10-K 1 wmar1229201210k.htm 10-K WMAR 12.29.2012 10K

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
Q
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 29, 2012
OR
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number 0-22512
WEST MARINE, INC.
(Exact Name of Registrant as Specified in Its Charter)
Delaware
77-0355502
(State or Other Jurisdiction of Incorporation or Organization)
(I.R.S. Employer Identification No.)
 
 
500 Westridge Drive, Watsonville, CA
95076-4100
(Address of Principal Executive Offices)
(Zip Code)
Registrant’s Telephone Number, Including Area Code: (831) 728-2700
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class
Name of Each Exchange on Which Registered
Common Stock, $0.001 par value
NASDAQ Global Select Market
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act of 1933, as amended.    Yes  o    No  Q
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Securities Exchange Act of 1934, as amended (Exchange Act).    Yes  o    No  Q
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act 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  Q    No  o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  Q    No  o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  Q
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 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  x
Non-accelerated filer  o (Do not check if a smaller reporting company)
  
Smaller reporting company  o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  o    No  Q
As of June 29, 2012, the last business day of the registrant’s most recently completed second fiscal quarter, the aggregate market value of the registrant’s common stock held by non-affiliates of the registrant was approximately $274.2 million based on the closing sale price of $11.75, as reported on the NASDAQ Global Market on such date.
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Class
  
Outstanding at February 28, 2013
Common stock, $.001 par value per share
  
23,936,887 shares
DOCUMENTS INCORPORATED BY REFERENCE
Document
  
Parts Into Which Incorporated
Proxy Statement for the Annual Meeting of Stockholders to be held on May 16, 2013
  
Part II, Item 5 and Part III



WEST MARINE, INC.
2012 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
 
 
 
Page
PART I
 
 
 
 
Item 1.
 
 
 
Item 1A.
 
 
 
Item 1B.
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
PART II
 
 
 
 
Item 5.
 
 
 
Item 6.
 
 
 
Item 7.
 
 
 
Item 7A.
 
 
 
Item 8.
 
 
 
Item 9.
 
 
 
Item 9A.
 
 
 
Item 9B.
 
 
PART III
 
 
 
 
Item 10.
 
 
 
Item 11.
 
 
 
Item 12.
 
 
 
Item 13.
 
 
 
Item 14.
 
 
PART IV
 
 
 
 
Item 15.
 


 



i


PRELIMINARY NOTE
This report is for the year ended December 29, 2012. This report modifies and supersedes documents filed prior to this report. The Securities and Exchange Commission (the “SEC”) allows us to “incorporate by reference” information that we file with them, which means that we can disclose important information to you by referring you directly to those documents. Information incorporated by reference is considered to be part of this report. In addition, information that we file with the SEC in the future automatically will update and supersede information contained in this report.
We undertake no obligation (other than that required by law) to publicly update or revise any disclosures contained in this report, whether as a result of new information, future events or otherwise. Website references throughout this report are for information only, and the content of these websites is not incorporated by reference and should not otherwise be considered a part of this report.
All references to 2012, 2011 and 2010 in this report refer to our fiscal years ended on December 29, 2012, December 31, 2011 and January 1, 2011, respectively. Fiscal years 2012, 2011 and 2010 were fifty-two week years.


ii


PART I
ITEM 1—BUSINESS
General
West Marine is the largest specialty retailer of boating supplies and accessories with 2012 net revenues of $675.3 million. We offer a broad assortment of core merchandise for boats, including maintenance items, sailboat hardware, electrical parts and boating safety products. We also offer a wide variety of merchandise for people who enjoy recreation activities on or around the water, such as, apparel, footwear, clothing accessories, fishing products, cabin and galley items and paddle sports equipment. We strive to meet the needs of individual boaters and boating businesses, provide great customer experiences, and offer the convenience of omni-channel shopping.
We have three reportable segments: Stores; Port Supply, our wholesale segment; and Direct-to-Consumer, which includes eCommerce, catalog and call center transactions. The Direct-to-Consumer segment was formerly referred to as our Direct-to-Customer segment. We consider our individual stores to be operating segments which we aggregate into one reportable segment. Our Stores segment generated approximately 90% of our 2012 net revenues. Our 300 company-operated stores open at the end of 2012 are located in 38 states, Puerto Rico and Canada. We sell to both retail and wholesale customers in our Stores segment. In addition, we have five franchised stores in Turkey. Our Port Supply segment is one of the largest wholesale distributors of marine supply and equipment in the United States. Products shipped to Port Supply customers directly from our warehouses represented approximately 4% of our 2012 net revenues. Our Direct-to-Consumer segment offers customers around the world approximately 75,000 products and accounted for the remaining 6% of our 2012 net revenues. Financial information about our segments appears in Note 10 to our consolidated financial statements, in Item 8 of this report.
West Marine, Inc. was incorporated in Delaware in September 1993 as the holding company for West Marine Products, Inc., which was incorporated in California in 1976. Unless the context otherwise requires, “West Marine,” “we,” “us,” “Company” and “our” refer to West Marine, Inc. and its subsidiaries. Our principal executive offices are located at 500 Westridge Drive, Watsonville, California 95076-4100, and our telephone number is (831) 728-2700. Our two distribution centers are located in Rock Hill, South Carolina and Hollister, California.
Stores Segment
Since opening our first store in California in 1975, we have grown through internal expansion and through strategic acquisitions to 300 Company-operated locations open at the end of 2012.
During 2012, we continued to focus on our real estate optimization strategy pursuant to which we are evolving toward having fewer but larger stores. We opened ten stores while closing 29 stores during fiscal 2012. We ended the year with an aggregate of 2.67 million total square feet of space for all Company-operated stores, down slightly from 2.72 million square feet at the end of fiscal 2011.We had 13 flagship stores open at the end of 2012, ranging in size from 20,000 to 50,000 square feet, offering an expansive array of merchandise - typically about 25,000 items - as well as displays designed to help customers make informed product selections. These stores offer not only an extensive assortment of core boating hardware and supplies, but also present a broader selection of boating-related lifestyle products, such as apparel. The flagship stores feature unique visual design elements and fixtures with nautical themes, designed to create an exciting atmosphere that we believe appeals to our customers.
We also operate large format stores, standard-sized stores and smaller “Express” stores. Our large format stores range from 13,000 to 19,000 square feet and carry about 15,000 items. The standard-sized stores typically range from 6,000 to 12,000 square feet and carry over 9,000 items. Express stores typically range from 2,500 to 3,000 square feet and carry over 4,000 items, mainly hardware and other supplies needed for day-to-day boat maintenance and repairs. In 2013, we currently expect to open two to four flagship stores, approximately four large format stores and one standard-sized store. These store openings will replace approximately 10 to 14 existing stores.
We regularly monitor and take steps to improve individual store performance, including remodeling or expanding stores, relocating stores to more profitable locations and closing lower-performing stores which, along with our flagship and large store concepts, form a part of our real estate optimization strategy. In 2012, we expanded three stores and reduced one store. In 2013, we plan to expand two existing stores with one becoming a flagship and the other a large format store. Additionally, we will continue to pursue opportunities to consolidate multi-store markets with larger stores. We will close stores as and when appropriate based on store operating data and as stores approach their lease end dates.
Our extensive store network gives us an advantage in serving wholesale customers seeking convenience and a larger assortment of products than those carried by typical distributors. We believe that with continued customer focus, expanded distribution capabilities with an emphasis on treating our larger stores in certain markets as hubs or regional distribution

1


centers, and our breadth of product selection and availability, we will continue to be recognized as the preferred wholesale distributor in the industry.
Port Supply Segment
Port Supply, our wholesale segment, expands our market share across a broader customer base and leverages our purchasing and distribution efficiencies. In 2012, we distributed marine supplies to domestic and international wholesale customers. Our largest wholesale customer accounted for less than 1% of total Port Supply segment revenues. Port Supply customers include businesses involved in boat sales, boat building, boat commissioning and repair, yacht chartering, marina operations and other boating-related activities. In addition, Port Supply sells to government and industrial customers who use our products for boating and non-boating purposes. We serve the wholesale segment through sales representatives, our call center and our wholesale eCommerce website at portsupply.com.
Direct-to-Consumer Segment
Our retail eCommerce website, direct mail catalogs, and virtual call center comprise the Direct-to-Consumer segment. This channel complements the Stores segment by building brand awareness, acting as an additional marketing vehicle, and providing our customers with the option of shopping from around the globe, 24 hours a day.
Our eCommerce website provides our customers with access to a broad selection of approximately 75,000 products, unique product advisor tips and technical information, over 12,000 product videos and customer-submitted product reviews. We also believe our website is a cost-effective means of testing market acceptance of new products and concepts.
This segment also provides customers with access to knowledgeable technical advisors who can assist our customers in understanding the various uses and applications of the products we sell. We operate a virtual call center from which our associates assist our customers by taking calls from their homes or from our support center in Watsonville, California. Our virtual call center supports sales generated through our eCommerce website, catalogs and stores, and provides customer service. Fulfillment of customer orders placed on the website or via our virtual call center is completed through our distribution centers, or in limited cases directly from the vendor to the customer.
We mail our catalogs to addresses from our proprietary customer list. In addition, we acquire potential customer names from a variety of sources. Our customer list is continually updated to include customer address changes and new customer prospects, and to eliminate non-responders and information of customers requesting to opt out of our marketing programs.
Foreign Sales
We promote and sell our marine products internationally through our Port Supply and Direct-to-Consumer segments. Through our Stores segment, we operate ten stores located in Canada. In addition, we have five franchised stores in Turkey. For each of 2012, 2011 and 2010, revenues from outside of the United States represented less than 5% of our total net revenues.
Customer Service
Offering exceptional customer service has been the cornerstone of West Marine since our beginning. We remain focused on the customer and providing great customer experiences. Many of our selling associates receive advanced product and technical training, empowering them to take great care of our customers. We will continue to listen to our customers and refine our business to meet their needs.
Merchandising
West Marine is committed to a broad assortment of merchandise that provides what our customers want, when they want it. Our merchandising department is responsible for vendor and product selections; and our planning and replenishment department is responsible for purchasing and managing inventory levels in our distribution centers and our stores. We also offer our customers the ability to special order products that we do not keep in inventory in our stores or at our distribution centers.
We purchased merchandise from more than 900 vendors during 2012 and realized savings through quantity purchases and direct shipments. In 2012, no single vendor accounted for more than 10% of our merchandise purchases, and our 20 largest vendors accounted for approximately 41% of our merchandise purchases. Generally, we purchase merchandise from our vendors on an order-by-order basis.
We continued to offer private label merchandise in 2012, which typically features higher gross margins than comparable branded products. Private label products, which we sell under the “West Marine,” “Black Tip,” “Third Reef,” “Pure Oceans,” "Lifesling", "SeaVolt," and “Seafit” brand names, usually are manufactured in Asia, the United States and Europe. We have a

2


limited number of long-term contracts with our manufacturing sources and we compete with other companies for production facilities and import quota capacity.
Logistics
We operate two full service multi-channel distribution centers: a 472,000 square foot facility in Rock Hill, South Carolina and a 240,000 square foot facility in Hollister, California. Generally, vendors ship products to our distribution centers where merchandise is inspected and prepared for shipment to stores or shipped directly to customers in order to fulfill inventory or outstanding customer orders for all of our business segments (Stores, Port Supply, and Direct-to-Consumer). Some vendors ship products directly to our stores. We use various third-party domestic and international transportation methods, such as ocean, air and ground, including Company-owned vehicles. Our distribution centers utilize advanced material handling equipment and voice-picking technologies, as well as radio frequency systems, to enable real-time management of inventory.
Marketing
Our overall marketing objective is to provide a customer-driven marketing strategy that delivers compelling product offers that are designed to drive customer traffic and are aligned with the customers' needs and our mission statement, to acquire new customers and to increase sales and profit. Our approach is to integrate across shopping channels allowing the customer to choose where they prefer to research products and shop. We position the West Marine brand to stand for better selection, trust, friendly and knowledgeable service, product value and shopping convenience. We market our products and services through direct mail catalogs and flyers, email and mass media, including advertisements in boating specialty publications, newspapers and on the Internet.
Both the West Advantage free and paid memberships allow our customers to earn points on qualifying purchases for future discounts, exclusive offers and invitations to unique shopping events designed to reward our customers for their support and loyalty.
We are committed to working towards conserving marine resources, reducing our impact on the environment and promoting boating participation. West Marine is committed to being a leader in sustainability within the industry through our initiative "Blue Future" where we support marine conservation and promote "Green Boating". We participate in a number of boat shows and sponsor boating-related events each year. These events are designed to encourage participation in boating, increase the number of people enjoying the boating lifestyle, promote environmental responsibility and improve West Marine’s brand recognition.
Competition
The market for marine supplies is highly competitive and our stores compete with other specialty boating supply stores, and a variety of local and regional specialty stores, sporting goods stores and mass merchants. Many of these competitors have stores in markets where we now operate. Also, we have a number of competitors engaged in the catalog, Internet and wholesale distribution of marine products. The principal factors of competition in our marketplace are selection, quality, availability, price, customer service, convenience and access to a wide variety of merchandise.
Trademarks and Service Marks
We own the trademarks and service marks “West Marine” and “Port Supply,” among others. These marks and a number of others are registered with the U.S. Patent and Trademark Office and in certain foreign countries. Each federal registration is renewable indefinitely if the mark is still in use at the time of renewal. We have a license to use the “BoatU.S.” tradename under a marketing agreement with the Boat Owners Association of the United States, although we have discontinued the use of the BoatU.S. tradename except in certain limited situations.
Associates
As of February 16, 2013, we had 3,955 associates, of whom 1,830 were full-time and 2,125 were part-time or temporary. A significant number of temporary associates are hired during the summer peak selling season. For example, West Marine employed 4,962 associates on June 30, 2012.
Available Information
West Marine’s Internet address is westmarine.com. We make available, free of charge through the “Investor Relations” portion of our website, our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Forms 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, including the exhibits thereto, as soon as reasonably practicable after such documents are electronically filed with, or furnished to, the SEC.

3


Interested persons may also access copies of these reports through the SEC’s website, sec.gov. We will furnish to our stockholders any exhibit to this annual report upon the written request of such stockholder and the payment of a specified fee, which is limited to our reasonable expenses.
We have adopted a code of ethics for our associates and Board of Directors, as well as an additional code of ethics for our senior financial officers (including our principal executive officer, principal financial officer and principal accounting officer). Copies of these codes of ethics are available on our website at westmarine.com, or printed copies can be obtained by writing to the Secretary, West Marine, Inc., 500 Westridge Drive, Watsonville, California 95076. Any amendments to these codes of ethics, as well as any waivers that are required to be disclosed under the rules of the SEC or the NASDAQ Stock Market, are posted on our website.
ITEM 1A—RISK FACTORS
Our business faces many risks. The risks described below may not be the only risks we face. Additional risks of which we are not yet aware, or that we currently think are immaterial, may also impair our business operations or financial results. If any of the events or circumstances described in the following risks actually occurs, our business, financial condition or results of operations could suffer and the trading price of our common stock could decline.
Economic conditions in the U.S. and key international markets or other conditions leading to a decline in consumer discretionary spending may materially adversely impact our operating results.
We sell products and services that consumers tend to view as discretionary items rather than necessities. As a result, our results of operations tend to be more sensitive to changes in macroeconomic conditions that impact consumer spending, including discretionary spending. Other factors, including consumer confidence, employment levels, interest rates, tax rates, consumer debt levels, consumers' ability to obtain credit, as well as fuel and energy costs could reduce consumer spending or change consumer purchasing habits. In the past three fiscal years, many of these factors adversely affected consumer spending and, consequently, our business and results of operations. A slowdown in the U.S. or global economy, continued economic and financial instability in Europe or an uncertain economic outlook could materially adversely affect consumer spending habits and our operating results in the future.
The domestic and international political situation also affects consumer confidence. The threat or outbreak of domestic or international terrorism, civil unrest or other hostilities could lead to a decrease in consumer spending. Similarly, an overly anti-business climate or sentiment could potentially lead consumers to decrease or shift their spending habits. Any of these events and factors could cause a decrease in revenue or an increase in inventory markdowns or certain operating expenses, which could materially adversely affect our results of operations.
An inability to find suitable new and expanded store sites or delays in new store openings could materially affect our financial performance.
In order to meet our growth objectives, we will need to secure an adequate number of suitable new or expanded store sites, typically near marinas or other locations readily accessible by boaters. We require that all proposed store sites satisfy our criteria regarding cost and location. In addition, we may experience increased competition for store sites and, at some point, exhaust available coastal locations for new stores. We cannot assure that we will be able to find a sufficient number of suitable new sites for any planned expansion in any future period.
Our expected financial performance is based on our new, remodeled, or expanded stores opening on expected dates. It is possible that events such as construction delays caused by permitting or licensing issues, material shortages, labor issues, weather delays or other acts of God, discovery of contaminants or accidents could delay planned new store openings beyond their expected dates or force us to abandon planned openings altogether. Any failure on our part to recognize or respond to these issues may adversely affect our revenue growth, which, in turn, may adversely affect our future operating results.
We experience fluctuations in our comparable store sales.
Our comparable store sales have fluctuated significantly in the past on an annual and quarterly basis, and we expect that they will continue to fluctuate in the future. A variety of factors affect comparable store sales including boat usage, boating participation, current economic conditions, competition, the timing and release of new merchandise and promotional events, changes in our merchandise mix, the success of marketing programs and weather conditions. These factors and others may cause our comparable store sales, customer traffic, and average order values to differ materially from prior periods and from expectations. Failure to meet the expectations of investors in one or more future periods could reduce the market price of our common stock.

4


We have undertaken a number of strategies designed to build our long-term strength. If one or more of these initiatives is unsuccessful, our profitability could be adversely affected.
Over the past few years, we launched a number of initiatives designed to increase sales and lower costs. These initiatives include optimizing our supply chain and inventory levels, closing under-performing stores with corresponding workforce adjustments, investing in our eCommerce website, expanding our merchandise assortments, investing in real estate optimization by expanding to more large format and flagship stores, expanding our wholesale business, improving the retail experience for our retail and wholesale customers, and placing emphasis on driving comparable store sales. To support these growth strategies, we are significantly increasing our investments in information technology infrastructure, adding key positions to our eCommerce and information technology departments, and investments in marketing to attract a broader base of customers. Each of these initiatives carries a certain level of risk, primarily related to increased expenses or reduced sales, which, when combined, could be material. If we fail to successfully execute one or more of these strategies, our profitability could be adversely affected.
Our eCommerce operations subject us to numerous risks that could have an adverse effect on our operating results.
We are also pursuing a heightened focus on technology to enhance our website and eCommerce business by broadening the selection of our online merchandise offering, improving product search performance, and increasing the overall speed of our website. Although revenues generated by eCommerce constitute a small, but increasing portion of our overall revenues, our eCommerce operations subject us to certain risks that could have an adverse effect on our operating results, including: diversion of traffic and sales from our stores; liability for online content; and risks related to the computer systems that operate our website and related support systems, such as computer viruses, electronic break-ins and similar disruptions. Also, changing regulations and laws governing the Internet and eCommerce transactions (including taxation, user privacy, data protection, pricing and electronic communications) could impede the growth of our eCommerce business and increase our cost of doing business.  In addition, other risks beyond our control, such as entry of our vendors in the eCommerce business in competition with us, online security breaches and general economic conditions specific to eCommerce could have an adverse effect on our results of operations.
If we are not able to anticipate and respond to changing consumer preferences in a timely manner, our merchandise expansion strategy and our operating results could materially suffer.
Our merchandise expansion strategy focuses on growing sales in more discretionary categories, such as apparel, footwear, clothing accessories, fishing, cabin/galley and paddle sports equipment. These categories differ from our core merchandise categories, which are needs-based and more directly related to owning and caring for a boat, the supply and demand of which typically is based on the frequency and duration of boat usage. This merchandise expansion strategy depends, in large part, on our ability to successfully introduce new products to consumers and the level of consumer acceptance. Consumers continue to have a wide variety of choices in terms of how and where they purchase these products. Failure to accurately predict and adapt to constantly changing consumer tastes, preferences, spending patterns and other lifestyle decisions, or to effectively address consumer concerns, could have a material adverse effect on our revenue, results of operations and reputation with our customers.
Our results of operations could be adversely affected if unseasonably cold weather, prolonged winter conditions, natural disasters, such as hurricanes or extraordinary amounts of rainfall, or man-made disasters occur, especially during the peak boating season in our second and third fiscal quarters.
Our business is highly seasonal. The majority of our revenues occur between the months of April and August, which represent the peak boating months in most of our markets. Our annual results would be materially and adversely affected if our net revenues were to fall below expected seasonal levels during this period. Our business also is significantly affected by weather patterns. Unseasonably cool weather, prolonged winter conditions, extraordinary amounts of rainfall or natural or man-made disasters may decrease boating use in the peak season, resulting in lower maintenance needs and, therefore, decreased revenues.
Intense competition in the boating supplies, apparel, and outdoor recreation markets could reduce our revenue and profitability.
The retail market for recreational boating supplies and apparel is highly competitive. Our stores compete with other specialty marine supply stores. Many of these competitors have stores in the markets in which we now operate and in which we plan to expand. We also compete, to a lesser extent, with sporting goods stores and mass merchants. Our eCommerce and call center operations compete with other eCommerce and catalog retailers. We also have a number of competitors in the wholesale distribution of marine products. In addition, a key competitive factor in the marine supplies market is price. Increased online shopping and the availability and use of smart-phones or other mobile devices allow customers to compare prices more quickly

5


than in the past. Online retail shopping is rapidly evolving, and we expect competition in the eCommerce market to intensify in the future as the Internet facilitates competitive entry and comparison shopping. Competitive pricing pressures have adversely affected our gross margins, and such pressures are expected to continue. In addition, if our competitors increase their spending on advertising and promotions relative to our spending, or if our advertising and promotions become less effective than those of our competitors, we could experience a material adverse effect on our results of operations. If we are unable to remain competitive in the key areas of customer service, the shopping experience across all channels, quality of products, depth of selection or store environment and location, we may lose market share to our competitors and our sales and profitability could suffer.
If any of our manufacturers, key vendors or third party service providers fail to supply us with merchandise or services, we may not be able to meet the demands of our customers or our business needs and our sales could decline.
We depend on merchandise purchased from our vendors, services provided by third parties, and merchandise sourced from third-party manufacturers to obtain products and services for our sales channels. Generally, we deal with our merchandise suppliers on an order-by-order basis and have limited long-term purchase contracts or other contractual assurances of continued supply or pricing. Accordingly, our vendors and manufacturers could discontinue selling products to us at any time. The loss of any key vendor or manufacturer for any reason could limit our ability to offer products that our customers want to purchase. In addition, we believe many of our vendors obtain their products from China, Taiwan, Korea, Mexico and other countries, and we source products from third-party manufacturers in these countries. A vendor could discontinue selling to us products manufactured in foreign countries at any time for reasons that may or may not be within our control or the vendor’s control, including foreign government regulations, political unrest, war, disruption or delays in shipments, changes in local economic conditions, quotas, quality control, increased costs for raw materials, and trade issues. Also, there is a risk that certain of our vendors or third party service providers may experience financial difficulty resulting in inability to provide service or manufacture or deliver products or services to us in a timely manner. Additionally, changes in commercial practices of our key vendors or manufacturers, such as changes in vendor support and incentives or changes in credit or payment terms or inability or failure of our service providers to provide required services, could negatively impact our operating results. Our operating results also could suffer if we are unable to promptly replace a vendor, manufacturer or service provider who is unwilling or unable to satisfy our requirements with a vendor, manufacturer or service provider providing equally appealing products or services.
Our results of operations could materially deteriorate if we fail to attract, develop and retain qualified associates, or if we lose key management.
Our success depends in part upon our ability to attract, develop and retain a sufficient number of qualified associates, including general managers, assistant managers, eCommerce associates and store associates, who understand retail and appreciate boating and the boating lifestyle and are able to communicate knowledgeably with our customers. Qualified individuals of the requisite caliber and in the numbers needed to fill these positions may be in short supply in some areas. Historically, turnover rates in the retail industry are high in comparison to other industries. In particular, the relatively rural location of our support center in Watsonville, California, has on occasion limited our ability to attract and recruit candidates with required background and experience in the retail, information technology and eCommerce fields.
Also, if we are unable to hire and retain associates capable of consistently providing a high level of customer service, as demonstrated by their enthusiasm for our culture and knowledge of our merchandise, our business could be materially adversely affected. Although none of our associates currently are covered by collective bargaining agreements, we cannot guarantee that our associates will not elect to be represented by labor unions in the future, which could increase our labor costs. Additionally, competition for qualified associates could require us to pay higher wages to attract a sufficient number of associates. An inability to recruit and retain a sufficient number of qualified individuals in the future may delay the planned openings of new stores. Any such delays, any material increases in associate turnover rates at existing stores or any increases in labor costs could have a material adverse effect on our business, financial condition or operating results.
Our performance also depends largely on the efforts and ability of our senior management. We do not maintain any key-man life insurance for our senior management, including Matthew Hyde, our President and Chief Executive Officer. If we do not effectively implement our strategic and business planning processes to attract, retain, train and develop future leaders, our business may suffer. We rely on the experience of our senior management, who have specific knowledge relating to us and our industry that is difficult to replace. If unexpected leadership turnover occurs without adequate succession plans, the loss of the services of these individuals could negatively impact our ability to be able to successfully manage our business or achieve our growth objectives.
We must successfully order and manage our inventory to reflect customer demand in a volatile market and anticipate changing consumer preferences and buying trends or our revenues and profitability will be adversely affected.

6


Our success depends upon our ability to successfully manage our inventory and to anticipate and respond to merchandise trends and customer demands in a timely manner. The retail consumer industry, by its nature, is volatile and sensitive to numerous economic factors, including consumer preferences, competition, market conditions and general economic conditions. None of these factors are within our control. We cannot predict consumer preferences with certainty, and consumer preferences often change over time. We usually must order merchandise well in advance of the following selling season. The extended lead times for many of our purchases may make it difficult for us to respond rapidly to new or changing product trends, increases in customer demand or changes in prices. If we misjudge either the market for our merchandise or our customers’ purchasing habits, our revenues may decline significantly and we may not have sufficient quantities of merchandise to satisfy customer demand or we may be required to mark down excess inventory, either of which would result in lower profit margins.
A natural disaster or other disruption at our support center or either of our distribution centers could cause us to lose merchandise or inhibit our ability to process orders and, therefore, make us unable to effectively deliver to our customers and retail stores.
We rely on the continuous operation of our support center in Watsonville, California, and our distribution centers in Hollister, California, and Rock Hill, South Carolina. Any natural disaster or other serious disruption to these operations due to fire, flood, earthquake, hurricane, terrorism or any other unforeseen circumstance could materially impair our ability to do business and adversely affect our financial position and future operating results.
We rely heavily on our information technology systems which exposes us to potential risks.
The efficient operation of our business is dependent on our information technology systems. During 2012, we implemented a new integrated point of sale and order entry management system. In the coming years, we will be making significant investments in our information technology infrastructure to upgrade and replace aging hardware and software, and we will be making significant investments in our eCommerce website as a growth strategy. The implementation of new systems and the ensuing business process change is frequently disruptive to the underlying business of an enterprise and can be time consuming and expensive. These implementations often require an increase in management responsibilities and could divert management attention. Any disruptions relating from our new processes and systems, or from any problems associated with the implementation, particularly any disruptions impacting our operations or our ability to accurately report our financial performance on a timely basis during the implementation period, could cause us to incur substantial additional expenses that could adversely impact our operating results.
Reliance on our information technology systems exposes us to potential risks, such as interruptions due to natural disasters, cyber-attacks, unplanned data center and system outages, fraud perpetrated by malicious individuals or other causes. Our information technology systems and processes are hosted in two locations: our support center in Watsonville, California and at a co-location site outside of the state of California managed by a third-party provider. We intend to increase our reliance on information technology systems in order to improve our business processes and supply chain efficiencies and this includes implementation of new software and hardware. Any unmitigated interruption of our information technology systems may have a negative impact on future financial results.
Security breaches, such as data breaches, data theft, unauthorized access or hacking, or inadvertent mishandling of sensitive data by our associates could compromise sensitive information belonging to us or our customers and could harm our business and reputation.
Our success depends, in part, on the secure and uninterrupted performance of our information technology systems. Our technology systems, as well as those of our service providers, are vulnerable to damage from a variety of sources including network and telecommunication failures, power outages, viruses, malicious human acts, natural disasters and human error. Sustained or repeated system outages that interrupt our ability to process orders and deliver products to our customers and our stores in a timely manner could have a material adverse effect on our results of operations and financial condition.
We store sensitive data, including our proprietary business information, customer and vendor information, and confidential associate information, in our on-site and co-location data centers and on our networks. Despite our security measures, our information technology and infrastructure, or that of our third party providers, may be vulnerable to attacks by hackers, cyber-attacks, or breached due to associate error, malfeasance or other disruptions that could result in unauthorized disclosure or loss of sensitive information. Any such security breach could cause us to be non-compliant with applicable laws or regulations, subject us to legal claims or proceedings, disrupt our operations, damage our reputation, and cause a loss of confidence in our products and services, any of which could adversely affect our business. Improper activities by third parties, advances in computer and software capabilities and encryption technologies, new tools and discoveries, and other new events or developments, may facilitate or result in a compromise or breach of our computer systems. Any such compromises or breaches could cause interruptions in our operations, damage our reputation, subject us to litigation, additional costs, fines or

7


liabilities, and potentially hurt sales, revenues and profits.
Credit card issuers have promulgated credit card security guidelines as part of their ongoing effort to battle identity theft and credit card fraud. We continue to work with our third-party providers and credit card issuers to assure that our products and services comply with the credit card association’s security regulations. There can be no assurances, however, that our processes and systems, or those of our third-party providers, are invulnerable to unauthorized access or hacking. Unauthorized intrusion into portions of our computer systems, or those of our third-party providers that process and store information related to our customer transactions, may result in a data breach and theft of customer data.
We rely on processes, proprietary and commercially available systems as well as software, tools and monitoring to provide information technology security for processing, transmitting and storing confidential customer information, such as customer’s payment cards and personal information. Furthermore, the systems currently used for transmission and approval of payment card transactions, and the technology utilized in payment cards themselves, all of which can put payment card data at risk, are determined and legally mandated by payment card industry standards, not by us. Compliance with these continually changing requirements may result in cost increases due to necessary system changes, security changes, administrative processes or technology changes, and such costs could adversely affect our financial position or results of operations.
Our founder and Chairman, Randolph K. Repass, beneficially owns approximately 30% of our common stock. As a result, his interests may differ from that of our other stockholders.
Randolph K. Repass, the Chairman of our Board of Directors, beneficially owns approximately 30% of our common stock. As a result, Mr. Repass has substantial influence in the election of directors of West Marine and, in general, the outcome of any matter submitted to a vote of our stockholders, including mergers, consolidations or the sale of all or substantially all of our assets. Due to his significant ownership position, Mr. Repass may be able, in concert with others, to prevent or to cause a change in control of West Marine.
We face periodic reviews, audits and investigations by government agencies and independent third parties, and these audits could have adverse findings, which may negatively impact our business.
We are subject to various routine and non-routine reviews, audits and investigations by various federal and state governmental regulators, including environmental, tax and customs agencies. Violation of the laws and regulations governing our operations, or changes in interpretations of those laws, could result in the imposition of civil or criminal penalties, the suspension or revocation of our licenses, or the revision and recoupment of past payments made based on audit findings. In addition, certain third party suppliers have rights under their contracts with us to review and audit our use of their products, and an unfavorable audit could result an adverse and possibly material claim for payment. Many proceedings and audits raise complex factual and legal issues and are subject to uncertainties. If we become subject to material fines or other payments due and owing, the cost of defense, or if other sanctions and/or corrective actions are imposed upon us or if we incur significant costs to refute or defend against any such fine, claim or other sanction, our results of operations may be negatively impacted.
Our business and financial results may be adversely affected by global climate change or by legal, regulatory or market responses to such change.
The growing political and scientific sentiment is that increased concentrations of carbon dioxide and other greenhouse gases in the atmosphere are influencing global weather patterns. Changing weather patterns, along with the increased frequency or duration of extreme weather conditions, especially during our peak boating season, could reduce the sale of our products or materially affect our store locations, which are primarily located in coastal areas, through storm damage, reduced traffic, or increased insurance rates. Additionally, concern over climate change, including global warming, has led to legislative and regulatory initiatives directed at limiting greenhouse gas emissions. For example, proposals that would impose mandatory requirements on greenhouse gas emissions continue to be considered by policy makers which, if adopted, may adversely affect the boating industry and the suppliers of our retail products. Laws enacted may increase production costs for many of our retail products and, therefore, the prices we pay to stock such products may increase. We may not be able to pass along these increased prices to our customers, which could adversely impact our business and financial results.
Our failure to comply with certain environmental regulations could adversely affect our business.
We sell paints, varnishes and other products that are subject to federal and state environmental laws and regulations concerning, among other things, registration, storage, distribution, transportation, handling and waste management of hazardous materials. Environmental laws and regulations continue to evolve and we may become subject to increasingly stringent environmental standards in the future. Our failure to comply with these regulations could result in fines and penalties and could have an adverse impact on our business. In addition, we have indemnified certain of our landlords for any hazardous waste which may be found on or about the particular property or operation. If any such hazardous waste were to be found on

8


property that we occupy, a significant claim giving rise to an indemnity obligation could adversely impact our operating results.
Because we self-insure against certain risks and maintain high deductibles on certain of our insurance policies, our operating results may be adversely affected if we suffer a substantial casualty.
We believe that insurance coverage is prudent for risk management, and we expect that our insurance costs will continue to increase. For certain types or levels of risk, including medical care, we have decided to limit our purchase of relevant insurance, choosing instead to self-insure. With medical insurance, we have individual and aggregate stop loss insurance to protect us from large claims. In other cases, we have elected to retain a higher portion of the risk in the form of higher deductibles. For example, during fiscal year 2011, we experienced higher year-over-year health care claims. If we suffer a substantial loss that is not covered by commercial insurance, the loss and attendant expenses could have a material adverse effect on our business and operating results.
In 2010, the Patient Protection and Affordable Care Act and the Health Care and Education Affordability Reconciliation Act were signed into law. These laws changed the way health care is financed and extend medical benefits and coverage. Any additional extended coverage and/or any further changes in health care legislation may significantly increase our health care costs, which could have an adverse impact on our results of operations.
In addition, we insure our workers’ compensation losses through a high deductible program. This high per-claim deductible permits us to maintain low premium rates but may result in unexpectedly high costs if actual losses greatly exceed the expected losses in a year, with a corresponding negative effect on our operating results.
Failure of our internal control over financial reporting could harm our business and financial results.
Our management is responsible for establishing and maintaining effective internal control over financial reporting. Internal control over financial reporting is a process to provide reasonable assurance regarding the reliability of financial reporting for external purposes in accordance with accounting principles generally accepted in the United States (“GAAP”). Because of its inherent limitations, internal control over financial reporting is not intended to provide absolute assurance that we would prevent or detect a misstatement of our financial statements or fraud. Any failure to maintain an effective system of internal control over financial reporting could limit our ability to report our financial results accurately and timely or to detect and prevent fraud. The identification of a material weakness could indicate a lack of controls adequate to generate accurate financial statements that, in turn, could cause a loss of investor confidence and decline in the market price of our common stock. We cannot provide assurance that we will be able to timely remediate any material weaknesses that may be identified in future periods or maintain all of the controls necessary for continued compliance. Likewise, we cannot assure that we will be able to retain sufficient skilled finance and accounting personnel, especially in light of the increased demand for such personnel among publicly-traded companies.
Failure to comply with the SEC’s permanent injunction entered on consent against us could subject us to further SEC enforcement actions, which could adversely affect our business.
As previously disclosed, we were the subject of a formal investigation by the SEC’s Division of Enforcement. We reached a consensual resolution of the SEC’s civil complaint resulting in a permanent injunction (the “SEC Injunction”) entered on August 31, 2009 in the U.S. District Court for the Northern District of California, San Jose Division. In agreeing to the entry of the SEC Injunction, we neither admitted nor denied the allegations in the SEC’s complaint. The SEC Injunction, by its terms, permanently restrains and enjoins us from, among other things, (1) filing with the SEC any report under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and rules and regulations adopted under the Exchange Act, that contains any untrue statement of a material fact, which omits to state any material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or that omits to disclose any information required to be disclosed, (2) failing to make and keep accurate books, records and accounts, and (3) failing to devise and maintain an adequate system of internal accounting controls and procedures. Our failure to comply with any of the provisions of the SEC Injunction could adversely affect our business as a result of further SEC investigations, enforcement action, criminal prosecution and penalties, which could be significant.
The price of our common stock may be subject to volatile fluctuations based on fluctuations in our quarterly results, general economic and market conditions and by our ability to meet market expectations.
The market price of our common stock may be subject to significant fluctuations in response to operating results, comparable store sales announcements, announcements by competitors, our ability to meet market expectations and other factors. Variations in the market price of our common stock may also be the result of changes in the trading characteristics that prevail in the market for our common stock, including low trading volumes, trading volume fluctuations and other similar factors. These market fluctuations, as well as general economic conditions, may adversely affect the market price of our

9


common stock. We cannot assure that the market price of our common stock will not fluctuate or decline significantly in the future.
Fluctuations in currency exchange rates may adversely impact our cash flows and earnings.
We operate retail stores located in Canada, and therefore our cash flows and earnings are exposed to currency exchange rate fluctuations between the U.S. dollar and the Canadian dollar. While we may attempt to limit our exposure to exchange rate changes by entering into short-term currency exchange contracts, there is no assurance that we will hedge or will be able to hedge such foreign currency exchange risk or that our hedges will be successful. Our currency exchange gains or losses may adversely impact our cash flows and earnings. Additionally, adverse movements in currency exchange rates could result in a reduction in growth of international Direct-to-Customer sales, impacting our cash flows and earnings.
We might be involved in claims or disputes related to intellectual property that require us to protect our rights or defend against claims of infringement, may be costly to resolve, prevent us from protecting our brand, from selling challenged products, technology and/or services and seriously harm our operating results and financial condition.
We take precautionary measures to protect our brand, including registering our various trademarks in the United States and internationally and by relying on trade secret, patent, copyright and trademark laws and confidentiality agreements with our associates and other third parties, all of which offer only limited protection. We do not know whether the U.S. Patent & Trademark Office will grant federal registrations based on our pending trademark applications. Even if federal registrations are granted to us, our trademark rights may be challenged. It is also possible that our competitors or others will adopt trademarks similar to ours, thus impeding our ability to build brand identity and possibly leading to customer confusion. Despite our efforts, the steps we have taken to protect our intellectual proprietary rights may not be adequate to preclude misappropriation of our proprietary information or infringement of our intellectual property rights, and our ability to police such misappropriation or infringement is uncertain, particularly in countries outside of the United States. Protecting against the unauthorized use of our trademarks and other proprietary rights is expensive, difficult and, in some cases, impossible. Litigation may be necessary in the future to enforce or defend our intellectual property rights, to protect our trade secrets or to determine the validity and scope of the proprietary rights of others. Such litigation could be costly and divert management resources, either of which could harm our business.
Furthermore, from time to time we have received communications from other parties asserting the existence of patent rights, copyrights, trademark rights or other intellectual property rights which they believe cover certain products we have developed and/or sell, as well as technology and/or services that we use in, or are relevant to, our business. The rate of patent infringement assertions both by operating entities and third party non-practicing entities (sometimes referred to as "patent trolls") is increasing, particularly in the United States and Canada.
We can be adversely affected by litigation, other proceedings or claims either brought by us to protect our rights or brought against us or against our manufacturers, suppliers or service providers alleging infringement of third party proprietary rights. Intellectual property disputes are often expensive to prosecute, defend or conduct, can be time-consuming, divert the time and attention of our technical and management personnel, and result in costly litigation. Additionally, claims against us, if successful, could require us to: pay substantial damages or royalties; comply with an injunction or other court order that could prevent us from offering certain of our products; seek a license for the use of certain intellectual property, which may not be available on commercially reasonable terms or at all; or obtain non-infringing products and/or technology, which could require significant effort and expense and ultimately may not be successful. There can be no assurance regarding the outcome of future legal proceedings, claims or investigations. The instigation of legal proceedings or claims, our inability to favorably resolve or settle such proceedings or claims, or the determination of any adverse findings against us in connection with such proceedings or claims could materially and adversely affect our business, financial condition and results of operations, as well as our business reputation.
Our business could suffer if a manufacturer fails to use acceptable labor practices.
We do not control our vendors or the manufacturers that produce the products we buy from them, nor do we control the labor practices of our vendors and these manufacturers. The violation of labor or other laws by any of our vendors or these manufacturers, or the divergence of the labor practices followed by any of our vendors or these manufacturers from those generally accepted as ethical in the United States, could interrupt, or otherwise disrupt, the shipment of finished products to us or damage our reputation. Any of these, in turn, could have a material adverse effect on our financial condition and results of operations.
Additionally, certain of our products are subject to regulation and regulatory standards set by various governmental authorities with respect to quality and safety. These regulations and standards may change from time to time. Our inability to comply on a timely basis with regulatory requirements could result in significant fines or penalties, which could adversely

10


affect our reputation and sales. Issues with the quality and safety of merchandise we sell, regardless of our culpability, or customer concerns about such issues, could result in damage to our reputation, lost sales, uninsured product liability claims or losses, merchandise recalls and increased costs.
We face the risk of exposure to product quality issues, product liability claims, product recalls and adverse publicity.
We market and distribute products purchased from third-party suppliers, including products which are marketed and resold under our private label brands. We may inadvertently resell product(s) that contain a defect which may cause property damage or personal injury to our end-user customers, which therefore exposes us to the risk of adverse publicity, product quality issues, product liability claims, and product recalls or other regulatory or enforcement actions, including those initiated by the U.S. Consumer Product Safety Commission, by state regulatory authorities or through private causes of action. We generally seek contractual indemnification and insurance coverage from our suppliers and we carry our own insurance. However, if the insurance coverage is not provided or adequate and/or the contractual indemnification is not provided by or enforceable against the supplier, product liability claims relating to the quality of or to defective and/or recalled products could have a material adverse effect on our ability to successfully market our products and on our business, financial condition and results of operations. In addition, even if a product liability claim is not successful or is not fully pursued, the costs associated with defending such claims and/or the negative publicity surrounding a product recall or any assertion that our products caused property damage or personal injury, could damage our brand identity and our reputation with existing and potential customers and have a material adverse effect on our business, financial condition and results of operations.
Changes in laws and regulations could increase our cost of doing business.
We are subject to a wide variety of laws and regulations in the United States and the other countries and jurisdictions in which we operate, and changes in the level of government regulation of our business have the potential to materially alter our business practices and/or our profitability. Changes in U.S. or foreign law that change our operating requirements with respect to sourcing or reselling products could increase our costs of compliance or make it too expensive for us to offer such products, which could lead to a reduction in revenue. Also, changing regulations and laws governing the Internet and eCommerce transactions (including taxation, user privacy, data protection, pricing and electronic communications) could impede the growth of our eCommerce business and increase our cost of doing business. In addition, changes in interpretations of laws or regulations, including interpretations that information, such as zip codes, constitute personally identifiable information could adversely impact industry practices related to collecting customer information. Any changes we make in the manner in which we collect such information could add significant costs, expose us to litigation, impact our marketing efforts, impede growth of our customer database and limit our customer-service offerings. Furthermore, changes in federal or state wage requirements (including changes in entitlement programs such as health insurance, paid leave programs, or other changes in workplace regulation) could adversely impact our ability to achieve our financial targets.
Pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act, the SEC promulgated final rules regarding disclosure of the use of certain minerals (tantalum, tin, gold and tungsten) known as conflict minerals, which are mined from the Democratic Republic of the Congo and adjoining countries, as well as procedures regarding a manufacturer's efforts to prevent the sourcing of such minerals and metals produced from those minerals. These new requirements will require due diligence efforts for the 2013 calendar year, with initial disclosure requirements effective in May 2014. There may be costs associated with complying with the disclosure requirements, such as costs related to determining the source of certain minerals used in our products, as well as costs of possible changes to products, processes or sources of supply as a consequence of such verification activities. We may also face reputational challenges if we are unable to verify the origins for any or all conflict minerals used in our products, or if we are unable to certify that our products are "conflict free."
We are subject to governmental export and import controls that could subject us to liability.
Many of the products we sell are sourced by our vendors and, to a limited extent, by us, in many foreign countries. In addition, we export merchandise to international customers. As a result, we are subject to the various risks of doing business in foreign markets and importing merchandise from abroad or exporting merchandise to customers abroad, such as: potential disruptions in supply; changes in duties, tariffs, quotas on imported and exported merchandise; strikes and other events affecting delivery; consumer perceptions of the safety of imported merchandise; concerns about human rights, working conditions and other labor rights and conditions in foreign countries where merchandise is produced; disruptions of shipping and international trade caused by natural and man-made disasters; significant delays in the delivery of cargo due to security considerations; compliance with laws and regulations concerning ethical business practices, such as the U.S. Foreign Corrupt Practices Act; and economic and political conditions or terrorist acts, or other problems in countries from or through which merchandise is imported and exported. Furthermore, in 2010, U.S. Customs and Border Protection completed its focused assessment related to our import practices during which certain deficiencies were identified. Although we have enhanced policies and procedures to address these deficiencies and to facilitate compliance with laws and regulations relating to doing

11


business in foreign markets and importing merchandise from, and exporting merchandise abroad, such laws and regulations are highly complex and there can be no assurance that our associates, contractors, agents, vendors or other third parties with whom we do business will not violate such laws and regulations or our policies, which could adversely affect our operations or operating results.
Changes in accounting standards, interpretations or applications of accounting principles, and subjective assumptions, estimates and judgments by management related to complex accounting matters, could significantly affect our financial results.
GAAP and related accounting pronouncements, implementation guidelines and interpretations with regard to a wide range of matters that are relevant to our business including, but not limited to, inventory valuation adjustments, capitalized indirect costs, costs associated with exit activities, impairment of long-lived assets, workers’ compensation reserves, and valuation allowances against our deferred tax assets, are highly complex and involve many subjective assumptions, estimates and judgments by our management. Changes in underlying assumptions, estimates or judgments by our management could significantly change our reported or expected financial performance. Additionally, changes in accounting principles and related accounting pronouncements, their interpretation and/or their application to our financial statements, particularly in light of the ongoing convergence of GAAP and International Financial Reporting Standards, could result in material charges to our financial statements.
ITEM 1B—UNRESOLVED STAFF COMMENTS
None.
ITEM 2—PROPERTIES
Our executive offices and support center are located in a 104,000 square foot facility in Watsonville, California, which we occupy under a lease that expires in 2016. We operate a 240,000 square foot distribution center located in Hollister, California, under a lease that expires in 2021. We also operate a 472,000 square foot distribution center located in Rock Hill, South Carolina, under a lease that expires in 2017. At December 29, 2012, our 300 stores comprised an aggregate of approximately 2.7 million square feet of space. Nearly all of our stores are leased, typically for a five-year or 10-year initial term, with options to renew for at least one five-year period. In some leases, we pay a fixed rent, in others we have a period of fixed rent and then a rent charge that is either fixed, determined by fair market rent or determined by a consumer price index calculation. Substantially all of our leases require us to pay insurance, utilities, real estate taxes, repair and maintenance expenses and common area maintenance.

ITEM 3—LEGAL PROCEEDINGS
We are involved in various legal and administrative proceedings, claims and litigation and regulatory compliance audits arising in the ordinary course of business. Accordingly, material adverse developments, settlements or resolutions may occur and negatively impact our results in the quarter and/or fiscal year in which such developments, settlements or resolutions are reached. Based on the facts currently available, we do not believe that the disposition of any claims, regulatory compliance audits, legal or administrative proceedings that are pending or asserted, individually and in the aggregate, will have a material adverse effect on our financial position. However, an adverse judgment by a court, administrative or regulatory agency, arbitrator or a settlement could adversely impact our results of operations in any given period.
For any claims, regulatory compliance audits, legal or administrative proceedings where we have 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.
ITEM 4—MINE SAFETY DISCLOSURE
None.

12


PART II
ITEM 5—MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Our common stock trades on the NASDAQ Global Select Market tier of the NASDAQ Stock Market (effective January 3, 2011) under the symbol “WMAR”. The following table sets forth, for the periods indicated, the high and low closing sales prices for our common stock, as reported by the NASDAQ Stock Market.
 
 
First
Quarter
 
Second
Quarter
 
Third
Quarter
 
Fourth
Quarter
2012
 
 
 
 
 
 
 
High
$
13.41

 
$
12.41

 
$
12.22

 
$
10.75

Low
$
10.35

 
$
9.94

 
$
9.67

 
$
9.39

2011
 
 
 
 
 
 
 
High
$
13.36

 
$
11.00

 
$
10.43

 
$
11.63

Low
$
9.80

 
$
9.85

 
$
7.70

 
$
7.01


As of February 28, 2013, there were approximately 6,180 holders of record of our common stock, and the last sale price reported on the NASDAQ Global Select Market was $12.51 per share. We have not paid any cash dividends on our common stock, and we do not anticipate doing so in the foreseeable future.
The information required by this item with respect to securities authorized for issuance under equity compensation plans is incorporated by reference from our definitive proxy statement for our 2013 annual meeting of stockholders.

13


The following graph compares the five-year cumulative total stockholder return on West Marine common stock with the five-year cumulative total return of (i) the NASDAQ Composite Index and (ii) peer companies in the Morningstar Industry Group—Specialty Retail index. The graph showing the Morningstar Industry Group—Specialty Retail was compiled and prepared for West Marine by Zacks Investment Research. We have been advised by Morningstar that Zacks Investment Research is the exclusive provider of Morningstar industry data for total return performance graphs. The index presented below consists of 79 specialty retailers.
 
 
12/29/2007
 
1/3/2009
 
1/2/2010
 
1/1/2011
 
12/31/2011
 
12/29/2012
West Marine, Inc.  
$
100.00

 
$
50.55

 
$
89.36

 
$
117.29

 
$
128.94

 
$
118.51

Specialty Retail
100.00

 
58.75

 
97.33

 
124.15

 
119.10

 
152.87

NASDAQ Composite Index
100.00

 
61.60

 
86.52

 
102.22

 
101.42

 
117.07


The performance graph set forth above will not be deemed to be incorporated by reference into any filing under the Securities Act of 1933 or under the Exchange Act, except to the extent that we specifically incorporate it by reference, and will not otherwise be deemed to be soliciting material or to be filed under such Acts.

14


ITEM 6—SELECTED CONSOLIDATED FINANCIAL DATA
The following consolidated balance sheet data for 2012 and 2011 and consolidated statement of operations data for 2012, 2011 and 2010 have been derived from our consolidated financial statements for the fiscal years appearing elsewhere in this report and should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations in Item 7 and our consolidated financial statements and notes thereto in Item 8.
 
(in thousands, except per share and operating data)
2012
 
2011
 
2010
 
2009
 
2008
 
Consolidated Statement of Operations Information:
 
 
 
 
 
 
 
 
 
 
Net revenues
$
675,251

 
$
643,443

 
$
622,802

 
$
588,416

 
$
631,258

  
Income (loss) from operations
25,170

 
22,139

(1)
14,884

 
10,345

 
(22,932
)
(2)
Income (loss) before income taxes
24,329

 
21,221

(1)
14,247

 
9,539

 
(25,270
)
(2)
Net income (loss)
15,529

 
29,662

(1)
13,227

 
12,376

 
(38,800
)
(2)(3)
Net income (loss) per share:
 
 
 
 
 
 
 
 
 
 
Basic
$
0.67

 
$
1.30

(1)
$
0.59

 
$
0.56

 
$
(1.76
)
(2)(3)
Diluted
0.65

 
1.27

(1)
0.57

 
0.50

 
(1.76
)
(2)(3)
Consolidated Balance Sheet Information:
 
 
 
 
 
 
 
 
 
 
Working capital
$
220,871

 
$
197,930

 
$
176,616

 
$
157,620

 
$
183,223

  
Total assets
354,268

 
335,657

 
308,886

 
292,237

 
314,592

  
Long-term debt, net of current portion

 

 

 

 
47,000

  
Operating Data:
 
 
 
 
 
 
 
 
 
 
Stores open at year-end
300

 
319

 
327

 
335

 
344

  
Comparable stores net sales increase (decrease)
3.3
%
 
2.3
%
 
6.3
%
 
(3.6
)%
 
(6.8
)%
 
 
(1)
Includes a $15.7 million non-cash benefit from the release of substantially all of our valuation allowance against deferred tax assets (see Note 8 to our consolidated financial statement for further discussion).
(2)
Includes the following items on a pre-tax basis: a $10.7 million charge for store closures and other restructuring costs (see Note 3 to our consolidated financial statements for further discussion); a $2.9 million non-cash charge for impairment of long-lived assets; and $2.2 million of costs related to the settled SEC investigation.
(3)
Includes the impact of a $23.2 million non-cash charge to provide a full valuation allowance against all net deferred tax assets, including 2008 additions to deferred tax assets.



15


ITEM 7—MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis is based upon our financial statements as of the dates and for the periods presented in this section. You should read this discussion and analysis in conjunction with the financial statements and supplementary data in Item 8.
Forward-Looking Statements
The statements in this Form 10-K that relate to future plans, events, expectations, objectives or performance (or assumptions underlying such matters) are forward-looking statements that involve a number of risks and uncertainties. These forward-looking statements include, among other things, statements that relate to our future plans, expectations, objectives, performance and similar projections, such as statements regarding our earnings and growth in profitability and expectations relating to our ability to continue to manage our expenses and execute on our strategies in a relatively flat boating equipment market, as well as facts and assumptions underlying these statements or projections. These forward-looking statements may involve known and unknown risks, uncertainties and other factors that may cause our actual results and performance in future periods to be materially different from any future results or performance suggested by the forward-looking statements in this report. Although we believe the expectations reflected in such forward-looking statements are based upon reasonable assumptions, we can give no assurance that actual results will not differ materially from these expectations. These risks, uncertainties and other factors are discussed under risk factors in Item 1A of this report.
Readers are cautioned not to place undue reliance on forward-looking statements, which are based only upon information available as of the date of this report. We do not undertake, and specifically disclaim any obligation, to publicly release the result of any revisions that may be made to any forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements even if experience or future changes make it clear that any projected results expressed or implied therein will not be realized.
Overview
We are the largest specialty retailer of boating supplies and accessories with 2012 net revenues of $675.3 million and net income of $15.5 million. Our business strategy is to offer a broad assortment of merchandise for the boat and for the boater that meets the needs of individual boaters and boating businesses, provides great customer experiences and offers the convenience of multi-channel shopping.
We are focused on the following key growth strategies during 2013:
eCommerce: We are focusing on becoming an omni-channel retailer in order to maximize our future sales opportunities by offering exceptional service and convenience to our customers no matter how they prefer to shop with us. During 2012, we began making additional investments and changes in the organization to better support our eCommerce business and integrate it with our store retail operations in such key areas as marketing and merchandising. We also made changes in our promotional strategies (such as a reduced hurdle for free shipping), and rolled out our improved buy on-line-ship-to-store offering, all of which appear to have been met with good customer response. We experienced accelerating sales results during the year, with quarterly sales changes for the first, second, third and fourth quarters of 2012 equaling -0.7%, -0.4%, 9.1%, and 12.8%, respectively, when compared to comparable periods in 2011.
Merchandise Expansion: This strategy builds on our core products and is intended to welcome a broader base of customers who are passionate about recreating on and around the water by providing customers a broader selection of authentic footwear, apparel, clothing accessories, fishing products and paddle sports equipment that satisfy the need for function both on and off the boat. We are offering this expanded assortment both in our larger-format stores and on our eCommerce website. During 2012, this group of products comprised approximately 15.2% of our net revenues, compared to approximately 13.9% last year, and 2012 overall product sales growth was 14.6%.
Real Estate Optimization: With this strategy, we are evolving to having fewer, larger and more dominant stores in our major markets. These stores drive sales and profitability by allowing us to offer an improved shopping experience with greatly expanded assortments in generally better store locations. The larger scale of these locations also allows us to staff the stores with sales associates with more specialized product knowledge. During 2012, we opened ten stores in connection with this program. For the year, the net increase in sales at stores in optimized markets was $5.0 million. The net difference in retail square footage was a decrease of 11.4%, but 2012 sales at these ten locations grew by 16.9%.
We will be investing significant resources in support of these key growth strategies. This will include capital investments

16


to improve our eCommerce website and to upgrade our information technology infrastructure to support our shift toward an omni-channel retail model designed to provide a seamless customer experience across all shopping channels. We will also incur additional investments in staffing to support execution in key areas such as information technology and eCommerce. In addition, there will be incremental investment in marketing which, along with a reallocation of some of our traditional media spending, is intended to reach out to a broader range of customers and grow our customer base. These strategies and investments are expected to better position us to deliver incremental sales and operating margin improvement over time.
We currently have three reportable segments: Stores; Port Supply; and Direct-to-Consumer. Our Stores segment generated approximately 90% of our 2012 net revenues. Our 300 Company-operated stores open at the end of 2012 are located in 38 states, Puerto Rico and Canada. In addition, we have five franchised stores located in Turkey. Our Port Supply segment is one of the largest wholesale distributors of marine equipment in the United States. Products shipped to Port Supply customers directly from our distribution centers represented approximately 4% of our 2012 net revenues. Our Direct-to-Consumer segment, which includes our retail eCommerce, direct mail catalogs and call center operations, offers customers around the world approximately 75,000 products, and it accounted for the remaining 6% of our 2012 net revenues.
Results of Operations
The following table sets forth certain income statement components expressed as a percent of net revenues:
 
 
2012
 
2011
 
2010
Net revenues
100.0
%
 
100.0
 %
 
100.0
%
Cost of goods sold
70.7
%
 
71.2
 %
 
71.8
%
Gross profit
29.3
%
 
28.8
 %
 
28.2
%
Selling, general and administrative expense
25.6
%
 
25.4
 %
 
25.8
%
Store closures and other restructuring costs
%
 
 %
 
%
Impairment of long-lived assets
%
 
 %
 
%
Income from operations
3.7
%
 
3.4
 %
 
2.4
%
Interest expense
0.1
%
 
0.1
 %
 
0.1
%
Income before income taxes
3.6
%
 
3.3
 %
 
2.3
%
Provision (benefit) for income taxes
1.3
%
 
(1.3
)%
 
0.2
%
Net income
2.3
%
 
4.6
 %
 
2.1
%
Fiscal 2012 compared with Fiscal 2011
Net revenues for 2012 were $675.3 million, an increase of 4.9%, compared to net revenues of $643.4 million for 2011. This increase was primarily due to a $16.7 million increase in comparable store sales and a $13.7 million increase related to our store optimization strategy, as discussed further below under "Segment revenues." From a merchandise perspective, sales increased in the electronics and fishing categories, which are primarily discretionary items, as well as in the apparel categories, which we attribute to our merchandise expansion strategy. We expect consumers will continue to carefully evaluate their needs-based boating purchases and their spending on discretionary items. In response, we will continue to focus on and invest in our eCommerce, Merchandise Expansion and Store Optimization strategies described above while closely managing selling, general and administrative ("SG&A") expense. Net income for 2012 was $15.5 million compared to net income for 2011 of $29.7 million. The decrease in net income was primarily attributable to the release of substantially all of our valuation allowance in 2011.
Segment revenues
Net revenues for the Stores segment increased $31.4 million, or 5.4%, to $610.2 million in 2012, primarily due to a $16.7 million, or 3.3% increase in comparable store sales. A driver of the comparable store sales was higher sales to wholesale customers through our store locations, which we believe resulted from our ongoing efforts to better serve this group of customers. In certain markets, our larger stores serve as hubs or regional distribution centers that offer better assortments and convenience with personal service and more delivery options for wholesale customers. Real estate activity connected with our store optimization strategy drove a $13.7 million increase in net revenues as stores opened during the fourth quarter of 2011 and stores opened during 2012 generated $59.0 million in sales, whereas stores closed during these same periods generated net revenues of $45.3 million last year, thereby effectively reducing revenues by such amount.
During 2013, we expect to open approximately two to four flagship stores, approximately four large format stores and one standard-sized store, Additionally, we plan to expand two existing stores with one becoming a flagship and the other a large

17


format store. We also expect to close approximately 10 to 14 existing stores in connection with our real estate optimization strategy of evolving to having fewer, larger stores in many of our key markets. As a result of these actions, we expect that our overall store count will decline and our total selling square footage will increase slightly. In addition, we will continue with our practice of monitoring the operating performance and economics of all store locations and evaluating for closure any underperforming stores when the economics and other factors favor doing so.
Port Supply segment net revenues through our distribution centers decreased $1.3 million, or 4.8%, to $26.1 million in 2012 compared to 2011. However, sales to the wholesale customer group increased in our Stores segment. We believe the shift from Port Supply to Stores was driven by our ongoing efforts to better serve our wholesale customers through our store locations.
Net revenues from our Direct-to-Consumer segment increased $1.8 million, or 4.7%, to $38.9 million from higher sales through our website. The increased sales resulted from continued improvements to both our website and product delivery options as well as expanded product assortments. These enhancements drove higher traffic to the website and resulted in higher average order values per transaction.
Comparable store sales
Comparable store sales for 2012 increased by 3.3%, or $16.7 million, compared to 2011. Comparable store sales changes during the first, second, third and fourth quarters of 2012 were 4.3%. 2.1%, 4.9% and 2.1%, respectively. The overall comparable store trends were positive and relatively consistent across all geographic regions. Our merchandise expansion strategy contributed to the positive comparable store sales in all regions, with the footwear, apparel and fishing categories performing above the total comparable store results. In all regions, we continue to identify opportunities to expand and customize our fishing assortments, which have delivered sales growth in that category. While it appears the economy has stabilized generally, there remains some cautiousness surrounding the market for discretionary items, such as boating supplies and related merchandise.
Gross profit
Gross profit increased by $13.1 million, or 7.1%, to $198.1 million in 2012, compared to $184.9 million for 2011, primarily due to higher sales. Gross profit increased as a percentage of net revenues by 0.5% to 29.3% in 2012, compared to 28.8% in 2011, primarily due to the leveraging of occupancy expense by 0.5% on higher sales and a 0.1% improvement in shrink. These improvements were partially offset by a 0.1% increase in unit buying and distribution costs.
Selling, general and administrative expense
SG&A expense for 2012 was $172.8 million, an increase of $10.0 million, or 6.1%, compared to $162.9 million for last year. SG&A increased as a percentage of revenues to 25.6% in 2012, compared to 25.4% in 2011. Drivers of higher SG&A expense included: a $3.2 million increase in support expense related to our key growth strategies, which includes investments in information technology infrastructure and the eCommerce website; $3.1 million in higher store project expense reflecting the opening of ten stores this year compared to six stores last year; $1.4 million in higher training costs including West Marine University, our biennial Company-wide training event and store associate training programs; $1.3 million in higher advertising to support additional circulation of marketing materials, to perform market tests and for Grand Openings at our new locations; and $1.2 million in additional expense related to our Chief Executive Officer transition.
Interest expense
Interest expense was $0.8 million in 2012, slightly down from $0.9 million in 2011. This expense consists primarily of the amortization of commitment fees, as our borrowings were minimal in 2012. Cash provided by operating activities funded property and equipment investments with excess cash being used to pay down our seasonal use of debt. This was the primary driver of the outstanding bank borrowings in 2012.
Income taxes
Our effective income tax rate for 2012 was a provision of 36.2%, compared to a benefit of 39.8% in 2011. The year-over-year change in our effective tax rate was primarily due to the release of substantially all of our valuation allowance during the second quarter of 2011, resulting in a $15.7 million benefit in that year. Our effective tax rate is subject to change based on the mix of income from different state and foreign jurisdictions that tax at different rates, as well as the change in status or outcome of uncertain tax positions. We currently anticipate the effective tax rate for fiscal year 2013 will be a provision of approximately 40.0%. For more information, see Note 8 to our consolidated financial statements.

18


Fiscal 2011 compared with Fiscal 2010
Net revenues for 2011 were $643.4 million, an increase of 3.3%, compared to net revenues of $622.8 million for 2010. Sales increased in the electronics and fishing categories, which are primarily discretionary items, as well as in the apparel categories, which we attribute to our merchandise expansion strategy. During the first half of the year, sales of usage-based items, such as maintenance, engine parts and electrical products, were lower than the prior due to inclement weather in many markets; however, as we progressed through the remainder of the fiscal year, we saw increased sales and ended the year with higher sales in these categories. Net income for 2011 was $29.7 million compared to net income for 2010 of $13.2 million. The increase in net income was attributable to the release of substantially all of our valuation allowance discussed below under “Income taxes” and net revenues growth outpacing the costs of goods sold.
Segment revenues
Net revenues for the Stores segment increased $18.4 million, or 3.3%, to $578.9 million in 2011, primarily due to an $11.6 million, or 2.3%, increase in comparable store sales. A driver of the comparable store sales increase was higher sales to wholesale customers through our store locations, which we believe resulted from our ongoing efforts to better serve this group of customers through store locations. Real estate activity connected with our store optimization strategy drove an $8.9 million increase in net revenues as stores opened during the fourth quarter of 2010, and stores opened during 2011 generated $39.9 million in sales, whereas stores closed during these same periods generated net revenues by $31.0 million in the prior year, which effectively reduced revenues by such amount.
Port Supply segment net revenues through our distribution centers decreased $0.9 million, or 3.0%, to $27.5 million in 2011 compared to 2010. However, sales to the wholesale customer group increased in our Stores segment.
Net revenues from our Direct-to-Consumer segment increased $3.1 million, or 9.2%, to $37.1 million from higher sales through our website. The increased sales resulted from technology upgrades completed in 2010, expanded marketing offerings and product assortments, which drove higher traffic to the website and resulted in higher average order values per transaction.
Comparable store sales
Comparable store sales for 2011 increased by 2.3%, or $11.6 million, compared to 2010. Comparable store sales changes during the first, second, third and fourth quarters of 2011 were 2.7%, 0.0%, 3.9% and 4.3%, respectively. The overall comparable store trends were positive across geographic regions, with the strongest growth in the Southeast. Our merchandise expansion strategy resulted in positive comparable store sales across all regions, with the strongest results in the for-the-boater category.
Gross profit
Gross profit increased by $9.3 million, or 5.3%, to $184.9 million in 2011, compared to $175.6 million for 2010, primarily due to higher sales. Gross profit increased as a percentage of net revenues by 0.6% to 28.8% in 2011, compared to 28.2% in 2010, primarily due to a 0.3% reduction in unit buying and distribution costs and a 0.2% improvement in inventory shrink. Additionally, increased revenues allowed us to leverage our relatively fixed occupancy expenses by 0.1%. These improvements were partially offset by lower raw product margin, down 0.1%, driven by a shift in revenues to lower-margin categories, such as electronics.
Selling, general and administrative expense
SG&A expense for 2011 was $162.9 million, an increase of $2.0 million, or 1.3%, compared to $160.8 million for last year. SG&A decreased as a percentage of revenues to 25.4% in 2011, compared to 25.8% in 2010. Drivers of higher SG&A expense included: a $2.6 million loss contingency accrual related to a recently-finalized software license audit; $1.3 million in higher information technology spending, including costs to implement our new point-of-sale and order entry systems; a variable selling expense increase of $1.2 million primarily due to higher store payroll supporting the higher sales year-over-year; a $0.7 million increase in benefits costs, including higher year-over-year health care claims; and a $0.6 million unfavorable impact versus 2010 of foreign currency exchange. These increases in SG&A were partially offset by a $4.4 million reduction in accrued bonus expense in 2011 due to increased bonus target thresholds, reflecting higher performance expectations when compared to the target thresholds for fiscal 2010.
Interest expense
Interest expense increased $0.3 million, or 44.1%, to $0.9 million in 2011, compared to $0.6 million in 2010. The increase in interest expense was due to both higher commitment fees and higher average interest rates, although average outstanding bank borrowings were lower in 2011, compared to 2010. Cash provided by operating activities funded property and

19


equipment investments with excess cash being used to pay down our seasonal use of debt. This was the primary driver of the lower average outstanding bank borrowings in 2011.
Income taxes
Our effective income tax rate for 2011 was a benefit of 39.8%, compared to a provision of 7.2% in 2010. The year-over-year change in our effective tax rate was primarily due to the release of substantially all of our valuation allowance during the second quarter of 2011, resulting in a $15.7 million benefit. In evaluating our ability to recover our deferred tax assets, we consider all available positive and negative evidence including our past operating results, the existence of cumulative losses in past fiscal years and our forecast of future taxable income in the jurisdictions in which we have operations. Given our improved financial performance in 2011 and expectations of future results at the time, we determined that there was sufficient positive evidence to support the release of the majority of the valuation allowance against our deferred tax assets in the second quarter of 2011. For more information, see Note 8 to our consolidated financial statements.
Liquidity and Capital Resources
Our use of cash to fund working capital, operating expenses, debt service and capital expenditures related primarily to the build-out of new stores and improvements in our information technology infrastructure. Funds generated by operating activities, available cash and our credit facility are our largest sources of cash. At the end of both 2012 and 2011, we were debt free. However, we may borrow against our credit facility during the first half of each year as we build inventory levels in preparation for the key boating season.
Working capital, the excess of current assets over current liabilities, increased to $220.9 million at the end of 2012, compared to $197.9 million at the end of 2011. The increase in working capital primarily was attributable to a $12.6 million higher cash balance at the end of 2012. In addition to the higher cash balance, assets held for sale increased by $4.3 million as the result of a reclassification from property and equipment. This reclassification was the result of an agreement we entered into to sell the vacant land and building of our former Ft. Lauderdale store, which closed when we opened our new flagship store in that market in November 2011. During the interim time, we had been marketing the site for lease. Working capital was also higher by $4.0 million at year-end 2012 due to lower accounts payable, which were lower due to the timing year-over-year of inventory purchases.
Operating Activities
During 2012, our primary source of liquidity was cash flow from operations. Net cash provided by operating activities decreased year-over-year by $11.2 million to $26.0 million in 2012, compared to $37.2 million last year. The decrease in cash provided by operating activities was due primarily to changes in operating assets and liabilities, including increases of prepayments and other receivables compared to the prior year and decreases in accounts payable resulting from the timing of payments to vendors. Prepayments and other receivables increased due to payments for sales taxes and bank fees. Additionally, we experienced net income of $15.5 million in 2012 versus net income of $29.7 million in 2011. Non-cash charges to earnings in 2012 included depreciation and amortization of $15.3 million, stock-based compensation of $3.1 million and deferred income taxes of $1.6 million.
During 2011, our primary source of liquidity was cash flow from operations. Net cash provided by operating activities increased year-over-year by $12.3 million to $37.2 million in 2011, compared to $24.9 million in 2010. The increase in cash provided by operating activities was due primarily to increases in cash provided by net income and reduced inventory levels, partially offset by an increase in cash used for accrued expenses. Cash used for inventory was lower due primarily to our continued focus on inventory management and ensuring the correct product assortment in each store based on customer demographics. Cash used for accrued expenses partially offset the increase in cash primarily as a result of lower accrued bonus expense given our increased bonus target thresholds in 2011 as compared to accrued bonus and related thresholds in fiscal 2010.
Investing Activities
In 2012, our capital expenditures were $17.8 million, primarily for new stores, store remodels, information technology and investment in supply chain efficiencies. We opened 10 new stores and remodeled four stores in 2012. During 2013, we expect to significantly increase capital spending, primarily in support of strategic growth initiatives which include new stores, store remodels and expansions, investing in our eCommerce website and information technology enhancements. We intend to fund our expansion through cash generated from operations and, if necessary, credit facility borrowings.
Financing Activities

20


Net cash provided by financing activities was $4.4 million in 2012, primarily consisting of a $4.9 million increase in cash from associate share-based compensation plans, partially offset by $0.6 million in cash used to pay loan costs associated with the first amendment to our amended and restated loan agreement. Net cash provided by financing activities was $2.4 million in 2011, attributed entirely to an increase in cash related to associate share-based compensation plans.
Credit Agreement
On November 30, 2012, we and certain of our subsidiaries, along with the lenders that are signatories thereto and Wells Fargo Bank, National Association (as successor by merger to Wells Fargo Retail Finance, LLC), as agent for the lenders, entered into a first amendment to our amended and restated loan and security agreement, to, among other things, amend the procedures by which we may request the issuance of letters of credit; reduce the interest rates applicable to borrowings under our amended and restated loan and security agreement; reduce the fee that we must pay on undrawn availability; extend the maturity of the agreement to November 30, 2017, and at our request, reduce the maximum available borrowing capacity from $140.0 million to $120.0 million. In addition, at our option and subject to certain conditions, we may increase our 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 our inventory (excluding capitalized indirect costs) and accounts receivable.
The revolving credit facility is available for general working capital and general corporate purposes. At our 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% and 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 2012, 2011 and 2010, the weighted-average interest rate on all of our outstanding borrowings was 4.7%, 3.1% and 1.5%, respectively.
Although the loan agreement contains customary covenants, including, but not limited to, restrictions on our 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, our loan is asset-based (which means our lenders maintain a security interest in our inventory and accounts receivable which serve as collateral for the loan), and the amount we may borrow under our revolving credit facility at any given time is determined by the estimated value of these assets as determined by the lenders’ appraisers. Additionally, we must maintain a 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 29, 2012, we were in compliance with the covenants under our loan agreement.
At the end of 2012 and 2011, there were no amounts outstanding under our revolving credit facilities, and we had $91.7 million and $86.9 million, respectively, available for future borrowings. At the end of 2012 and 2011, we had $5.1 million and $8.3 million, respectively, of outstanding commercial and stand-by letters of credit. We strategically manage our debt over the course of our fiscal year. We incur seasonal fluctuations in our cash flows and, therefore, we incur debt as we build up our inventories for spring in order to maintain stock levels sufficient to fulfill customer needs and maximize sales during the main boating season. Additionally, we hire a significant number of temporary associates during the summer, our peak selling season. Our weighted-average outstanding balances for the first quarters of 2012 and 2011 were $0.1 million and $6.1 million, respectively. For our second quarters of 2012 and 2011, the weighted-average outstanding balances were $0.1 million and $13.4 million, respectively, and the third quarter weighted-average outstanding balances for both 2012 and 2011 were not material. The fourth quarter weighted-average outstanding balances for both 2012 and 2011 were not material.
We may borrow against our aggregate borrowing base up to the maximum revolver amount, which was $120.0 million at year-end 2012 and $140.0 million at year-end 2011. Our borrowing base at each of our last two fiscal year-ends consisted of the following (in millions):

21


 
 
2012
 
2011
Accounts receivable availability
$
4.4

 
$
4.6

Inventory availability
108.3

 
106.6

Less: reserves
(5.4
)
 
(5.6
)
Less: minimum availability
(10.7
)
 
(10.6
)
Total borrowing base
$
96.6

 
$
95.0


Our aggregate borrowing base was reduced by the following obligations (in millions):
 
Ending loan balance/(overpayment)
$
(0.2
)
 
$
(0.2
)
Outstanding letters of credit
5.1

 
8.3

Total obligations
$
4.9

 
$
8.1


Accordingly, our availability as of fiscal year end 2012 and 2011, respectively, was (in millions):
 
Total borrowing base
$
96.6

 
$
95.0

Less: obligations
(4.9
)
 
(8.1
)
Total availability
$
91.7

 
$
86.9


Contractual obligations
Aggregate information about our unconditional contractual obligations as of December 29, 2012 is presented in the following table (in thousands).
 
Payments due by period
 
Total
 
Less than
1 year
 
1-3 years
 
3-5 years
 
More than
5 years
Contractual cash obligations:
 
 
 
 
 
 
 
 
 
Operating leases(1)
$
271,849

 
$
46,618

 
$
78,091

 
$
56,212

 
$
90,928

Purchase commitments(2)
28,064

 
26,864

 
1,200

 

 

Bank letters of credit
5,444

 
5,444

 

 

 

Other long-term liabilities
3,129

 
2,485

 
644

 

 

 
$
308,486

 
$
81,411

 
$
79,935

 
$
56,212

 
$
90,928

 
(1)
Operating lease amounts in this table represent minimum amounts due under existing agreements and exclude costs of insurance, taxes, repairs and maintenance.
(2)
All but a limited number of our purchase commitments are cancelable by us without penalty; however, we do intend to honor these commitments.
We are party to various arrangements that are conditional in nature and obligate us to make payments only upon the occurrence of certain events, such as delivery of functioning software products. Because it is not possible to predict the timing or amounts that may be due under these conditional arrangements, no such amounts have been included in the table above.
Off-balance sheet arrangements
Operating leases are the only financing arrangements not reported on our consolidated balance sheets. We do not participate in transactions that generate relationships with unconsolidated entities or financial partnerships, such as special purpose entities or variable interest entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other limited purposes. As of December 29, 2012, we are not involved in any unconsolidated special purpose entities or variable interest entities.
Seasonality

22


Historically, our business has been highly seasonal. In 2012, approximately 65% of our net sales and all of our net income occurred during the second and third quarters, principally during the period from April through August, which represents the peak months for boat buying, usage and maintenance in most of our markets.
Business Trends

During 2012, we continued to deliver consistent sales growth in each fiscal quarter. We believe this resulted from a combination of internal and external factors. Early in the year, we benefited from a relatively warm and dry spring in many of our markets, which drove sales of maintenance and other usage-related merchandise categories. As previously disclosed, we did not experience a material adverse impact on our results attributable to Hurricane Sandy, which affected the Northeastern part of the country in early November.
We saw a significant impact on results from our key growth strategies in eCommerce, merchandise expansion and real estate optimization, as outlined in the "Overview" section above. In 2013, in addition to focusing on implementing and building upon our key growth strategies, we also will continue to manage our business conservatively from an operating expense standpoint, while taking steps to remain flexible and to maximize sales in the face of varying marketplace demand.
Although we believe we have seen some recovery in customer boat usage and demand for higher-priced items, we believe that the ongoing uncertainty in economic conditions has had, and may continue to have, an adverse impact on discretionary consumer spending in an already challenging climate for the boating industry, and we believe that economic uncertainty could continue to have an impact on our sales, with corresponding risks to our earnings and cash flow in 2013 (see the “Fiscal 2012 Compared with Fiscal 2011 — Segment Revenues” discussion above). For 2013, we will continue to control expense growth and maximize cash flow by:
continuing to control our operating expenses through variable expense management, along with reengineering and streamlining business processes, where applicable;
continuing to improve the quality of our inventory by tightly controlling overstocked or discontinued goods;
proceeding with our ongoing real estate optimization program, evolving to having fewer, larger stores with anticipated improved store economics;
managing the business to the budget established for 2013, which reflects prudent investment in growth while focusing on expense control and emphasizing working capital management; and
exploring methods and strategies to drive traffic, sales, conversion, and market presence.
More broadly, in order to better meet the needs of our customers and provide a better customer experience, we will be investing significant resources in support of our key growth strategies, including a 40% to 60% increase in our capital investments as compared to 2012. The majority of these additional investments are targeted to improve our eCommerce website and to continue to upgrade our information technology infrastructure. These strategies and investments support our shift toward an omni-channel retail model designed to provide a seamless customer experience across all shopping channels and to better position us to deliver incremental sales and operating margin improvement over time.
Critical Accounting Policies and Estimates
Management’s discussion and analysis of West Marine’s financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in conformity with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires the appropriate application of certain accounting policies, many of which require us to make estimates and assumptions about future events and their impact on amounts reported in our financial statements and related notes. Since future events and their impact cannot be determined with certainty, actual results could differ from our assumptions and estimates, and such differences could be material.
We believe our application of accounting policies, and the estimates inherently required therein, are reasonable. These accounting policies and estimates are periodically reevaluated and adjustments are made when facts and circumstances dictate a change. Our accounting policies are more fully described in Note 1 to our consolidated financial statements, in Item 8 of this report.
Management believes that the following accounting estimates are the most critical to aid in fully understanding and evaluating our reported financial results, and they require management’s most difficult, subjective or complex judgments, resulting from the need to make estimates about the effect of matters that are inherently uncertain. Management has reviewed these critical accounting estimates and related disclosures with the audit committee of our board of directors.
 

23


 
 
 
 
 
Description
  
Judgments and Uncertainties
  
Effect if Actual Results Differ From
Assumptions
Inventory—Valuation Adjustments
  
 
  
 
We value our merchandise inventories at the lower of the cost or market value on an average cost basis. Inventory cost is written down to market value when cost exceeds market value, which we estimate using current levels of aged and discontinued product and historical analysis of items sold below cost. Lower of cost or market adjustments included in ending inventory at December 29, 2012 and December 31, 2011 were $2.7 million and $3.4 million, respectively.
  
Our lower of cost or market adjustments contain uncertainties because the calculations require management to make assumptions and to apply judgment regarding forecasted consumer demand, the promotional environment, technological obsolescence and consumer preferences.
  
We have not made any material changes in our inventory valuation methodology during the past three fiscal years. We do not believe there is a reasonable likelihood that there will be a material change in the future estimates or assumptions we use to calculate our lower of cost or market adjustments. However, if estimates regarding consumer demand are inaccurate or changes in technology affect demand for certain products in an unforeseen manner, we may be exposed to losses that could be material. If we had to take additional markdowns of 10% on all items included in merchandise inventory write-downs at December 29, 2012, net income would be affected by approximately $0.7 million in the fiscal year then ended.
 
 
 
Inventory—Capitalized Indirect Costs
  
 
  
 
Inventory cost includes certain indirect costs related to the purchasing, transportation and warehousing of merchandise. Capitalized indirect costs include freight charges for moving merchandise to warehouses or store locations and operating costs of our merchandising, replenishment and distribution activities. We recognize indirect costs included in inventory value as an increase in cost of goods sold as the related products are sold. Indirect costs included in inventory value at December 29, 2012 and December 31, 2011 were $18.7 million and $17.8 million, respectively.
  
Our capitalized indirect costs contain uncertainties because the calculations require management to make assumptions and to apply judgment relating to factors of our cost accounting system, the soundness of the underlying principles and their consistent application. In interim periods, the calculation of capitalized indirect costs requires management to estimate capitalized indirect costs, merchandise purchases and inventory levels for the full fiscal year.
  
We have not made any material changes in our capitalized indirect cost methodology during the past three fiscal years. We do not believe there is a reasonable likelihood that there will be a material change in the future assumptions or estimates we use to calculate our capitalized indirect costs. However, if our assumptions or estimates are inaccurate, we may be exposed to losses or gains that could be material. A 10% difference in our expenses included in capitalized indirect costs at December 29, 2012 would have affected net income by approximately $1.1 million in the fiscal year then ended.

24


Description
 
Judgments and Uncertainties
 
Effect if Actual Results Differ From
Assumptions
Vendor Allowances Receivable
 
 
 
 
We establish a receivable and reduce inventory cost for income generated from vendor-sponsored programs, or vendor allowances, that is earned but not yet received from our vendors, which we calculate based on provisions of the programs in place. Due to the complexity of the individual agreements with vendors, we perform detailed analyses and review historical trends to determine an appropriate level for the vendor allowances receivable. Our receivable for vendor allowances at December 29, 2012 and December 31, 2011 was $3.0 million and $3.0 million, respectively, and is included in other current assets.
 
Our vendor allowances receivable contains uncertainties because the calculation requires management to make assumptions and to apply judgment regarding a number of factors, including our ability to collect amounts due from vendors and in interim periods requires management to estimate future inventory purchases.
 
We have not made any material changes in the accounting methodology used to establish our vendor allowances receivable during the past three fiscal years. We do not believe there is a reasonable likelihood that there will be a material change in the future estimates or assumptions we use to calculate our vendor allowances receivable. However, if our assumptions or estimates are inaccurate, we may be exposed to losses or gains that could be material. A 10% difference in our estimate of our ability to collect vendor allowances at December 29, 2012 would have affected net income by approximately $0.1 million in the fiscal year then ended.
 
 
 
Costs Associated With Exit Activities
 
 
 
 
We occasionally vacate stores prior to the expiration of the related lease. For vacated locations that are under long-term leases, we record an expense for the net present value of the difference between our future lease payments and related costs (e.g., real estate taxes and common area maintenance) from the date of closure through the end of the remaining lease term, net of expected future sublease rental income.
 
Our estimate of future cash flows is based on our analysis of the specific real estate market, including input from real estate firms; and economic conditions that can be difficult to predict. Costs associated with exit activities included in accrued expenses at December 29, 2012 and December 31, 2011 were $0.9 million and $1.1 million, respectively.
 
Our location closing liability contains uncertainties because management is required to make assumptions and to apply judgment to estimate the duration of future vacancy periods, the amount and timing of future settlement payments and the amount and timing of potential sublease rental income. When making these assumptions, management considers a number of factors, including historical settlement experience, the owner of the property, the location and condition of the property, the terms of the underlying lease, the specific marketplace demand and general economic conditions.
 
We have not made any material changes in the accounting methodology used to establish our location closing liability during the past three fiscal years. We do not believe there is a reasonable likelihood that there will be a material change in the estimates or assumptions we use to calculate our location closing liability. However, if actual results are not consistent with our estimates or assumptions, we may be exposed to losses or gains that could be material. A 10% change in our location closing liability or to our estimated sub-lease income at December 29, 2012 would have affected net earnings by approximately $0.1 million in the fiscal year then ended.


















25


Description
 
Judgments and Uncertainties
 
Effect if Actual Results Differ From
Assumptions
Impairment of long-lived assets
 
 
 
 
Long-lived assets other than goodwill and indefinite-lived intangible assets, which are separately tested for impairment, are reviewed and evaluated quarterly.
 
When evaluating long-lived assets for potential impairment, we first compare the carrying value of the asset to the asset’s estimated future cash flows (undiscounted and without interest charges). If the estimated future cash flows are less than the carrying value of the asset, we calculate an impairment loss. The impairment loss calculation compares the carrying value of the asset to the asset’s estimated fair value, which may be based on estimated future undiscounted cash flows. We recognize an impairment loss if the amount of the asset’s carrying value exceeds the asset’s estimated fair value. If we recognize an impairment loss, the adjusted carrying amount of the asset becomes its new cost basis. We may also accelerate depreciation over the asset’s revised useful life if it is identified for replacement or abandonment at a specific future date.
 
In fiscal year 2012 we did not have any non-cash charges for impairment of long-lived assets. In fiscal year 2011, we recorded a non-cash charge of less than $0.1 million for impairment of long-lived assets.
 
Our impairment loss calculations contain uncertainties because they require management to make assumptions and to apply judgment in order to estimate future cash flows and asset fair values, including forecasting useful lives of the assets. Depending on the assumptions and estimates used, the estimated future cash flows projected in the evaluation of long-lived assets can vary within a wide range of outcomes. We believe we have approximately $0.1 million in net carrying value of assets held for use where an impairment charge is reasonably possible within the next twelve months.
 
We have not made any material changes in our impairment loss assessment methodology during the past three fiscal years. We do not believe there is a reasonable likelihood that there will be a material change in the estimates or assumptions we use to calculate long-lived asset impairment losses. However, if actual results are not consistent with our estimates and assumptions used in estimating future cash flows and asset fair values, we may be exposed to losses that could be material.
 
 
 
 
 
 
 
 

26


Description
 
Judgments and Uncertainties
 
Effect if Actual Results Differ From
Assumptions
Income Taxes
 
 
 
 
We estimate our annual effective income tax rate based on projected taxable income for the full year and record a quarterly income tax provision in accordance with the anticipated annual rate. Our effective tax rate is subject to change based on the mix of income from different state and foreign jurisdictions that tax at different rates, as well as the change in status or outcome of tax audits. Our income tax returns are periodically audited by the taxing authority in the jurisdictions in which we operate; these audits include questions regarding our tax filings, including the timing and amount of deductions and allocation of income among the various jurisdictions.
 
The application of income tax law is inherently complex. Laws and regulations in this area are voluminous and are often ambiguous. As such, we are required to make many subjective assumptions and judgments regarding our effective tax rate and our income tax exposure. Our effective income tax rate is affected by changes in tax law in the jurisdictions in which we currently operate, tax jurisdictions of new stores, company earnings and the results of tax audits.
 
Interpretations of and guidance surrounding income tax laws and regulations change over time. Although we believe that the judgments and estimates discussed herein are reasonable, actual results could differ, and we may be exposed to losses or gains that could be material.



27


 
 
 
 
 
 
 
 
Description
 
Judgments and Uncertainties
 
Effect if Actual Results Differ From
Assumptions
Liabilities for Self Insurance or High Deductible Losses
 
 
 
 
We are self-insured for certain losses, including those related to employee healthcare. However, we obtain third-party insurance coverage to limit our exposure to these claims. In other cases, we purchase commercial insurance, such as for workers’ compensation and general liability claims. We insure workers’ compensation losses through a high-deductible program, and we recognize our liability for the ultimate payment of incurred claims and claims adjustment expenses by accruing liabilities on an actuarial basis which represent estimates of future amounts necessary to pay claims and related expenses with respect to covered events that have occurred.
 
When estimating our liabilities relating to self-insurance or high-deductible insurance programs, we consider a number of factors, including historical claims experience, severity factors and actuarial analysis.
 
Periodically, management reviews its assumptions and the valuations provided by actuarial analysis to determine the adequacy of our self-insured liabilities.
 
Liabilities for our self-insured losses or high-deductible insurance programs contain uncertainties because management is required to make assumptions and to apply judgment to estimate the ultimate cost to settle reported claims and claims incurred but not reported as of the balance sheet date.
 
We have not made any material changes to our self insurance accrual methodology during the past three fiscal years. We do not believe there is a reasonable likelihood that there will be a material change in the estimates or assumptions we use to calculate these liabilities. However, if actual results are not consistent with our estimates or assumptions, we may be exposed to losses or gains that could be material.

A 10% change in our self-insured liabilities and loss reserves relating to high-deductible insurance programs at December 29, 2012, would have affected net income by approximately $0.3 million in the fiscal year then ended.


28


Description
 
Judgments and Uncertainties
 
Effect if Actual Results Differ From
Assumptions
Share-Based Compensation
 
 
 
 
We have a share-based compensation plan under which we award non-qualified stock options and restricted stock. We also have an associate stock buying plan. For more information, see Note 2 to our consolidated financial statements in Item 8 of this report.
 
We determine the fair value of our non-qualified stock option awards at the date of grant using the Black-Scholes Merton option-pricing model.
 
We determine the fair value of our restricted stock awards and associate stock buying plan purchases using similar valuation techniques and the closing market price of our common stock.
 
The fair value of our restricted stock units is based on the closing market price of our common stock.
 
Option-pricing models and generally accepted valuation techniques require management to make assumptions and to apply judgment to determine the fair value of our awards. These assumptions and judgments include estimating the future volatility of our stock price, expected dividend yield, future employee turnover rates and future employee stock option exercise behaviors. Changes in these assumptions can materially affect the fair value estimate.
 
We have not made any material changes in our methodology for determining fair value of stock options during the past three fiscal years. We do not believe there is a reasonable likelihood that there will be a material change in the future estimates or assumptions we use to determine share-based compensation expense. However, if actual results are not consistent with our estimates or assumptions, we may be exposed to changes in share-based compensation expense that could be material.
 
If actual results are not consistent with the assumptions used, the share-based compensation expense reported in our financial statements may not be representative of the actual economic cost of the share-based compensation.
 
A 10% change in our assumptions, such as volatility or expected term, for share-based compensation expense for the fiscal year ended December 29, 2012, would have affected net income by less than $0.1 million in the fiscal year then ended.

ITEM 7A—QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We do not undertake any specific actions to diminish our exposure to interest rate or currency rate risk, and we are not a party to any interest rate or currency rate risk management transactions. We do not purchase or hold any derivative financial instruments. We believe there has been no material change in our exposure to market risk from that discussed in the 2011 Form 10-K.
At the end of the 2012, we had no outstanding long-term debt and as such would not be impacted by a change in interest rates. In the fourth quarter of 2012, we entered into a five-year, amended and restated loan and security agreement pursuant to which the Company has up to $120.0 million in borrowing capacity, There are various interest rate options available, for more information, see Note 5 to our consolidated financial statements in Item 8 of this report.
Our only significant risk exposure is from U.S. dollar to Canadian dollar exchange rate fluctuations. A 10% increase in the exchange rate of the U.S. dollar versus the Canadian dollar would have an effect of reducing our pre-tax income and cash flows by approximately $0.8 million over the next year.

29


ITEM 8—FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Management’s Report on Internal Control Over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Because of its inherent limitations, internal control over financial reporting may not prevent or detect material misstatements due to error or fraud on a timely basis. Also, projections of any evaluation of effectiveness of internal control over financial reporting to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Management has assessed the effectiveness of our internal control over financial reporting as of December 29, 2012. In making its assessment of the effectiveness of internal control over financial reporting, management used the criteria set forth in Internal Control—Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Management has concluded that our internal control over financial reporting was effective as of December 29, 2012, based on the criteria set forth in Internal Control—Integrated Framework issued by the COSO.
Our internal control over financial reporting as of December 29, 2012 has been audited by Grant Thornton LLP, an independent registered public accounting firm, as stated in their report which is included in this report.
 
 
 
 
/S/    MATTHEW L. HYDE        
 
/S/    THOMAS R. MORAN        
Matthew L. Hyde
 
Thomas R. Moran
President and Chief Executive Officer
(principal executive officer)
 
Senior Vice President and Chief Financial Officer
(principal financial officer)
 
 
 
March 7, 2013
 
March 7, 2013

30


REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
West Marine, Inc.
We have audited the internal control over financial reporting of West Marine, Inc. (a Delaware corporation) and Subsidiaries (the “Company”) as of December 29, 2012, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management's Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 29, 2012, based on criteria established in Internal Control-Integrated Framework issued by COSO.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of the Company as of December 29, 2012 and December 31, 2011 and the related consolidated statements of income, comprehensive income, stockholders' equity, and cash flows for each of the three years in the period ended December 29, 2012. Our report dated March 7, 2013 expressed an unqualified opinion on those consolidated financial statements.

/s/ GRANT THORNTON LLP
San Francisco, CA
March 7, 2013

31


REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
West Marine, Inc.
We have audited the accompanying consolidated balance sheets of West Marine, Inc. (a Delaware corporation) and Subsidiaries (the “Company”) as of December 29, 2012 and December 31, 2011, and the related consolidated statements of income, comprehensive income, stockholders’ equity, and cash flows for each of the three years in the period ended December 29, 2012. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of West Marine, Inc. and Subsidiaries as of December 29, 2012 and December 31, 2011, and the results of their operations and their cash flows for each of the three years in the period ended December 29, 2012 in conformity with accounting principles generally accepted in the United States of America.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), West Marine, Inc. and Subsidiaries’ internal control over financial reporting as of December 29, 2012, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated March 7, 2013 expressed an unqualified opinion.
/s/ GRANT THORNTON LLP
San Francisco, CA
March 7, 2013

32


WEST MARINE, INC.
CONSOLIDATED BALANCE SHEETS
DECEMBER 29, 2012 AND DECEMBER 31, 2011
(in thousands, except share data)
 
 
Fiscal Year-End
 
2012
 
2011
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
56,542

 
$
43,966

Trade receivables, net of allowances of $278 in 2012 and $301 in 2011
6,723

 
5,771

Merchandise inventories
194,332

 
193,375

Deferred income taxes
4,622

 
7,118

Assets held for sale
4,283

 

Other current assets
16,371

 
13,792

Total current assets
282,873

 
264,022

Property and equipment, net
59,532

 
60,746

Long-term deferred income taxes
8,392

 
7,800

Other assets
3,471

 
3,089

TOTAL ASSETS
$
354,268

 
$
335,657

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
21,074

 
$
25,085

Accrued expenses and other
40,928

 
41,007

Total current liabilities
62,002

 
66,092

Deferred rent and other
13,858

 
13,922

Total liabilities
75,860

 
80,014

Stockholders’ equity:
 
 
 
Preferred stock, $.001 par value: 1,000,000 shares authorized; no shares outstanding

 

Common stock, $.001 par value: 50,000,000 shares authorized; 23,777,030 shares issued and 23,746,140 shares outstanding at December 29, 2012 and 23,022,654 shares issued and 22,991,764 shares outstanding at December 31, 2011
24

 
23

Treasury stock
(385
)
 
(385
)
Additional paid-in capital
193,388

 
186,089

Accumulated other comprehensive loss
(791
)
 
(727
)
Retained earnings
86,172

 
70,643

Total stockholders’ equity
278,408

 
255,643

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY
$
354,268

 
$
335,657





See notes to consolidated financial statements.

33


WEST MARINE, INC.
CONSOLIDATED STATEMENTS OF INCOME
FOR THE FISCAL YEARS ENDED DECEMBER 29, 2012, DECEMBER 31, 2011 AND JANUARY 1, 2011
(in thousands, except per share data)
 
 
2012
 
2011
 
2010
Net revenues
$
675,251

 
$
643,443

 
$
622,802

Cost of goods sold
477,145

 
458,444

 
447,161

Gross profit
198,106

 
184,999

 
175,641

Selling, general and administrative expense
172,837

 
162,860

 
160,838

Restructuring costs (recoveries) (Note 3)
99

 
(50
)
 
(261
)
Impairment of long-lived assets (Note 1)

 
50

 
180

Income from operations
25,170

 
22,139

 
14,884

Interest expense
841

 
918

 
637

Income before income taxes
24,329

 
21,221

 
14,247

Provision (benefit) for income taxes
8,800

 
(8,441
)
 
1,020

Net income
$
15,529

 
$
29,662

 
$
13,227

Net income per common and common equivalent share:
 
 
 
 
 
Basic
$
0.67

 
$
1.30

 
$
0.59

Diluted
$
0.65

 
$
1.27

 
$
0.57

Weighted-average common and common equivalent shares outstanding:
 
 
 
 
 
Basic
23,312

 
22,762

 
22,492

Diluted
23,771

 
23,286

 
23,014



See notes to consolidated financial statements.

34


WEST MARINE, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
FOR THE FISCAL YEARS ENDED DECEMBER 29, 2012, DECEMBER 31, 2011 AND JANUARY 1, 2011
(in thousands)

 
2012
 
2011
 
2010
Net income
$
15,529

 
$
29,662

 
$
13,227

Other comprehensive income (loss), net of tax
 
 
 
 
 
Foreign currency translation adjustment, net of tax of $0
(64
)
 
22

 
(243
)
Other comprehensive income (loss)
(64
)
 
22

 
(243
)
Total comprehensive income
$
15,465

 
$
29,684

 
$
12,984



See notes to consolidated financial statements.

35


WEST MARINE, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
FOR THE FISCAL YEARS ENDED DECEMBER 29, 2012, DECEMBER 31, 2011 AND JANUARY 1, 2011
(in thousands, except share data)
 
 
Common
Shares
Outstanding
 
Common
Stock
 
Treasury
Stock
 
Additional
Paid-in
Capital
 
Retained
Earnings
 
Accumulated
Other
Comprehensive
Income (Loss)
 
Total
Stockholders’
Equity
 
Balance at January 2, 2010
22,345,983

 
$
22

 
$
(385
)
 
$
177,459

 
$
27,754

 
$
(506
)
 
$
204,344

 
Net income
 
 
 
 
 
 
 
 
13,227

 
 
 
13,227

 
Foreign currency translation adjustment, net of tax of $0
 
 
 
 
 
 
 
 
 
 
(243
)
 
(243
)
 
Common stock issued under equity compensation plan
195,758

 
1

 
 
 
3,522

 
 
 
 
 
3,522

 
Tax benefit from equity issuance, including excess tax benefit of $283
 
 
 
 
 
 
292

 
 
 
 
 
292

 
Sale of common stock pursuant to Associates Stock Buying Plan
83,452

 
 
 
 
 
618

 
 
 
 
 
618

 
Balance at January 1, 2011
22,625,193

 
$
23

 
$
(385
)
 
$
181,891

 
$
40,981

 
$
(749
)
 
$
221,761

 
Net income
 
 
 
 
 
 
 
 
29,662

 
 
 
29,662

 
Foreign currency translation adjustment, net of tax of $0
 
 
 
 
 
 
 
 
 
 
22

 
22

 
Common stock issued under equity compensation plan
282,813

 
 
 
 
 
3,733

 
 
 
 
 
3,733

 
Tax deficiency from equity issuance, including excess tax benefit of $347
 
 
 
 
 
 
(204
)
 
 
 
 
 
(204
)
 
Sale of common stock pursuant to Associates Stock Buying Plan
83,758

 
 
 
 
 
669

 
 
 
 
 
669

 
Balance at December 31, 2011
22,991,764

 
$
23

 
$
(385
)
 
$
186,089

 
$
70,643

 
$
(727
)
 
$
255,643

 
Net income
 
 
 
 
 
 
 
 
15,529

 
 
 
15,529

 
Foreign currency translation adjustment, net of tax of $0
 
 
 
 
 
 
 
 
 
 
(64
)
 
(64
)
 
Common stock issued under equity compensation plan
667,281

 
1

 
 
 
6,990

 
 
 
 
 
6,991

 
Tax deficiency from equity issuance, including excess tax benefit of $380
 
 
 
 
 
 
(389
)
 
 
 
 
 
(389
)
 
Sale of common stock pursuant to Associates Stock Buying Plan
87,095

 
 
 
 
 
698

 
 
 
 
 
698

 
Balance at December 29, 2012
23,746,140

 
$
24

 
$
(385
)
 
$
193,388

 
$
86,172

 
$
(791
)
 
$
278,408

 

See notes to consolidated financial statements.

36


WEST MARINE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE FISCAL YEARS ENDED DECEMBER 29, 2012, DECEMBER 31, 2011 AND JANUARY 1, 2011
(in thousands)
 
 
2012
 
2011
 
2010
OPERATING ACTIVITIES:
 
 
 
 
 
Net income
$
15,529

 
$
29,662

 
$
13,227

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
 
Depreciation and amortization
15,301

 
14,314

 
14,926

Impairment of long-lived assets

 
50

 
180

Share-based compensation
3,128

 
2,394

 
2,506

Tax benefit (deficiency) from equity issuance
(389
)
 
(204
)
 
292

Excess tax benefit from share-based compensation
(380
)
 
(347
)
 
(283
)
Deferred income taxes
1,588

 
(12,745
)
 
(825
)
Provision for doubtful accounts
223

 
54

 
80

Lower of cost or market inventory adjustments
925

 
1,154

 
1,966

Loss (gain) on asset disposals
103

 
(13
)
 
192

Changes in assets and liabilities:
 
 
 
 
 
Trade receivables
(1,175
)
 
(220
)
 
(119
)
Merchandise inventories
(1,882
)
 
7,059

 
(6,922
)
Other current assets
(2,578
)
 
2,946

 
3,066

Other assets
(164
)
 
112

 
(582
)
Accounts payable
(4,769
)
 
(4,610
)
 
(4,358
)
Accrued expenses and other
329

 
(2,330
)
 
(440
)
Deferred items and other non-current liabilities
252

 
(47
)
 
1,987

Net cash provided by operating activities
26,041

 
37,229

 
24,893

INVESTING ACTIVITIES:
 
 
 
 
 
Proceeds from sale of property and equipment
122

 
64

 
71

Purchases of property and equipment
(17,953
)
 
(17,710
)
 
(14,139
)
Net cash used in investing activities
(17,831
)
 
(17,646
)
 
(14,068
)
FINANCING ACTIVITIES:
 
 
 
 
 
Borrowings on line of credit
5,224

 
28,758

 
46,890

Repayments on line of credit
(5,224
)
 
(28,758
)
 
(46,890
)
Payment of loan costs
(561
)
 

 
(980
)
Proceeds from exercise of stock options
3,863

 
1,339

 
1,017

Proceeds from sale of common stock pursuant to Associates Stock Buying Plan
698

 
669

 
618

Excess tax benefit from share-based compensation
380

 
347

 
283

Net cash provided by financing activities
4,380

 
2,355

 
938

Effect of exchange rate changes on cash
(14
)
 
9

 
(23
)
NET INCREASE IN CASH
12,576

 
21,947

 
11,740

CASH AT BEGINNING OF PERIOD
43,966

 
22,019

 
10,279

CASH AT END OF PERIOD
$
56,542

 
$
43,966

 
$
22,019

Other cash flow information:
 
 
 
 
 
Cash paid for interest
$
693

 
$
645

 
$
475

Cash paid (refunded) for income taxes
7,222

 
3,547

 
(2,325
)
Non-cash investing activities
 
 
 
 
 
Property and equipment additions in accounts payable
999

 
1,757

 
1,465



See notes to consolidated financial statements.

37


WEST MARINE, INC.
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 specialty retailer of boating supplies and has three reportable segments—Stores, Port Supply (wholesale) and Direct-to-Consumer (retail eCommerce, direct mail catalogs, and call center)—which all sell aftermarket recreational boating supplies directly to customers. At December 29, 2012, West Marine offered its products through 300 Company-operated stores in 38 states, Puerto Rico, Canada and five franchised stores in Turkey, through its call center channel and on the Internet. The Company is also engaged, through its Port Supply division and its stores, in the wholesale distribution of products to commercial customers and other retailers.
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. Fiscal years 2012, 2011 and 2010 consisted of the 52 weeks ended December 29, 2012, December 31, 2011 and January 1, 2011, respectively. References to 2012, 2011 and 2010 are to the fiscal years ended December 29, 2012, December 31, 2011 and January 1, 2011, respectively.
ACCOUNTING ESTIMATES—The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America 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; goodwill impairment; 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 for merchandising, replenishment and distribution activities. Indirect costs included in inventory value at the end of fiscal years 2012 and 2011 were $18.7 million million and $17.8 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 $2.0 million and $2.3 million at the end of fiscal years 2012 and 2011, 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 $2.7 million and $3.4 million at the end of fiscal years 2012 and 2011, 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 11 months. Advertising costs, which are included in selling, general and administrative (“SG&A”) expense, are expensed as incurred and were $6.4 million, $6.0 million and $5.6 million in 2012, 2011 and 2010, respectively. The capitalized value of prepaid catalog and advertising costs on the Balance Sheet was immaterial as of December 29, 2012 and December 31, 2011, respectively.
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:

38

Table of Contents                 
WEST MARINE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
 

 
 
 
 
 
 
 
  
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.
ASSETS HELD FOR SALE—The Company entered into an agreement to sell the land and building of its former Ft. Lauderdale store during the third quarter of fiscal 2012. The location has been vacant since the Company's new flagship store opened in November 2011. During the interim time, the Company was actively marketing the site for lease. On September 28, 2012, the Company received an offer for the site and has accepted the purchase agreement price of $4.5 million. The sale is subject to customary closing conditions and closing costs and is expected to close in March 2013. These assets have been removed from property, plant and equipment and are presented in the current assets section of the balance sheet as assets held for sale. The Company does not expect a significant gain or loss on the sale.
CAPITALIZED INTEREST—The Company capitalizes interest on major capital projects. The Company did not capitalize interest in 2012 and capitalized $0.1 million in 2011.
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.
INTANGIBLE ASSETS—The Company completes an impairment test annually or more frequently if evidence of possible impairment arises. No impairment was recognized in 2010, 2011 or 2012. Amortization expense for other intangible assets was less than $0.1 million in each of the years 2012, 2011 and 2010. Amortization expense in each of the next five years is not expected to be significant.
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 amount as a liability when incurred. Liabilities for asset retirement obligations were $0.8 million as of December 29, 2012, $0.8 million as of December 31, 2011 and $0.7 million as of January 1, 2011. There were no significant changes attributable to the following components during the 2012, 2011, or 2010 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 intangible assets and property and equipment, for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. If the estimated undiscounted future cash flows from the long-lived asset are less than the carrying value, a loss equal to the difference between carrying value and the fair market value of the asset is recorded. The Company recorded no asset impairment charges in 2012, less than $0.1 million in 2011 and $0.2 million in 2010.
FACILITY CLOSING COSTS—The Company records an obligation for the present value of estimated costs that will not be recovered in the period a store, distribution center or other facility is closed. These costs include employment termination benefits, lease contract termination costs and the book value of abandoned property. For more information, see Note 3.
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 which 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 10 years, including periods of free rent,

39

Table of Contents                 
WEST MARINE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
 

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.
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 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 we expect those temporary differences to be recovered or settled. We recognize the effect of changes in tax rates on deferred tax assets and liabilities in the period that includes the enactment date of the change. In determining our provision for income taxes, we use an annual effective income tax rate based on annual income, permanent differences between book and taxable income, and statutory income tax rates. The effective tax rate is adjusted as additional information becomes available. The effective rate also reflects our assessment of the ultimate outcome of tax audits. Discrete events such as audit settlements and changes in tax laws are recognized in the period in which they occur. 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 8.
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 accounting principles generally accepted in the United States, or 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—Include 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 29, 2012, the entire $56.5 million of the Company's cash consisted of cash on hand and bank deposits and was classified within Level 1 because they were valued using quoted market prices. As of December 31, 2011, the entire $44.0 million of the Company's cash consisted of cash on hand and bank deposits and was classified within Level 1 because they were valued using quoted market prices.
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. Reserves for sales returns were as follows:
 
 
2012
 
2011
 
2010
 
 
 
(in thousands)
 
 
Reserve for product sales returns—beginning balance
$
(1,082
)
 
$
(995
)
 
$
(924
)
Additions
(1,702
)
 
(1,792
)
 
(1,614
)
Deductions
1,655

 
1,705

 
1,543

Reserve for product sales returns—ending balance
$
(1,129
)
 
$
(1,082
)
 
$
(995
)

ACCOUNTS RECEIVABLE—Accounts receivable consists of amounts owed to West Marine for sales of services or goods on credit for our wholesale 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 financial condition of our customers and the economic risks for certain customers. The allowances for doubtful accounts receivable were as follows:

40

Table of Contents                 
WEST MARINE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
 

 
 
2012
 
2011
 
2010
 
 
 
(in thousands)
 
 
Allowance for doubtful accounts receivable—beginning balance
$
(301
)
 
$
(431
)
 
$
(580
)
Additions
(788
)
 
(687
)
 
(701
)
Deductions and other adjustments
811

 
817

 
850

Allowance for doubtful accounts receivable—ending balance
$
(278
)
 
$
(301
)
 
$
(431
)

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 2012, 2011 and 2010 were $18.7 million, $15.4 million and $14.4 million, respectively. 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 future redemption of the card by the customer is remote, also called breakage. Breakage for unused gift cards is recognized using the redemption recognition method. 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 2012, 2011 and 2010 was $0.8 million, $0.6 million and $0.5 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. 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.
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.
COMPREHENSIVE INCOME (LOSS)—Comprehensive income (loss) 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 2012, 2011 and 2010 were $0.1 million, $(0.2) million and $0.4 million, respectively.
ACCRUED EXPENSES—Accrued expenses consist of the following (in thousands):
 
 
2012
 
2011
Accrued compensation and benefits
$
12,184

 
$
10,617

Accrued bonus
4,705

 
3,560

Unredeemed gift cards
6,765

 
6,585

Other accrued expenses
17,274

 
20,245

Accrued expenses
$
40,928

 
$
41,007


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

41

Table of Contents                 
WEST MARINE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
 

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, 2.2 million shares and 2.1 million shares of common stock that were outstanding in 2012, 2011 and 2010, 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):
 
 
2012
 
2011
 
2010
 
Shares
 
Net Income
Per  Share
 
Shares
 
Net Income
Per  Share
 
Shares
 
Net Income
Per  Share
Basic
23,312

 
$
0.67

 
22,762

 
$
1.30

 
22,492

 
$
0.59

Effect of dilutive stock options
459

 
(0.02
)
 
524

 
(0.03
)
 
522

 
(0.02
)
Diluted
23,771

 
$
0.65

 
23,286

 
$
1.27

 
23,014

 
$
0.57


DERIVATIVE INSTRUMENTS—The Company did not purchase or hold any derivative financial instruments during the three years ended December 29, 2012.
CASH AND CASH EQUIVALENTS—Cash consists entirely of cash on hand and bank deposits, of which approximately $54.3 million exceeded FDIC insurance limits as of December 29, 2012. As of December 29, 2012, the Company had no cash equivalents. As of December 31, 2011, approximately $42.6 million exceeded FDIC insurance limits. As of December 31, 2011, the Company had no cash equivalents.
We had no outstanding checks in excess of funds on deposit (book overdrafts) at December 29, 2012.
SABBATICAL LEAVE—Certain full-time associates are eligible to receive sabbatical leave after each 10 years of continuous employment. The estimated sabbatical liability is based on a number of factors, including actuarial assumptions and historical trends. In fiscal years 2012 and 2011, the Company had a recorded liability of $1.0 million and $0.9 million, respectively, as an estimate of accumulated sabbatical leave as of the respective balance sheet dates.
NOTE 2: SHARE-BASED COMPENSATION
West Marine’s Omnibus Equity Incentive Plan (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 upon whose judgment, interest and special effort the successful conduct of its operation is largely dependent. The Plan permits a variety of compensation methods, including non-qualified stock options, incentive stock options, restricted stock, restricted stock units and other share-based awards. All associates and non-employee directors are eligible to participate under the Plan, with the exception of Randolph K. Repass, Chairman of the Company’s Board of Directors and a significant, but not controlling, stockholder. At year-end 2012, 10,300,000 shares of common stock had been reserved under the Plan and 1,836,467 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 share awards, restricted stock units and Associates Stock Buying Plan ("Buying Plan") issuances, each as described further below.
Share-based compensation expense for 2012, 2011 and 2010 was approximately $3.1 million, $2.4 million and $2.5 million, respectively, of which expense for stock options was $1.9 million, $1.8 million and $2.2 million in 2012, 2011 and 2010, respectively. In 2012, the Company recognized $0.4 million in tax benefits from stock options exercised, restricted stock vested and disqualifying Buying Plan transactions, of which $0.4 million was recognized as excess tax benefits in additional paid-in capital and $0.4 million was recognized as cash flow from financing activities. In 2011, the Company recognized $0.2 million in tax benefits from stock options exercised, restricted stock vested and disqualifying Buying Plan transactions, of which $0.3 million was recognized as excess tax benefits in additional paid-in capital and $0.3 million was recognized as cash flow from financing activities. In 2010, the Company recognized $0.3 million in tax benefits from stock options exercised, restricted stock vested and disqualifying stock purchase plan transactions, of which $0.3 million was recognized as excess tax benefits in additional paid-in capital and $0.3 million was recognized as cash flow from financing activities. The tax benefit was included in the Company’s consolidated statement of operations for the same period. Share-based compensation of $0.5 million was included in capitalized indirect inventory in 2012, $0.4 million in 2011 and $0.3 million in 2010.

42

Table of Contents                 
WEST MARINE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
 

Included in cost of goods sold and SG&A expense is share-based compensation expense, net of estimated forfeitures, that have been included in the statements of operations for all share-based compensation arrangements as follows:
 
(in thousands)
2012
 
2011
 
2010
Cost of goods sold
$
542

 
$
409

 
$
334

Selling, general and administrative expense
2,586

 
1,985

 
2,172

Share-based compensation expense
$
3,128

 
$
2,394

 
$
2,506


Stock Options
West Marine awards 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 expire five years following the grant date. Grants in 2006 vested over four years and generally expired five years from the grant date. Grants in 2011 and 2012 vest over three years and expire seven years from the grant date. Prior to 2011, options granted to non-employee directors vested after six months and expire five years from the grant date. Options granted to non-employee directors in 2012 vest 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. The Company has determined the fair value of options awarded by applying the Black-Scholes Merton option pricing valuation model and using following assumptions:
 
 
2012
 
2011
 
2010
Expected price volatility
49
%
 
49
%
 
51
%
Risk-free interest rate
0.5% - 0.6%

 
1.4
%
 
0.9% - 1.7%

Weighted-average expected term (years)
4.5

 
4.5

 
3.5

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.
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 2012, 2011 and 2010 is as follows:
 

43

Table of Contents                 
WEST MARINE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
 

 
Number of
Shares
 
Weighted
Average
Exercise
Price
 
Weighted
Average
Option
Grant Date
Fair Value
Outstanding at year-end 2009 (1,969,741 stock options exercisable at a weighted-average exercise price of $15.32)
3,636,572

 
11.37

 
5.80

Granted
734,875

 
10.95

 
4.12

Exercised
(184,995
)
 
5.49

 
2.82

Forfeited
(79,856
)
 
8.11

 
2.89

Expired
(354,795
)
 
18.84

 
12.00

Outstanding at year-end 2010 (2,238,084 stock options exercisable at a weighted-average exercise price of $12.85)
3,751,801

 
10.93

 
5.08

Granted
452,887

 
10.36

 
4.27

Exercised
(270,721
)
 
4.95

 
1.77

Forfeited
(96,340
)
 
8.56

 
3.18

Expired
(303,087
)
 
13.71

 
5.57

Outstanding at year-end 2011 (2,492,684 stock options exercisable at a weighted-average exercise price of $11.72)
3,534,540

 
11.14

 
5.24

Granted
361,636

 
10.69

 
4.28

Exercised
(642,246
)
 
6.07

 
2.04

Forfeited
(35,256
)
 
10.01

 
3.91

Expired
(701,943
)
 
15.92

 
7.84

Outstanding at year-end 2012 (1,678,468 stock options exercisable at a weighted-average exercise price of $11.25)
2,516,731

 
11.05

 
5.21


The weighted-average grant date fair value of options granted in 2012, 2011 and 2010 was $4.28, $4.27 and $4.12 per share, respectively. The aggregate fair value of options vested during 2012, 2011 and 2010 was $3.3 million, $4.2 million and $5.4 million, respectively.
As of market close December 29, 2012, the aggregate intrinsic value for stock options outstanding was $4.1 million, and $3.9 million for exercisable options. The total intrinsic value of options actually exercised was $3.0 million in 2012, $1.3 million in 2011 and $0.9 million in 2010. In 2012, the weighted-average grant date fair value of options granted was $4.28 per share. There were 1,103,102 options that vested in 2012 with an aggregate grant date fair value of $3.3 million. At December 29, 2012, unrecognized compensation expense for stock options, net of expected forfeitures, was $2.5 million, with a weighted-average remaining expense recognition period of 1.8 years.
Additional information for options outstanding at year-end 2012 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
$        0 – $  7.00
705,786

 
1.0

 
$
5.25

 
705,786

 
1.0

 
$
5.25

7.01 –   10.75
683,071

 
5.8

 
10.31

 
141,742

 
5.4

 
10.35

10.76 –   15.54
776,599

 
2.8

 
11.35

 
479,665

 
2.2

 
11.40

15.55 –   22.00
167,195

 
0.4

 
16.22

 
167,195

 
0.4

 
16.22

22.01 –   29.70
184,080

 
1.2

 
29.50

 
184,080

 
1.2

 
29.50

$       0 –   29.70
2,516,731

 
2.8

 
$
11.05

 
1,678,468

 
1.7

 
$
11.25


At December 29, 2012, there were 1,787,251 stock options expected to vest in the future, with an intrinsic value of $2.9 million, a weighted-average exercise price of $9.16 per share and a weighted-average remaining contractual term of 0.8 years.

44

Table of Contents                 
WEST MARINE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
 

Restricted Share Awards
The Plan also provides for awards of shares to eligible associates and non-employee directors that are subject to restrictions on transfer for a period of time (“restricted shares”). Vesting of restricted shares for eligible associates and non-employee directors is subject to continuing service to West Marine. Restricted shares granted to non-employee directors in 2011 vest 100% one year after the grant date. No restricted shares were awarded in 2012. Compensation expense for restricted share awards was $0.1 million in 2012. There was no unrecognized compensation expense for unvested restricted share awards, net of expected forfeitures, in 2012. A summary of restricted share activity in 2012, 2011 and 2010 is as follows:
 
 
Number of
Shares
 
Weighted
Average
Grant
Date Fair
Value
Unvested at year-end 2009 (weighted-average remaining vesting period of 0.4 years)
7,025

 
5.97

Granted
7,303

 
10.60

Vested
(7,025
)
 
5.97

Forfeited

 


Unvested at year-end 2010 (weighted-average remaining vesting period of 0.5 years)
7,303

 
10.60

Granted
13,347

 
9.95

Vested
(7,303
)
 
10.60

Forfeited

 
 
Unvested at year-end 2011 (weighted-average remaining vesting period of 0.5 years)
13,347

 
9.95

Granted

 
 
Vested
(13,347
)
 
9.95

Forfeited

 
 
Unvested at year-end 2012

 


The weighted-average grant date fair value of restricted shares granted in 2011 and 2010 was $9.95 and $10.60 per share, respectively. There were no restricted shares granted in 2012. The total fair value of restricted shares vested in 2012, 2011 and 2010 was $0.1 million, $0.1 million and less than $0.1 million, respectively.
Restricted Stock Units
The Plan also provides for awards of restricted stock units (“RSU's”) to eligible associates and non-employee directors that are subject to the recipient's continuing service to the Company. RSU's granted to eligible associates in 2011 and 2012 vest over a three-year period at the rate of 33%, 33% and 34% on the anniversary of the grant date. RSU's granted to eligible non-employee directors in 2012 vest on the one-year anniversary of the grant date. Compensation expense for RSU's was $0.9 million in 2012. Unrecognized compensation expense for unvested RSU's, net of expected forfeitures, was $2.2 million in 2012. A summary of RSU activity in 2012 and 2011 is as follows:
 
 
Number of
RSU's
 
Weighted
Average
Grant
Date Fair
Value
Unvested at year-end 2010

 
 
Granted
134,544

 
10.36

Vested

 
 
Forfeited
(1,406
)
 
10.36

Unvested at year-end 2011 (weighted-average remaining vesting period of 2.4 years)
133,138

 
10.36

Granted
188,001

 
10.56

Vested
(44,052
)
 
 
Forfeited
(2,236
)
 
10.34

Unvested at year-end 2012 (weighted-average remaining vesting period of 2.0 years)
274,851

 
10.50



45

Table of Contents                 
WEST MARINE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
 

The weighted-average grant date fair value of RSU's granted in 2012 and 2011 was $10.56 and $10.36 per share. The total fair value of RSUs vested in 2012 was $0.5 million.
Associates Stock Buying Plan
The Company has a Buying Plan under which all 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 2012, 2011 and 2010 were 87,095, 83,758 and 83,452, respectively. Expense recognized in 2012 was $0.2 million. Expense recognized in each of the years 2011 and 2010 was $0.3 million. Shares available for future issuance under the Buying Plan at the end of 2012, 2011 and 2010 were 504,743, 591,838 and 675,596, respectively. Assumptions used in determining the fair value of shares issued under the Buying Plan during 2012, 2011 and 2010 were as follows:
 
 
2012
 
2011
 
2010
Expected price volatility
39%-49%

 
36%-67%

 
52%-60%

Risk-free interest rate
0.1%-0.2%

 
0.1
%
 
0.2%-0.3%

Weighted-average expected term (years)
0.5

 
0.5

 
0.5

Dividend yield

 

 

Manager Share Appreciation Plan

During 2012, West Marine introduced and awarded a new form of compensation, the Manager Share Appreciation Plan (“MSAP”). This award is a long-term cash incentive intended to both motivate and reward certain West Marine Associates. The MSAP award is a cash incentive which is tied to appreciation in West Marine's stock price. The appreciation on MSAP awards is capped. The plan is cash-settled plan and earned by associates over a number of years; therefore, it is within the scope of Accounting Standards Codification 718, Compensation - Stock Compensation because the amount earned by the associates is based on the price of the Company's stock. Additionally, since the award is settled in cash, the fair value of the award is recorded as a liability, rather than equity. As such, the Company re-measures the awards at fair value each reporting period until the award is 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 are used to determine the fair values of the awards that have been granted. The Company is using the forfeiture rate of its non-qualified stock options, since the Company does not have sufficient history of the MSAP awards. The Company believes this is a reasonable interim assumption until the Company has sufficient forfeiture history on these awards. The fair value of the award at December 29, 2012 was $2.04 per award. Assumptions used in determining the fair value of the MSAP awards during 2012 were as follows:

 
2012
 
Expected price volatility
45
%
 
Risk-free interest rate
0.6
%
 
Weighted-average expected term (years)
4.2

 
Dividend yield

 
There were 162,125 grants of MSAP awards on June 1, 2012, to eligible associates. During 2012, there were 13,375 MSAP forfeitures resulting in net MSAP shares of 148,750. The MSAP compensation expense recorded for 2012 was $0.1 million and the corresponding liability at December 29, 2012 was also $0.1 million.
NOTE 3: RESTRUCTURING COSTS
Restructuring charges include severance costs, lease termination fees, legal and professional fees paid for lease termination negotiations, and other costs associated with the closure of facilities that are part of formal restructuring plans. Severance benefits are detailed in approved severance plans, which are specific as to number, position, location and timing. In addition, severance benefits are communicated in specific detail to affected employees and are unlikely to change when costs

46


are recorded. Costs are recognized over the period services are rendered, otherwise they are recognized when they are communicated to the employees. These costs are not material to any reportable segment. Other associated costs, such as legal and professional fees, are expensed as incurred. Accrued liabilities related to costs associated with restructuring activities outstanding as of December 29, 2012 were $0.9 million. Restructuring charges are expected to be fully paid by April 2019, and the cumulative amount incurred through December 29, 2012 is $20.2 million. The restructuring charges are reflected on the consolidated statement of income on the restructuring costs (recoveries) line.
Costs and obligations (included in “Accrued liabilities” in the Company’s consolidated balance sheets) recorded in 2012, 2011 and 2010 in conjunction with the restructuring costs are as follows (in thousands):
 
 
Termination
Benefits
and Other
Costs
 
Store Lease
Termination
Costs
 
Total
Ending balance, January 2, 2010
$
590

 
$
3,936

 
$
4,526

Reduction in charges
(45
)
 
(216
)
 
(261
)
Payments
(252
)
 
(1,771