SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

BUSINESS—West Marine Inc. and its consolidated subsidiaries (“West Marine” or the “Company,” unless the context requires otherwise) is the largest waterlife outfitter in the United States. At January 3, 2015, West Marine offered its products through 279 stores in 38 states, Puerto Rico and Canada, through its call center channel and on the Internet. As previously disclosed, over the next few years, to ensure focus on and to enable the Company to redirect resources for investment in its growth strategies, the Company will be closing each of our Canadian stores as leases expire. The first of these ten stores closed in January 2015 and the Company is planning to close six more stores by September 2015. The Company is also engaged, through its wholesale channel in the wholesale distribution of marine equipment serving boat manufacturers, marine services, commercial vessel operations and government agencies.

West Marine is an omni channel retail organization operating one reporting segment in accordance with the Financial Accounting Standards Board ("FASB") Accounting Standards Codification ("ASC") Topic 280, Segment Reporting. The metrics used by our Chief Executive Officer (as the Company's chief operating decision maker or the "CODM") to assess the performance of the Company are focused on viewing the business as a single integrated business. The CODM's process for allocating resources is based upon the omni-channel view of the Company. Additionally, the Company has integrated systems and concentrated its strategic focus on omni-channel retailing. In addition, the Company has commingled sales channel payroll expense, inventories, merchandise procurement and distribution networks. Revenues from customers are derived from merchandise sales and the Company does not rely on any individual major customers.

The Company considers its merchandise expansion strategy to be strategically important to the future success of the Company and is providing the following product category information. The Company's merchandise mix over the last three years is reflected in the table below:



	2014		2013		2012
Core boating products	81.3	%	83.5	%	84.7	%
Merchandise expansion products	18.7	%	16.5	%	15.3	%
Total	100.0	%	100.0	%	100.0	%

The Company considers core boating products to be maintenance related products, electronics, sailboat hardware, anchors/docking/moorings, engine systems, safety, electrical, plumbing, boats, outboards, ventilation, deck hardware/fasteners, navigation, trailering, seating/boat covers and barbecues/appliances. The Company considers its merchandise expansion products to be comprised of apparel, footwear, clothing accessories, fishing, watersports, paddlesports, coolers, bikes and cabin/galley.

West Marine was incorporated in Delaware in September 1993 as the holding company for West Marine Products, Inc., which was incorporated in California in 1976. The Company’s principal executive offices are located in Watsonville, California.

PRINCIPLES OF CONSOLIDATION—The consolidated financial statements include the accounts of West Marine, Inc. and its subsidiaries, all of which are wholly-owned, directly or indirectly. Intercompany balances and transactions are eliminated in consolidation.

YEAR-END—The Company’s fiscal year consists of 52 or 53 weeks, ending on the Saturday closest to December 31 and as a result, a 53-week year occurs every 5 to 6 years. The 2014 fiscal year consisted of the 53 weeks ended January 3, 2015 and fiscal years 2013 and 2012 consisted of the 52 weeks ended December 28, 2013 and December 29, 2012, respectively. References to 2014, 2013 and 2012 are to the fiscal years ended January 3, 2015, December 28, 2013 and December 29, 2012, 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 center activities. Indirect costs included in inventory value at the end of fiscal years 2014 and 2013 were $19.9 million and $18.9 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 $2.2 million and $2.4 million at the end of fiscal years 2014 and 2013, 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 $3.5 million and $3.0 million at the end of fiscal years 2014 and 2013, 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 $16.0 million, $14.7 million and $15.9 million in 2014, 2013 and 2012, respectively. Advertising costs were partially offset by vendor allowances of $10.6 million, $9.8 million and $9.5 million in 2014, 2013 and 2012, respectively, which are included in cost of goods sold. The capitalized value of prepaid catalog and advertising costs on the Balance Sheet was immaterial as of January 3, 2015 and December 28, 2013, 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:




			Estimated Useful Lives
	Furniture and equipment		3–7 years
	Computer software and hardware		3–7 years
	Buildings		25 years

Leasehold improvements are amortized over the lesser of the expected lease term or the estimated useful life of the improvement which is usually about 10 years.

CAPITALIZED INTEREST—The Company capitalizes interest on major capital projects. The Company did not capitalize interest in 2014, 2013 and 2012.

CAPITALIZED SOFTWARE COSTS—Capitalized computer software, included in property and equipment, reflects costs related to internally-developed or purchased software that are capitalized and amortized on a straight-line basis, generally over a period ranging from three to seven years.

ASSET RETIREMENT OBLIGATIONS—The Company estimates the fair value of obligations to clean up and restore leased properties under agreements with landlords and records the amount as a liability when incurred. Liabilities for asset retirement obligations were $0.6 million as of January 3, 2015, and $0.7 million as of December 28, 2013. There were no significant changes attributable to the following components during the 2014, 2013 or 2012 reporting periods: liabilities incurred, liabilities settled, accretion expense, and revisions in estimated cash flows.

IMPAIRMENT OF LONG-LIVED ASSETS—The Company reviews long-lived assets, including property and equipment, for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. If 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 fiscal years 2014, 2013 and 2012.

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. Accrued liabilities related to costs associated with facility closing activities as of January 3, 2015 and December 28, 2013 were $0.6 million and$0.7 million and consist primarily of lease termination fees. These facility closing charges are expected to be fully paid by April 2019. These costs are included in the Selling, general and administrative expense line on the Company's Consolidated Statements of Income and were $0.1 million, less than $0.1 million and $0.1 million in 2014, 2013 and 2012, respectively.

On September 25, 2014, management presented and the Board of Directors approved the Company’s strategic plan which included a plan to exit all of its Canadian stores as the leases expired and a withdrawal from the country. As such, the Board determined that it would be in the best interests of the Company and its stockholders to continue the Company’s focus of time and resources on its domestic growth strategies. In accordance with ASC 712, Nonretirement Postemployment Benefits, the Company recorded a $0.1 million restructuring charge in the third quarter of 2014 for severance costs. Additionally, in accordance with ASC 420-10, Exit or Disposal Cost Obligations, the Company expects to record an additional $0.1 million for future termination benefits over the next three years. Other associated costs, such as legal and professional fees, will be expensed as incurred. The restructuring charges are and will be reflected on the consolidated statements of income as part of SG&A. As of January 3, 2015, we have accrued $0.1 million for Canadian exit activities which is included in the $0.1 million restructuring costs for 2014.

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, and records the difference between the amount charged to rent expense and the rent paid as deferred rent. Tenant improvement allowances received from landlords are deferred and amortized to reduce rent expense over the expected life of the lease. As of January 3, 2015 and December 28, 2013, deferred rent totaled $12.0 million and $10.9 million, respectively. Deferred rent is included in the Deferred rent and other line item on the Company's consolidated balance sheet.

INCOME TAXES—Income taxes are accounted for using the asset and liability method. Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to the differences between existing financial statement carrying amounts and their respective tax bases, and 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. A valuation allowance is recorded to reduce deferred tax assets to the amount estimated as more likely than not to be realized. The Company also accounts for uncertainties in income taxes recognized in its financial statements. For more information, see Note 7.

SALES AND USE TAX—Net revenues are recorded net of sales and use taxes. Net sales and use taxes are collected and remitted to all jurisdictions in which the Company has a physical presence in accordance with state, provincial and local tax laws.

FAIR VALUE OF FINANCIAL INSTRUMENTS—Fair value of financial instruments represents the price that would be received to sell an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability.

The fair value hierarchy prescribed under accounting principles generally accepted in the United States ("GAAP") contains three levels, which prioritizes the inputs used in the valuation methodologies in measuring fair value:

Level 1—Observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets.

Level 2—Other inputs that are directly or indirectly observable in the marketplace.

Level 3—Unobservable inputs which are supported by little or no market activity.

The fair value hierarchy also requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. As of January 3, 2015 and December 28, 2013, there were no financial instruments which require disclosure under the fair value hierarchy.

REVENUE RECOGNITION—Sales, net of estimated returns, are recorded when merchandise is purchased by customers at store locations. Revenue is recognized when merchandise shipped from a warehouse is received by the customer, based upon the estimated date of receipt by the customer. The Company reserves for sales returns through estimates based on historical experience. The sales return reserve for fiscal years 2014, 2013, and 2012 was $(1.2) million, $(1.6) million and $(1.1) million, respectively.

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:



	2014			2013			2012
				(in thousands)
Allowance for doubtful accounts receivable—beginning balance	$	(243	)	$	(277	)	$	(301	)
Additions	(307		)	(325		)	(788		)
Deductions and other adjustments	303			359			812
Allowance for doubtful accounts receivable—ending balance	$	(247	)	$	(243	)	$	(277	)

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 2014, 2013 and 2012 were $18.1 million, $18.1 million and $18.7 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 2014, 2013 and 2012 was $0.7 million, $0.8 million and $0.8 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. As of January 3, 2015 and December 28, 2013, the Company had a recorded liability for the West Advantage customer loyalty program of $1.2 million and $0.8 million, respectively.

COST OF GOODS SOLD—Cost of goods sold includes costs related to the purchase, transportation and storage of merchandise, shipping expense and store occupancy costs. Consideration in the form of cash or credits received from vendors is recorded as a reduction to cost of goods sold as the related products are sold.

VENDOR ALLOWANCES—The Company receives various payments and allowances from its vendors through a variety of programs and arrangements. Monies received from vendors include rebates, allowances and promotional funds. The amounts to be received are subject to the terms of the vendor agreements, which are subject to ongoing negotiations that may be impacted in the future based on changes in market conditions, vendor marketing strategies and changes in the profitability or sell-through of the related merchandise.

Rebates and other miscellaneous incentives are earned based on purchases, receipts or product sales and are accrued ratably over the purchase or sale of the related product. These monies are recorded as a reduction of merchandise inventories based on inventory turns and as the product is sold.

COMPREHENSIVE INCOME (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 2014, 2013 and 2012 were $(0.5) million, $(0.6) million and $0.1 million, respectively.

ACCRUED EXPENSES—Accrued expenses consist of the following (in thousands):



	2014		2013
Accrued compensation and benefits	$	10,748	$	7,251
Accrued paid time off	3,496		4,125
Accrued bonus	9		7
Unredeemed gift cards	7,152		6,854
Other accrued expenses	19,517		19,054
Accrued expenses	$	40,922	$	37,291

NET INCOME PER SHARE—Basic net income per share is computed by dividing net income available to common stockholders by the weighted average number of common shares outstanding during the period. Diluted net income per share reflects the potential dilution that could occur if unvested restricted shares and outstanding options to purchase common stock were exercised. Options to purchase approximately 0.7 million shares, 0.2 million shares and 0.5 million shares of common stock that were outstanding in 2014, 2013 and 2012, 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):



	2014			2013			2012
	Shares	Net Income Per Share		Shares	Net Income Per Share		Shares	Net Income Per Share
Basic	24,244	$	0.08	24,259	$	0.32	23,312	$	0.63
Effect of dilutive stock options	164	—		342	—		459	(0.01		)
Diluted	24,408	$	0.08	24,601	$	0.32	23,771	$	0.62

DERIVATIVE INSTRUMENTS—The Company did not purchase or hold any derivative financial instruments during the three years ended January 3, 2015.

CASH AND CASH EQUIVALENTS—Cash consists entirely of cash on hand and bank deposits, of which approximately $43.2 million exceeded FDIC insurance limits as of January 3, 2015. As of December 28, 2013, approximately $46.3 million exceeded FDIC insurance limits.

The Company classifies amounts in transit from banks for customer credit card and debit card transactions as cash and cash equivalents as the banks process the majority of these amounts within three to five business days. The amounts due from banks for these transactions classified as cash and cash equivalents totaled $3.3 million and $2.8 million at January 3, 2015 and December 28, 2013, respectively

We had no outstanding checks in excess of funds on deposit (book overdrafts) at January 3, 2015 and December 28, 2013.

SABBATICAL LEAVE—Certain full-time associates are eligible to receive sabbatical leave after each 5 years of continuous employment. The estimated sabbatical liability is based on a number of factors, including actuarial assumptions and historical trends. In fiscal years 2014 and 2013, the Company had a recorded liability of $1.3 million and $1.0 million, respectively, as an estimate of accumulated sabbatical leave as of the respective balance sheet dates.

Recently Issued Accounting Pronouncements

In March 2013, FASB issued Accounting Standards Update ("ASU") 2013-05, Foreign Currency Matters, (Topic 830), which clarifies the accounting for the release of a cumulative translation adjustment into net income when a parent either sells a part or all of its investment in a foreign entity or no longer holds a controlling financial interest in a subsidiary or group of assets that is a nonprofit activity or a business within a foreign entity. The new standard was effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2013. The adoption of this guidance did not have a material impact on the Company's financial statements.

In July 2013, FASB issued ASU 2013-11, Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists. This guidance requires an entity to net its liability for unrecognized tax positions against a net operating loss carryforward, a similar tax loss or a tax credit carryforward when settlement in this manner is available under the tax law. The provisions of this guidance were effective as of the beginning of the 2014 fiscal year and did not have a material impact on the Company's consolidated financial statements.

In April 2014, FASB issued ASU 2014-08, Reporting of Discontinued Operations and Disclosures of Disposals of Components of an Entity. ASU 2014-08 provides a narrower definition of discontinued operations than the definition under existing GAAP. The new guidance requires that only disposal of a component of an entity, or a group of components of an entity, that represents a strategic shift that has, or will have, a major effect on the reporting entity's operations and financial results should be reported in the financial statements as discontinued operations. ASU 2014-08 also provides guidance on the financial statement presentations and disclosures of discontinued operations. ASU 2014-08 is effective prospectively for disposals (or classifications as held for disposal) of components of an entity that occur in annual or interim periods beginning after December 15, 2014. The Company is currently evaluating the new standard, but does not expect the adoption of ASU 2014-08 will have a material impact on the Company's consolidated financial statements.

In May 2014, FASB issued ASU 2014-09, Revenue from Contracts with Customers. ASU 2014-09 supersedes the revenue recognition requirements in Topic 605, Revenue Recognition and requires entities to recognize revenue in a way that depicts the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. ASU 2014-09 is effective retrospectively for annual or interim reporting periods beginning after December 15, 2016 with early application not permitted. The Company is currently evaluating the new standard, and has not concluded whether the adoption of ASU 2014-09 will have a material impact on the Company's consolidated financial statements.