10-K 1 wmar201610-k.htm 10-K Document
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 31, 2016
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 July 1, 2016, 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 $155.0 million based on the closing sale price of $8.52, 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 16, 2017
Common stock, $.001 par value per share
  
25,001,598 shares
DOCUMENTS INCORPORATED BY REFERENCE
Document
  
Parts Into Which Incorporated
Proxy Statement for the Annual Meeting of Stockholders to be held on June 1, 2017
  
Part II, Item 5 and Part III



WEST MARINE, INC.
2016 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.
 
 
 
Item 16.
 


 



i


PRELIMINARY NOTE
This Annual Report on Form 10-K is for the year ended December 31, 2016 ("this report"). 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 2016, 2015 and 2014 in this report refer to our fiscal years ended on December 31, 2016, January 2, 2016 and January 3, 2015, respectively. Fiscal year 2014 was a 53-week year, while both fiscal years 2016 and 2015 were 52-week years.


ii


PART I
ITEM 1—BUSINESS
General
Each person has a unique connection to the water. At West Marine, our knowledge, enthusiasm and products prepare waterlife adventurers to foster that connection and explore their passions. With 254 stores located in 38 states, Puerto Rico and Canada, and two eCommerce websites reaching domestic, international and professional customers, West Marine is recognized as a leading waterlife outfitter for cruisers, sailors, anglers and paddlesports enthusiasts. Since first opening our doors in 1968, West Marine associates continue to share the same love for the water as our customers and provide helpful advice on the gear and gadgets they need to be safe and have fun.
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,” 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.
Business Strategies
West Marine is a leading omni-channel specialty retailer in our industry, serving people who enjoy recreating on or around the water. We offer a broad selection of core boating and water recreation products through physical stores and two eCommerce websites, primarily serving the needs of boat owners and professionals who provide services to them.
Over the past few years, we have implemented three key strategies to broaden the scope and appeal of West Marine as a waterlife outfitter, while maintaining our position as a leading boat parts specialty retailer. To expand our brand position, we have been focusing our efforts and investments on our omni-channel business model to improve our operating margin, grow our customer base and increase revenues. Our strategic goals are reflected in our "15/50 plan".
eCommerce
The first number in the 15/50 plan reflects our objective to grow our eCommerce business to 15% of total sales by the end of 2019. Over the past several years, we have invested in our retail and professional eCommerce websites, serving our retail and professional customers at westmarine.com and westmarinepro.com, respectively. In 2016, our eCommerce channel grew by 19.7% and represented 11.4% of our 2016 sales, furthering progress toward our 15% goal. We believe the enhancements we have made will continue to drive growth and strengthen our omni-channel shopping experience. Additionally, we have augmented the westmarine.com website with outlet store pages, which allows us to offer special promotional items to our customers, and we have improved functionality with features such as inventory on hand at specific stores and more efficient check out processes.
Store Optimization
The second number in the 15/50 plan reflects our goal of deriving 50% of total sales from our optimized and revitalized stores, which we refer to as waterlife stores. We achieved this goal in 2016, which is earlier than we originally projected, and we expect to continue to increase the number of waterlife stores that provide an enhanced shopping experience for our customers, both in terms of store design and expanded product assortment. Our store optimization strategy has evolved over time from store consolidations, where we create fewer and better stores in our major markets, to include revitalizations of select stores. In connection with the store consolidation component of our store optimization strategy, during 2016, we opened five stores, while closing nine stores in those same markets. A store revitalization consists of light remodeling, space optimization, product assortment changes, new product category introduction and associate training. We also deploy more flexible fixtures that enable us to vary our seasonal product assortments in a more cost effective manner. These changes allow us to offer merchandise expansion products, appeal to a broader base of customers, and provide the space and flexibility to appropriately transition products as the seasons change. During 2016, we revitalized 18 stores in key markets and expect to revitalize up to 10 stores in 2017. For more information, see "Stores" below.
We ended the year with an aggregate of 2.56 million total square feet of space for all stores, down from 2.61 million square feet at the end of 2015, largely the result of store optimization and closing under-performing stores.
Merchandise Expansion
Our eCommerce and store optimization strategies are supported by our merchandise expansion product categories. This strategy also welcomes a broader base of customers who are passionate about recreating on and around the water by providing a wider selection of products. We offer this expanded assortment in our waterlife stores and on our eCommerce website, and a selection of these products also are offered in revitalized stores. During 2016, sales of this group of products increased by 2.0%. In an effort to accelerate our merchandise expansion strategy, we are further increasing the balance of products in certain categories,

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such as footwear, clothing and paddlesports, in our waterlife stores. Additionally, we are testing new product categories to better serve our customers and further position West Marine as the foremost authority for all waterlife needs and wants.
Merchandising
Our merchandise mix over the last three years is reflected in the following table:
 
2016
 
2015
 
2014
Core boating products (1)
76.5
%
 
77.1
%
 
81.3
%
Merchandise expansion products (2)
23.5
%
 
22.9
%
 
18.7
%
Total
100.0
%
 
100.0
%
 
100.0
%
(1) 
Core boating products are comprised of maintenance, 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.
(2) 
Merchandise expansion products are comprised of apparel, footwear, clothing accessories, fishing, watersports, paddlesports, coolers and waterlife lifestyle accessories.
We are committed to offering a broad assortment of merchandise that provides our customers what they want, when they want it. As we grow revenues through our merchandise expansion strategy, we expect that core boating product sales will continue to grow, but at a slower pace than merchandise expansion product sales. We believe that there is an opportunity to further drive sales of core products, particularly through our smaller traditional stores, and during 2017, we will continue to increase and improve product assortments to achieve this goal.
Our merchandising department is responsible for vendor and product selections and works closely with our planning and replenishment department, which is responsible for purchasing and managing inventory levels in our distribution centers and in our stores. We also offer our customers the ability to special order products that we do not stock in our stores or at our distribution centers.
Generally, we build inventory levels during the first quarter of each year in preparation of the key boating season and we may also take advantage of key product offerings or opportunistic purchases from our vendors during the fourth quarter of the prior year. We purchased merchandise from more than 800 vendors during 2016, and no single vendor accounted for more than 9% of our merchandise purchases. In 2016, our 20 largest vendors accounted for approximately 43% of our merchandise purchases. Generally, we purchase merchandise from our vendors on an order-by-order basis.
Private brand merchandise, which typically has higher gross margins than other branded products, made up about 23% of our sales in 2016. We added resources to our private brand strategy in 2016 and, in 2017, we are expanding this investment. In addition, we continue to identify key vendor partnerships to increase gross margins over time and provide exciting and differentiating products to our customers. Private brand products, which we sell under the “West Marine,” “Black Tip,” “Third Reef,” “Pure Oceans,” "Lifesling," and “Seafit” brand names, usually are manufactured in Asia, the United States and Europe.
Omni-channel Shopping Experience
Our strategy is to offer a seamless omni-channel shopping experience to retail and professional customers through our stores, eCommerce websites, catalog and call center operations. Although we sell through all of these channels, our primary sales channel remains our stores.
Stores
The following table shows the number of stores opened and closed in each of our last three fiscal years:
 
Fiscal 2016
 
Fiscal 2015
 
Fiscal 2014
 
Waterlife (1)
 
Traditional (2)
 
Total
 
Waterlife (1)
 
Traditional (2)
 
Total
 
Waterlife (1)
 
Traditional (2)
 
Total
Beginning stores
64

 
199

 
263

 
60

 
219

 
279

 
48

 
239

 
287

New stores
5

 

 
5

 
3

 

 
3

 
7

 

 
7

Closed stores
(2
)
 
(12
)
 
(14
)
 
(1
)
 
(18
)
 
(19
)
 
(2
)
 
(13
)
 
(15
)
Waterlife conversions
8

 
(8
)
 

 
2

 
(2
)
 

 
5

 
(5
)
 

Expansion

 

 

 

 

 

 
2

 
(2
)
 

Ending stores
75

 
179

 
254

 
64

 
199

 
263

 
60

 
219

 
279


2


(1) 
Waterlife stores typically are larger than 10,000 sq. ft. and include flagship stores that range from 18,000 sq. ft. to 50,000 sq. ft.
(2) 
West Marine Traditional stores are less than 10,000 sq. ft.
At the end of 2016, we had 254 stores, compared to 263 stores at the end of 2015. Store count declined by 3.4% year-over-year and selling square footage decreased by 2.0%. In 2017, we expect to open up to six stores and plan to close approximately 15 stores. The store closures include store optimization efforts with the intent of improving operating margin and revenue.
In addition, we previously announced our intention to wind down the operations of our Canadian retail stores to focus our financial and management resources on our U.S. growth initiatives. As a result, in 2015, we closed eight of our Canadian stores and will be closing the remaining two stores by June 2017.
Our waterlife stores offer an expansive array of merchandise, an enhanced customer experience, a more appealing selling environment, and displays designed to help customers make informed product selections. These stores not only offer an extensive assortment of core boating hardware and supplies, but also present a broader selection of waterlife products. Because these stores are larger, they provide more flexibility to accommodate seasonal product changes and the ability to welcome a broader group of customers who enjoy recreating on or around the water. At our waterlife stores, we have added in-store specialists for key categories such as apparel, paddlesports, fishing and electronics. These associates enhance our ability to understand and meet our customers' needs.
Our smaller, traditional stores focus on carrying core boating products and support our omni-channel strategy by directing our customers to shop through our other channels, such as our eCommerce website, to access the broader and vast array of our merchandise expansion and waterlife products. Beginning in 2016, we tested increasing select lifestyle products relevant to the local market in some of our traditional stores. For example, in markets where our customers enjoy recreational fishing, we increased our offering of fishing-related products while continuing to provide ample selection and inventory of our core boating products. This early test has shown promising results and we expect to increase offerings of select merchandise expansion products in our traditional stores where appropriate.
Our extensive store network gives us an advantage in serving all of our customers, including professional customers seeking convenience and a larger assortment of products than those carried by typical distributors. Our professional customers include businesses involved in boat sales, boat building, boat commissioning, boat repair, yacht chartering and marina operations. In addition, we sell to government and industrial customers. We believe that with continued professional customer focus and broad product selection and availability, we will continue to be recognized as one of the preferred distributors in the industry. 
Direct-to-Consumer
Our eCommerce websites at westmarine.com and westmarinepro.com and our call center comprise our direct-to-consumer sales channel. This channel complements our stores 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. We offer a return-to-store option for direct-to-consumer orders and an in-store delivery service for online orders. This "ship-to-store" model provides free delivery to a local store and our customers continue to embrace this service, especially for large bulky items and hazardous products, which provides us an advantage over pure-play ecommerce retailers. In 2016, we rolled out store inventory visibility on our websites giving our customers the ability to view availability of products in their local stores.
Our westmarine.com website provides our retail customers access to a broad selection of approximately 130,000 products, unique product advisor tips and technical information, over 1,000 product videos and 50,000 total reviews. We also believe our website is a cost-effective means of testing market acceptance of new products and concepts.
Our westmarinepro.com website provides our professional customers the same functionality as on our retail site, along with the ability to build requisition lists, look up invoices and view their discounted pricing. In 2017, we expect to complete site enhancements that will allow our professional customers to view online inventory availability at their local West Marine retail store.
Our eCommerce websites and call center also provide customers with access to knowledgeable technical advisors, "how to" instructional videos and enhanced product features to assist our customers in understanding the various uses and applications of the products we sell. Our call center operations allows our associates to process customer orders remotely or from our support center in Watsonville, California. Our call center provides enhanced customer service and supports sales generated through our eCommerce website, catalogs and stores.
Customer Service
Since our founding, exceptional customer service has been the cornerstone at West Marine. Our focus on delivering an outstanding customer experience is accomplished through advanced product and technical training for our associates and then

3


empowering them to resolve customer issues at the local level. Through listening to our customers, we continually refine our business processes to meet their needs.
Marketing
Our marketing objective is to deliver intelligent, consistent, actionable, relevant content and customer experiences across all touch points. Our approach includes a seamless omni-channel customer experience, personalization and customer retention strategies through a fully-integrated marketing program that includes direct mail, email, traditional and digital advertising, such as paid search and digital display ads, digital radio, social media and mobile technology. We position the West Marine brand to stand for a unique value proposition supported by extensive product offerings, friendly and knowledgeable customer service and shopping convenience, whether on-line or in a store. The goal of this work is to expand our customer base and drive business growth, sales and profit.
Our loyalty program, West Advantage Rewards, includes both free and paid memberships that 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. Through West Advantage Rewards, we have built an extensive and proprietary customer list which allows us to provide compelling and relevant offers to our customers. In addition, we acquire potential customer names from a variety of sources. Our customer list is continually updated with customer-provided information and new customer prospects, and to eliminate non-responders and accommodate requests from customers to opt out of our marketing programs.
West Marine is dedicated to promoting boating participation and to being a leader in sustainability within our industry. The West Marine BlueFuture® program is committed to supporting healthy and vibrant marine habitats and sustainable fisheries, as well as connecting future generations to the water through our youth recreation and education initiatives. We also support marine conservation in our daily operations by offering our customers environmentally preferable products, including our own "Pure Oceans” private label brand. These important initiatives are designed to encourage participation in boating and related water activities, promote environmental responsibility and improve West Marine’s brand perception and recognition.
Logistics and Distribution
We operate two full-service 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 received and prepared for shipment to stores or shipped directly to customers. Some vendors ship products directly from their facilities to our stores. We also fulfill orders for our professional customers with van delivery in certain markets, which serve as hubs or regional distribution centers. We believe our network of regional distribution facilities provides us with a competitive advantage to better serve our professional customers who value the service levels our hubs are able to provide to them. We use various third-party domestic and international transportation methods, such as ocean, air and ground, including company-owned vehicles. Our distribution centers utilize material handling equipment and voice-picking technologies, as well as radio frequency systems, to enable real-time management of inventory.
Information Technology
We continue to invest in information technology to provide a platform for growth over the next several years to improve our customers' experience while shopping on the website. In recent years, we have also invested significant resources to strengthen our cybersecurity programs to protect customer, employee and corporate data and have implemented "tokenization" (i.e., a process by which sensitive credit card information at the point-of-sales terminal or online interface is replaced with randomly generated proxy numbers, or "tokens") and EMV compatibility (i.e., credit cards with chips or integrated circuits on the card). In 2017, we will continue investing in the growth of our eCommerce business, including improvements in our technology infrastructure.
Competition
The market for marine supplies is highly competitive. 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 operate. Also, we have a number of competitors engaged in the catalog, Internet and 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. Although we face tough competition in the marine market, we believe that we offer our customers a value proposition that is unmatched by our competitors through our 254 stores, our eCommerce websites, our regional distribution capabilities and our knowledgeable, skilled associates.
Trademarks and Service Marks
We own the trademarks and service marks “West Marine®”, “West Marine ProTM ,” "Pure Oceans®,” among others. These marks and a number of others are registered (or in the process of being 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.

4


Associates
As of February 16, 2017, we had 3,831 associates, of whom 1,850 were full-time and 1,981 were part-time or temporary. A significant number of temporary associates are hired during the summer peak selling season. For example, West Marine employed 4,579 associates on July 2, 2016.
International Sales
We promote and sell our marine products internationally, primarily through our direct-to-consumer sales channels. As previously disclosed, to ensure focus and to enable us to redirect resources for investment in our growth strategies, we closed eight of our Canadian stores during 2015, and we will close the remaining two stores by June 2017. For each of 2016, 2015 and 2014, revenues from outside of the United States represented less than 5% of our total net revenues.
Available Information
West Marine’s Internet address is westmarine.com. The information contained on, or that can be accessed through our website is not part of this report. We have included our website address in this report solely as an inactive textual reference.
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 Securities Exchange Act of 1934, as amended ("the Exchange Act"), including the exhibits thereto, as soon as reasonably practicable after such documents are electronically filed with, or furnished to, the SEC. 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 that we call "Living our Values - West Marine Code of Ethics" for our associates, contractors, officers, and Board of Directors, which includes ethical standards for our senior financial officers (including our principal executive officer, principal financial officer and principal accounting officer). A copy of this code of ethics is available on our website, or a printed copy can be obtained by writing to the Secretary, West Marine, Inc., 500 Westridge Drive, Watsonville, California 95076. Any amendments to this code of ethics, as well as any waivers that are required to be disclosed under the rules of the SEC or the NASDAQ Stock Market, will be 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 risk factors actually occurs, our business, financial condition or results of operations could suffer and the trading price of our common stock could decline.
If we are not able to respond to trends emerging in the boating industry and attract a more diverse customer base, our revenues and operating results could materially suffer.
We have identified mega-trends impacting the boating industry, including:
Recently, boat sales have improved over prior years; however, boat sales are still well below pre-recession levels, and sales are trending towards boats that are smaller and easier to maintain.
The average age of our core customer base ranges from 50 to 54 years old for power boaters and from 55 to 60 years old for sailors.
We believe there is increasing competition for our customers' recreational time, and we do not expect a meaningful change in this longer-term trend.
Omni-channel retailers have higher cost-to-serve models than pure-play eCommerce retailers, putting pressure on margins as competition increases with greater price transparency.
Intense competition in the boating supplies, apparel and outdoor recreation markets could reduce our revenue and profitability.
We face strong competition in the retail market for recreational boating supplies and apparel from multi-channel retailers, internet-based businesses, catalog retailers, traditional marine supply stores, sporting goods stores and mass merchants. We also have a number of competitors serving professional customers in the distribution of marine products. A key competitive factor in the marine supplies market is price. Price transparency and comparability continues to increase, particularly as a result of digital technology, including increased use of smart-phones or other mobile devices which allow customers to compare prices on a real time basis. The retail industry continues to experience a trend towards an increase in sales initiated online and

5


increased use of mobile applications. Some online-only businesses have lower operating costs than omni-channel retailers like us. Because our business strategy is based on offering an exceptional customer experience and a full range of services to complement the products we offer, our cost structure is higher than some of our competitors, and this, in conjunction with price transparency, puts pressure on our margins and such pressures are expected to continue. In addition, some of our competitors have greater financial resources than us and may be able to offer lower prices than us for a sustained period of time or may increase their spending on advertising and promotions relative to our spending. Also, 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 for all customers, 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.
Our business is highly seasonal and weather dependent and our results of operations could be adversely affected if unseasonably cold weather, prolonged winter conditions, sustained high winds, natural disasters, such as hurricanes, extraordinary amounts of rainfall, earthquakes or man-made disasters occur, particularly during the peak boating season in our second and third fiscal quarters.
The majority of our revenues and profits occur between the months of April and September, which represent the peak boating months in most of our markets. Our results would be materially and adversely affected if our net revenues were to fall below expected seasonal levels during this period. Our store optimization and merchandise expansion strategies include a focus on providing the space and flexibility to appropriately transition products as we enter and exit peak boating season. If we are not able to successfully implement these strategies on an ongoing basis, we will continue to experience net losses in the first and fourth quarters of each fiscal year.
Our business is also significantly affected by weather patterns. Unseasonably cool weather, prolonged winter conditions, sustained high winds, extraordinary amounts of rainfall or natural or man-made disasters may decrease boating use in the peak season, resulting in lower maintenance needs and boat usage and, therefore, decreased revenues.
Our support center, one of our two distribution centers and our management information systems are located in northern California. If we encounter any disruptions to our operations within these buildings or if they were to shut down for any reason, including fire, earthquake or other natural disaster, we may be delayed or prevented from effectively operating our stores, shipping and processing our products and/or operating our eCommerce websites. Furthermore, the risk of disruption or shut down at these buildings is greater than it might be if they were located in another region, as northern California is prone to natural disasters such as earthquakes, floods and wildfires. Any disruption or shut down at these locations could significantly impact our operations and have a material adverse effect on our financial condition and results of operations.
We continue to invest in a number of strategies designed to build our long-term strength. If one or more of these strategies is unsuccessful, our profitability could be adversely affected.
Over the past few years, we have launched a number of strategies designed to increase sales, lower costs and strengthen our focus on profitability. These strategies include:
investing in our eCommerce websites;
investing in new and existing stores to improve customers' experiences and introducing new and expanded product categories;
expanding our business serving professional customers; and
improving the retail experience for our retail and professional customers.
To support these growth strategies, we have invested in store development, information technology infrastructure, added key positions to our eCommerce and information technology departments, and made enhancements in marketing to attract a more diverse customer base. If we fail to successfully execute one or more of these strategies, or if positive results from these strategies take longer to realize than originally expected, our profitability in the short and/or long-term could be adversely affected.
Efforts to increase our gross margin and improve profitability due to changes in customer and product mix may not be successful.
We continue to increase our investments in core product merchandise in many markets to support our initiatives to increase sales and profitability. These products generally are sold at higher gross margins and not susceptible to higher seasonal clearance. While we are experiencing increased growth in the sale of core products to retail customers, growth in sales of our merchandise expansion categories is increasing at a more rapid pace, although off a smaller baseline. Our merchandise expansion products are generally sold at lower margins, and some of the products, such as clothing and footwear, are subject to clearance activity as seasonal assortments change. As a result of this product mix shift, we are experiencing gross margin

6


pressure. If this product mix significantly increases, or our initiatives to increase gross profit are not successful, we will face additional gross margin pressure which could adversely impact our profitability.
In addition, in 2016 we restructured certain pricing tiers and other aspects of distribution model servicing our professional customers to offset increased costs and distribution expenses. Because this market is fragmented and highly competitive, we anticipated some sales and market share loss as we worked to improve our gross margins and operational efficiencies. If sales decline and/or we experience market share loss greater than anticipated levels, or if margin gains are not sufficient to offset revenue loss, our financial condition and results of operations could be adversely affected.
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, 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, conversion 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 adversely impact the market price of our common stock.
Our inability to achieve steady, profitable growth would materially adversely affect our results of operations and financial condition. 
A critical component of our business strategy is to ensure steady growth in profitability. In connection with this strategy, we implemented and continue to refine our key growth strategies designed to broaden our brand with increase product assortment, revitalize our store experience, increase our eCommerce presence and enhance our operational efficiency. For additional information regarding our strategic plan, see Item 1. Business, "Business Strategies" in this Annual Report on Form 10-K. It may take longer than expected, and require increased investments, to execute on our strategies to broaden our brand appeal which could delay or prevent us from achieving profitability or otherwise have a material adverse effect on our results of operations and financial condition.
Delays in new store openings, unplanned cost overruns, or inability to find suitable sites could materially affect our store optimization strategy and, consequently, our financial performance.
Our expected financial performance is based on our new, remodeled or expanded stores opening on expected dates and on budget. 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 store openings beyond their expected dates, give rise to cost overruns, or force us to abandon planned openings altogether. Additionally, we may incur cost overruns on projects if we underestimate the scope of work or level of expense required. Any failure on our part to recognize or respond to any of the foregoing issues may adversely affect our revenue growth, which, in turn, may adversely affect our operating results. Additionally, if we are unable to find suitable sites, our financial performance may be adversely impacted.
Our eCommerce operations subject us to numerous risks that could have an adverse effect on our operating results.
We are pursuing a heightened focus on technology to enhance our eCommerce business by broadening the selection of our on-line merchandise offering and improving product search performance. Revenues generated by eCommerce constitute an increasing portion of our overall revenues and 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 on-line content; and risks related to the computer systems that operate our websites and related support systems, such as computer viruses, electronic break-ins and similar disruptions. 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, and on-line security breaches could have an adverse effect on our results of operations.
Our business may be adversely affected if we are unable to provide our customers a cost-effective shopping platform that is able to respond and adapt to rapid changes in technology.
The number of people who access the Internet through devices other than personal computers, including mobile phones, smartphones, handheld computers such as notebooks and tablets, video game consoles and television set-top devices, has increased dramatically in the past several years. As new mobile devices and platforms are released, it is difficult to predict the problems we may encounter in developing applications for alternative devices and platforms, and we may need to devote significant resources to the creation, support and maintenance of such applications. If we are unable to attract consumers to our websites through these devices or are slow to develop a version of our websites that is more compatible with alternative

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devices or a mobile application, we may fail to capture a significant share of consumers using these devices or applications, which could adversely affect our business.
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 categories that appeal to customers that enjoy recreating on or around the water, not necessarily boat ownership. These categories differ from our core merchandise categories, which are 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 attract a more diverse waterlife consumer and to introduce new products to all of our customers, as well as the level of consumer acceptance of these strategies. 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 expectations and concerns, could have a material adverse effect on our revenue, results of operations and reputation with our customers.
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.
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 industry, by its nature, is volatile and sensitive to numerous 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 typically order merchandise well in advance of the peak selling season. The extended lead times for many of our purchases 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, we may not have sufficient quantities of merchandise to satisfy customer demand or we may be required to mark down excess inventory, any of which would result in lower profit margins.
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 products manufactured in foreign countries to us at any time for reasons that may or may not be within our 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, 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, appreciate boating and water-related activities, and the varied product lines we carry, 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.
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

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openings of new stores. Any such delays, any material increases in associate turnover rates or any increases in labor costs could have a material adverse effect on our business, financial condition or operating results.
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 and 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.
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, 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.
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.
Any failure to amend or extend our line of credit could have an adverse material effect on our future operating results.
Our current loan and security agreement expires in November 2017. We are in the process of negotiating and amending the current loan and security agreement; however, if we fail to amend the current line of credit or are unable to secure a line of credit from another bank, our business and results of operations could be adversely affected.
Economic conditions in the U.S. and key international markets or other conditions leading to a decline in consumer discretionary spending may materially and 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 recent past, 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 and adversely affect consumer spending habits and our operating results in the future. Legislative changes, including those related to trade and import taxes, could have an adverse impact on our results.
The domestic and international political climate 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.
Any failure to maintain the security of the information relating to our business, customers, associates and vendors, whether as a result of cybersecurity attacks or otherwise, could damage our reputation with customers, associates and vendors, cause us to incur substantial additional costs, including fines and penalties, and to become subject to litigation, and could adversely affect our operating results.
We receive certain personal information about our customers, associates and vendors. We also rely on business partners to provide services to us that may include the sharing of important business information or data about our customers, associates and vendors. In addition, our point of sale at stores and online operations depend upon the secure transmission of confidential information over public networks, including information permitting cashless payments. While we maintain security measures to protect and to prevent unauthorized access to such information, it is possible that unauthorized parties (through cyberattacks, which are rapidly evolving and becoming increasingly sophisticated, or by other means) might compromise our security measures or those of our service providers and obtain the personal information of customers, associates and vendors that we hold or other confidential company data. Such an occurrence could adversely affect our reputation with our customers, associates and vendors, as well as our operations, results of operations, financial condition and liquidity, and could result in

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litigation against us or the imposition of fines and penalties. Moreover, a security breach could require that we expend significant additional resources to upgrade further the security measures that we employ to guard such important personal information against cyberattacks and other attempts to access such information and could result in a disruption of our operations. Likewise, with increased cybersecurity attacks in various industries, including the retail sector, we cannot be assured that we will be able to attract and retain sufficient qualified IT security personnel, especially in light of the increased demand for such personnel in all industries.
In addition, states and the federal government are increasingly enacting laws and regulations to protect consumers against identity theft.  These laws will likely increase the costs of doing business and, if we fail to comply with these laws and regulations, to implement appropriate safeguards or to detect and provide prompt notice of unauthorized access as required by some of these new laws, we could be subject to potential claims for damages and other remedies, which could harm our business.
If we are unable to implement, maintain and/or upgrade our information systems and software programs or if we are unable to convert to alternate systems in an efficient and timely manner, our operations may be disrupted or become less efficient and our key growth strategies may not be successful.
We depend on information systems for many aspects of our business. We rely on certain software vendors to implement, maintain and periodically upgrade many of these systems so that we can continue to support our business. We could be materially adversely affected if our information systems are disrupted or if we are unable to implement, improve, upgrade, maintain and expand systems, particularly in light of our continued focus on our omni-channel business model and growth strategies.
The success of our key growth strategies is dependent in varying degrees on the timely delivery and the functionality of information technology systems to support them. Extended delays or cost overruns in securing, developing and otherwise implementing technology solutions to support our strategic business initiatives would delay and possibly even prevent us from realizing the projected benefits of those initiatives.
Our success also depends on our ability to anticipate and implement innovations in sales and marketing technology to appeal to existing and potential customers who increasingly rely on multiple portals, including mobile technologies, to meet their shopping needs. Failure to enhance our technology and marketing efforts to align with our customers’ shopping preferences could significantly impair our ability to meet our strategic business and financial goals.
A significant amount of our common stock is beneficially owned by our founder, Randolph K. Repass, and a limited number of institutional investors, whose interests may differ from that of our other stockholders.
Randolph K. Repass, our founder and a member of our board of directors, beneficially owns approximately 26% of our common stock. As a result, Mr. Repass has substantial influence in the election of our directors 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. The interests of Mr. Repass in any matter to be voted on or in any transaction with us may be different than those of other stockholders. Additionally, because of our current common stock price, aggregate market capitalization, the potential market value of our assets and cash position, we may be an attractive target to a buyer or subject to a hostile takeover. Since our stock is concentrated in the hands of Mr. Repass and a limited number of independent stockholders, any of such stockholders could exercise their rights to influence the strategic direction of West Marine to the detriment of our existing plans.
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 consumer protection, 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 service suppliers have rights under their contracts with us to review and audit our use of their licensed products, and an unfavorable audit could result in 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.

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Non-compliance with the Payment Card Industry Data Security Standard (“PCI DSS”) may subject us to fines, penalties and civil liability.
We are subject to compliance with PCI DSS, an information security standard for organizations that handle cardholder information from major debit and credit card companies. As PCI DSS standards change, our continued compliance efforts may result in significant expenses and any failure to fully comply with PCI DSS on an ongoing basis may subject us to fines, penalties and civil liability, and, in extreme circumstances, could result in the loss of our ability to accept debit and credit card payments or prohibit us from processing transactions through American Express, MasterCard, VISA and other card and payment networks. Even if we are compliant with PCI DSS or other applicable security standards, we still may not be able to prevent security breaches involving customer transaction data.
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 injunctions and/or 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 our leased properties. If any such hazardous waste were to be found on 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. This puts us at risk for costs to be unpredictable from period to period and we have experienced significant variances in costs from one quarter to another. With medical insurance, we have individual and aggregate stop loss insurance to protect us from large claims. Additionally, we may incur certain types of losses that we cannot insure or which we believe are not economically reasonable to insure, such as losses due to acts of war, employee and certain other crime, and some natural disasters. For example, 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.
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. Additionally, unanticipated changes in any applicable actuarial assumptions and management estimates underlying our recorded liabilities for these losses, including potential increases in medical and indemnity costs, could result in materially different amounts of expense than expected under these programs, which could have a material adverse effect on our financial condition and results of operations.
With the passage in 2010 of the U.S. Patient Protection and Affordable Care Act (the "ACA"), we are required to provide affordable coverage, as defined in the ACA, to all employees, or otherwise be subject to a payment per employee based on the affordability criteria in the ACA. Many of these requirements are currently contemplated to be phased in over a period of time. Additionally, some states and localities have passed state and local laws mandating the provision of certain levels of health benefits by some employers. Increased health care and insurance costs could have a material adverse effect on our business, financial condition and results of operations. In addition, changes in federal or state workplace regulations could adversely affect our operating results.
We have begun to operate a wholly-owned captive insurance subsidiary and participation in a reinsurance program for extended warranties starting in 2017. Our overall business may be adversely affected if the captive insurance is not successful or we incur larger losses than anticipated.
With our captive insurance program, there is inherent risk involved and it's the function of West Marine, Inc. to absorb negative loss developments. Specifically, with product warranty programs, future developments regarding the products comprising the program and their attendant loss development remains uncertain. If future loss experience materially deviates from our current estimates, it may have a 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

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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 attract and 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 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 any information required to be disclosed, (2) failing to make and keep accurate books, records or accounts which, in reasonable detail, accurately and fairly reflect our transactions and dispositions of assets, and (3) failing to devise and maintain an adequate system of internal accounting controls sufficient to provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in conformity with GAAP. 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, and/or 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 common stock. We cannot assure that the market price of our common stock will not fluctuate or decline significantly in the future.
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.
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 third parties, all of which offer only limited protection. We do not know whether the U.S. Patent & Trademark Office or corresponding foreign agencies will grant registrations based on our pending trademark applications. Even if 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 property 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.
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 or purchased for resale, 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.
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

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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.
We face the risk of exposure to product quality issues, product liability claims, product recalls and adverse publicity.
We contract to manufacture, 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 products that contain a defect that 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, or failure to comply with, laws and regulations could increase our cost of doing business and/or adversely impact the boating industry, and, we are subject to governmental export and import controls that could subject us to liability.
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, eCommerce, electronic devices and other services (including taxation, user privacy, data protection, pricing and electronic and mobile communications, environmental regulations and information reporting requirements) could diminish the demand for our products and services, 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 as to what constitutes personally identifiable information, could adversely impact industry practices related to the collection and use of customer information. Any changes we make in the manner in which we collect and/or use 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 minimum wage requirements, 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.
Various federal and state labor laws govern our relationships with our employees and affect operating costs. These laws include employee classifications as exempt or non-exempt, minimum wage requirements, unemployment tax rates, workers' compensation rates, overtime, family leave, safety standards, payroll taxes, citizenship requirements and other wage and benefit requirements for employees classified as non-exempt. As our associates are paid at rates set above, but related to, the applicable minimum wage, further increases in the minimum wage could increase our labor costs. Significant additional government regulations could materially affect our business, financial condition and results of operations.
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 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. Additionally, failure to comply with laws and regulations concerning ethical business practices by these vendors or manufacturers, such as the U.S. Foreign Corrupt Practices Act, 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 affect our reputation and sales. Issues with the quality and safety of merchandise we sell, regardless of our culpability, or

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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.
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; and economic and political conditions or terrorist acts, or other problems in countries from or through which merchandise is imported and exported. Although we have policies and procedures to address these deficiencies and to facilitate compliance with laws and regulations relating to doing 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.
We are required to disclose the use of 'conflict minerals' in certain of the products we distribute, which imposes costs on us and could raise reputational and other risks.
The SEC has promulgated rules in connection with the Dodd-Frank Wall Street Reform and Consumer Protection Act regarding disclosure of the use of “conflict minerals” (which are defined as tin, tantalum, tungsten and gold) that are mined from the Democratic Republic of the Congo and adjoining countries. These rules have required, and currently will continue to require, due diligence and the filing of reports annually with the SEC regarding such matters. There are costs associated with complying with these disclosure requirements, including costs to determine the source and custody of conflict minerals, if any, that are used in the manufacture of our products. We also may face reputational challenges if we are unable to verify the origins for all conflict minerals used in our products, or if we are unable to conclude that our products are “conflict free.”  Over time, conflict minerals reporting requirements may affect the sourcing, price and availability of our products, and may affect the availability and price of conflict minerals that are certified as conflict free, which may adversely affect our business, financial condition or results of operations.
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.
Our business and financial results may be adversely affected by global climate change or by legal, regulatory or market responses to such change.
The prevailing 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 peak boating season, could reduce boat usage, the sale of our products or materially affect our store locations, which are primarily located in coastal areas, through storm damage, restricted water access from droughts, 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.
ITEM 1B—UNRESOLVED STAFF COMMENTS
None.

14


ITEM 2—PROPERTIES
Our executive offices and support center are located in a 98,000 square foot facility in Watsonville, California, which we occupy under a lease that was last amended in October 2016. The amendment extends the term to October 31, 2021, with one five-year extension at our option. Base rent is initially fixed at $1.2 million per year for the first two years. The base rent could be adjusted if we exercise our right under the amendment to give back a portion of the leased space during the term, subject to certain conditions.
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 2022.
At December 31, 2016, our 254 stores comprised an aggregate of approximately 2.6 million square feet of space. 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 and in others we have a period of fixed rent and then a rent charge that is either fixed, determined by fair market rent, periodic rent adjustments based on store revenues or by a consumer price index calculation.
Substantially all of our leases, including those covering our support center and distribution facilities, require us to pay insurance, utilities, real estate taxes, repair and maintenance expenses and common area maintenance.
ITEM 3—LEGAL PROCEEDINGS
As previously reported, in February 2016, the Superior Court of the State of California, County of San Diego, approved the settlement, on an individual and class-wide basis, of a complaint brought by a California former hourly employee who alleged that West Marine failed to properly pay overtime to California employees who earned bonuses or commissions in violations of certain provisions of California Labor Code and the California Business and Professional Code. The aggregate obligation, including settlement funds, plaintiff’s attorneys’ fees and costs and settlement administration costs had no material impact on our financial statements. See Note 6 to our consolidated financial statements for further discussion.
We are also involved in various other 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 the class action lawsuit discussed above or any other 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 or results of operations. However, an adverse judgment by a court, administrative or regulatory agency, arbitrator or a settlement could adversely impact our financial position or results of operations in any given period.
For any other 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 individually and in aggregate.
ITEM 4—MINE SAFETY DISCLOSURE
None.

15


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 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
2016
 
 
 
 
 
 
 
High
$
9.49

 
$
10.03

 
$
9.90

 
$
11.35

Low
$
7.94

 
$
8.24

 
$
8.13

 
$
7.88

2015
 
 
 
 
 
 
 
High
$
13.48

 
$
10.81

 
$
9.95

 
$
10.28

Low
$
9.24

 
$
8.93

 
$
7.74

 
$
8.26

As of February 16, 2017, there were approximately 6,047 holders of record of our common stock, and the last sale price reported on the NASDAQ Global Select Market was $9.17 per share.
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 2017 annual meeting of stockholders, to be filed within 120 days after the end of the fiscal year covered by this report.

16


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 Morningstar index presented below consists of 224 specialty retailers.
a10kgraph2016.jpg 
Fiscal Year End:
12/31/2011
 
12/29/2012
 
12/28/2013
 
1/3/2015
 
1/2/2016
 
12/31/2016
West Marine, Inc.  
$
100.00

 
$
91.92

 
$
121.58

 
$
107.48

 
$
73.00

 
$
90.03

Specialty Retail
100.00

 
128.04

 
185.52

 
183.15

 
210.29

 
229.70

NASDAQ Composite Index
100.00

 
115.15

 
163.76

 
188.49

 
201.98

 
219.89

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.

17


ITEM 6—SELECTED CONSOLIDATED FINANCIAL DATA
The following consolidated balance sheet data for 2016 and 2015 and consolidated statement of operations data for 2016, 2015 and 2014 have been derived from our audited 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. The consolidated balance sheet data for 2014, 2013 and 2012, as well as the statement of operations data for 2012, are derived from audited consolidated financial statements and the notes thereto that are not included in this annual report on Form 10-K.
(in thousands, except per share and operating data)
2016
 
2015
 
2014
 
2013
 
2012
 
Consolidated Statements of Operations Information:
 
 
 
 
 
 
 
 
 
 
Net revenues
$
703,371

 
$
704,825

 
$
675,751

 
$
663,174

 
$
675,251

  
Income from operations
12,036

 
7,746

 
4,432

 
15,743

 
25,298

 
Income before income taxes
11,604

 
7,294

 
4,004

 
15,309

 
24,457

 
Net income
6,535

 
4,520

 
1,948

 
7,837

 
14,719

 
Net income per share:
 
 
 
 
 
 
 
 
 
 
Basic
$
0.26

 
$
0.18

 
$
0.08

 
$
0.32

 
$
0.63

 
Diluted
0.26

 
0.18

 
0.08

 
0.32

 
0.62

 
Consolidated Balance Sheet Information:
 
 
 
 
 
 
 
 
 
 
Working capital
$
237,455

 
$
226,698

 
$
224,026

 
$
222,980

 
$
217,750

  
Total assets
406,102

 
391,815

 
385,501

 
364,243

 
350,979

  
Operating Data:
 
 
 
 
 
 
 
 
 
 
Stores open at year-end
254

 
263

 
279

 
287

 
300

  
Comparable stores net sales increase (decrease) (1)
0.8
%
 
4.9
%
 
1.2
%
 
(1.8
)%
 
3.1
%
 
 
(1)
Comparable store sales are calculated by including net sales of stores that have been open at least 13 months. Therefore, a store is included in the comparable store sales in the fiscal period in which it commences its 14th month of operations. Stores that were closed or substantially remodeled (i.e., resulting in an increase or decrease of 40% or more of selling square footage) are excluded from the comparable store sales base. Substantially remodeled stores are re-included in the comparable store sales in the fiscal period in which the 14th of operations commences following the completion of the remodel. Beginning in fiscal 2013 and in line with our omni-channel focus, we reported comparable store sales results to include sales from our direct-to-consumer and professional channels. For fiscal year 2012, previously-reported comparable store sales, which excluded direct-to-consumer and professional sales, were 3.3%.





18


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 of this Annual Report on Form 10-K.
Forward-Looking Statements
The statements in this report 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:
future earnings and growth in sales and profitability;
the continued success of our key growth strategies: eCommerce expansion, store optimization, and merchandise expansion;
our ability to continue to manage our expenses and execute on our growth 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
West Marine, a leading omni-channel specialty retailer exclusively offering boating gear, apparel, footwear and other waterlife-related products to anyone who enjoys recreational time on or around the water, generated 2016 net revenues of $703.4 million and net income of $6.5 million. Providing great customer experiences and a consistent brand is important to us, regardless of the sales channel our customer uses. Our 254 stores open at the end of 2016 are located in 38 states, Puerto Rico and Canada. As previously disclosed, to ensure focus on and to enable us to redirect resources for investment in our growth strategies, we planned to close our ten Canadian stores as leases expire. Eight stores were closed during 2015 with the remaining two stores to be closed by June 2017. As a result of our numerous stores and our eCommerce websites reaching domestic and international customers, we are recognized as a dominant waterlife outfitter for cruisers, sailors, anglers and paddlesports enthusiasts.
We have been focusing on the following key growth strategies and will continue to focus on and invest in these strategies in 2017 (for additional information refer to Item 1. Business of this annual report on form 10-K):
eCommerce
Store optimization
Merchandise expansion
We have invested significant resources in support of these key growth strategies and the pace of our investments will continue through 2017, including additional capital investments to further improve our eCommerce websites and to upgrade our information technology infrastructure. This work supports our 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 of these initiatives in key areas, such as information technology and eCommerce. In addition, there will be incremental investments in marketing which, along with a reallocation of some of our traditional media spending, is intended to attract a more diverse group of customers and, thereby, grow our customer base. These strategies and investments are expected to better position us to deliver incremental sales and operating margin improvement over time.

19


Results of Operations
The following table sets forth certain income statement components expressed as a percent of net revenues:
 
 
2016
 
2015
 
2014
Net revenues
100.0
%
 
100.0
%
 
100.0
%
Cost of goods sold
70.8
%
 
71.3
%
 
71.4
%
Gross profit
29.2
%
 
28.7
%
 
28.6
%
Selling, general and administrative expense
27.5
%
 
27.6
%
 
27.9
%
Income from operations
1.7
%
 
1.1
%
 
0.7
%
Interest expense
0.1
%
 
0.1
%
 
0.1
%
Income before income taxes
1.6
%
 
1.0
%
 
0.6
%
Provision for income taxes
0.7
%
 
0.4
%
 
0.3
%
Net income
0.9
%
 
0.6
%
 
0.3
%
Fiscal 2016 compared with Fiscal 2015
Revenues
Net revenues for 2016 were $703.4 million, a decrease of $1.5 million, or 0.2%, compared to net revenues of $704.8 million for 2015. This decrease primarily was due to the closure of underperforming stores and store optimization projects during the period. Comparable store sales, however, increased by $5.1 million, or 0.8%, during the period. Comparable store sales results for the first, second, third and fourth quarters of 2016 were increases of 2.7%, 1.1% and 0.2% and a decrease of (1.0)%, respectively.
Revenues from core products, which represented 76.5% and 77.1% of our total revenues for 2016 and 2015, respectively, decreased by 1.0% during 2016 as compared to last year. Contributing toward lower core product revenues was a 3% decline in revenues from our professional customers.
As compared to last year, we saw positive sales growth from our three key strategies: eCommerce; merchandise expansion; and store optimization. Sales through our eCommerce channel, driven by domestic eCommerce growth, increased by 19.7% for the year. The eCommerce channel represented 11.4% of our 2016 revenues, as compared to 9.5% last year. Sales in our merchandise expansion categories increased by 2.0%. Merchandise expansion products represented 23.5% of our 2016 revenues, as compared to 22.9% last year. Finally, with respect to our progress toward our goal of 50% of sales from waterlife stores, we reached our goal and achieved 50.1% for the year, compared to 46.0% in 2015. During 2016, we re-branded our professional services business, formerly Port Supply, to WestMarinePro. Our portsupply.com site became westmarinepro.com and, while still a small portion of the overall professional services business, sales through this site increased by 42.9% compared to 2015.
Gross profit
Gross profit increased by $3.6 million, or 1.8%, to $205.7 million in 2016, compared to $202.0 million for 2015, primarily due to improvements in cost of goods sold. Gross margin increased to 29.2% in 2016, compared to 28.7% in 2015. This primarily was driven by an improvement in supply chain efficiencies of 0.3%, due to improved inventory management. Additionally, occupancy expense decreased year-over-year as a percentage of revenues by 0.2% as a result of closing underperforming stores and our store optimization strategy. In addition, purchasing efficiencies improved year-over-year by 0.2% of revenues. The increase in gross margin was partially offset by higher shrinkage, which increased by 0.1%. 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.
Selling, general and administrative ("SG&A") expense
SG&A expense for 2016 was $193.6 million, a decrease of $0.7 million, or 0.3%, compared to $194.3 million last year. SG&A expense decreased as a percentage of revenues to 27.5% in 2016, compared to 27.6% in 2015. Primary drivers of lower SG&A expense were: $3.5 million lower payroll expense, primarily attributable to variable compensation; $0.7 million related to the sale of a Perth Amboy, New Jersey store location; and a $0.7 million partial settlement received from the Deepwater Horizon Settlement program. These expense containment factors were partially offset by $1.7 million in higher training costs, including West Marine University, our biennial company-wide training event, and other store associate training programs; $1.7 million higher depreciation related to store and technology investments; and $1.2 million attributable to higher benefit costs, including an increase in year-over-year healthcare claims.

20


Interest expense
Interest expense was $0.4 million in 2016, down from $0.5 million in 2015. This expense consists primarily of the amortization of commitment fees, as our borrowings were minimal in 2016. Cash provided by operating activities funded property and equipment investments.
Net Income
Net income for 2016 was $6.5 million, compared to net income for 2015 of $4.5 million. Our effective income tax rate for 2016 was 43.7%, compared to 38.0% in 2015. The year-over-year change in our effective tax rate primarily was due to additional foreign tax expense for our Puerto Rico subsidiary in 2016 related to partially disallowed inter-company expense which drove an overall 3% increase in the effective tax rate. In addition, for 2016, our reserve for uncertain tax positions related to state and foreign interest increased the effective rate by 2%. Whereas in 2015, there was an overall reduction of 4% related to releases of reserves due to lapses of statute of limitations.
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. Our foreign earnings are not indefinitely reinvested outside the U.S. and are subject to current U.S. income tax. For more information, see Note 7 to our consolidated financial statements.
Fiscal 2015 compared with Fiscal 2014
Revenues
Net revenues for 2015 were $704.8 million, an increase of $29.1 million or 4.3%, compared to net revenues of $675.8 million for 2014. This increase primarily was due to a $37.5 million, or 6.0%, increase in comparable store sales (excluding the 53rd week in fiscal 2014). Comparable store sales results for the first, second and third quarters of 2015 were increases of 13.3% and 7.0% and a decrease of (0.7)%, respectively. Fiscal 2014 was a 53-week year and included an extra week in the fourth quarter. Excluding this extra week, comparable store sales results for the fourth quarter were an increase of 8.0%.
Revenues from core products, which represented 79.2% and 81.3% of our total revenues for 2015 and 2014, respectively, increased by 2.8% during 2015 as compared to 2014. We believe our core product sales benefited from our focus on core boating products in traditional stores, more normal weather patterns during the key boating season, and generally favorable boating industry results during 2015.
As compared to the same period last year, we saw positive sales growth from our three key strategies: eCommerce; merchandise expansion; and store optimization. Sales through our eCommerce channel, driven by domestic eCommerce growth, increased by 32.5% for the year. The eCommerce channel represented 9.5% of our 2015 revenues, as compared to 7.7% in 2014. Sales in our merchandise expansion categories increased by 16.4%. Merchandise expansion products represented 20.8% of our 2015 revenues, as compared to 18.7% of our 2014 revenues. Finally, with respect to our progress toward our goal of 50% of sales from waterlife stores, we achieved 45.7% for 2015 compared to 41.0% in 2014. We also experienced increased sales to professional customers during 2015, primarily through our store locations. During 2015, we launched a new website targeting professional customers and, while still a small portion of the overall professional services business, sales through this site increased by 71.8% compared to 2014.
Gross profit
Gross profit increased by $8.9 million, or 4.6%, to $202.0 million in 2015, compared to $193.2 million for 2014, primarily due to higher sales. Gross margin increased to 28.7% in 2015, compared to 28.6% in 2014. This primarily was driven by an improvement in occupancy expenses, which were relatively flat year-over-year and improved as a percentage of revenues by 0.5% on higher sales. In addition, buying and distribution costs improved year-over-year by 0.1% of revenues. The increase in gross margin was partially offset by a decline in raw product margin, which decreased by 0.5%, primarily due to a product mix shift from core boating products to include more merchandise expansion products.
Selling, general and administrative expense
SG&A expense for 2015 was $194.3 million, an increase of $5.5 million, or 2.9%, compared to $188.8 million in 2014. SG&A decreased as a percentage of revenues to 27.6% in 2015, compared to 27.9% in 2014. Drivers of higher SG&A expense included a $6.8 million increase for variable compensation in line with partial achievement of target thresholds, and a $2.8 million increase in depreciation expense, primarily to support our growth strategies and infrastructure investments. These increases were partially offset by $1.5 million lower expenses associated with the extra fiscal week included in 2014 results, $1.4 million lower marketing and advertising expenses, and $1.1 million lower store payroll costs and lower expense related to healthcare claims incurred in 2015 compared to 2014.

21


Interest expense
Interest expense was $0.5 million in 2015, up from $0.4 million in 2014. Cash provided by operating activities funded property and equipment investments.
Net Income
Net income for 2015 was $4.5 million compared to net income for 2014 of $1.9 million. Our effective income tax rate for 2015 was 38.0%, compared to 51.3% in 2014. The year-over-year change in our effective tax rate primarily was due to the 2014 placement of a valuation allowance of $0.8 million against our Canadian net deferred tax assets, partially offset by the 2014 release of uncertain tax benefits and prior year deferred true ups. The primary driver of our 2015 tax rate relates to changes to our reserve for uncertain tax positions. During the fourth quarter of 2015, we released a portion of a reserve for statutes of limitations, which drove our rate down (4%). This reduction was partially offset by increases in reserves for our Puerto Rican operations, which added 2% back to the rate. The normal effective tax rate would have been approximately 38.7% without the drivers detailed above.
Liquidity and Capital Resources
Our cash was used to fund working capital, operating expenses, debt service and capital expenditures, primarily related to the build-out of new stores, store revitalization projects and improvements in our information technology infrastructure, which support our store optimization and eCommerce growth strategies. Funds generated by operating activities, available cash and our credit facility are our largest sources of cash. At the end of both 2016 and 2015, we were debt free. The highest outstanding balance during 2016 and 2015 was $0.3 million and $0.2 million, respectively. 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. We believe that our cash, cash flow from operating activities and available borrowings under our credit facility will be sufficient to meet our capital requirements for at least the foreseeable future.
Working capital, the excess of current assets over current liabilities, increased to $237.1 million at the end of 2016, compared to $226.7 million at the end of 2015. The increase in working capital primarily was attributable to a $28.0 million increase in cash, partially offset by a $10.8 million decrease in inventory and a $6.7 million increase in accounts payable. The increase in cash is due to improved profit margin and inventory management, as well as timing of payments with our trade vendors.
Operating Activities
During 2016, our primary source of liquidity was cash flow from operations. Net cash provided by operating activities increased year-over-year by $26.0 million, to $49.3 million, compared to $23.3 million last year. The increase in cash provided by operating activities was due to changes in operating assets and liabilities, including decreases in merchandise inventories and other current assets and increases in accounts payable and other accrued expenses, when compared to fiscal 2015. Additionally, net income improved to $6.5 million versus the prior year's net income of $4.5 million. These improvements to operating cash were offset by decreases in accrued payroll due to a decrease in variable compensation year-over-year. Non-cash charges to earnings in 2016 included depreciation and amortization of $22.2 million, stock-based compensation of $2.8 million and deferred income taxes of $2.5 million.
During 2015, our primary source of liquidity was cash flow from operations. Net cash provided by operating activities decreased year-over-year by $0.7 million, to $23.3 million, compared to $24.0 million in 2014. The decrease in cash provided by operating activities primarily was due to changes in operating assets and liabilities, including lower increases in merchandise inventories when compared to fiscal 2014 to support higher sales and to help drive our strategy of merchandise expansion, as well as growing sales of core products, decreases in accounts payable resulting from the timing of payments to vendors and increases in accrued expenses due to timing of payments and accrued variable compensation. Additionally, net income increased to $4.5 million versus the prior year's net income of $1.9 million. Non-cash charges to earnings in 2015 included depreciation and amortization of $20.7 million, stock-based compensation of $2.8 million and deferred income taxes of $1.8 million.
During 2014, our primary source of liquidity was cash flow from operations. Net cash provided by operating activities increased year-over-year by $10.4 million, to $24.0 million, compared to $13.6 million in 2013. The increase in cash provided by operating activities primarily was due to changes in operating assets and liabilities, including increases in accounts payable resulting from the timing of payments to vendors and increases in accrued expenses. Additionally, this was offset by a decrease in net income of $1.9 million in 2014 versus net income of $7.8 million in 2013. Non-cash charges to earnings in 2014 included depreciation and amortization of $18.2 million, stock-based compensation of $3.1 million and deferred income taxes of $3.3 million.
Investing Activities
In 2016, our capital expenditures were $22.7 million, primarily for new stores, store remodels, eCommerce website development, information technology and investment in supply chain efficiencies. We opened five new stores in 2016. In 2017, we expect capital spending to be slightly below depreciation expense at approximately $22.2 million. Additionally, we will continue

22


to invest in enhancements to our information technology infrastructure (including hardware and software). We intend to fund our expansion through cash generated from operations and, if necessary, credit facility borrowings.
In 2015 and 2014, our capital expenditures were $22.5 million and $24.5 million, respectively, mostly for new stores, store remodels, information technology and investment in supply chain efficiencies. We opened three new stores in 2015 and, in 2014, we opened seven new stores and remodeled three stores.
Financing Activities
Net cash provided by financing activities was $0.4 million in 2016, primarily attributable to cash from share-based compensation plans, partially offset by withholding of shares for statutory taxes related to restricted stock units vesting during the year. Net cash provided by financing activities was $1.6 million in 2015, primarily consisting of $1.6 million increase in cash from associate share-based compensation plans. Net cash used in financing activities was $2.2 million in 2014, primarily consisting of $4.8 million used toward share repurchases, partially offset by $2.5 million increase in cash from associate share-based compensation plans.
Credit Agreement
Our loan and security agreement, as amended, with Wells Fargo Bank, National Association and the other signatory lenders provides a maximum available borrowing capacity of $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. The loan and security agreement expires in November 2017. For more information, see Item 1A. Risk Factors— "Any failure to amend or extend our line of credit could have an adverse material effect on our future operating results."
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 2016, 2015 and 2014, the weighted-average interest rate on all of our outstanding borrowings was 4.0%, 3.8% and 3.8%, 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 31, 2016, we were in compliance with the covenants under our loan agreement.
At the end of 2016 and 2015, there were no amounts outstanding under our revolving credit facilities, and we had $104.3 million and $105.3 million, respectively, available for future borrowings. At the end of 2016 and 2015, we had $4.2 million and $4.8 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. The highest outstanding balance during 2016 and 2015 was $0.3 million and $0.2 million, respectively. Our weighted-average outstanding balances for both the first quarters of 2016 and 2015 were less than $0.1 million. For both our second quarters of 2016 and 2015, the weighted-average outstanding balances were not material. The third quarter weighted-average outstanding balances

23


for 2016 and 2015 were not material and less than $0.1 million, respectively. The fourth quarter weighted-average outstanding balances for both 2016 and 2015 were less than $0.1 million.
We may borrow against our aggregate borrowing base up to the maximum revolver amount, which was $120.0 million at both year-end 2016 and 2015. Our borrowing base at each of our last two fiscal year-ends consisted of the following (in millions):
 
 
2016
 
2015
Accounts receivable availability
$
5.0

 
$
5.6

Inventory availability
122.4

 
123.3

Less: reserves
(6.9
)
 
(6.6
)
Less: minimum availability
(12.0
)
 
(12.2
)
Total borrowing base
$
108.5

 
$
110.1

Our aggregate borrowing base was reduced by the following obligations (in millions):
Ending loan balance
$

 
$

Outstanding letters of credit
4.2

 
4.8

Total obligations
$
4.2

 
$
4.8


Accordingly, our availability as of fiscal year end 2016 and 2015, respectively, was (in millions):
Total borrowing base
$
108.5

 
$
110.1

Less: obligations
(4.2
)
 
(4.8
)
Total availability
$
104.3

 
$
105.3

Non GAAP Measure
In addition to disclosing financial results that are determined in accordance with accounting principles generally accepted in the UnitedStates of America. ("GAAP"), we are providing EBITDA, which is a non-GAAP financial measure, as a supplemental measure to help investors evaluate our fundamental operational performance. EBITDA is defined as net income (loss) plus interest expense, income tax expense(benefit), and depreciation and amortization. EBITDA is not a presentation made in accordance with GAAP, is not a measure of financial performance or condition, liquidity or profitability, and should not be considered as an alternative to (1) net income, operating income or any other performance measures determined in accordance with GAAP or (2) operating cash flows determined in accordance with GAAP. Additionally, EBITDA is not intended to be a measure of free cash flow for management’s discretionary use, as it does not consider certain cash requirements such as interest payments, tax payments and debt service requirements or replacement of fixed assets. By eliminating interest, income taxes, depreciation and amortization, we believe the result is a useful measure across time in evaluating our fundamental core operating performance. We also believe that EBITDA provides a clearer picture of operating performance of the business, given the significant investments we are making in the growth of the business, by eliminating the effects of depreciation and interest expense.
Our presentation of EBITDA has limitations as an analytical tool and should not be considered in isolation or as a substitute for analysis of our results as reported under GAAP. Because not all companies use identical calculations, the presentation of EBITDA may not be comparable to other similarly titled measures of other companies. Management believes that the presentation of EBITDA is useful to investors because these measures are frequently used by securities analysts, investors and other interested parties in the evaluation of the operating performance of companies in industries similar to ours. Management also uses EBITDA to evaluate our operations. However, as indicated, EBITDA does not include interest expense on borrowed money, the payment of income taxes, amortization of our definite-lived intangible assets, or depreciation expense on our capital assets, which are necessary elements of our operations. Since EBITDA does not account for these and other expenses, its utility as a measure of our operating performance has limitations. Due to these limitations, management does not view EBITDA in isolation but also uses other measurements, such as net income, revenues and gross profit, to measure operating performance.
The following table sets forth a reconciliation of net income, the most directly comparable GAAP financial measure, to EBITDA (in millions):

24


 
 
 
 
 
2016
 
2015
Net income
$
6.5

 
$
4.5

Add:
 
 
 
Interest expense
0.4

 
0.5

Depreciation and amortization *
22.0

 
20.5

Income tax expense
5.1

 
2.8

EBITDA
$
34.0

 
$
28.3

* Included in cost of goods sold and SG&A. Amortization of deferred financing costs related to our revolving credit facility are included in interest expense.
Contractual obligations
Aggregate information about our unconditional contractual obligations as of December 31, 2016 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)
$
289,375

 
$
49,353

 
$
84,237

 
$
66,067

 
$
89,718

Purchase commitments(2)
56,227

 
56,227

 

 

 

Bank letters of credit
4,220

 
4,220

 

 

 

Other long-term liabilities
7,897

 
2,879

 
2,962

 
1,762

 
294

 
$
357,719

 
$
112,679

 
$
87,199

 
$
67,829

 
$
90,012

 
(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. This table does not include amounts related to our uncertain tax positions of $0.8 million. We do not anticipate a material effect on our liquidity as a result of payments in future periods of liabilities for uncertain tax positions.
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.
Seasonality
Historically, our business has been highly seasonal. In 2016, approximately 63% 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
We believe that there are fundamental trends continuing to impact our industry that are affecting our customers and their purchase patterns. These trends reinforce our realization that the core boat parts and accessories business will not be sufficient to meet our growth expectations. To accomplish our goal of achieving steady, profitable growth, we are continuing our emphasis on execution of our growth strategies to expand our potential market and reduce our dependence on weather.
Our key growth strategies, including our 15/50 plan, have delivered encouraging results. As we continue to test and learn, we have ramped up our investments, with the results outlined below:

25


eCommerce: The first number in the 15/50 plan refers to our objective to grow our eCommerce business to 15% of total sales by the end of 2019. Sales from eCommerce increased by 19.7% for the 52 weeks ended December 31, 2016 as compared to 52 weeks ended January 2, 2016. eCommerce sales represented 11.4% of total sales this year, up from 9.5% for the prior year.
Store optimization: The second number in the 15/50 plan reflects our goal of deriving 50% of total sales from our waterlife stores. We achieved this goal in 2016, which is earlier than we originally projected. We expect to increase the number of waterlife stores, which provide a new shopping experience for our customers, both in terms of store design and expanded product assortment. For the 52 weeks ended December 31, 2016, sales through waterlife stores represented 50.1% of total sales, compared to 46.0% for the 52 weeks ended January 2, 2016.
Merchandise expansion: Sales in our merchandise expansion categories support the eCommerce and store optimization strategies and grew by 2.0% for the 52 weeks ended December 31, 2016. During this same period, sales in our core categories decreased by 1.0%. This strategy welcomes a broader base of customers who are passionate about recreating on and around the water by providing a wider selection of products. We offer this expanded assortment in our waterlife stores, on our retail eCommerce website and, in a targeted fashion, in our revitalized stores. Sales of merchandise expansion products represented 23.5% of total sales for 2016, up from 22.9% in 2015.
We continue to see evidence of positive inter-dependence across our growth strategies. Specifically, our eCommerce and store optimization strategies are enabling us to better present our merchandise expansion product offerings, and all of our strategies have resulted in attracting new customers and building upon our customer base.
Given the success of our growth strategies, and the need to continue to drive them at a fast pace in order to reposition our business to provide steady profitable growth, our financial plans for 2017 reflect further investment of resources in support of our key growth strategies. We expect overall capital spending to be slightly below depreciation expense, which was approximately $22.2 million in 2016.
Recent Accounting Pronouncements
See Note 1 to our consolidated financial statements for further discussion on recent accounting pronouncements.
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 GAAP. 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 also described in Note 1 and Note 2 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.
 

26


 
 
 
 
 
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 31, 2016 and January 2, 2016 were $4.7 million and $4.5 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 31, 2016, 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 31, 2016 and January 2, 2016 were $19.3 million and $19.7 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 31, 2016 would have affected net income by approximately $1.2 million in the fiscal year then ended.

27


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 31, 2016 and January 2, 2016 was $3.3 million and $3.6 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 31, 2016 would have affected net income by approximately less than $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 at December 31, 2016 and January 2, 2016 were $1.0 million and $1.5 million, respectively. Of these amounts, $0.6 million and $0.9 million, respectively, were included in deferred rent and other.
 
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 sublease income at December 31, 2016 would have affected net income by approximately less than $0.1 million in the fiscal year then ended.


















28


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 charge. The impairment calculation compares the carrying value of the asset to the asset’s estimated fair value less disposal costs, which is based on discounted cash flows. We recognize an impairment charge if the amount of the asset’s carrying value exceeds the asset’s estimated fair value. If we recognize an impairment, 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 years 2016 and 2015, we did not have any non-cash charges for impairment of long-lived assets.
 
Our impairment calculations contain uncertainties because they require management to make assumptions and to apply judgment in order to estimate future discounted 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 do not believe material impairment charges for long-lived assets are reasonably possible within the next twelve months.
 
We have not made any material changes in our impairment 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 charges. 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 charges that could be material.
 
 
 
 
 
 
 
 

29


Description
 
Judgments and Uncertainties
 
Effect if Actual Results Differ From
Assumptions
Income Taxes
 
 
 
 
We compute our provision for income taxes using the asset and liability method, under which deferred tax assets and liabilities are recognized for the expected future tax consequences of temporary differences between the financial reporting and tax bases of assets and liabilities and for operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using the currently enacted tax rates that are expected to apply to taxable income for the years in which those tax assets and liabilities are expected to be realized. Our effective tax rate is subject to change based on the mix of income from different state and other 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.
 
Significant judgments are required in order to determine the realizability of deferred tax assets. In assessing the need for a valuation allowance, we evaluate all significant available positive and negative evidence, including historical operating results, estimates of future taxable income and the existence of prudent and feasible tax planning strategies.  Furthermore, 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 our judgments and estimates are reasonable, actual results could differ, and we may be exposed to losses or gains that could be material.



30


 
 
 
 
 
 
 
 
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 that 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.
 
The self-insurance liability at December 31, 2016 and January 2, 2016 was $5.2 million and $5.8 million, respectively.
 
Liabilities for our self-insured losses and 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 31, 2016 would have affected net income by approximately $0.5 million in the fiscal year then ended.


31


Description
 
Judgments and Uncertainties
 
Effect if Actual Results Differ From
Assumptions
Share-Based Compensation
 
 
 
 
We have a share-based compensation plan under which we may award non-qualified stock options, restricted stock and other share-based awards. 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 units, performance-based restricted stock units and associate stock buying plan purchases using similar valuation techniques and 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 31, 2016, 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 our last annual report on Form 10-K.
At the end of the 2016, we had no outstanding long-term debt. In the fourth quarter of 2012, we entered into a five-year, amended and restated loan and security agreement pursuant to which we have up to $120.0 million in borrowing capacity. There are various interest rate options available, for more information, see Note 4 to our consolidated financial statements in Item 8 of this report.
Our only 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 $0.2 million over the next year.

32


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 GAAP. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. 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 31, 2016. In making its assessment of the effectiveness of internal control over financial reporting, management used the criteria set forth in "Internal Control—Integrated Framework" (2013), 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 31, 2016, based on the criteria set forth in "Internal Control—Integrated Framework" issued by the COSO.
Our internal control over financial reporting as of December 31, 2016 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report, which is included in this annual report on Form 10-K.

 
 
 
/S/    MATTHEW L. HYDE        
 
/S/    JEFFREY L. LASHER        
Matthew L. Hyde
 
Jeffrey L. Lasher
President and Chief Executive Officer
(principal executive officer)
 
Executive Vice President and Chief Financial Officer
(principal financial officer)
 
 
 
February 28, 2017
 
February 28, 2017

33


REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders
West Marine, Inc.

In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of income, comprehensive income, stockholders’ equity and cash flows present fairly, in all material respects, the financial position of West Marine, Inc. and its subsidiaries at December 31, 2016 and January 2, 2016, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2016 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the index appearing under Item 15(a)(2) presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company's management is responsible for these financial statements and financial statement schedule, 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 opinions on these financial statements, on the financial statement schedule, and on the Company's internal control over financial reporting based on our integrated 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 audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
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 (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) 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 (iii) 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.


/s/ PRICEWATERHOUSECOOPERS LLP
San Francisco, California
February 28, 2017



34


WEST MARINE, INC.
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2016 AND JANUARY 2, 2016
(in thousands, except share data)
 
 
Fiscal Year-End
 
2016
 
2015
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
76,141

 
$
48,159

Trade receivables, net of allowances of $268 in 2016 and $265 in 2015
6,413

 
7,141

Merchandise inventories, net
212,106

 
222,853

Other current assets
20,568

 
23,571

Total current assets
315,228

 
301,724

Property and equipment, net
82,517

 
81,561

Long-term deferred income taxes
3,862

 
4,321

Other assets
4,495

 
4,209

TOTAL ASSETS
$
406,102

 
$
391,815

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
32,999

 
$
26,275

Accrued payroll
15,609

 
21,506

Accrued expenses and other
29,510

 
27,245

Total current liabilities
78,118

 
75,026

Deferred rent and other
19,253

 
17,330

Total liabilities
97,371

 
92,356

Commitments and Contingencies - Note 6

 

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; 25,690,484 shares issued and 25,001,595 shares outstanding at December 31, 2016 and 25,421,685 shares issued and 24,732,796 shares outstanding at January 2, 2016
26

 
25

Treasury stock
(9,461
)
 
(9,285
)
Additional paid-in capital
214,790

 
211,663

Accumulated other comprehensive loss
(534
)
 
(319
)
Retained earnings
103,910

 
97,375

Total stockholders’ equity
308,731

 
299,459

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY
$
406,102

 
$
391,815





See notes to consolidated financial statements.

35


WEST MARINE, INC.
CONSOLIDATED STATEMENTS OF INCOME
FOR THE FISCAL YEARS ENDED DECEMBER 31, 2016, JANUARY 2, 2016 AND JANUARY 3, 2015
(in thousands, except per share data)
 
 
2016
 
2015
 
2014
Net revenues
$
703,371

 
$
704,825

 
$
675,751

Cost of goods sold
497,711

 
502,780

 
482,564

Gross profit
205,660

 
202,045

 
193,187

Selling, general and administrative expense
193,624

 
194,299

 
188,755

Income from operations
12,036

 
7,746

 
4,432

Interest expense
432

 
452

 
428

Income before income taxes
11,604

 
7,294

 
4,004

Provision for income taxes
5,069

 
2,774

 
2,056

Net income
$
6,535

 
$
4,520

 
$
1,948

Net income per common and common equivalent share:
 
 
 
 
 
Basic
$
0.26

 
$
0.18

 
$
0.08

Diluted
$
0.26

 
$
0.18

 
$
0.08

Weighted-average common and common equivalent shares outstanding:
 
 
 
 
 
Basic
24,893

 
24,629

 
24,244

Diluted
24,988

 
24,734

 
24,408



See notes to consolidated financial statements.

36


WEST MARINE, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
FOR THE FISCAL YEARS ENDED DECEMBER 31, 2016, JANUARY 2, 2016 AND JANUARY 3, 2015
(in thousands)
 
2016
 
2015
 
2014
Net income
$
6,535

 
$
4,520

 
$
1,948

Other comprehensive (loss) income
 
 
 
 
 
Foreign currency translation adjustment
(215
)
 
245

 
1

Total comprehensive income
$
6,320

 
$
4,765

 
$
1,949



See notes to consolidated financial statements.

37


WEST MARINE, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
FOR THE FISCAL YEARS ENDED DECEMBER 31, 2016, JANUARY 2, 2016 AND JANUARY 3, 2015
(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 December 28, 2013
24,296,497

 
$
25

 
$
(4,405
)
 
$
202,622

 
$
90,907

 
$
(565
)
 
$
288,584

 
Net income
 
 
 
 
 
 
 
 
1,948

 
 
 
1,948

 
Foreign currency translation adjustment, net of tax of $92
 
 
 
 
 
 
 
 
 
 
1

 
1

 
Common stock issued under equity compensation plan
391,950

 

 
 
 
4,760

 
 
 
 
 
4,760

 
Tax benefit from equity issuance, including excess tax benefit of $217

 
 
 
 
 
 
(173
)
 
 
 
 
 
(173
)
 
Treasury shares acquired
(359,905
)
 
 
 
(4,766
)
 
 
 
 
 
 
 
(4,766
)
 
Sale of common stock pursuant to Associates Stock Buying Plan
75,119

 
 
 
 
 
654

 
 
 
 
 
654

 
Balance at January 3, 2015
24,403,661

 
$
25

 
$
(9,171
)
 
$
207,863

 
$
92,855

 
$
(564
)
 
$
291,008

 
Net income
 
 
 
 
 
 
 
 
4,520

 
 
 
4,520

 
Foreign currency translation adjustment, net of tax of $93
 
 
 
 
 
 
 
 
 
 
245

 
245

 
Common stock issued under equity compensation plan
259,155

 

 
 
 
3,928

 
 
 
 
 
3,928

 
Tax benefit from equity issuance, including excess tax benefit of $0
 
 
 
 
 
 
(718
)
 
 
 
 
 
(718
)
 
Treasury shares acquired

 
 
 
(114
)
 
 
 
 
 
 
 
(114
)
 
Sale of common stock pursuant to Associates Stock Buying Plan
69,980

 
 
 
 
 
590

 
 
 
 
 
590

 
Balance at January 2, 2016
24,732,796

 
$
25

 
$
(9,285
)
 
$
211,663

 
$
97,375

 
$
(319
)
 
$
299,459

 
Net income
 
 
 
 
 
 
 
 
6,535

 
 
 
6,535

 
Foreign currency translation adjustment, net of tax of $168
 
 
 
 
 
 
 
 
 
 
(215
)
 
(215
)
 
Common stock issued under equity compensation plan
187,688

 
1

 
 
 
2,780

 
 
 
 
 
2,781

 
Tax benefit from equity issuance, including excess tax benefit of $0
 
 
 
 
 
 
(262
)
 
 
 
 
 
(262
)
 
Treasury shares acquired

 
 
 
(176
)
 
 
 
 
 
 
 
(176
)
 
Sale of common stock pursuant to Associates Stock Buying Plan
81,111

 
 
 
 
 
609

 
 
 
 
 
609

 
Balance at December 31, 2016
25,001,595

 
$
26

 
$
(9,461
)
 
$
214,790

 
$
103,910

 
$
(534
)
 
$
308,731

 

See notes to consolidated financial statements.

38


WEST MARINE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE FISCAL YEARS ENDED DECEMBER 31, 2016, JANUARY 2, 2016 AND JANUARY 3, 2015
(in thousands)
 
 
2016
 
2015
 
2014
OPERATING ACTIVITIES:
 
 
 
 
 
Net income
$
6,535

 
$
4,520

 
$
1,948

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
 
Depreciation and amortization
22,166

 
20,687

 
18,234

Share-based compensation
2,779

 
2,787

 
3,109

Excess tax benefit from share-based compensation

 

 
(217
)
Deferred income taxes
2,453

 
1,780

 
3,287

Provision for doubtful accounts
128

 
208

 
37

Lower of cost or market inventory adjustments
2,223

 
1,832

 
1,759

(Gain)/loss on asset disposals
(336
)
 
855

 
330

Changes in assets and liabilities:
 
 
 
 
 
Trade receivables
600

 
(507
)
 
(439
)
Merchandise inventories
8,524

 
(10,387
)
 
(13,021
)
Other current assets
2,789

 
2,220

 
(6,431
)
Other assets
(481
)
 
(379
)
 
(659
)
Accounts payable
5,929

 
(7,901
)
 
10,787

Accrued payroll
(5,897
)
 
7,252

 
2,870

Accrued expenses and other
2,003

 
(141
)
 
588

Deferred items and other non-current liabilities
(70
)
 
480

 
1,776

Net cash provided by operating activities
49,345

 
23,306

 
23,958

INVESTING ACTIVITIES:
 
 
 
 
 
Proceeds from sale of property and equipment
884

 
67

 
57

Purchases of property and equipment
(22,679
)
 
(22,613
)
 
(24,573
)
Net cash used in investing activities
(21,795
)
 
(22,546
)
 
(24,516
)
FINANCING ACTIVITIES:
 
 
 
 
 
Borrowings on line of credit
1,051

 
875

 
2,240

Repayments on line of credit
(1,051
)
 
(875
)
 
(2,240
)
Proceeds from exercise of stock options
1

 
1,141

 
1,651

Proceeds from sale of common stock pursuant to Associates Stock Buying Plan
609

 
590

 
654

Excess tax benefit from share-based compensation

 

 
217

Treasury stock
(176
)
 
(114
)
 
(4,766
)
Net cash provided by (used in) financing activities
434

 
1,617

 
(2,244
)
Effect of exchange rate changes on cash
(2
)
 
107

 
69

NET INCREASE (DECREASE) IN CASH
27,982

 
2,484

 
(2,733
)
CASH AT BEGINNING OF PERIOD
48,159

 
45,675

 
48,408

CASH AT END OF PERIOD
$
76,141

 
$
48,159

 
$
45,675

Other cash flow information:
 
 
 
 
 
Cash paid for interest
$
275

 
$
287

 
$
328

Cash paid for income taxes, net of refunds of $2,990, $151 and $1,394
(339
)
 
(27
)
 
2,064

Non-cash investing activities
 
 
 
 
 
Property and equipment additions in accounts payable
2,452

 
1,657

 
725



See notes to consolidated financial statements.

39


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 leading waterlife outfitter in the United States. At December 31, 2016, West Marine offered its products through 254 stores in 38 states, Puerto Rico and Canada, through its call center channel and on the Internet. As previously disclosed, the Company closed eight Canadian stores in 2015 and will close the remaining two stores by June 2017. The Company is also engaged in the distribution of marine equipment to its professional customers serving boat manufacturers, marine services, commercial vessel operations and government agencies.
West Marine is an omni-channel retail organization operating one reporting segment in accordance with the Financial Accounting Standards Board ("FASB") Accounting Standards Codification ("ASC") Topic 280, Segment Reporting. The metrics used by its Chief Executive Officer (as the Company's chief operating decision maker or the "CODM") to assess the performance of the Company are focused on viewing the business as a single integrated business. The CODM's process for allocating resources is based upon the omni-channel view of the Company. Additionally, the Company has integrated systems and concentrated its strategic focus on omni-channel retailing. In addition, the Company has commingled sales channel payroll expense, inventories, merchandise procurement and distribution networks. Revenues from customers are derived from merchandise sales and the Company does not rely on any individual major customer.
The Company considers its merchandise expansion strategy to be strategically important to its future success and is providing the following product category information. The Company's merchandise mix over the last three years is reflected in the table below:
 
2016
 
2015
 
2014
Core boating products
76.5
%
 
77.1
%
 
81.3
%
Merchandise expansion products
23.5
%
 
22.9
%
 
18.7
%
Total
100.0
%
 
100.0
%
 
100.0
%
The Company considers core boating products to be comprised of maintenance related products, electronics, sailboat hardware, anchors/docking/moorings, engine systems, safety, electrical, plumbing, boats, outboards, ventilation, deck hardware/fasteners, navigation, trailering, seating/boat covers and barbecues/appliances. The Company considers its merchandise expansion products to be comprised of apparel, footwear, clothing accessories, fishing, watersports, paddlesports, coolers, bikes and cabin/galley.
West Marine was incorporated in Delaware in September 1993 as the holding company for West Marine Products, Inc., which was incorporated in California in 1976. The Company’s principal executive offices are located in Watsonville, California.
PRINCIPLES OF CONSOLIDATION—The consolidated financial statements include the accounts of West Marine, Inc. and its subsidiaries, all of which are wholly-owned, directly or indirectly. Intercompany balances and transactions are eliminated in consolidation.
YEAR-END—The Company’s fiscal year consists of 52 or 53 weeks, ending on the Saturday closest to December 31 and as a result, a 53-week year occurs every five to six years. The fiscal years 2016 and 2015 consisted of the 52 weeks ended December 31, 2016 and January 2, 2016, respectively, while the 2014 fiscal year consisted of the 53 weeks ended January 3, 2015. References to 2016, 2015 and 2014 are to the fiscal years ended December 31, 2016, January 2, 2016 and January 3, 2015, respectively.
ACCOUNTING ESTIMATES—The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America ("GAAP") requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Such estimates include, but are not limited to, the following: useful lives and recoverability of fixed assets; inventory obsolescence and shrinkage reserves; capitalized indirect inventory costs; allowance for doubtful accounts receivable; calculation of accrued liabilities, including workers’ compensation and other self-insured liabilities; sabbatical liability, sales returns reserves, unredeemed gift cards and loyalty program awards; vendor consideration earned; fair value of share-based compensation instruments, income tax valuation allowances and uncertain tax positions; legal liabilities and other contingencies; and asset retirement obligations. Actual results could differ from those estimates.
INVENTORIES—Merchandise inventories are carried at the lower of cost or market on an average cost basis. Capitalized indirect costs include freight charges for transporting merchandise to warehouses or store locations and operating costs incurred

40

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

for merchandising, replenishment and distribution center activities. Indirect costs included in inventory value at the end of fiscal years 2016 and 2015 were $19.3 million and $19.7 million, respectively. Indirect costs included in inventory value are recognized as an increase in cost of goods sold as the related products are sold.
Inventories are written down to market value when cost exceeds market value, based on historical experience and current information. Reserves for estimated inventory shrinkage based on historical shrinkage rates determined by the Company’s physical merchandise inventory counts and cycle counts were $2.1 million and $2.3 million at the end of 2016 and 2015, respectively. Reserves for estimated inventory market value below cost, based upon current levels of aged and discontinued product and historical analysis of inventory sold below cost, were $4.7 million and $4.5 million at the end of 2016 and 2015, respectively.
DEFERRED CATALOG AND ADVERTISING COSTS—The Company capitalizes the direct cost of producing and distributing its catalogs. Capitalized catalog costs are amortized, once a catalog is mailed, over the expected net sales period, which is generally from one month to 24 months. Advertising costs, which are included in selling, general and administrative ("SG&A") expense, are expensed as incurred and were $13.9 million, $14.7 million and $16.0 million in 2016, 2015 and 2014, respectively. Advertising costs were partially offset by vendor allowances of $12.9 million, $11.2 million and $10.6 million in 2016, 2015 and 2014, respectively, which are included in cost of goods sold. The capitalized value of prepaid catalog and advertising costs on the balance sheet were immaterial as of December 31, 2016 and January 2, 2016.
PROPERTY AND EQUIPMENT—Property and equipment is stated at cost and depreciated using the straight-line method over the estimated useful lives of the various assets, as follows:
 
 
 
 
 
 
 
  
Estimated
Useful
Lives
 
 
Furniture and equipment
  
3–7 years
  
 
Computer software and hardware
  
3–7 years
  
 
Buildings
  
25 years
  
Leasehold improvements are amortized over the lesser of the expected lease term or the estimated useful life of the improvement, which is usually about 10 years.
CAPITALIZED INTEREST—The Company capitalizes interest on major capital projects. The Company did not capitalize interest in 2016, 2015 or 2014.
CAPITALIZED SOFTWARE COSTS—Capitalized computer software, included in property and equipment, reflects costs related to internally-developed or purchased software that are capitalized and amortized on a straight-line basis, generally over a period ranging from three to seven years.
ASSET RETIREMENT OBLIGATIONS—The Company estimates the fair value of obligations to clean up and restore leased properties under agreements with landlords and records the estimated amount as a liability when incurred. Liabilities for asset retirement obligations were $0.1 million as of December 31, 2016, and $0.6 million as of January 2, 2016. There were no significant changes attributable to the following components during the 2016, 2015 and 2014 reporting periods: liabilities incurred; liabilities settled; accretion expense; and revisions in estimated cash flows.
IMPAIRMENT OF LONG-LIVED ASSETS—The Company reviews long-lived assets, including property and equipment, for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. If facts indicate a potential impairment, the Company would assess the recoverability by determining if the carrying value of the long-lived assets exceeds the sum of the projected undiscounted cash flows expected to result from the use and eventual disposition of the assets over the remaining economic life. If the recoverability test indicates that the carrying value of the long-lived assets is not recoverable, the Company will estimate the fair value of the long-lived assets using appropriate valuation methodologies, which would typically include an estimate of discounted cash flows. Any impairment would be measured as the difference between the long-lived assets' carrying amount and the estimated fair value less disposal costs. The Company recorded no asset impairment charges in fiscal years 2016, 2015 and 2014.
COSTS ASSOCIATED WITH EXIT ACTIVITIES—The Company occasionally vacates stores prior to the expiration of the related lease. For vacated locations that are under long-term leases, the Company records an expense for the net present value of the difference between its future lease payments and related costs, such as real estate taxes and common area maintenance costs, from the date of closure through the end of the remaining lease term, net of expected future sublease rental income. Costs associated with exit activities as of December 31, 2016 and January 2, 2016 were $1.0 million and $1.5 million, respectively. Of these amounts,

41

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

as of December 31, 2016 and January 2, 2016, $0.6 million and $0.9 million, respectively, were included in deferred rent and other.
SELF-INSURANCE OR HIGH DEDUCTIBLE LOSSES—The Company uses a combination of insurance and self-insurance for a number of risk management activities, including workers’ compensation, general liability and employee-related health care benefits, a portion of healthcare costs is paid by its associates. Liabilities associated with these risks are estimated primarily based on amounts determined by actuarial analysis, and accrued in part by considering historical claims experience, demographic factors, severity factors and other actuarial assumptions. Any actuarial projection of losses is subject to a high degree of variability. Among the causes of this variability are unpredictable external factors affecting future inflation rates, litigation trends, legal interpretations, benefit level changes and claim settlement patterns.
DEFERRED RENT—Certain of the Company’s operating leases contain periods of free or reduced rent or contain predetermined fixed increases in the minimum rent amount during the lease term. For these leases, the Company recognizes rent expense on a straight-line basis over the expected life of the lease, generally about 13 years, including periods of free rent, and records the difference between the amount charged to rent expense and the rent paid as deferred rent. Tenant improvement allowances received from landlords are deferred and amortized to reduce rent expense over the expected life of the lease. As of December 31, 2016 and January 2, 2016, deferred rent totaled $10.9 million and $11.9 million, respectively, of which $1.1 million and $1.3 million is included in accrued expenses for December 31, 2016 and January 2, 2016, respectively. The non-current portion is included in the deferred rent and other line item on the Company's consolidated balance sheet.
INCOME TAXES—Income taxes are accounted for using the asset and liability method. Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to the differences between existing financial statement carrying amounts and their respective tax bases and for operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured at the tax rate expected to be in effect for the taxable years in which the Company expects those temporary differences to be recovered or settled. The Company recognizes the effect of changes in tax rates on deferred tax assets and liabilities in the period that includes the enactment date of the change. A valuation allowance is recorded to reduce deferred tax assets to the amount estimated as more likely than not to be realized. The Company also accounts for uncertainties in income taxes recognized in its financial statements. For more information, see Note 7.
SALES AND USE TAX—Net revenues are recorded net of sales and use taxes. Net sales and use taxes are collected and remitted to all jurisdictions in which the Company has a physical presence in accordance with state, provincial and local tax laws.
FAIR VALUE OF FINANCIAL INSTRUMENTS—Fair value of financial instruments represents the price that would be received to sell an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability.
The fair value hierarchy prescribed under GAAP contains three levels, which prioritizes the inputs used in the valuation methodologies in measuring fair value:
Level 1—Observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets.
Level 2—Other inputs that are directly or indirectly observable in the marketplace.
Level 3—Unobservable inputs which are supported by little or no market activity.
The fair value hierarchy also requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. As of December 31, 2016 and January 2, 2016, there were no financial instruments which require disclosure under the fair value hierarchy.
REVENUE RECOGNITION—Sales, net of estimated returns, are recorded when merchandise is purchased by customers at store locations. Revenue is recognized when merchandise shipped from a warehouse is received by the customer, based upon the estimated date of receipt by the customer. The Company reserves for sales returns through estimates based on historical experience. The sales return reserve for fiscal years 2016, 2015 and 2014 was $(1.4) million, $(1.3) million and $(1.2) million, respectively.
ACCOUNTS RECEIVABLE—Accounts receivable consists of amounts owed to West Marine for sales of services or goods on credit for our professional customers. The Company maintains an allowance for doubtful accounts receivable for estimated losses resulting from the inability of our customers to make required payments. The Company determines this allowance based on overall estimated exposure. Factors impacting the allowance include the level of gross receivables, the aging of accounts receivable at the date of the consolidated financial statements, the financial condition of the Company's customers and the economic risks for certain customers. The allowances for doubtful accounts receivable were as follows:

42

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

 
 
2016
 
2015
 
2014
 
 
 
(in thousands)
 
 
Allowance for doubtful accounts receivable—beginning balance
$
(265
)
 
$
(247
)
 
$
(243
)
Additions
(191
)
 
(174
)
 
(307
)
Deductions and other adjustments
188

 
156

 
303

Allowance for doubtful accounts receivable—ending balance
$
(268
)
 
$
(265
)
 
$
(247
)
The Company's policy for writing off uncollectible trade accounts receivables consists of systematic follow-up of delinquent accounts (over 90 days past the customer's terms of sale) and management review of accounts over a set dollar amount.
UNREDEEMED GIFT CARDS—Aggregate sales of gift cards for fiscal years 2016, 2015 and 2014 were $18.4 million, $18.4 million and $18.1 million, respectively. West Marine uses the proportional model for deferral of gift card sales. In line with the proportional method, sales of gift cards are deferred and treated as a liability on our balance sheet either until redeemed by customers in exchange for products or until we determine that breakage has occurred. Breakage is estimated in proportion to actual redemption. Under this method, we estimate breakage based on Company-specific data by analyzing historical experience and deriving a rate that represents the amount of gift cards that are expected to be unused and not subject to escheatment. This rate is then applied, and breakage is recognized in income, over the period of redemption. Gift card breakage income for 2016, 2015 and 2014 was $0.9 million, $0.7 million and $0.7 million, respectively, and is included as net revenues in the Company's operating results.
WEST ADVANTAGE CUSTOMER LOYALTY PROGRAMS—The Company has a customer loyalty program which allows members to earn points on qualifying purchases. Points earned entitle members to receive certificates that may be redeemed on future purchases through any retail sales channel. The certificates expire one year after they are issued. A liability is recognized and recorded as a reduction of revenue at the time the points are earned, based on the retail value of certificates projected to be redeemed, less the applicable estimate of breakage based upon historical redemption patterns. As of December 31, 2016 and January 2, 2016, the Company had a recorded liability for the West Advantage customer loyalty program of $1.3 million and $1.3 million, respectively.
COST OF GOODS SOLD—Cost of goods sold includes costs related to the purchase, transportation and storage of merchandise, shipping expense and store occupancy costs. Consideration in the form of cash or credits received from vendors is recorded as a reduction to cost of goods sold as the related products are sold.
VENDOR ALLOWANCES—The Company receives various payments and allowances from its vendors through a variety of programs and arrangements. Monies received from vendors include rebates, allowances and promotional funds. The amounts to be received are subject to the terms of the vendor agreements, which are subject to ongoing negotiations that may be impacted in the future based on changes in market conditions, vendor marketing strategies and changes in the profitability or sell-through of the related merchandise.
Rebates and other miscellaneous incentives are earned based on purchases, receipts or product sales and are accrued ratably over the purchase or sale of the related product. These monies are recorded as a reduction of merchandise inventories based on inventory turns and as the product is sold. 
COMPREHENSIVE INCOME—Comprehensive income consists of net income and other comprehensive income (loss). Other comprehensive income (loss) includes income, expenses, gains and losses that bypass the income statement and are reported directly as a separate component of equity. The Company’s comprehensive income consists of net income and foreign currency translation adjustments for all periods presented.
FOREIGN CURRENCY—Translation adjustments result from translating foreign subsidiaries’ financial statements into U.S. dollars. West Marine Canada’s functional currency is the Canadian dollar. Balance sheet accounts are translated at exchange rates in effect at the balance sheet date. Income statement accounts are translated at average exchange rates during the year. Resulting translation adjustments are included as a component of other comprehensive income in the consolidated statements of stockholders’ equity. Gains (losses) from foreign currency transactions included in SG&A expense for 2016, 2015 and 2014 were $0.1 million, $(0.7) million and $(0.5) million, respectively.

43

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

ACCRUED EXPENSES—Accrued expenses consist of the following (in thousands):
 
 
2016
 
2015
Unredeemed gift cards
$
7,546

 
$
7,336

Other accrued expenses
21,964

 
19,909

Accrued expenses
$
29,510

 
$
27,245

NET INCOME PER SHARE—Basic net income per share is computed by dividing net income available to common stockholders by the weighted-average number of common shares outstanding during the period. Diluted net income per share reflects the potential dilution that could occur if unvested restricted shares and outstanding options to purchase common stock were exercised. Options to purchase approximately 0.5 million shares, 0.6 million shares and 0.7 million shares of common stock that were outstanding in 2016, 2015 and 2014, respectively, have been excluded from the calculation of diluted income per share because inclusion of such shares would be anti-dilutive.
The following is a reconciliation of the Company’s basic and diluted net income per share computations (shares in thousands):
 
2016
 
2015
 
2014
 
Shares
 
Net Income
Per  Share
 
Shares
 
Net Income
Per  Share
 
Shares
 
Net Income
Per  Share
Basic
24,893

 
$
0.26

 
24,629

 
$
0.18

 
24,244

 
$
0.08

Effect of dilutive stock options
95

 

 
105

 

 
164

 

Diluted
24,988

 
$
0.26

 
24,734

 
$
0.18

 
24,408

 
$
0.08

.
CASH AND CASH EQUIVALENTS—Cash consists entirely of cash on hand and bank deposits, of which approximately $74.4 million exceeded FDIC insurance limits as of December 31, 2016. As of January 2, 2016, approximately $46.6 million exceeded FDIC insurance limits.
The Company classifies amounts in transit from banks for customer credit card and debit card transactions as cash and cash equivalents as the banks process the majority of these amounts within three to five business days. The amounts due from banks for these transactions classified as cash and cash equivalents totaled $3.9 million and $3.5 million at December 31, 2016 and January 2, 2016, respectively
We had no outstanding checks in excess of funds on deposit (book overdrafts) at December 31, 2016 and January 2, 2016.
SABBATICAL LEAVE—Certain full-time associates are eligible to receive sabbatical leave after each 5 years of continuous employment. The estimated sabbatical liability is based on a number of factors, including actuarial assumptions and historical trends. In fiscal years 2016 and 2015, the Company had a recorded liability of $1.0 million and $1.2 million, respectively, as an estimate of accumulated sabbatical leave as of the respective balance sheet dates.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
ASU 2014-09, Revenue from Contracts with Customers (Topic 606)
ASU 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date
ASU 2016-10, Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing
ASU 2016-12, Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients
In May 2014, FASB issued an accounting standards update ("ASU") 2014-09, which supersedes the revenue recognition requirements in ASC Topic 605, Revenue Recognition, and requires entities to recognize revenue in a way that depicts the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In August 2015, FASB issued ASU 2015-14, which deferred the effective date of ASU 2014-09 to December 15, 2017 for annual reporting periods beginning after that date. FASB also approved permitting early adoption of the standard, but not before the original effective date of December 15, 2016. The Company will not be early adopting the standard; therefore, the new standard will be effective for the Company's 2018 fiscal year. The standard permits the use of either the full retrospective or modified retrospective approach. The Company currently expects to adopt the new standard using the modified retrospective approach.

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In April 2016, FASB issued ASU 2016-10, which clarifies the following two aspects of Topic 606: identifying performance obligations; and licensing implementation guidance. The Company is currently assessing and evaluating the new standard and has not yet concluded whether the adoption of ASU 2016-10 will have a material impact on the Company's consolidated financial statements. The Company currently expects to adopt an accounting policy to account for shipping and handling activities that occur after the customer has obtained control of a good as an activity to fulfill the promise to transfer the good, rather than as an additional promised service. This guidance does not represent a change from current practice for the Company. The Company does not have any license or royalty revenue.
In May 2016, FASB issued ASU 2016-12, which focuses on clarifying the guidance on assessing collectability, presentation of sales taxes, non-cash consideration, and completed contracts and contract modification at transition. The Company has not yet concluded whether the adoption of ASU 2016-12 will have a material impact on its consolidated financial statements. Consistent with its current accounting policy, the Company currently expects to exclude amounts collected from customers for all sales (and other similar) taxes from the transaction price.
In August 2014, FASB issued ASU 2014-15, Presentation of Financial Statements - Going Concern (Subtopic 205-40), Disclosure of Uncertainties about an Entity's Ability to Continue as a Going Concern, which requires management to disclose their assessment of the entity's ability to continue as a going concern. Under this guidance, management is required to evaluate whether there is substantial doubt about the entity's ability to continue as a going concern and, if so, provide certain footnote disclosures.The amendment is effective for the annual period ending after December 15, 2016, and interim periods thereafter. The Company adopted the standard for the year ended December 31, 2016. The adoption of this standard did not have an impact on our consolidated financial statements and related footnotes.
In July 2015, FASB issued ASU 2015-11, Simplifying the Measurement of Inventory. The update requires an entity to measure inventory at the lower of cost or market and net realizable value. Subsequent measurement is unchanged for inventory using last -in, first out or the retail inventory method. The effective date for ASU 2015-11 is for fiscal years beginning after December 15, 2016. The Company expects the adoption of this accounting guidance will not have an impact on the Company's consolidated financial statements.
In February 2016, FASB issued ASU 2016-02, Leases (Topic 842), which is intended to increase transparency and comparability among organizations by recognizing lease assets and liabilities on the balance sheet for leases with a term of more than 12 months. In addition, the update will require additional disclosures regarding key information about leasing arrangements. Under existing guidance, operating leases with a term of more than 12 months are not recorded as lease assets and lease liabilities on the balance sheet. The update will be effective for the Company beginning in the first quarter of fiscal year 2019, with early adoption permitted. The Company is currently evaluating the impact of the adoption of this accounting guidance on its consolidated financial statements. The Company expects the adoption of this accounting guidance to result in an increase in lease assets and a corresponding increase in lease liabilities on its consolidated balance sheets.
In March 2016, FASB issued ASU 2016-09, Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting, which is intended to simplify several aspects of the accounting for share-based payment transactions, including the accounting for income taxes, forfeitures and statutory tax withholding requirements, as well as classification in the statement of cash flows. The update is effective for annual periods beginning after December 15, 2016, with early adoption permitted. The Company is not planning to early adopt and expects that this guidance will not have a material impact on its consolidated financial statements.
In August 2016, FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments,which is intended to decrease the diversity in practice in how certain cash receipts and cash payments are presented and classified in the statement of cash flows. The amendments in this update provide guidance on eight specific cashflow issues. The amendments in ASU 2016-15 are effective for the Company for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years, and should be applied using the retrospective transition method for each period presented. Early adoption is permitted, but all amendments must be adopted in the same period. The Company is not planning to early adopt and is currently evaluating the impact that the amendments will have on its consolidated financial statements.
In October 2016, FASB issued ASU 2016-16, Intra-Entity Transfers of Assets Other Than Inventory. The effective date for ASU 2016-16 is for fiscal years beginning after December 15, 2017. ASU 2016-16 is applied on a modified retrospective basis and the Company will recognize any effects of adoption in the retained earnings at the beginning of its 2018 fiscal year. The Company is currently evaluating the impact this guidance will have on its consolidated financial statements.
NOTE 2: SHARE-BASED COMPENSATION
West Marine’s Omnibus Equity Incentive Plan, as amended (the “Plan”) is intended to provide flexibility to the Company in its ability to motivate, attract and retain the services of associates and non-employee directors. The Plan permits a variety of compensation methods, including non-qualified stock options, incentive stock options, restricted stock and other share-based

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
 

awards, such as time-based and performance-based restricted stock units. Key associates and non-employee directors are eligible to participate under the Plan. At year-end 2016, 10,300,000 shares of common stock had been reserved under the Plan and 959,702 shares were available for future issuance. 
The Company recognizes compensation expense for share-based payments based on the grant date fair value of the awards. Share-based payments consist of stock option grants, restricted stock awards, restricted stock units, performance-based restricted stock units and Associates Stock Buying Plan ("Buying Plan") issuances, each as described further below.
Share-based compensation expense for 2016, 2015 and 2014 was approximately $2.8 million, $2.8 million and $3.1 million, respectively, of which expense for stock options was $0.1 million, $0.3 million and $0.8 million in 2016, 2015 and 2014, respectively. In 2015, the Company recognized no tax benefits from stock option exercises, restricted stock vesting or disqualifying Buying Plan transactions. In 2014, the Company recognized $0.2 million in tax benefits from stock options exercised, restricted stock vesting and disqualifying Buying Plan transactions, of which $0.2 million was recognized as excess tax benefits in additional paid-in capital and $0.2 million was included as part of cash flow from financing activities. The tax benefit was included in the Company’s consolidated statement of income for the same period. Share-based compensation of $0.4 million was included in capitalized indirect inventory in 2016, $0.4 million in 2015 and $0.4 million in 2014.
Included in cost of goods sold and SG&A expense is share-based compensation expense, net of estimated forfeitures, that has been included in the statements of income for all share-based compensation arrangements as follows:
(in thousands)
2016
 
2015
 
2014
Cost of goods sold
$
431

 
$
448

 
$
429

Selling, general and administrative expense
2,348

 
2,339

 
2,680

Share-based compensation expense
$
2,779

 
$
2,787

 
$
3,109


Stock Options
West Marine awarded options to purchase shares of common stock to its non-employee directors and to certain eligible associates employed at the time of the grant. For fiscal 2007 through 2010, options granted to associates under the Plan vested over three years and expired five years following the grant date. Grants in 2011, 2012 and 2013 vested over three years and expired seven years from the grant date. Prior to 2011, options granted to non-employee directors vested after six months and expired five years from the grant date. Options granted to non-employee directors in 2012 vested after one year and expire seven years from the grant date. Options granted to non-employee directors in 2011 vested after six months and expire seven years from the grant date. One non-employee director elected to receive options in 2016. Following the grant in 2016, the Company stopped awarding option grants. The Company has determined the fair value of options awarded by applying the Black-Scholes Merton option pricing valuation model and using following assumptions:
 
2016
 
2015
 
2014
Expected price volatility
33
%
 
%
 
%
Risk-free interest rate
1.2
%
 
%
 
%
Weighted-average expected term (years)
4.0

 
0.0

 
0.0

Dividend yield

 

 

Expected price volatility: This is the percentage amount by which the price of West Marine common stock is expected to fluctuate annually during the estimated expected life for stock options. Expected price volatility is calculated using historical monthly closing prices over a period matching the weighted-average expected term, as management believes such changes are the best indicator of future volatility. An increase in expected price volatility would increase compensation expense.
Share issuance: The Company’s policy is to issue new shares of common stock for purchase under the Plan. Shares of common stock are authorized by the Company’s Board of Directors, subject to stockholder approval, for issuance under the Plan. Subject to adjustment, the maximum number of shares currently available for grant under the Plan may not exceed 10,300,000 shares.
Risk-free interest rate: This is the U.S. Treasury zero-coupon rate, as of the grant date, for issues having a term equal to the expected life of the stock option. An increase in the risk-free interest rate would increase compensation expense.
Expected term: This is the period of time over which stock options are expected to remain outstanding. The Company calculates expected term based on the average of the vesting period and the full contractual term. An increase in the expected term would increase compensation expense.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
 

Dividend yield: The Company historically has not made any dividend payments, nor does it expect to pay dividends in the foreseeable future. An increase in the dividend yield would decrease compensation expense.
A summary of the Company’s stock option activity in 2016, 2015 and 2014 is as follows:
 
Number of
Shares
 
Weighted
Average
Exercise
Price
 
Weighted
Average
Option
Grant Date
Fair Value
Outstanding at year-end 2013 (1,179,770 stock options exercisable at a weighted-average exercise price of $12.63)

1,699,886

 
12.13

 
5.43

Granted

 

 

Exercised
(236,052
)
 
7.14

 
2.54

Forfeited
(47,924
)
 
10.96

 
4.12

Expired
(324,832
)
 
19.86

 
11.39

Outstanding at year-end 2014 (896,687 stock options exercisable at a weighted-average exercise price of $10.87)

1,091,078

 
10.95

 
4.32

Granted

 

 

Exercised
(106,783
)
 
10.69

 
4.18

Forfeited
(17,823
)
 
11.19

 
4.09

Expired
(345,984
)
 
11.12

 
4.49

Outstanding at year-end 2015 (575,015 stock options exercisable at a weighted-average exercise price of $10.82)

620,488

 
10.88

 
4.26

Granted
10,123

 
8.99

 
2.47

Exercised
(124
)
 
10.36

 
4.27

Forfeited
(2,670
)
 
11.69

 
4.08

Expired
(109,288
)
 
10.56

 
4.15

Outstanding at year-end 2016 (508,629 stock options exercisable at a weighted-average exercise price of $10.94)
518,529

 
10.91

 
4.25

The weighted-average grant date fair value of options granted in 2016 was $2.47 per share. There were no stock options granted in 2015 and 2014. The aggregate fair value of options vested during 2016, 2015 and 2014 was $0.5 million, $1.6 million and $2.5 million, respectively.
As of market close December 31, 2016, the aggregate intrinsic value of stock options was $0.1 million, and less than $0.1 million for exercisable options. The total intrinsic value of options actually exercised was $0.0 million in 2016, $0.1 million in 2015 and $1.0 million in 2014. There were 128,349 options that vested in 2016 with an aggregate grant date fair value of $0.5 million. At December 31, 2016, unrecognized compensation expense for stock options, net of expected forfeitures, was less than $0.1 million, with a weighted-average remaining expense recognition period of 0.40 years.
Additional information for options outstanding at year-end 2016 is as follows: