agreement (the "First Amendment")
dated as of December 28, 2008, with the Lender under the Amended and Restated
Loan and Security Agreement, as amended, dated as of June 20, 2008 (the "Loan
Agreement").





Under the
First Amendment, (i), the Lender has agreed to forbear from exercising its
rights in respect of the Event of Default described below under the Loan
Agreement, (ii) we may not select a LIBOR-based interest rate under the Loan
Agreement, and (iii) the Lender agreed to permit an overadvance in the amount of
$1.5 million until January 13, 2009.  As of December 31, 2008, an
event of default had occurred under the Loan Agreement due to our failure to
maintain a "Fixed Charge Coverage Ratio" (as defined in the Loan Agreement) of
not less than 1.00 to 1.00 (the "Event of Default").  On December 28,
2008, availability under the Loan Agreement was less than $10.5 million, thereby
requiring the testing of the Fixed Charge Coverage Ratio.  The
forbearance period under the First Amendment ended on January 31,
2009.  We acknowledged, among other things, that we had no defenses,
claims or set-offs to the obligations under the Loan Agreement and provided the
Lender a general release of claims.





Also on
January 9, 2009, we entered into a letter agreement (the "Turnaround Letter
Agreement") with the Lender in which, as an inducement to the Lender to enter
into the First Amendment, we agreed to engage a certified turnaround
professional on or before January 12, 2009 and for a minimum term of 90
days.  On January 9, 2009, we engaged FTI Consulting, to prepare cash
flow and operating budgets to be presented periodically to the Board of
Directors of the Company and to the Lender in accordance with the Turnaround
Letter Agreement.





On
January 29, 2009, we entered into a Second Amendment to Amended and Restated
Loan and Security Agreement and Limited Forbearance Agreement (the “Second
Amendment”) with the Lender under the Loan Agreement.  Under the
Second Amendment, the Lender has agreed to extend the period during which it
will forbear from exercising its rights in respect of certain defaults under the
Loan Agreement from January 31, 2009 until the earlier to occur of any further
default under the Loan Agreement or March 2, 2009.  There can be no
assurance that there will not be another event of default or that the Lender
will extend the forbearance period beyond March 2,
2009.   Additional financing may not be available at terms
acceptable to us, or at all.  Failure to obtain financing in such
circumstances may require us to significantly curtail our
operations.


31


The
amount we can borrow under our credit facility with the Lender is limited to a
percentage of the value of eligible inventory, minus certain
reserves.  A significant decrease in eligible inventory due to the
aging of inventory, an unfavorable inventory appraisal or other factors, could
have an adverse effect on our borrowing capabilities under our credit facility,
which may adversely affect the adequacy of our working capital.  In
January 2009, the Lender commissioned a third party appraiser to update the
calculation of the “net orderly liquidation value” as defined in the agreement,
and this valuation may impact the amount that we will be able to continue to
borrow and pay bills as they become due.  In the likely event of an
unfavorable inventory appraisal, we would need to further reduce our operating
costs and seek alternative funding, the nature and source of which has not been
identified and may not be available on acceptable terms, or at
all.  If we are unable to implement either or both of these steps, our
operations would be materially and adversely impacted.





No
assurance can be given that our Board of Directors will be successful in its
evaluation of strategic alternatives.





On February 2, 2009, we announced that
our Board of Directors commenced an evaluation of strategic alternatives and
retained Wedbush Morgan Securities as its financial advisor in this
process.  The review process may include such alternatives as raising
additional capital, amending or replacing our current bank credit facility,
further reducing expenses, or continuing to execute our current operating
plan.  No timetable has been set for completion of the review and no
assurance can be given that the Board will have sufficient time to complete its
evaluation.  We have no commitment or agreement with respect to any
transaction, and there can be no assurance that any transaction will
result.





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.





Not Applicable.


32


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. amended as of November 5, 2007 (incorporated by
      reference to Exhibit 3.2 of the Company’s Form 10-Q filed on November 9,
      2007)




3.3
            Certificate
      of Amendment to the Amended and Restated Certificate of Incorporation of
      Sport Chalet, Inc. (incorporated by reference to Exhibit 3.1 of the
      Company’s Form 8-K filed on September 22,
2005)




4.1
            Form
      of Certificate for Class A Common Stock, par value $0.01 per share
      (incorporated by reference to Exhibit 4.1 to the Company's Form 8-A filed
      on September 29, 2005)




4.2
            Form
      of Certificate for Class B Common Stock, par value $0.01 per share
      (incorporated by reference to Exhibit 4.2 to the Company's Form 8-A filed
      on September 29, 2005)




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




33


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
      11, 2009
                  By:
                  /s/
                  Howard K. KaminskyHoward
      K. KaminskyExecutive
      Vice President-Finance,Chief
      Financial Officer and Secretary(On
      behalf of the Registrant and asPrincipal
      Financial and Accounting
Officer)


34