NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BUSINESS
—West Marine Inc. and its consolidated subsidiaries (“West Marine” or the “Company,” unless the context requires otherwise) is a leading waterlife outfitter in the United States. At
December 31, 2016
, West Marine offered its products through
254
stores in
38
states, Puerto Rico and Canada, through its call center channel and on the Internet. As previously disclosed, the Company closed eight Canadian stores in 2015 and will close the remaining two stores by June 2017. The Company is also engaged in the distribution of marine equipment to its professional customers serving boat manufacturers, marine services, commercial vessel operations and government agencies.
West Marine is an omni-channel retail organization operating one reporting segment in accordance with the Financial Accounting Standards Board ("FASB") Accounting Standards Codification ("ASC") Topic 280,
Segment Reporting
. The metrics used by its Chief Executive Officer (as the Company's chief operating decision maker or the "CODM") to assess the performance of the Company are focused on viewing the business as a single integrated business. The CODM's process for allocating resources is based upon the omni-channel view of the Company. Additionally, the Company has integrated systems and concentrated its strategic focus on omni-channel retailing. In addition, the Company has commingled sales channel payroll expense, inventories, merchandise procurement and distribution networks. Revenues from customers are derived from merchandise sales and the Company does not rely on any individual major customer.
The Company considers its merchandise expansion strategy to be strategically important to its future success and is providing the following product category information. The Company's merchandise mix over the last three years is reflected in the table below:
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|
|
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|
|
|
|
|
|
|
2016
|
|
2015
|
|
2014
|
Core boating products
|
76.5
|
%
|
|
77.1
|
%
|
|
81.3
|
%
|
Merchandise expansion products
|
23.5
|
%
|
|
22.9
|
%
|
|
18.7
|
%
|
Total
|
100.0
|
%
|
|
100.0
|
%
|
|
100.0
|
%
|
The Company considers core boating products to be comprised of maintenance related products, electronics, sailboat hardware, anchors/docking/moorings, engine systems, safety, electrical, plumbing, boats, outboards, ventilation, deck hardware/fasteners, navigation, trailering, seating/boat covers and barbecues/appliances. The Company considers its merchandise expansion products to be comprised of apparel, footwear, clothing accessories, fishing, watersports, paddlesports, coolers, bikes and cabin/galley.
West Marine was incorporated in Delaware in September 1993 as the holding company for West Marine Products, Inc., which was incorporated in California in 1976. The Company’s principal executive offices are located in Watsonville, California.
PRINCIPLES OF CONSOLIDATION
—The consolidated financial statements include the accounts of West Marine, Inc. and its subsidiaries, all of which are wholly-owned, directly or indirectly. Intercompany balances and transactions are eliminated in consolidation.
YEAR-END
—The Company’s fiscal year consists of 52 or 53 weeks, ending on the Saturday closest to December 31 and as a result, a 53-week year occurs every five to six years. The fiscal years
2016
and
2015
consisted of the 52 weeks ended
December 31, 2016
and
January 2, 2016
, respectively, while the
2014
fiscal year consisted of the 53 weeks ended
January 3, 2015
. References to
2016
,
2015
and
2014
are to the fiscal years ended
December 31, 2016
,
January 2, 2016
and
January 3, 2015
, respectively.
ACCOUNTING ESTIMATES
—The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America ("GAAP") requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Such estimates include, but are not limited to, the following: useful lives and recoverability of fixed assets; inventory obsolescence and shrinkage reserves; capitalized indirect inventory costs; allowance for doubtful accounts receivable; calculation of accrued liabilities, including workers’ compensation and other self-insured liabilities; sabbatical liability, sales returns reserves, unredeemed gift cards and loyalty program awards; vendor consideration earned; fair value of share-based compensation instruments, income tax valuation allowances and uncertain tax positions; legal liabilities and other contingencies; and asset retirement obligations. Actual results could differ from those estimates.
INVENTORIES
—Merchandise inventories are carried at the lower of cost or market on an average cost basis. Capitalized indirect costs include freight charges for transporting merchandise to warehouses or store locations and operating costs incurred
WEST MARINE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
for merchandising, replenishment and distribution center activities. Indirect costs included in inventory value at the end of fiscal years
2016
and
2015
were
$19.3 million
and
$19.7 million
, respectively. Indirect costs included in inventory value are recognized as an increase in cost of goods sold as the related products are sold.
Inventories are written down to market value when cost exceeds market value, based on historical experience and current information. Reserves for estimated inventory shrinkage based on historical shrinkage rates determined by the Company’s physical merchandise inventory counts and cycle counts were
$2.1 million
and
$2.3 million
at the end of
2016
and
2015
, respectively. Reserves for estimated inventory market value below cost, based upon current levels of aged and discontinued product and historical analysis of inventory sold below cost, were
$4.7 million
and
$4.5 million
at the end of
2016
and
2015
, respectively.
DEFERRED CATALOG AND ADVERTISING COSTS
—The Company capitalizes the direct cost of producing and distributing its catalogs. Capitalized catalog costs are amortized, once a catalog is mailed, over the expected net sales period, which is generally from
one
month to
24
months. Advertising costs, which are included in selling, general and administrative ("SG&A") expense, are expensed as incurred and were
$13.9 million
,
$14.7 million
and
$16.0 million
in
2016
,
2015
and
2014
, respectively. Advertising costs were partially offset by vendor allowances of
$12.9 million
,
$11.2 million
and
$10.6 million
in
2016
,
2015
and
2014
, respectively, which are included in cost of goods sold. The capitalized value of prepaid catalog and advertising costs on the balance sheet were immaterial as of
December 31, 2016
and
January 2, 2016
.
PROPERTY AND EQUIPMENT
—Property and equipment is stated at cost and depreciated using the straight-line method over the estimated useful lives of the various assets, as follows:
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|
Estimated
Useful
Lives
|
|
|
Furniture and equipment
|
|
3–7 years
|
|
|
Computer software and hardware
|
|
3–7 years
|
|
|
Buildings
|
|
25 years
|
|
Leasehold improvements are amortized over the lesser of the expected lease term or the estimated useful life of the improvement, which is usually about
10
years.
CAPITALIZED INTEREST
—The Company capitalizes interest on major capital projects. The Company did not capitalize interest in 2016, 2015 or 2014.
CAPITALIZED SOFTWARE COSTS
—Capitalized computer software, included in property and equipment, reflects costs related to internally-developed or purchased software that are capitalized and amortized on a straight-line basis, generally over a period ranging from
three
to
seven
years.
ASSET RETIREMENT OBLIGATIONS
—The Company estimates the fair value of obligations to clean up and restore leased properties under agreements with landlords and records the estimated amount as a liability when incurred. Liabilities for asset retirement obligations were
$0.1 million
as of
December 31, 2016
, and
$0.6 million
as of
January 2, 2016
. There were no significant changes attributable to the following components during the 2016, 2015 and 2014 reporting periods: liabilities incurred; liabilities settled; accretion expense; and revisions in estimated cash flows.
IMPAIRMENT OF LONG-LIVED ASSETS
—The Company reviews long-lived assets, including property and equipment, for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. If facts indicate a potential impairment, the Company would assess the recoverability by determining if the carrying value of the long-lived assets exceeds the sum of the projected undiscounted cash flows expected to result from the use and eventual disposition of the assets over the remaining economic life. If the recoverability test indicates that the carrying value of the long-lived assets is not recoverable, the Company will estimate the fair value of the long-lived assets using appropriate valuation methodologies, which would typically include an estimate of discounted cash flows. Any impairment would be measured as the difference between the long-lived assets' carrying amount and the estimated fair value less disposal costs. The Company recorded no asset impairment charges in fiscal years 2016, 2015 and 2014.
COSTS ASSOCIATED WITH EXIT ACTIVITIES
—The Company occasionally vacates stores prior to the expiration of the related lease. For vacated locations that are under long-term leases, the Company records an expense for the net present value of the difference between its future lease payments and related costs, such as real estate taxes and common area maintenance costs, from the date of closure through the end of the remaining lease term, net of expected future sublease rental income. Costs associated with exit activities as of
December 31, 2016
and
January 2, 2016
were
$1.0 million
and
$1.5 million
, respectively. Of these amounts,
WEST MARINE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
as of December 31, 2016 and January 2, 2016,
$0.6 million
and
$0.9 million
, respectively, were included in deferred rent and other.
SELF-INSURANCE OR HIGH DEDUCTIBLE LOSSES
—The Company uses a combination of insurance and self-insurance for a number of risk management activities, including workers’ compensation, general liability and employee-related health care benefits, a portion of healthcare costs is paid by its associates. Liabilities associated with these risks are estimated primarily based on amounts determined by actuarial analysis, and accrued in part by considering historical claims experience, demographic factors, severity factors and other actuarial assumptions. Any actuarial projection of losses is subject to a high degree of variability. Among the causes of this variability are unpredictable external factors affecting future inflation rates, litigation trends, legal interpretations, benefit level changes and claim settlement patterns.
DEFERRED RENT
—Certain of the Company’s operating leases contain periods of free or reduced rent or contain predetermined fixed increases in the minimum rent amount during the lease term. For these leases, the Company recognizes rent expense on a straight-line basis over the expected life of the lease, generally about
13
years, including periods of free rent, and records the difference between the amount charged to rent expense and the rent paid as deferred rent. Tenant improvement allowances received from landlords are deferred and amortized to reduce rent expense over the expected life of the lease. As of
December 31, 2016
and
January 2, 2016
, deferred rent totaled
$10.9 million
and
$11.9 million
, respectively, of which
$1.1 million
and
$1.3 million
is included in accrued expenses for December 31, 2016 and January 2, 2016, respectively. The non-current portion is included in the deferred rent and other line item on the Company's consolidated balance sheet.
INCOME TAXES
—Income taxes are accounted for using the asset and liability method. Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to the differences between existing financial statement carrying amounts and their respective tax bases and for operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured at the tax rate expected to be in effect for the taxable years in which the Company expects those temporary differences to be recovered or settled. The Company recognizes the effect of changes in tax rates on deferred tax assets and liabilities in the period that includes the enactment date of the change. A valuation allowance is recorded to reduce deferred tax assets to the amount estimated as more likely than not to be realized. The Company also accounts for uncertainties in income taxes recognized in its financial statements. For more information, see Note 7.
SALES AND USE TAX
—Net revenues are recorded net of sales and use taxes. Net sales and use taxes are collected and remitted to all jurisdictions in which the Company has a physical presence in accordance with state, provincial and local tax laws.
FAIR VALUE OF FINANCIAL INSTRUMENTS
—Fair value of financial instruments represents the price that would be received to sell an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability.
The fair value hierarchy prescribed under GAAP contains three levels, which prioritizes the inputs used in the valuation methodologies in measuring fair value:
Level 1—Observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets.
Level 2—Other inputs that are directly or indirectly observable in the marketplace.
Level 3—Unobservable inputs which are supported by little or no market activity.
The fair value hierarchy also requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. As of
December 31, 2016
and
January 2, 2016
, there were no financial instruments which require disclosure under the fair value hierarchy.
REVENUE RECOGNITION
—Sales, net of estimated returns, are recorded when merchandise is purchased by customers at store locations. Revenue is recognized when merchandise shipped from a warehouse is received by the customer, based upon the estimated date of receipt by the customer. The Company reserves for sales returns through estimates based on historical experience. The sales return reserve for fiscal years
2016
,
2015
and
2014
was
$(1.4) million
,
$(1.3) million
and
$(1.2) million
, respectively.
ACCOUNTS RECEIVABLE
—Accounts receivable consists of amounts owed to West Marine for sales of services or goods on credit for our professional customers. The Company maintains an allowance for doubtful accounts receivable for estimated losses resulting from the inability of our customers to make required payments. The Company determines this allowance based on overall estimated exposure. Factors impacting the allowance include the level of gross receivables, the aging of accounts receivable at the date of the consolidated financial statements, the financial condition of the Company's customers and the economic risks for certain customers. The allowances for doubtful accounts receivable were as follows:
WEST MARINE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
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|
|
|
|
2016
|
|
2015
|
|
2014
|
|
|
|
(in thousands)
|
|
|
Allowance for doubtful accounts receivable—beginning balance
|
$
|
(265
|
)
|
|
$
|
(247
|
)
|
|
$
|
(243
|
)
|
Additions
|
(191
|
)
|
|
(174
|
)
|
|
(307
|
)
|
Deductions and other adjustments
|
188
|
|
|
156
|
|
|
303
|
|
Allowance for doubtful accounts receivable—ending balance
|
$
|
(268
|
)
|
|
$
|
(265
|
)
|
|
$
|
(247
|
)
|
The Company's policy for writing off uncollectible trade accounts receivables consists of systematic follow-up of delinquent accounts (over 90 days past the customer's terms of sale) and management review of accounts over a set dollar amount.
UNREDEEMED GIFT CARDS
—Aggregate sales of gift cards for fiscal years
2016
,
2015
and
2014
were
$18.4 million
,
$18.4 million
and
$18.1 million
, respectively. West Marine uses the proportional model for deferral of gift card sales. In line with the proportional method, sales of gift cards are deferred and treated as a liability on our balance sheet either until redeemed by customers in exchange for products or until we determine that breakage has occurred. Breakage is estimated in proportion to actual redemption. Under this method, we estimate breakage based on Company-specific data by analyzing historical experience and deriving a rate that represents the amount of gift cards that are expected to be unused and not subject to escheatment. This rate is then applied, and breakage is recognized in income, over the period of redemption. Gift card breakage income for
2016
,
2015
and
2014
was
$0.9 million
,
$0.7 million
and
$0.7 million
, respectively, and is included as net revenues in the Company's operating results.
WEST ADVANTAGE CUSTOMER LOYALTY PROGRAMS
—The Company has a customer loyalty program which allows members to earn points on qualifying purchases. Points earned entitle members to receive certificates that may be redeemed on future purchases through any retail sales channel. The certificates expire one year after they are issued. A liability is recognized and recorded as a reduction of revenue at the time the points are earned, based on the retail value of certificates projected to be redeemed, less the applicable estimate of breakage based upon historical redemption patterns. As of
December 31, 2016
and
January 2, 2016
, the Company had a recorded liability for the West Advantage customer loyalty program of
$1.3 million
and
$1.3 million
, respectively.
COST OF GOODS SOLD
—Cost of goods sold includes costs related to the purchase, transportation and storage of merchandise, shipping expense and store occupancy costs. Consideration in the form of cash or credits received from vendors is recorded as a reduction to cost of goods sold as the related products are sold.
VENDOR ALLOWANCES
—The Company receives various payments and allowances from its vendors through a variety of programs and arrangements. Monies received from vendors include rebates, allowances and promotional funds. The amounts to be received are subject to the terms of the vendor agreements, which are subject to ongoing negotiations that may be impacted in the future based on changes in market conditions, vendor marketing strategies and changes in the profitability or sell-through of the related merchandise.
Rebates and other miscellaneous incentives are earned based on purchases, receipts or product sales and are accrued ratably over the purchase or sale of the related product. These monies are recorded as a reduction of merchandise inventories based on inventory turns and as the product is sold.
COMPREHENSIVE INCOME
—Comprehensive income consists of net income and other comprehensive income (loss). Other comprehensive income (loss) includes income, expenses, gains and losses that bypass the income statement and are reported directly as a separate component of equity. The Company’s comprehensive income consists of net income and foreign currency translation adjustments for all periods presented.
FOREIGN CURRENCY
—Translation adjustments result from translating foreign subsidiaries’ financial statements into U.S. dollars. West Marine Canada’s functional currency is the Canadian dollar. Balance sheet accounts are translated at exchange rates in effect at the balance sheet date. Income statement accounts are translated at average exchange rates during the year. Resulting translation adjustments are included as a component of other comprehensive income in the consolidated statements of stockholders’ equity. Gains (losses) from foreign currency transactions included in SG&A expense for
2016
,
2015
and
2014
were
$0.1 million
,
$(0.7) million
and
$(0.5) million
, respectively.
WEST MARINE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
ACCRUED EXPENSES
—Accrued expenses consist of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
2016
|
|
2015
|
Unredeemed gift cards
|
$
|
7,546
|
|
|
$
|
7,336
|
|
Other accrued expenses
|
21,964
|
|
|
19,909
|
|
Accrued expenses
|
$
|
29,510
|
|
|
$
|
27,245
|
|
NET INCOME PER SHARE
—Basic net income per share is computed by dividing net income available to common stockholders by the weighted-average number of common shares outstanding during the period. Diluted net income per share reflects the potential dilution that could occur if unvested restricted shares and outstanding options to purchase common stock were exercised. Options to purchase approximately
0.5 million
shares,
0.6 million
shares and
0.7 million
shares of common stock that were outstanding in
2016
,
2015
and
2014
, respectively, have been excluded from the calculation of diluted income per share because inclusion of such shares would be anti-dilutive.
The following is a reconciliation of the Company’s basic and diluted net income per share computations (shares in thousands):
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|
|
|
|
|
|
|
2016
|
|
2015
|
|
2014
|
|
Shares
|
|
Net Income
Per Share
|
|
Shares
|
|
Net Income
Per Share
|
|
Shares
|
|
Net Income
Per Share
|
Basic
|
24,893
|
|
|
$
|
0.26
|
|
|
24,629
|
|
|
$
|
0.18
|
|
|
24,244
|
|
|
$
|
0.08
|
|
Effect of dilutive stock options
|
95
|
|
|
—
|
|
|
105
|
|
|
—
|
|
|
164
|
|
|
—
|
|
Diluted
|
24,988
|
|
|
$
|
0.26
|
|
|
24,734
|
|
|
$
|
0.18
|
|
|
24,408
|
|
|
$
|
0.08
|
|
.
CASH AND CASH EQUIVALENTS
—Cash consists entirely of cash on hand and bank deposits, of which approximately
$74.4 million
exceeded FDIC insurance limits as of
December 31, 2016
. As of
January 2, 2016
, approximately
$46.6 million
exceeded FDIC insurance limits.
The Company classifies amounts in transit from banks for customer credit card and debit card transactions as cash and cash equivalents as the banks process the majority of these amounts within three to five business days. The amounts due from banks for these transactions classified as cash and cash equivalents totaled
$3.9 million
and
$3.5 million
at
December 31, 2016
and
January 2, 2016
, respectively
We had no outstanding checks in excess of funds on deposit (book overdrafts) at
December 31, 2016
and
January 2, 2016
.
SABBATICAL LEAVE
—Certain full-time associates are eligible to receive sabbatical leave after each
5
years of continuous employment. The estimated sabbatical liability is based on a number of factors, including actuarial assumptions and historical trends. In fiscal years
2016
and
2015
, the Company had a recorded liability of
$1.0 million
and
$1.2 million
, respectively, as an estimate of accumulated sabbatical leave as of the respective balance sheet dates.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
—
ASU 2014-09, Revenue from Contracts with Customers (Topic 606)
ASU 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date
ASU 2016-10, Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing
ASU 2016-12, Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients
In May 2014, FASB issued an accounting standards update ("ASU") 2014-09, which supersedes the revenue recognition requirements in ASC Topic 605
, Revenue Recognition,
and requires entities to recognize revenue in a way that depicts the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In August 2015, FASB issued ASU 2015-14, which deferred the effective date of ASU 2014-09 to December 15, 2017 for annual reporting periods beginning after that date. FASB also approved permitting early adoption of the standard, but not before the original effective date of December 15, 2016. The Company will not be early adopting the standard; therefore, the new standard will be effective for the Company's 2018 fiscal year. The standard permits the use of either the full retrospective or modified retrospective approach. The Company currently expects to adopt the new standard using the modified retrospective approach.
WEST MARINE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
In April 2016, FASB issued ASU 2016-10, which clarifies the following two aspects of Topic 606: identifying performance obligations; and licensing implementation guidance. The Company is currently assessing and evaluating the new standard and has not yet concluded whether the adoption of ASU 2016-10 will have a material impact on the Company's consolidated financial statements. The Company currently expects to adopt an accounting policy to account for shipping and handling activities that occur after the customer has obtained control of a good as an activity to fulfill the promise to transfer the good, rather than as an additional promised service. This guidance does not represent a change from current practice for the Company. The Company does not have any license or royalty revenue.
In May 2016, FASB issued ASU 2016-12, which focuses on clarifying the guidance on assessing collectability, presentation of sales taxes, non-cash consideration, and completed contracts and contract modification at transition. The Company has not yet concluded whether the adoption of ASU 2016-12 will have a material impact on its consolidated financial statements. Consistent with its current accounting policy, the Company currently expects to exclude amounts collected from customers for all sales (and other similar) taxes from the transaction price.
In August 2014, FASB issued ASU 2014-15,
Presentation of Financial Statements - Going Concern (Subtopic 205-40), Disclosure of Uncertainties about an Entity's Ability to Continue as a Going Concern,
which requires management to disclose their assessment of the entity's ability to continue as a going concern. Under this guidance, management is required to evaluate whether there is substantial doubt about the entity's ability to continue as a going concern and, if so, provide certain footnote disclosures.The amendment is effective for the annual period ending after December 15, 2016, and interim periods thereafter. The Company adopted the standard for the year ended December 31, 2016. The adoption of this standard did not have an impact on our consolidated financial statements and related footnotes.
In July 2015, FASB issued ASU 2015-11,
Simplifying the Measurement of Inventory.
The update requires an entity to measure inventory at the lower of cost or market and net realizable value. Subsequent measurement is unchanged for inventory using last -in, first out or the retail inventory method. The effective date for ASU 2015-11 is for fiscal years beginning after December 15, 2016. The Company expects the adoption of this accounting guidance will not have an impact on the Company's consolidated financial statements.
In February 2016, FASB issued ASU 2016-02,
Leases (Topic 842)
, which is intended to increase transparency and comparability among organizations by recognizing lease assets and liabilities on the balance sheet for leases with a term of more than 12 months. In addition, the update will require additional disclosures regarding key information about leasing arrangements. Under existing guidance, operating leases with a term of more than 12 months are not recorded as lease assets and lease liabilities on the balance sheet. The update will be effective for the Company beginning in the first quarter of fiscal year 2019, with early adoption permitted. The Company is currently evaluating the impact of the adoption of this accounting guidance on its consolidated financial statements. The Company expects the adoption of this accounting guidance to result in an increase in lease assets and a corresponding increase in lease liabilities on its consolidated balance sheets.
In March 2016, FASB issued ASU 2016-09,
Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting
, which is intended to simplify several aspects of the accounting for share-based payment transactions, including the accounting for income taxes, forfeitures and statutory tax withholding requirements, as well as classification in the statement of cash flows. The update is effective for annual periods beginning after December 15, 2016, with early adoption permitted. The Company is not planning to early adopt and expects that this guidance will not have a material impact on its consolidated financial statements.
In August 2016, FASB issued ASU 2016-15,
Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments,
which is intended to decrease the diversity in practice in how certain cash receipts and cash payments are presented and classified in the statement of cash flows. The amendments in this update provide guidance on eight specific cashflow issues. The amendments in ASU 2016-15 are effective for the Company for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years, and should be applied using the retrospective transition method for each period presented. Early adoption is permitted, but all amendments must be adopted in the same period. The Company is not planning to early adopt and is currently evaluating the impact that the amendments will have on its consolidated financial statements.
In October 2016, FASB issued ASU 2016-16,
Intra-Entity Transfers of Assets Other Than Inventory
. The effective date for ASU 2016-16 is for fiscal years beginning after December 15, 2017. ASU 2016-16 is applied on a modified retrospective basis and the Company will recognize any effects of adoption in the retained earnings at the beginning of its 2018 fiscal year. The Company is currently evaluating the impact this guidance will have on its consolidated financial statements.
NOTE 2: SHARE-BASED COMPENSATION
West Marine’s Omnibus Equity Incentive Plan, as amended (the “Plan”) is intended to provide flexibility to the Company in its ability to motivate, attract and retain the services of associates and non-employee directors. The Plan permits a variety of compensation methods, including non-qualified stock options, incentive stock options, restricted stock and other share-based
WEST MARINE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
awards, such as time-based and performance-based restricted stock units. Key associates and non-employee directors are eligible to participate under the Plan. At year-end
2016
,
10,300,000
shares of common stock had been reserved under the Plan and
959,702
shares were available for future issuance.
The Company recognizes compensation expense for share-based payments based on the grant date fair value of the awards. Share-based payments consist of stock option grants, restricted stock awards, restricted stock units, performance-based restricted stock units and Associates Stock Buying Plan ("Buying Plan") issuances, each as described further below.
Share-based compensation expense for
2016
,
2015
and
2014
was approximately
$2.8 million
,
$2.8 million
and
$3.1 million
, respectively, of which expense for stock options was
$0.1 million
,
$0.3 million
and
$0.8 million
in
2016
,
2015
and
2014
, respectively. In 2015, the Company recognized
no
tax benefits from stock option exercises, restricted stock vesting or disqualifying Buying Plan transactions. In 2014, the Company recognized
$0.2 million
in tax benefits from stock options exercised, restricted stock vesting and disqualifying Buying Plan transactions, of which
$0.2 million
was recognized as excess tax benefits in additional paid-in capital and
$0.2 million
was included as part of cash flow from financing activities. The tax benefit was included in the Company’s consolidated statement of income for the same period. Share-based compensation of
$0.4 million
was included in capitalized indirect inventory in
2016
,
$0.4 million
in
2015
and
$0.4 million
in
2014
.
Included in cost of goods sold and SG&A expense is share-based compensation expense, net of estimated forfeitures, that has been included in the statements of income for all share-based compensation arrangements as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
(in thousands)
|
2016
|
|
2015
|
|
2014
|
Cost of goods sold
|
$
|
431
|
|
|
$
|
448
|
|
|
$
|
429
|
|
Selling, general and administrative expense
|
2,348
|
|
|
2,339
|
|
|
2,680
|
|
Share-based compensation expense
|
$
|
2,779
|
|
|
$
|
2,787
|
|
|
$
|
3,109
|
|
Stock Options
West Marine awarded options to purchase shares of common stock to its non-employee directors and to certain eligible associates employed at the time of the grant. For fiscal 2007 through 2010, options granted to associates under the Plan vested over three years and expired five years following the grant date. Grants in 2011, 2012 and 2013 vested over three years and expired seven years from the grant date. Prior to 2011, options granted to non-employee directors vested after six months and expired five years from the grant date. Options granted to non-employee directors in 2012 vested after one year and expire seven years from the grant date. Options granted to non-employee directors in 2011 vested after six months and expire seven years from the grant date. One non-employee director elected to receive options in 2016. Following the grant in 2016, the Company stopped awarding option grants. The Company has determined the fair value of options awarded by applying the Black-Scholes Merton option pricing valuation model and using following assumptions:
|
|
|
|
|
|
|
|
|
|
|
2016
|
|
2015
|
|
2014
|
Expected price volatility
|
33
|
%
|
|
—
|
%
|
|
—
|
%
|
Risk-free interest rate
|
1.2
|
%
|
|
—
|
%
|
|
—
|
%
|
Weighted-average expected term (years)
|
4.0
|
|
|
0.0
|
|
|
0.0
|
|
Dividend yield
|
—
|
|
|
—
|
|
|
—
|
|
Expected price volatility: This is the percentage amount by which the price of West Marine common stock is expected to fluctuate annually during the estimated expected life for stock options. Expected price volatility is calculated using historical monthly closing prices over a period matching the weighted-average expected term, as management believes such changes are the best indicator of future volatility. An increase in expected price volatility would increase compensation expense.
Share issuance: The Company’s policy is to issue new shares of common stock for purchase under the Plan. Shares of common stock are authorized by the Company’s Board of Directors, subject to stockholder approval, for issuance under the Plan. Subject to adjustment, the maximum number of shares currently available for grant under the Plan may not exceed
10,300,000
shares.
Risk-free interest rate: This is the U.S. Treasury zero-coupon rate, as of the grant date, for issues having a term equal to the expected life of the stock option. An increase in the risk-free interest rate would increase compensation expense.
Expected term: This is the period of time over which stock options are expected to remain outstanding. The Company calculates expected term based on the average of the vesting period and the full contractual term. An increase in the expected term would increase compensation expense.
WEST MARINE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Dividend yield: The Company historically has not made any dividend payments, nor does it expect to pay dividends in the foreseeable future. An increase in the dividend yield would decrease compensation expense.
A summary of the Company’s stock option activity in
2016
,
2015
and
2014
is as follows:
|
|
|
|
|
|
|
|
|
|
|
Number of
Shares
|
|
Weighted
Average
Exercise
Price
|
|
Weighted
Average
Option
Grant Date
Fair Value
|
Outstanding at year-end 2013 (1,179,770 stock options exercisable at a weighted-average exercise price of $12.63)
|
1,699,886
|
|
|
12.13
|
|
|
5.43
|
|
Granted
|
—
|
|
|
—
|
|
|
—
|
|
Exercised
|
(236,052
|
)
|
|
7.14
|
|
|
2.54
|
|
Forfeited
|
(47,924
|
)
|
|
10.96
|
|
|
4.12
|
|
Expired
|
(324,832
|
)
|
|
19.86
|
|
|
11.39
|
|
Outstanding at year-end 2014 (896,687 stock options exercisable at a weighted-average exercise price of $10.87)
|
1,091,078
|
|
|
10.95
|
|
|
4.32
|
|
Granted
|
—
|
|
|
—
|
|
|
—
|
|
Exercised
|
(106,783
|
)
|
|
10.69
|
|
|
4.18
|
|
Forfeited
|
(17,823
|
)
|
|
11.19
|
|
|
4.09
|
|
Expired
|
(345,984
|
)
|
|
11.12
|
|
|
4.49
|
|
Outstanding at year-end 2015 (575,015 stock options exercisable at a weighted-average exercise price of $10.82)
|
620,488
|
|
|
10.88
|
|
|
4.26
|
|
Granted
|
10,123
|
|
|
8.99
|
|
|
2.47
|
|
Exercised
|
(124
|
)
|
|
10.36
|
|
|
4.27
|
|
Forfeited
|
(2,670
|
)
|
|
11.69
|
|
|
4.08
|
|
Expired
|
(109,288
|
)
|
|
10.56
|
|
|
4.15
|
|
Outstanding at year-end 2016 (508,629 stock options exercisable at a weighted-average exercise price of $10.94)
|
518,529
|
|
|
10.91
|
|
|
4.25
|
|
The weighted-average grant date fair value of options granted in
2016
was
$2.47
per share. There were no stock options granted in 2015 and 2014. The aggregate fair value of options vested during
2016
,
2015
and
2014
was
$0.5 million
,
$1.6 million
and
$2.5 million
, respectively.
As of market close
December 31, 2016
, the aggregate intrinsic value of stock options was
$0.1 million
, and less than
$0.1 million
for exercisable options. The total intrinsic value of options actually exercised was
$0.0 million
in
2016
,
$0.1 million
in
2015
and
$1.0 million
in
2014
. There were
128,349
options that vested in
2016
with an aggregate grant date fair value of
$0.5 million
. At
December 31, 2016
, unrecognized compensation expense for stock options, net of expected forfeitures, was less than
$0.1 million
, with a weighted-average remaining expense recognition period of
0.40
years.
Additional information for options outstanding at year-end
2016
is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding Options
|
|
Exercisable Options
|
Range of Exercise Prices
|
Shares
Underlying
|
|
Weighted
Average
Remaining
Contractual
Term (Years)
|
|
Weighted
Average
Exercise
Price
|
|
Exercisable
Shares
|
|
Weighted
Average
Remaining
Contractual
Term (Years)
|
|
Weighted
Average
Exercise
Price
|
$ 7.01 – 10.75
|
299,420
|
|
|
1.9
|
|
10.27
|
|
|
289,297
|
|
|
1.8
|
|
10.32
|
|
10.76 – 15.54
|
219,109
|
|
|
3.0
|
|
11.77
|
|
|
219,332
|
|
|
3.0
|
|
11.77
|
|
$ 7.01 – 15.54
|
518,529
|
|
|
2.4
|
|
$
|
10.91
|
|
|
508,629
|
|
|
2.3
|
|
$
|
10.94
|
|
In fiscal year 2016, there were
127,884
stock options that were vested, and expected to vest in the future, with
no
intrinsic value, a weighted-average exercise price of
$11.56
per share and a weighted-average remaining contractual term of
0.03
years.
Restricted Stock Units
The Plan also allows for awards of time-released restricted stock units (“RSUs”) to eligible associates and non-employee directors that are subject to the recipient's continuing service to the Company. RSUs granted to eligible associates in 2016, 2015
WEST MARINE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
and 2014 vest over a three-year period at the rate of 33%, 33% and 34% on the anniversary of the grant date. RSUs granted to non-employee directors in 2016, 2015 and 2014 vest the earlier of either the one-year anniversary of the grant date or the Company's annual stockholder meeting date following the grant date. Compensation expense for
2016
,
2015
and
2014
was
$2.2 million
,
$2.1 million
and
$2.1 million
, respectively. Unrecognized compensation expense for unvested RSUs, net of expected forfeitures, was
$2.6 million
in
2016
, and the Company expects to recognize this expense within less than
two
years. A summary of RSU activity in
2016
,
2015
and
2014
is as follows:
|
|
|
|
|
|
|
|
Number of
RSU's
|
|
Weighted
Average
Grant
Date Fair
Value
|
Unvested at year-end 2013 (weighted-average remaining vesting period of 1.8 years)
|
346,384
|
|
|
11.31
|
|
Granted
|
220,777
|
|
|
11.78
|
|
Vested
|
(163,990
|
)
|
|
|
Forfeited
|
(55,008
|
)
|
|
11.56
|
|
Unvested at year-end 2014 (weighted-average remaining vesting period of 1.6 years)
|
348,163
|
|
|
11.60
|
|
Granted
|
251,164
|
|
|
10.66
|
|
Vested
|
(169,692
|
)
|
|
|
Forfeited
|
(41,479
|
)
|
|
11.71
|
|
Unvested at year-end 2015 (weighted-average remaining vesting period of 1.6 years)
|
388,156
|
|
|
11.11
|
|
Granted
|
258,036
|
|
|
9.17
|
|
Vested
|
(189,763
|
)
|
|
|
Forfeited
|
(33,831
|
)
|
|
10.98
|
|
Unvested at year-end 2016 (weighted-average remaining vesting period of 1.6 years)
|
422,598
|
|
|
9.92
|
|
The total fair value of RSUs vested in
2016
and
2015
was
$2.1 million
and
$1.9 million
, respectively.
Performance-based Restricted Stock Units
Starting in 2014, performance-based restricted stock units (“PSUs”) were granted to certain eligible associates and are subject to the Company satisfying a performance metric approved by the Compensation and Leadership Development Committee of the Board of Directors and the recipient's continuing service to the Company. The PSUs represent a promise to deliver shares to the associates at a future date if both the performance and time-based vesting conditions were met. PSUs do not consist of legally issued shares until all vesting criteria are satisfied. During 2014,
82,324
PSUs were granted, however, the minimum performance hurdle was not met and, as a result, the
82,324
PSUs were canceled. Accordingly, there was
no
compensation expense in 2014. PSUs granted to certain eligible associates in 2016 and 2015 vest over a three-year period at the rate of 33%, 33% and 34% on the anniversary of the grant date, unless the minimum performance hurdle is not met and such PSUs are cancelled. Compensation expense for PSUs was
$0.3 million
and
$0.2 million
in
2016
and 2015, respectively. Unrecognized compensation expense for unvested PSUs, net of expected forfeitures, was
$0.7 million
in 2016 and the Company expects to recognize this expense within less than
two
years. A summary of PSU activity in 2016, 2015 and 2014 is as follows:
WEST MARINE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
|
|
|
|
|
|
|
|
Number of
PSU's
|
|
Weighted
Average
Grant
Date Fair
Value
|
Unvested at year-end 2013
|
—
|
|
|
|
Granted
|
82,324
|
|
|
12.03
|
|
Vested
|
—
|
|
|
|
Canceled
|
(82,324
|
)
|
|
12.03
|
|
Unvested at year-end 2014
|
—
|
|
|
|
Granted
|
83,991
|
|
|
11.03
|
|
Vested
|
—
|
|
|
|
Forfeited
|
(3,333
|
)
|
|
11.03
|
|
Unvested at year-end 2015 (weighted-average remaining vesting period of 2.3 years)
|
80,658
|
|
|
11.02
|
|
Granted
|
93,440
|
|
|
9.20
|
|
Vested
|
(17,564
|
)
|
|
10.99
|
|
Forfeited
|
(14,844
|
)
|
|
10.89
|
|
Unvested at year-end 2016 (weighted-average remaining vesting period of 1.9 years)
|
141,690
|
|
|
9.82
|
|
Associates Stock Buying Plan
The Company has the Buying Plan under which eligible associates may elect to participate on semiannual grant dates. Participating associates purchase West Marine shares at 85% of the lower of the closing price on (a) the grant date or (b) the purchase date. The Buying Plan includes a twelve calendar month holding period for all purchases beginning on the date on which shares are purchased by participants under the Buying Plan. The number of shares purchased under the Buying Plan in
2016
,
2015
and
2014
were
81,111
,
69,980
and
75,119
, respectively. Expense recognized in each of the years 2016, 2015 and 2014 was $0.2 million. Shares available for future issuance under the Buying Plan at the end of
2016
,
2015
and
2014
were
195,890
,
277,001
and
346,981
, respectively. Assumptions used in determining the fair value of shares issued under the Buying Plan during
2016
,
2015
and
2014
were as follows:
|
|
|
|
|
|
|
|
|
|
|
2016
|
|
2015
|
|
2014
|
Expected price volatility
|
27%-37%
|
|
|
35%-36%
|
|
|
30%-34%
|
|
Risk-free interest rate
|
0.4% - 0.5%
|
|
|
0.1% - 0.3%
|
|
|
0.1
|
%
|
Weighted-average expected term (years)
|
0.5
|
|
|
0.5
|
|
|
0.5
|
|
Dividend yield
|
—
|
|
|
—
|
|
|
—
|
|
Manager Share Appreciation Plan
In November 2015, West Marine ended the Manager Share Appreciation Plan ("MSAP") as the plan was not meeting the Company's goals. The plan was introduced in 2012, and was a long-term cash incentive plan. The MSAP award was a cash incentive which was tied to appreciation in West Marine's stock price. The appreciation on MSAP awards was capped. The plan was a cash-settled plan and earned by associates over a number of years; therefore, it was within the scope of ASC 718,
Compensation - Stock Compensation
, because the amount earned by the associates was based on the price of the Company's stock. Additionally, since the award was settled in cash, the fair value of the award was recorded as a liability, rather than equity. As such, the Company re-measured the awards at fair value each reporting period until the award was settled. The awards vest 33%, 33% and 34% over a three-year period.
Fair value was determined using a Monte Carlo simulation model. A Monte Carlo simulation is a generally accepted statistical technique used, in this instance, to simulate a range of possible future stock prices for West Marine. These stock prices were used to determine the fair values of the awards that had been granted. The Company used the forfeiture rate of its non-qualified stock options, since the Company did not have sufficient history of the MSAP awards. The Company believed this was a reasonable interim assumption until the Company had sufficient forfeiture history on these awards. The fair value at January 3, 2015 and December 28, 2013 (the only dates awards were made under the MSAP) was
$2.04
and
$2.59
per award, respectively. Assumptions used in determining the fair value of the MSAP awards during
2016
,
2015
and
2014
were as follows:
WEST MARINE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
|
|
|
|
|
|
|
|
|
|
|
|
2016
|
|
2015
|
|
2014
|
|
Expected price volatility
|
—
|
%
|
|
32%-39%
|
|
|
34%-37%
|
|
|
Risk-free interest rate
|
—
|
%
|
|
0.5%-1.2%
|
|
|
0.8%-1.4%
|
|
Weighted-average expected term (years)
|
|
|
|
4.2
|
|
|
4.1
|
|
|
Dividend yield
|
—
|
|
|
—
|
|
|
—
|
|
|
A summary of the MSAP award activity in
2016
,
2015
and
2014
is as follows:
|
|
|
|
|
|
Number of
MSAP's
|
|
Unvested at year-end 2013
|
237,770
|
|
|
Granted
|
244,750
|
|
|
Vested
|
(78,911
|
)
|
|
Forfeited
|
(73,250
|
)
|
|
Unvested at year-end 2014
|
330,359
|
|
|
Granted
|
242,400
|
|
|
Vested
|
(103,648
|
)
|
|
Awards paid out
|
(382,054
|
)
|
|
Forfeited
|
(87,057
|
)
|
|
Unvested at year-end 2015
|
—
|
|
|
Granted
|
—
|
|
|
Vested
|
—
|
|
|
Awards paid out
|
—
|
|
|
Forfeited
|
—
|
|
|
Unvested at year-end 2016
|
—
|
|
|
The MSAP compensation expense recorded for 2015 was
$0.2 million
and the plan ended in November 2015; therefore, the liability did not exist at January 2, 2016. The MSAP compensation expense recorded for 2014 was
$0.4 million
.
Included in cost of goods sold and SG&A expense is MSAP compensation expense, net of estimated forfeitures, that have been included in the statements of operations for all MSAP compensation arrangements as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
(in thousands)
|
2016
|
|
2015
|
|
2014
|
Cost of goods sold
|
|
|
|
$
|
(11
|
)
|
|
$
|
33
|
|
Selling, general and administrative expense
|
|
|
|
(216
|
)
|
|
388
|
|
MSAP compensation expense
|
$
|
—
|
|
|
$
|
(227
|
)
|
|
$
|
421
|
|
NOTE 3: PROPERTY AND EQUIPMENT
Property and equipment consisted of the following at fiscal year-end
2016
and
2015
(in thousands):
|
|
|
|
|
|
|
|
|
|
At Year-End
|
|
2016
|
|
2015
|
Furniture and equipment
|
$
|
82,070
|
|
|
$
|
79,337
|
|
Computer software and hardware
|
103,640
|
|
|
95,574
|
|
Leasehold improvements
|
81,149
|
|
|
77,775
|
|
Land and building
|
—
|
|
|
600
|
|
Property and equipment, at cost
|
266,859
|
|
|
253,286
|
|
Accumulated depreciation and amortization
|
(184,342
|
)
|
|
(171,725
|
)
|
Property and equipment, net
|
$
|
82,517
|
|
|
$
|
81,561
|
|
Depreciation and amortization expense for property and equipment was
$22.0 million
,
$20.5 million
and
$18.0 million
in
2016
,
2015
and
2014
, respectively.
NOTE 4: LINES OF CREDIT AND LONG–TERM DEBT
The Company's loan and security agreement, as amended, with Wells Fargo Bank, National Association and the other lenders party thereto provides a maximum available borrowing capacity of
$120.0 million
. In addition, at the Company's option and subject to certain conditions, the Company may increase its borrowing capacity up to an additional
$25.0 million
. All other material terms of the amended and restated loan and security agreement remained unchanged. The amount available to be borrowed is based on a percentage of certain of the Company's inventory (excluding capitalized indirect costs) and accounts receivable.
The revolving credit facility is guaranteed by West Marine, Inc. and West Marine Canada Corp. (an indirect subsidiary of West Marine, Inc.) and secured by a security interest in all of the Company's accounts receivable and inventory, certain other related assets, and all proceeds thereof. The revolving credit facility is available for general working capital and general corporate purposes.
At the Company’s election, borrowings under the revolving credit facility will bear interest at one of the following options:
1.
The prime rate, which is defined in the loan agreement as the highest of:
a.
Federal funds rate, as in effect from time to time, plus one-half of one percent;
b.
LIBOR rate for a one-month interest period plus one percent; or
c.
The rate of interest in effect for such day as publicly announced from time to time by Wells Fargo as its “prime rate;” or
2.
The LIBOR rate quoted by the British Bankers Association for the applicable interest period.
In each case, the applicable interest rate is increased by a margin imposed by the loan agreement. The applicable margin for any date will depend upon the amount of available credit under the revolving credit facility. The margin range for option (1) above is between
0.5%
to
1.0%
and for option (2) above is between
1.5%
and
2.0%
.
The loan agreement also imposes a fee on the unused portion of the revolving credit facility available. For
2016
, the weighted-average interest rate on all of our outstanding borrowings was
4.0%
. For 2015 and 2014, the weighted-average interest rate on all of our outstanding borrowings was
3.8%
.
Although the loan agreement contains customary covenants, including, but not limited to, restrictions on the Company’s ability to incur liens, make acquisitions and investments, pay dividends and sell or transfer assets, it does not contain debt or other similar financial covenants, such as maintaining certain specific leverage, debt service or interest coverage ratios. Instead, the loan is asset-based (which means the Company’s lenders maintain a security interest in the Company’s inventory and accounts receivable which serve as collateral for the loan), and the amount the Company may borrow under its revolving credit facility at any given time is determined by the estimated value of these assets as determined by the lenders’ appraisers. Additionally, the Company must maintain minimum revolving credit availability equal to the greater of
$7 million
or
10%
of the borrowing base. In addition, there are customary events of default under our loan agreement, including failure to comply with our covenants. If we fail to comply with any of the covenants contained in the loan agreement, an event of default occurs which, if not waived by our lenders or cured within the applicable time periods, results in the lenders having the right to accelerate repayment of all outstanding indebtedness under the loan agreement before the stated maturity date and the revolving credit facility could be terminated. As of
December 31, 2016
, the Company was in compliance with the covenants under this loan agreement.
At the end of fiscal year
2016
, there were no amounts outstanding under this revolving credit facility,
$104.3 million
was available for future borrowings, and there was
$0.2 million
in unamortized loan costs. At the end of fiscal year
2015
, there were no amounts outstanding under this revolving credit facility,
$105.3 million
was available for future borrowings, and there was
$0.4 million
in unamortized loan costs. At the end of fiscal years
2016
and
2015
, the Company had
$4.2 million
and
$4.8 million
of outstanding commercial and stand-by letters of credit, respectively. The highest outstanding balance during 2016 and 2015 was
$0.3 million
and
$0.2 million
, respectively.
NOTE 5: RELATED PARTY TRANSACTIONS
Randolph K. Repass, West Marine's founder and a member of the Company's board of directors, is a general partner of
two
partnerships in which he, together with certain members of his family, owns substantially all of the partnership interests. Currently, West Marine leases two properties from the partnerships: the Watsonville Support Center and the Santa Cruz store, which relocated to a larger building in the same center in mid-2016. Both locations are in California.
The lease for the Watsonville Support Center is West Marine's most significant related party transaction. On October 26, 2016, West Marine Products, Inc., a wholly-owned subsidiary of West Marine, Inc., and the landlord entered into an amendment to this lease which would have expired on October 31, 2016. The amendment extended the term to October 31, 2021, with one five-year
extension at the option of the Company. Base rent is initially fixed at
$1.2 million
per year, with contractual increases in year three and year four. In addition, base rent could be adjusted if the Company exercises its right under the amendment to give back a portion of the leased space during the term, subject to certain conditions.
Negotiations for both the Support Center lease amendment and the Santa Cruz store lease were conducted at arms' length using independent representatives for each party.
During 2014, West Marine terminated
one
related party lease, Braintree, Massachusetts store location.
West Marine made payments to the above-related parties during fiscal years 2016, 2015 and 2014 in the aggregate amount of approximately
$1.6 million
,
$1.6 million
and
$1.7 million
, respectively.
All related party transactions, including the related party new and renewal leases noted above, are pre-approved by West Marine's Board of Directors acting through the Audit and Finance Committee. The Audit and Finance Committee reviews and determines that the related party transaction is in the best interest of the Company and its stockholders.
NOTE 6: COMMITMENTS AND CONTINGENCIES
The Company leases certain equipment, and space for its retail stores, its distribution centers and its support center. The Company also sublets space at various locations with both month-to-month and non-cancelable sublease agreements. The operating leases of certain stores provide for periodic rent adjustments based on store revenues, the consumer price index and contractual rent increases.
The aggregate minimum annual contractual payments under non-cancelable leases, reduced for sublease income, in effect at fiscal year-end
2016
were as follows (in thousands):
|
|
|
|
|
|
|
2017
|
$
|
49,353
|
|
2018
|
44,817
|
|
2019
|
39,420
|
|
2020
|
35,337
|
|
2021
|
30,730
|
|
Thereafter
|
89,718
|
|
Minimum non-cancelable lease payments, net
|
$
|
289,375
|
|
The table above includes
$8.8 million
in related party lease payments. No assets of the Company were subject to capital leases at fiscal year-end
2016
or
2015
. All but a limited number of the Company’s purchase commitments, which are not material, are cancelable without payment and, therefore, have been excluded from the table above.
Rent expense is included in the Cost of goods sold line on the Consolidated Statement of Income. Following is a summary of rent expense by component (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2016
|
|
2015
|
|
2014
|
Minimum rent
|
$
|
49,010
|
|
|
$
|
49,540
|
|
|
$
|
51,603
|
|
Percentage rent
|
59
|
|
|
62
|
|
|
60
|
|
Sublease income
|
—
|
|
|
—
|
|
|
(12
|
)
|
Rent paid to related parties
|
1,420
|
|
|
1,381
|
|
|
1,479
|
|
Total rent expense
|
$
|
50,489
|
|
|
$
|
50,983
|
|
|
$
|
53,130
|
|
In February of 2016, the Superior Court of the State of California, County of San Diego, approved the settlement, on an individual and class-wide basis, of a complaint brought by a California former hourly employee who alleged that the Company failed to properly pay overtime to California employees who earned bonuses or commissions in violations of certain provisions of California Labor Code and the California Business and Professional Code. The aggregate obligation, including settlement funds, plaintiff’s attorneys’ fees and costs and settlement administration costs had no material impact on our financial statements. The Court approved the settlement of
$0.1 million
, which was recorded in accrued expenses and other on the consolidated balance sheet for 2015. The Company's aggregate obligation, including settlement funds, plaintiff’s attorneys’ fees and costs and settlement administration costs had no material impact on its financial statements.
WEST MARINE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
The Company currently is under audit for sales taxes in several jurisdictions. The tax periods open to examination by the major taxing jurisdictions for sales and use taxes are fiscal 2012 through fiscal 2016. Management believes that the ultimate resolution of these matters will not have a material effect on the Company’s financial condition or results of operations.
The Company also is party to various other routine and non-routine legal and administrative proceedings, claims, product recalls, litigation and reviews, audits and investigations by various federal and state governmental regulators arising from normal business activities, including commercial, product and product safety, customer, intellectual property, labor and employment-related claims, custom, tax and environmental claims and proceedings in which private plaintiffs or governmental agencies allege that we violated local, state or federal laws. In addition, certain third-party service suppliers have rights under their contracts with the Company to review and audit its use of their products. Many of these legal and administrative proceedings investigations and audits raise complex factual and legal issues and are subject to uncertainties. The Company cannot predict with assurance the outcome of these matters. Accordingly, material adverse developments, settlements, or resolutions may occur and negatively impact results in the quarter and/or fiscal year in which such developments, settlements or resolutions are reached.
Based on the facts currently available, the Company does not believe that the disposition of matters that are pending or asserted, individually or in the aggregate, will have a material adverse effect on future financial results. However, changes in current facts or circumstances and/or an adverse judgment by a court, administrative or regulatory agency, arbitrator or a settlement could adversely impact the Company’s results of operations in any given period.
The Company accrues a liability for and contingency arising from these claims, audits, legal or administrative proceedings where the Company believes it is probable it will pay some amounts and the amounts can be estimated; in some cases, however, it is too early to predict a final outcome. When the Company has determined that a loss is probable, there is no material difference between the amount accrued and the reasonably possible amount of loss. For any such matters where a loss is reasonably possible, the range of estimated loss is not material, individually and in the aggregate.
At December 31, 2016, accrued liabilities included a loss contingency accrual of
$0.9 million
related to all pending legal, regulatory and administrative claims. At January 2, 2016, accrued liabilities included a loss contingency accrual of
$0.3 million
related to all pending legal, regulatory and administrative claims.
NOTE 7: INCOME TAXES
Earnings from continuing operations before income tax expense was as follows for 2016, 2015 and 2014 (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2016
|
|
2015
|
|
2014
|
United States
|
$
|
10,907
|
|
|
$
|
7,346
|
|
|
$
|
2,939
|
|
Outside the United States
|
697
|
|
|
(52
|
)
|
|
1,065
|
|
Earnings from continuing operations before income tax expense
|
$
|
11,604
|
|
|
$
|
7,294
|
|
|
$
|
4,004
|
|
Following is a summary of the (benefit)/expense provision for income taxes (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2016
|
|
2015
|
|
2014
|
Current:
|
|
|
|
|
|
Federal
|
$
|
1,789
|
|
|
$
|
1,754
|
|
|
$
|
(1,125
|
)
|
State
|
529
|
|
|
(316
|
)
|
|
31
|
|
Foreign
|
544
|
|
|
368
|
|
|
296
|
|
Current taxes (benefit)
|
2,862
|
|
|
1,806
|
|
|
(798
|
)
|
Deferred:
|
|
|
|
|
|
Federal
|
1,784
|
|
|
672
|
|
|
1,200
|
|
State
|
542
|
|
|
117
|
|
|
511
|
|
Foreign
|
(119
|
)
|
|
179
|
|
|
1,143
|
|
Deferred taxes
|
2,207
|
|
|
968
|
|
|
2,854
|
|
Income tax expense
|
$
|
5,069
|
|
|
$
|
2,774
|
|
|
$
|
2,056
|
|
Following is a summary of the difference between the effective income tax rate and the statutory federal income tax rate:
WEST MARINE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
|
|
|
|
|
|
|
|
|
|
|
2016
|
|
2015
|
|
2014
|
Statutory federal tax rate
|
35.0
|
%
|
|
35.0
|
%
|
|
35.0
|
%
|
State income taxes, net of federal tax benefit
|
4.4
|
|
|
4.5
|
|
|
5.6
|
|
Non-deductible permanent items
|
(0.5
|
)
|
|
(0.5
|
)
|
|
1.4
|
|
Change in valuation allowance
|
0.5
|
|
|
0.7
|
|
|
47.5
|
|
Uncertain tax positions
|
1.3
|
|
|
(1.6
|
)
|
|
(23.7
|
)
|
Impact of foreign operations
|
3.7
|
|
|
0.9
|
|
|
(3.7
|
)
|
Prior period true-up adjustments
|
(0.8
|
)
|
|
(1.0
|
)
|
|
(10.2
|
)
|
Other
|
0.1
|
|
|
—
|
|
|
(0.6
|
)
|
Effective tax rate
|
43.7
|
%
|
|
38.0
|
%
|
|
51.3
|
%
|
Deferred tax assets and liabilities are recognized for the differences between the bases of the related assets and liabilities for financial reporting and income tax purposes, and are calculated using enacted tax rates in effect for the year the differences are expected to reverse. Following is a summary of the tax effects of temporary differences that give rise to significant components of deferred tax assets and liabilities (in thousands):
|
|
|
|
|
|
|
|
|
|
2016
|
|
2015
|
Assets:
|
|
|
|
Accrued payroll and benefits
|
$
|
5,828
|
|
|
$
|
6,431
|
|
Capitalized inventory costs
|
118
|
|
|
139
|
|
Accrued expenses
|
3,448
|
|
|
3,145
|
|
Intangible assets
|
664
|
|
|
1,333
|
|
Net operating losses and tax credits
|
7,733
|
|
|
8,210
|
|
Deferred rent
|
4,653
|
|
|
4,844
|
|
Vendor allowances
|
2,847
|
|
|
2,453
|
|
Other
|
2,608
|
|
|
2,583
|
|
Total deferred income tax assets
|
27,899
|
|
|
29,138
|
|
Valuation allowance
|
(6,024
|
)
|
|
(6,209
|
)
|
Deferred income taxes, net of valuation allowance
|
21,875
|
|
|
22,929
|
|
Liabilities:
|
|
|
|
Prepaid expenses
|
(1,899
|
)
|
|
(2,007
|
)
|
Property and equipment
|
(15,999
|
)
|
|
(14,257
|
)
|
Federal effect of state and foreign deferred items
|
(1,346
|
)
|
|
(1,512
|
)
|
Other liabilities
|
(1,032
|
)
|
|
(1,101
|
)
|
Total deferred tax liabilities
|
(20,276
|
)
|
|
(18,877
|
)
|
Net deferred income tax assets
|
$
|
1,599
|
|
|
$
|
4,052
|
|
Net deferred tax assets included in the accompanying consolidated balance sheets are as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
2016
|
|
2015
|
Non-current deferred income tax assets
|
$
|
3,862
|
|
|
$
|
4,321
|
|
Non-current deferred income tax liabilities
|
(2,263
|
)
|
|
(269
|
)
|
Net deferred tax assets
|
$
|
1,599
|
|
|
$
|
4,052
|
|
At year-end 2016, the Company had
$11.6 million
of state income tax net loss carryforwards that expire between 2022 and 2034. The Company also had foreign net loss carryforwards in the amount of
$2.9 million
that expire between 2028 and 2035. In addition, the Company had California state Enterprise Zone credits of
$5.3 million
available for use in the tax years 2016 through 2024, and South Carolina tax credits of
$0.6 million
available for use for tax years 2016 through 2018. These carryforwards are available to offset future taxable income.
WEST MARINE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
A valuation allowance must be provided if it is more likely than not that some portion or all of the deferred tax assets will not be realized, based upon consideration of all positive and negative evidence. Sources of evidence include, among other things, a history of pretax earnings or losses, expectations of future results, tax planning opportunities, and appropriate tax law.
Since the Company has a significant net operating loss carryforward in South Carolina, realization of a benefit from state tax credits is not more likely than not. Therefore, a full valuation allowance remains in place against these credits until such time as the Company determines it is able to either benefit from the credits or they expire. The Company has also determined that it is not more likely than not that the Company will be able to realize the tax benefit for a portion of the California Enterprise Zone credits before they expire in 2024. Therefore, the Company maintains a valuation allowance against these state tax credits in the amount of
$4.1 million
. This valuation allowance will also remain in place until such time as the Company determines it is able to either benefit from the credits or they expire.
For 2016, the Company maintained a full valuation allowance of
$1.4 million
against its Canadian deferred tax assets. The Company expects to close its remaining two stores in Canada during 2017.
Following is a summary of the change in valuation allowance (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2016
|
|
2015
|
|
2014
|
Valuation allowance—beginning of year
|
$
|
6,209
|
|
|
$
|
6,807
|
|
|
$
|
3,884
|
|
Valuation allowance increases
|
—
|
|
|
143
|
|
|
2,923
|
|
Valuation allowance reductions
|
(185
|
)
|
|
(741
|
)
|
|
—
|
|
Valuation allowance—end of year
|
$
|
6,024
|
|
|
$
|
6,209
|
|
|
$
|
6,807
|
|
West Marine and its subsidiaries file income tax returns in the U.S. federal jurisdiction, various states and cities, and Puerto Rico and Canada. The Company has substantially settled all federal income tax matters through 2012, state and local jurisdictions through 2011 and foreign jurisdictions through 2008. The Company could be subject to audits in these jurisdictions for subsequent years.
Unrecognized tax benefits activity is summarized below (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2016
|
|
2015
|
|
2014
|
Unrecognized tax benefit—beginning of year
|
$
|
862
|
|
|
$
|
1,093
|
|
|
$
|
2,476
|
|
Additions based on tax positions related to the current year
|
—
|
|
|
50
|
|
|
167
|
|
Additions for tax positions of prior years
|
—
|
|
|
31
|
|
|
218
|
|
Settlements
|
—
|
|
|
(22
|
)
|
|
(1,463
|
)
|
Lapse of statutes of limitations
|
(27
|
)
|
|
(290
|
)
|
|
(305
|
)
|
Unrecognized tax benefit—end of year
|
$
|
835
|
|
|
$
|
862
|
|
|
$
|
1,093
|
|
Included in the balance of unrecognized tax benefits at
December 31, 2016
and
January 2, 2016
are
$0.4 million
of tax benefits for each year that, if recognized, would affect the Company’s effective tax rate.
The Company recognizes accrued interest and penalties (not included in the table above) as a component of income tax expense. For the year ended December 31, 2016, the Company recognized an expense of $0.2 million related to accrued state and foreign interest. For each of the years ended January 2, 2016 and January 3, 2015, the Company recognized a benefit of less than
$0.1 million
in accrued interest. For all years ended December 31, 2016, January 2, 2016 and January 3, 2015, the Company recognized less than $0.1 million in penalties. The accrued interest balance at December 31, 2016 and January 2, 2016 was $0.6 million and $0.3 million, respectively, and the accrued penalties balance at the end of both years was $0.1 million.
NOTE 8: EMPLOYEE BENEFIT PLANS
The Company has a defined contribution savings plan covering all eligible associates. The Company matches
33%
of an employee’s contribution up to
5%
of the employee’s annual compensation, subject to statutory limitations. The Company’s contributions to the plan were
$0.6 million
,
$0.6 million
and
$0.6 million
for
2016
,
2015
and
2014
, respectively. Plan participants may choose from an array of mutual fund investment options. The plan does not provide for investments in West Marine common stock.
WEST MARINE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
NOTE 9: QUARTERLY FINANCIAL DATA
(Unaudited and in thousands, except per share data)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2016
|
|
First Quarter
|
|
Second Quarter
|
|
Third Quarter
|
|
Fourth Quarter
|
|
|
|
|
Net revenues
|
$
|
130,405
|
|
|
$
|
251,599
|
|
|
$
|
191,852
|
|
|
$
|
129,515
|
|
Gross profit
|
32,905
|
|
|
89,230
|
|
|
55,350
|
|
|
28,175
|
|
Selling, general and administrative expense
|
48,043
|
|
|
52,718
|
|
|
47,871
|
|
|
44,992
|
|
Income (loss) from operations
|
(15,138
|
)
|
|
36,512
|
|
|
7,479
|
|
|
(16,817
|
)
|
Net income (loss)
|
(9,113
|
)
|
|
21,584
|
|
|
3,853
|
|
|
(9,789
|
)
|
Net income (loss) per share:
|
|
|
|
|
|
|
|
Basic
|
$
|
(0.37
|
)
|
|
$
|
0.87
|
|
|
$
|
0.15
|
|
|
$
|
(0.39
|
)
|
Diluted
|
(0.37
|
)
|
|
0.86
|
|
|
0.15
|
|
|
(0.39
|
)
|
|
|
|
|
|
|
|
|
|
2015
|
|
First Quarter
|
|
Second Quarter
|
|
Third Quarter
|
|
Fourth Quarter
|
|
|
|
|
Net revenues
|
$
|
127,067
|
|
|
$
|
253,177
|
|
|
$
|
194,375
|
|
|
$
|
130,205
|
|
Gross profit
|
26,982
|
|
|
90,760
|
|
|
56,260
|
|
|
28,043
|
|
Selling, general and administrative expense
|
44,975
|
|
|
53,492
|
|
|
47,576
|
|
|
48,256
|
|
Income (loss) from operations
|
(17,993
|
)
|
|
37,268
|
|
|
8,684
|
|
|
(20,213
|
)
|
Net income (loss)
|
(10,259
|
)
|
|
20,945
|
|
|
4,892
|
|
|
(11,058
|
)
|
Net income (loss) per share:
|
|
|
|
|
|
|
|
Basic
|
$
|
(0.42
|
)
|
|
$
|
0.85
|
|
|
$
|
0.20
|
|
|
$
|
(0.45
|
)
|
Diluted
|
(0.42
|
)
|
|
0.85
|
|
|
0.20
|
|
|
(0.45
|
)
|