UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended September 27, 2008
OR
¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission file number 0-22512
WEST MARINE, INC.
(Exact Name of Registrant as Specified in Its Charter)
Delaware | 77-0355502 | |
(State or Other Jurisdiction of Incorporation or Organization) |
(IRS Employer Identification No.) |
500 Westridge Drive
Watsonville, CA 95076-4100
(Address of Principal Executive Offices) (Zip Code)
Registrants Telephone Number, Including Area Code: (831) 728-2700
Indicate by a check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company (as defined in Rule 12b-2 of the Exchange Act). (Check one):
Large accelerated filer ¨ | Accelerated filer x | Non-accelerated filer ¨ | Smaller reporting company ¨ | |||
(Do not check if a smaller reporting company) |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
At October 31, 2008, the number of shares outstanding of the registrants common stock was 22,022,199.
Page No. | ||||
PART 1 Financial Information | 3 | |||
Item 1. | Financial Statements | 3 | ||
3 | ||||
4 | ||||
5 | ||||
6 | ||||
13 | ||||
Item 2. | Managements Discussion and Analysis of Financial Condition and Results of Operations | 14 | ||
Item 3. | Quantitative and Qualitative Disclosures About Market Risk | 18 | ||
Item 4. | Controls and Procedures | 18 | ||
PART II Other Information | 19 | |||
Item 1. | Legal Proceedings | 19 | ||
Item 1A. | Risk Factors | 19 | ||
Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds | 19 | ||
Item 3. | Defaults Upon Senior Securities | 19 | ||
Item 4. | Submission of Matters to a Vote of Security Holders | 19 | ||
Item 5. | Other Information | 19 | ||
Item 6. | Exhibits | 20 |
EXPLANATORY NOTE
In this report, we have restated our previously issued condensed consolidated financial statements for the 13-week and 39-week periods ended September 29, 2007 to reflect required accounting corrections. The restatement of the prior interim periods contained in this report should be read in conjunction with our annual report on Form 10-K for the year ended December 29, 2007, as filed with the Securities and Exchange Commission (SEC) on April 4, 2008. Also see Note 2 to our condensed consolidated financial statements in Item 1 of this report for additional information regarding the restatement.
2
PART I FINANCIAL INFORMATION
CONDENSED CONSOLIDATED BALANCE SHEETS
SEPTEMBER 27, 2008, DECEMBER 29, 2007 AND SEPTEMBER 29, 2007
(Unaudited and in thousands, except share data)
September 27, 2008 |
December 29, 2007 |
September 29, 2007 |
||||||||||
Restated (Note 2) |
||||||||||||
ASSETS |
||||||||||||
Current assets: |
||||||||||||
Cash |
$ | 6,050 | $ | 6,126 | $ | 6,578 | ||||||
Trade receivables, net |
7,891 | 6,704 | 7,605 | |||||||||
Merchandise inventories |
245,069 | 248,307 | 254,736 | |||||||||
Deferred income taxes |
| 7,976 | 7,776 | |||||||||
Other current assets |
18,219 | 21,469 | 19,491 | |||||||||
Total current assets |
277,229 | 290,582 | 296,186 | |||||||||
Property and equipment, net |
62,068 | 67,521 | 70,365 | |||||||||
Goodwill |
| | 56,905 | |||||||||
Intangibles, net |
163 | 192 | 201 | |||||||||
Other assets |
3,054 | 10,023 | 3,487 | |||||||||
TOTAL ASSETS |
$ | 342,514 | $ | 368,318 | $ | 427,144 | ||||||
LIABILITIES AND STOCKHOLDERS EQUITY |
||||||||||||
Current liabilities: |
||||||||||||
Accounts payable |
$ | 43,649 | $ | 35,122 | $ | 52,442 | ||||||
Accrued expenses and other |
44,405 | 47,738 | 46,298 | |||||||||
Total current liabilities |
88,054 | 82,860 | 98,740 | |||||||||
Long-term debt |
29,300 | 52,338 | 30,318 | |||||||||
Deferred rent, and other |
8,358 | 8,608 | 9,237 | |||||||||
Total liabilities |
125,712 | 143,806 | 138,295 | |||||||||
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; 22,047,925 shares issued and 22,020,353 shares outstanding at September 27, 2008; 21,917,077 shares issued and 21,893,474 shares outstanding at December 29, 2007; and 21,862,151 shares issued and 21,838,548 shares outstanding at September 29, 2007 |
22 | 22 | 22 | |||||||||
Treasury stock |
(366 | ) | (348 | ) | (348 | ) | ||||||
Additional paid-in capital |
172,978 | 170,988 | 169,752 | |||||||||
Accumulated other comprehensive loss |
(210 | ) | (327 | ) | (341 | ) | ||||||
Retained earnings |
44,378 | 54,177 | 119,764 | |||||||||
Total stockholders equity |
216,802 | 224,512 | 288,849 | |||||||||
TOTAL LIABILITIES AND STOCKHOLDERS EQUITY |
$ | 342,514 | $ | 368,318 | $ | 427,144 | ||||||
See accompanying notes to condensed consolidated financial statements.
3
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited and in thousands, except per share data)
13 Weeks Ended | 39 Weeks Ended | ||||||||||||
September 27, 2008 |
September 29, 2007 |
September 27, 2008 |
September 29, 2007 | ||||||||||
Restated (Note 2) |
Restated (Note 2) | ||||||||||||
Net revenues |
$ | 180,249 | $ | 188,391 | $ | 520,193 | $ | 561,265 | |||||
Cost of goods sold |
130,518 | 130,475 | 369,566 | 390,353 | |||||||||
Gross profit |
49,731 | 57,916 | 150,627 | 170,912 | |||||||||
Selling, general and administrative expense |
43,853 | 46,835 | 139,546 | 141,665 | |||||||||
Store closures and other restructuring costs |
1,660 | | 1,660 | | |||||||||
Impairment of long-lived assets |
206 | 36 | 2,423 | 446 | |||||||||
Income from operations |
4,012 | 11,045 | 6,998 | 28,801 | |||||||||
Interest expense |
327 | 515 | 1,935 | 3,211 | |||||||||
Income before income taxes |
3,685 | 10,530 | 5,063 | 25,590 | |||||||||
Income taxes |
264 | 4,370 | 14,862 | 9,980 | |||||||||
Net income (loss) |
$ | 3,421 | $ | 6,160 | $ | (9,799 | ) | $ | 15,610 | ||||
Net income (loss) per share: |
|||||||||||||
Basic |
$ | 0.16 | $ | 0.28 | $ | (0.45 | ) | $ | 0.72 | ||||
Diluted |
$ | 0.16 | $ | 0.28 | $ | (0.45 | ) | $ | 0.71 | ||||
Weighted average common and common equivalent shares outstanding: |
|||||||||||||
Basic |
22,020 | 21,815 | 21,962 | 21,725 | |||||||||
Diluted |
22,024 | 21,959 | 21,962 | 21,977 |
See accompanying notes to condensed consolidated financial statements.
4
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited and in thousands)
39 Weeks Ended | ||||||||
September 27, 2008 |
September 29, 2007 |
|||||||
Restated (Note 2) |
||||||||
OPERATING ACTIVITIES: |
||||||||
Net income (loss) |
$ | (9,799 | ) | $ | 15,610 | |||
Adjustments to reconcile net income (loss) to net cash provided by operating activities: |
||||||||
Depreciation and amortization |
14,170 | 14,761 | ||||||
Impairment of long-lived assets |
2,423 | 446 | ||||||
Share-based compensation |
1,634 | 1,242 | ||||||
Tax expense (benefit) from equity issuance |
(92 | ) | 374 | |||||
Excess tax benefit from share-based compensation |
(1 | ) | (389 | ) | ||||
Provision for deferred income taxes |
14,782 | 2,414 | ||||||
Provision for doubtful accounts |
399 | 174 | ||||||
Lower of cost or market inventory adjustments |
2,585 | 3,084 | ||||||
Loss on asset disposals |
246 | 111 | ||||||
Changes in assets and liabilities: |
||||||||
Trade receivables |
(1,586 | ) | (2,066 | ) | ||||
Merchandise inventories |
653 | (4,757 | ) | |||||
Other current assets |
3,266 | 4,218 | ||||||
Other assets |
449 | (441 | ) | |||||
Accounts payable |
8,171 | 13,957 | ||||||
Accrued expenses and other |
(3,585 | ) | 606 | |||||
Deferred items and other non-current liabilities |
236 | 482 | ||||||
Net cash provided by operating activities |
33,951 | 49,826 | ||||||
INVESTING ACTIVITIES: |
||||||||
Proceeds from sale of property and equipment |
40 | 204 | ||||||
Purchases of property and equipment |
(11,498 | ) | (14,793 | ) | ||||
Net cash used in investing activities |
(11,458 | ) | (14,589 | ) | ||||
FINANCING ACTIVITIES: |
||||||||
Borrowings on line of credit |
60,818 | 66,475 | ||||||
Repayments on line of credit |
(83,818 | ) | (105,184 | ) | ||||
Proceeds from exercise of stock options |
4 | 2,942 | ||||||
Proceeds from sale of common stock pursuant to Associates Stock Buying Plan |
444 | 562 | ||||||
Excess tax benefit from share-based compensation |
1 | 389 | ||||||
Treasury shares acquired |
(18 | ) | (66 | ) | ||||
Net cash used in financing activities |
(22,569 | ) | (34,882 | ) | ||||
NET INCREASE (DECREASE) IN CASH |
(76 | ) | 355 | |||||
CASH AT BEGINNING OF PERIOD |
6,126 | 6,223 | ||||||
CASH AT END OF PERIOD |
$ | 6,050 | $ | 6,578 | ||||
Other cash flow information: |
||||||||
Cash paid for interest |
$ | 2,087 | $ | 4,118 | ||||
Cash paid (received) for income taxes |
(2,423 | ) | 2,746 | |||||
Non-cash investing activities |
||||||||
Property and equipment additions in accounts payable |
716 | 135 |
See accompanying notes to condensed consolidated financial statements.
5
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Thirteen and Thirty-nine Weeks Ended September 27, 2008 and September 29, 2007
(Unaudited)
NOTE 1: BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have been prepared from the records of West Marine, Inc. and its subsidiaries (collectively, the Company) in accordance with accounting principles generally accepted in the United States of America (GAAP) for interim financial information and the instructions to Form 10-Q and Article 10 of Regulation S-X. In the opinion of management, all adjustments (consisting only of normal recurring items, except as discussed in Notes 3, 5, and 9 below) necessary to fairly present the financial position at September 27, 2008 and September 29, 2007, and the interim results of operations for the 13-week and 39-week periods and cash flows for the 39-week periods then ended, have been included.
The condensed consolidated balance sheet at December 29, 2007 presented herein has been derived from the audited consolidated financial statements of the Company for the year then ended that was included in the Companys Annual Report on Form 10-K for the year ended December 29, 2007 (the 2007 Form 10-K). These unaudited condensed consolidated interim financial statements should be read in conjunction with the audited consolidated financial statements, including the notes thereto, for the fiscal year ended December 29, 2007, that were included in the 2007 Form 10-K.
Accounting policies followed by the Company are described in Note 1 in the audited consolidated financial statements for the year ended December 29, 2007. Certain information and disclosures normally included in the notes to annual financial statements prepared in accordance with GAAP have been omitted for purposes of the condensed consolidated interim financial statements presented herein. The preparation of financial statements in conformity with 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 financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The results of operations for the 13-week and 39-week periods ended September 27, 2008 are not necessarily indicative of the results to be expected for any other interim period or for the fiscal year ending January 3, 2009. Historically, the Companys consolidated revenues and net income are higher in the second and third quarters and decrease in the first and fourth quarters of the fiscal year. The increase in revenues and earnings, principally during the period from April through August, is representative of the peak months for boat buying, usage and maintenance in most of our retail markets.
The Companys fiscal year consists of 52 or 53 weeks, ending on the Saturday closest to December 31. The 2008 fiscal year consists of 53 weeks ending on January 3, 2009 and the 2007 fiscal year consisted of the 52 weeks ended December 29, 2007. All quarters of both fiscal years 2008 and 2007 consist of 13 weeks, except the fourth quarter of 2008, which will consist of 14 weeks. All references to years relate to fiscal years rather than calendar years.
Fair Value of Financial Instruments
On the first day of fiscal 2008, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 157, Fair Value Measurements, for financial assets and liabilities. The Company has elected to adopt SFAS No. 157 for fair value measurement of non-financial assets and liabilities which are non-recurring (example, store asset impairment) at the beginning of fiscal 2009, as allowed by Financial Accounting Standards Board (FASB) Statement of Position No. 157-2. SFAS No. 157 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (i.e., an exit price). The Companys cash is its primary financial asset and borrowings under a credit facility, which has a variable interest rate, is its primary financial liability. The Companys financial instruments carrying values approximate fair value due to the short-term nature of these items and/or the current interest rates payable in relation to current market conditions. Interest rate risk is the risk that the Companys earnings are subject to fluctuations in interest rates on debt and is fully dependent upon the volatility of these rates. The Company does not use derivative instruments to moderate its exposure to interest rate risk, if any. Financial risk is the risk that the Companys earnings are subject to fluctuations in interest rates or foreign exchange rates and is dependent upon the volatility of these rates.
Also effective December 30, 2007, the Company adopted SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities including an amendment of FASB Statement No. 115. SFAS No. 159 permits entities to choose to measure many financial instruments and certain other items at fair value. Election of the fair value option is irrevocable and is applied on a contract-by-contract basis. The Company has elected not to apply the fair value option to its eligible financial assets and liabilities, and accordingly, the adoption of SFAS No. 159 had no financial statement impact.
6
Recently Issued Accounting Standards
The following recently issued accounting standards have been grouped by their required effective dates for the Company:
First Quarter of 2008
As discussed above, the Company adopted SFAS Nos. 157 and 159 during the first fiscal quarter of 2008.
In December 2007, the SEC issued Staff Accounting Bulletin (SAB) No. 110, Certain Assumptions Used in Valuation Methods Expected Term, which amended SAB No. 107 to allow for the continued use of the simplified method to estimate the expected term in valuing stock options beyond December 31, 2007. The simplified method can only be applied to certain types of stock options for which sufficient exercise history is not available. The Company adopted SAB No. 110 on December 30, 2007 and will continue to use the simplified method until sufficient exercise history is available.
First Quarter of 2009
In December 2007, the FASB issued SFAS No. 141 (revised 2007), Business Combinations (SFAS No. 141(R)), which replaces SFAS No. 141, Business Combinations. SFAS No. 141(R) retains the underlying concepts of SFAS No. 141 in that all business combinations are still required to be accounted for at fair value under the acquisition method of accounting but SFAS No. 141(R) changed the method of applying the acquisition method in a number of significant aspects. Acquisition costs will generally be expensed as incurred; non-controlling interests will be valued at fair value at the acquisition date; in-process research and development will be recorded at fair value as an indefinite-lived intangible asset at the acquisition date; restructuring costs associated with a business combination will generally be expensed subsequent to the acquisition date; and changes in deferred tax asset valuation allowances and income tax uncertainties after the acquisition date generally will affect income tax expense. SFAS No. 141(R) is effective on a prospective basis for all business combinations for which the acquisition date is on or after the beginning of the first annual period subsequent to December 15, 2008, with the exception of the accounting for valuation allowances on deferred taxes and acquired tax contingencies. SFAS No. 141(R) amends SFAS No. 109, Accounting for Income Taxes, such that adjustments made to valuation allowances on deferred taxes and acquired tax contingencies associated with acquisitions that closed prior to the effective date of SFAS No. 141(R) would also apply the provisions of SFAS No. 141(R). The Company does not currently anticipate any business combinations and, therefore, management does not anticipate that the statement will have a significant impact on the Companys financial position, results of operations or cash flows.
In December 2007, the FASB issued SFAS No. 160, Non-controlling Interests in Consolidated Financial Statementsan amendment of Accounting Research Bulletin (ARB) No. 51. This statement is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008, with earlier adoption prohibited. This statement requires the recognition of a non-controlling interest (minority interest) as equity in the consolidated financial statements and separate from the parents equity. The amount of net income attributable to the non-controlling interest will be included in consolidated net income on the face of the income statement. It also amends certain of ARB No. 51s, Consolidated Financial Statements, consolidation procedures for consistency with the requirements of SFAS No. 141(R). This statement also includes expanded disclosure requirements regarding the interests of the parent and its non-controlling interest. The Company is currently evaluating this new statement and anticipates that the statement will not have a significant impact on the reporting of its financial position, results of operations or cash flows.
In April 2008, the FASB issued Staff Position (FSP) No. 142-3, Determination of the Useful Life on Intangible Assets. This FSP is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008, with earlier adoption prohibited. This FSP amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under SFAS No. 142, Goodwill and Other Intangible Assets. The guidance for determining the useful life of a recognized intangible asset shall be applied prospectively to intangible assets acquired after the effective date. The Company is currently evaluating this new FSP and anticipates that the FSP will not have a significant impact on the reporting of the Companys financial position, results of operations or cash flows.
7
NOTE 2: RESTATEMENT OF PRIOR PERIODS
As discussed in the 2007 Form 10-K and subsequent to the issuance of the Companys Form 10-Q for the quarterly period ended September 29, 2007, management determined that reserves for estimated workers compensation claims were understated due to an error. This prompted the Company to review other reserves and accounts involving management estimates. As a result of this review, in addition to the workers compensation liability adjustment, the Company identified several other errors that individually were not material but, in the aggregate, required correction in the Companys previously issued 2007 quarterly and prior-period annual financial statements relating to, among other things, inventory reserves, vendor allowances, capitalized indirect costs, sales and use tax accruals, sales return reserves, software development costs, software asset impairments, foreign currency translation gains/losses, deferred income taxes and share-based compensation. The Company also identified certain items incorrectly presented on a net basis in its statement of cash flows, including changes in merchandise inventories, repayments and borrowings on the Companys credit facility, and the non-cash portion of fixed asset purchases. The Company also identified errors in its segment disclosure, as required information regarding assets, capital expenditures and depreciation for its reportable segments was incorrectly excluded. As a result, upon the recommendation of management, the Board of Directors authorized the restatement of, among other things, the first three fiscal quarters of 2007, including the interim period ended September 29, 2007 that is being restated in this Form 10-Q.
The effect of the restatement on the condensed consolidated balance sheet as of September 29, 2007 and the condensed consolidated statements of operations for the thirteen weeks and thirty-nine weeks ended September 29, 2007 and condensed consolidated statement of cash flows for the thirty-nine weeks ended September 29, 2007 is as follows:
Condensed Consolidated Balance Sheet Data
(in thousands)
September 29, 2007 | |||||||||||
As Previously Reported |
Restatement Adjustments |
As Restated |
|||||||||
Assets |
|||||||||||
Merchandise inventories |
$ | 255,085 | $ | (349 | ) | $ | 254,736 | ||||
Deferred income taxes |
5,999 | 1,777 | 7,776 | ||||||||
Other current items |
18,647 | 844 | 19,491 | ||||||||
Total current assets |
293,914 | 2,272 | 296,186 | ||||||||
Property and equipment, net |
70,398 | (33 | ) | 70,365 | |||||||
Other non-current assets |
3,615 | (128 | ) | 3,487 | |||||||
Total assets |
425,033 | 2,111 | 427,144 | ||||||||
Liabilities |
|||||||||||
Accounts payable |
51,929 | 513 | 52,442 | ||||||||
Accrued expenses and other |
42,920 | 3,378 | 46,298 | ||||||||
Total current liabilities |
94,849 | 3,891 | 98,740 | ||||||||
Deferred items |
7,709 | 1,528 | 9,237 | ||||||||
Total liabilities |
132,876 | 5,419 | 138,295 | ||||||||
Stockholders Equity |
|||||||||||
Accumulated other comprehensive income (loss) |
414 | (755 | ) | (341 | ) | ||||||
Retained earnings |
122,317 | (2,553 | ) | 119,764 | |||||||
Total stockholders equity |
292,157 | (3,308 | ) | 288,849 | |||||||
Total liabilities and stockholders equity |
425,033 | 2,111 | 427,144 |
Condensed Consolidated Statement of Operations Data
(in thousands, except per share data)
13 Weeks Ended September 29, 2007 |
39 Weeks Ended September 29, 2007 | |||||||||||||||||||
As Previously Reported |
Restatement Adjustments |
As Restated |
As Previously Reported |
Restatement Adjustments |
As Restated | |||||||||||||||
Net revenues |
$ | 187,531 | $ | 860 | $ | 188,391 | $ | 561,353 | $ | (88 | ) | $ | 561,265 | |||||||
Cost of goods sold |
129,929 | 546 | 130,475 | 390,853 | (500 | ) | 390,353 | |||||||||||||
Gross profit |
57,602 | 314 | 57,916 | 170,500 | 412 | 170,912 | ||||||||||||||
Selling, general and administrative expense |
48,006 | (1,171 | ) | 46,835 | 144,079 | (2,414 | ) | 141,665 | ||||||||||||
Impairment of long-lived assets |
| 36 | 36 | | 446 | 446 | ||||||||||||||
Income from operations |
9,596 | 1,449 | 11,045 | 26,421 | 2,380 | 28,801 | ||||||||||||||
Income before income taxes |
9,081 | 1,449 | 10,530 | 23,210 | 2,380 | 25,590 | ||||||||||||||
Income taxes |
3,817 | 553 | 4,370 | 9,062 | 918 | 9,980 | ||||||||||||||
Net income |
5,264 | 896 | 6,160 | 14,148 | 1,462 | 15,610 | ||||||||||||||
Net income per sharebasic |
$ | 0.24 | $ | 0.04 | $ | 0.28 | $ | 0.65 | $ | 0.07 | $ | 0.72 | ||||||||
Net income per sharediluted |
$ | 0.24 | $ | 0.04 | $ | 0.28 | $ | 0.64 | $ | 0.07 | $ | 0.71 |
8
Condensed Consolidated Statement of Cash Flows Data
(in thousands)
For the 39 Weeks Ended September 29, 2007 |
||||||||||||
As Previously Reported |
Restatement Adjustments |
As Restated |
||||||||||
Operating Activities |
||||||||||||
Net income |
$ | 14,148 | $ | 1,462 | $ | 15,610 | ||||||
Adjustments to reconcile net income to net cash provided by operating activities: |
||||||||||||
Depreciation and amortization |
14,848 | (87 | ) | 14,761 | ||||||||
Impairment of long-lived assets |
| 446 | 446 | |||||||||
Lower of cost or market inventory adjustments |
| 3,084 | 3,084 | |||||||||
Provision for deferred income taxes |
1,600 | 814 | 2,414 | |||||||||
Loss on asset disposals |
559 | (448 | ) | 111 | ||||||||
Changes in assets and liabilities: |
||||||||||||
Merchandise inventories |
(1,068 | ) | (3,689 | ) | (4,757 | ) | ||||||
Other current assets |
4,147 | 71 | 4,218 | |||||||||
Other assets |
675 | (1,116 | ) | (441 | ) | |||||||
Accrued expenses and other |
1,096 | (490 | ) | 606 | ||||||||
Deferred items |
529 | (47 | ) | 482 | ||||||||
Net cash provided by operating activities |
49,826 | | 49,826 | |||||||||
Financing Activities |
||||||||||||
Borrowings on line of credit |
(38,709 | ) | 105,184 | 66,475 | ||||||||
Repayment on line of credit |
| (105,184 | ) | (105,184 | ) |
NOTE 3: INCOME TAXES
The Company calculates its interim income tax provision in accordance with Accounting Principles Board Opinion No. 28, Interim Financial Reporting, and FASB Interpretation No. 18, Accounting for Income Taxes in Interim Periods. At the end of each interim period, the Company estimates the annual effective tax rate and applies that rate to its year-to-date ordinary earnings. The tax expense or benefit related to significant, unusual or extraordinary items that will be separately reported or reported net of their related tax effect, are individually computed and recognized in the interim period in which those items occur. In addition, the effect of changes in enacted tax laws or rates or tax status is recognized in the interim period in which the change occurs.
The computation of the annual estimated effective tax rate at each interim period requires certain estimates and significant judgment including, but not limited to, the expected operating income (loss) for the year, projections of the proportion of income earned and taxed in foreign jurisdictions, permanent and temporary differences as a result of differences between amounts measured and recognized in accordance with tax laws and financial accounting standards, and the likelihood of recovering deferred tax assets generated in the current year. The accounting estimates used to compute the provision (benefit) for income taxes may change as new events occur, additional information is obtained or as the tax environment changes.
The Companys income tax expense and effective tax rate were $14.9 million and 293.5%, respectively, for the thirty-nine weeks ended September 27, 2008, and $10.0 million and 39.0%, respectively, for the thirty-nine weeks ended September 29, 2007.
Each quarter, management is required to evaluate changes in assumptions about valuation allowances. In the second quarter of 2008, the Company recorded a charge of $14.6 million to provide a full valuation allowance against the Companys net deferred tax assets.
At year-end 2007 and for the first quarter of 2008, management forecasted sufficient income in future years to fully utilize all of the Companys net deferred tax assets. However, in the second quarter of 2008, with lower projected earnings in the near term, managements assumptions about the Companys ability to use these assets changed. In making the determination to record the valuation allowance in the second quarter, management noted that SFAS No. 109 paragraph 17 requires a valuation allowance if, based on all available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized. The valuation allowance should be sufficient to reduce the deferred tax assets to the amount that is more likely than not to be realized. Cumulative losses are a form of objective negative evidence that carries more weight than subjective positive evidence, such as forecasts. After examining all of the available evidence, both positive and negative, including evidence that circumstances did not improve in the third quarter, the Company determined a full valuation allowance was appropriate.
This fiscal 2008 adjustment will have no impact on the Companys cash flow or future prospects, nor does it alter the Companys ability to utilize the underlying net operating losses and credit carryforwards for income tax purposes in the future, the utilization of which is limited to achieving future taxable income.
Under GAAP, when the Companys results demonstrate a pattern of future profitability and reverse the current cumulative loss trend, this valuation allowance may be adjusted and may result in the reinstatement of all or a part of the net deferred tax assets.
9
NOTE 4: SHARE-BASED COMPENSATION
For purposes of calculating the share-based compensation under SFAS No. 123(R), the Company estimates the fair value of stock options under the Omnibus Equity Incentive Plan (the Incentive Plan) and shares issued under the Associates Stock Buying Plan (the Buying Plan), using a Black-Scholes option-pricing model. Estimates of fair value are not intended to predict actual future events or the value ultimately realized by persons who receive stock options.
Included in cost of goods sold and selling, general and administrative expense are share-based compensation expenses, net of estimated forfeitures, that have been included in the statement of operations for all share-based compensation arrangements was as follows:
(in thousands, except per share amounts) |
13 weeks Ended September 27, 2008 |
13 weeks Ended September 29, 2007 |
39 weeks Ended September 27, 2008 |
39 weeks Ended September 29, 2007 | ||||||||
Selling, general and administrative expense |
$ | 436 | $ | 443 | $ | 1,279 | $ | 1,134 | ||||
Cost of goods sold |
115 | 42 | 355 | 108 | ||||||||
Share-based compensation expense |
$ | 551 | $ | 485 | $ | 1,634 | $ | 1,242 | ||||
Stock Options: The Incentive Plan provides for the granting of stock options to certain eligible associates employed at the time of the grant, and such grants to associates represent non-qualified stock options. The exercise price of an option is established at the fair market value of a share of the Companys common stock on the date of grant. Options awarded under the Incentive Plan generally vest over three years (options awarded under the Incentive Plan in 2006 generally vest over four years) and expire five years following the grant date. As of September 27, 2008, there was $3.9 million of unrecognized share-based compensation expense for stock options, net of expected forfeitures, with a weighted-average future expense recognition period of approximately 2.1 years.
The following table summarizes the activity for stock options for the thirty-nine weeks ended September 27, 2008:
Options | Weighted- Average Exercise Price |
Weighted-Average Remaining Contractual Term (in Years) | ||||||
Outstanding at December 30, 2007 (beginning of fiscal year) |
2,914,874 | $ | 17.96 | 4.2 | ||||
Granted |
1,210,110 | 5.15 | 4.6 | |||||
Exercised |
(791 | ) | 4.61 | |||||
Forfeited |
(79,804 | ) | 12.21 | |||||
Expired |
(239,019 | ) | 19.93 | |||||
Outstanding at September 27, 2008 |
3,805,370 | $ | 13.89 | 4.2 | ||||
Vested as of September 27, 2008 |
2,160,950 | $ | 18.48 | 4.1 | ||||
Restricted Share Awards: The Incentive Plan also provides for awards of shares to eligible associates and directors that are subject to restrictions on transfer for a period of time (commonly referred to as restricted shares). Compensation expense for restricted shares was $0.1 million for each of the 13 weeks ended September 27, 2008 and September 29, 2007, and $0.2 million for each of the 39 weeks ended September 27, 2008 and September 29, 2007.
Associate Stock Buying Plan: The Company also has a Buying Plan under which all eligible associates may elect to participate on the grant dates twice each year. Associates who own 5% or more of Company stock are prohibited from participating in the Buying Plan; however, all other associates may participate.
NOTE 5: IMPAIRMENT OF LONG-LIVED ASSETS
The Companys condensed consolidated financial statements for the 13-week and 39-week periods ended September 27, 2008 include $0.2 million and $2.4 million of asset impairment charges, respectively. These charges are based on managements analysis of expected future cash flows associated with certain retail stores and information technology assets. See Note 9 for more information. These impairment charges reduced the carrying value of long-lived assets, primarily leasehold improvements, fixtures and equipment, to their estimated fair value.
10
NOTE 6: SEGMENT INFORMATION
The Company has three reportable segmentsStores, Port Supply (wholesale) and Direct Sales (catalog and Internet)all of which sell merchandise directly to customers. The customer base overlaps between the Stores and Port Supply segments, and between the Stores and Direct Sales segments. All processes for the three segments within the supply chain are commingled, including purchases from vendors, distribution center activity and customer delivery.
In addition to the Companys ten stores located in Canada and one franchised store located in Turkey, revenues are attributed to geographic locations based on the location to which the Company ships its products. Through the Direct Sales segment, we promote and sell products internationally through both our catalogs and e-commerce websites. The Company operates primarily in the United States with foreign revenues representing 5% or less of total net revenues during the 13 weeks and 39 weeks ended September 27, 2008 and September 29, 2007, and foreign long-lived assets totaled less than 2% of long-lived assets at each of these dates.
Segment assets are those directly allocated to an operating segments operations. For the Stores segment, assets primarily include leasehold improvements, computer assets, fixtures, land and buildings. For the Port Supply and Direct Sales segments, assets primarily include computer assets. Unallocated assets include merchandise inventory, shared technology infrastructure, distribution centers, corporate headquarters, prepaid expenses, deferred taxes and other assets. Capital expenditures and depreciation expense for each segment are allocated to the assets assigned to the segment. Contribution is defined as net revenues less product costs and direct expenses.
Following is financial information related to the Companys business segments (in thousands):
13 Weeks Ended | 39 Weeks Ended | |||||||||||||||
September 27, 2008 |
September 29, 2007 |
September 27, 2008 |
September 29, 2007 |
|||||||||||||
Net revenues: |
||||||||||||||||
Stores |
$ | 159,807 | $ | 167,351 | $ | 456,537 | $ | 492,668 | ||||||||
Direct Sales |
10,476 | 10,908 | 31,854 | 34,738 | ||||||||||||
Port Supply |
9,966 | 10,132 | 31,802 | 33,859 | ||||||||||||
Consolidated net revenues |
$ | 180,249 | $ | 188,391 | $ | 520,193 | $ | 561,265 | ||||||||
Contribution: |
||||||||||||||||
Stores |
$ | 19,365 | $ | 25,838 | $ | 54,755 | $ | 69,748 | ||||||||
Direct Sales |
1,325 | 1,488 | 4,969 | 5,081 | ||||||||||||
Port Supply |
(423 | ) | (70 | ) | (726 | ) | 1,976 | |||||||||
Consolidated contribution |
$ | 20,267 | $ | 27,256 | $ | 58,998 | $ | 76,805 | ||||||||
Reconciliation of consolidated contribution to net income: |
||||||||||||||||
Consolidated contribution |
$ | 20,267 | $ | 27,256 | $ | 58,998 | $ | 76,805 | ||||||||
Less: |
||||||||||||||||
Indirect costs of goods sold not included in consolidated contribution |
(8,209 | ) | (8,010 | ) | (22,688 | ) | (23,807 | ) | ||||||||
General and administrative expense |
(8,046 | ) | (8,201 | ) | (29,312 | ) | (24,197 | ) | ||||||||
Interest expense |
(327 | ) | (515 | ) | (1,935 | ) | (3,211 | ) | ||||||||
Income taxes |
(264 | ) | (4,370 | ) | (14,862 | ) | (9,980 | ) | ||||||||
Net income (loss) |
$ | 3,421 | $ | 6,160 | $ | (9,799 | ) | $ | 15,610 | |||||||
13 Weeks Ended | 39 Weeks Ended | |||||||||||||||
September 27, 2008 |
September 29, 2007 |
September 27, 2008 |
September 29, 2007 |
|||||||||||||
Assets: |
||||||||||||||||
Stores |
$ | 34,453 | $ | 98,663 | (1) | |||||||||||
Port Supply |
7,324 | 7,985 | ||||||||||||||
Direct Sales |
1,559 | 2,260 | ||||||||||||||
Unallocated |
299,178 | 318,236 | ||||||||||||||
Total assets |
$ | 342,514 | $ | 427,144 | ||||||||||||
Capital expenditures: |
||||||||||||||||
Stores |
$ | 2,060 | $ | 3,109 | $ | 6,924 | $ | 7,904 | ||||||||
Port Supply |
139 | | 866 | 100 | ||||||||||||
Direct Sales |
| 463 | 131 | 2,532 | ||||||||||||
Unallocated |
161 | 1,025 | 3,577 | 4,257 | ||||||||||||
Total capital expenditures |
$ | 2,360 | $ | 4,597 | $ | 11,498 | $ | 14,793 | ||||||||
Depreciation and amortization: |
||||||||||||||||
Stores |
$ | 2,688 | $ | 3,110 | $ | 8,395 | $ | 9,227 | ||||||||
Port Supply |
75 | 101 | 247 | 308 | ||||||||||||
Direct Sales |
119 | 144 | 381 | 609 | ||||||||||||
Unallocated |
1,828 | 1,624 | 5,147 | 4,617 | ||||||||||||
Total depreciation and amortization |
$ | 4,710 | $ | 4,979 | $ | 14,170 | $ | 14,761 | ||||||||
(1) | Includes $56.9 million of goodwill written off in the fourth quarter of 2007. |
11
NOTE 7: COMPREHENSIVE INCOME (LOSS)
Comprehensive income (loss) consists of net income (loss) and other comprehensive income (loss) (income, expenses, gains and losses that bypass the income statement and are reported directly as a separate component of equity). The Companys comprehensive income (loss) consists of net income (loss) and foreign currency translation adjustments for all periods presented, and did not differ significantly from the reported net income (loss).
NOTE 8: CONTINGENCIES
On March 21, 2008, a former hourly associate filed a lawsuit in the California Superior Court, County of Orange. The suit alleges, among other things, that the Company engaged in unfair business practices and failed to provide meal and rest periods, correct itemized statements, and appropriately pay discharged associates in violation of certain applicable sections of the California Labor Code and the California Business and Professions Code. The plaintiff seeks to represent himself and all similarly situated current and former hourly-paid associates employed by West Marine in the State of California. The plaintiff seeks reimbursement of wages, penalties and interest allegedly owed under the relevant California code sections, as well as an unspecified amount of damages and attorneys fees and costs recoverable by law. The Company filed an answer denying all charges and have served discovery. The Company believes that it has meritorious defenses to this lawsuit and the Company continues to vigorously defend it, including plaintiffs efforts to certify a California class action. Additionally, the Company is involved in various other legal proceedings, claims and litigation including the SEC investigation discussed in our 2007 Form 10-K, as well as those arising in the ordinary course of business. Based on the facts currently available, the Company does not believe that the disposition of matters that are pending or asserted will have a material adverse effect on its financial position or results of operations. However, an adverse judgment by a court, administrative or regulatory agency, arbitrator or a settlement could adversely impact the Companys results of operations in any given period.
NOTE 9: STORE CLOSURE AND OTHER RESTRUCTURING COSTS
Restructuring charges include severance costs, lease termination fees, legal and professional fees paid for lease termination negotiations, and other costs associated with the closure of facilities. The Company has accounted for severance costs in accordance with SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities. These benefits are detailed in an approved severance plan, which is specific as to number, position, location, and timing. In addition, severance benefits are communicated in specific detail to affected employees and it is unlikely that the plan will change when the costs are recorded. Costs are recognized ratably over the period services are rendered, otherwise they are recognized when they are communicated to the employees. Other associated costs, such as legal and professional fees, have been expensed as incurred, in accordance with SFAS No. 146.
During the third quarter of 2008 management closed eight stores. The remaining eleven to sixteen stores identified for closure will be closed during the fourth quarter. The closures were primarily due to relocation, or consolidation of smaller stores into fewer, larger stores to better serve the Companys markets. Additionally, in July 2008 management decided to close the distribution center located in Hagerstown, Maryland and the call center located in Largo, Florida. The Company recognized restructuring expense of $0.9 million for stores, $0.1 million for Port Supply, $0.5 million for the distribution center, and $0.2 million for reductions in force at the Watsonville Support Center.
The pretax restructuring charges recognized by the Company during the thirteen weeks ended September 27, 2008 were as follows (in thousands):
Lease termination costs |
$ | 444 | |
Employee severances |
885 | ||
Professional services and other cash costs |
331 | ||
$ | 1,660 | ||
The following reconciles restructuring accruals and cash payments during the third quarter (in thousands):
Restructuring accrual, June 28, 2008 |
$ | | ||
Charges to earnings |
1,660 | |||
Cash paid |
(900 | ) | ||
Restructuring accrual, September 27, 2008 |
$ | 760 | ||
12
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
West Marine, Inc.
Watsonville, California
We have reviewed the accompanying condensed consolidated balance sheets of West Marine, Inc. and subsidiaries (West Marine) as of September 27, 2008 and September 29, 2007, and the related condensed consolidated statements of operations for the 13-week and 39-week periods ended September 27, 2008 and September 29, 2007, and cash flows for the 39-week periods then ended. These interim financial statements are the responsibility of West Marines management.
We conducted our reviews in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.
Based on our reviews, we are not aware of any material modifications that should be made to such condensed consolidated interim financial statements for them to be in conformity with accounting principles generally accepted in the United States of America.
As discussed in Note 2, the accompanying condensed consolidated financial statements as of and for the 13-week and 39-week periods ended September 29, 2007 have been restated.
We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of West Marine, Inc. and subsidiaries as of December 29, 2007, and the related consolidated statements of operations, stockholders equity, and cash flows for the year then ended (not presented herein); and in our report dated April 4, 2008, we expressed an unqualified opinion on those consolidated financial statements and included explanatory paragraphs relating to a restatement and the adoption of new accounting standards. In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of December 29, 2007 is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.
/s/ DELOITTE & TOUCHE LLP
San Francisco, California
November 4, 2008
13
ITEM 2 MANAGEMENTS 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 notes thereto found in Item 1 of this Form 10-Q and our consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 29, 2007. All references to the third quarter and the first nine months of 2008 mean the 13-week and 39-week periods ended September 27, 2008, respectively, and all references to the third quarter and first nine months of 2007 mean the 13-week and 39-week periods ended September 29, 2007, respectively. Unless the context otherwise requires, West Marine, we, us and our refer to West Marine, Inc. and its subsidiaries.
Overview
West Marine is one of the largest boating supplies retailers in the world. We have three reportable segments Stores, Port Supply (wholesale) and Direct Sales (catalog and Internet) all of which sell aftermarket recreational boating supplies directly to customers. At the end of the third quarter of 2008, we offered our products through 361 stores in 38 states, Puerto Rico, Canada and a franchised store located in Turkey; on the Internet (www.westmarine.com and www.boatus-store.com); and through catalogs. We are also engaged, through our Port Supply division, in our stores and on the Internet (www.portsupply.com), in the wholesale distribution of boating products to commercial customers. Our principal executive offices are located at 500 Westridge Drive, Watsonville, California 95076-4100, and our telephone number is (831)728-2700.
Restatement
As discussed in our Annual Report on Form 10-K for the year ended December 29, 2007, we restated our consolidated financial statements for the fiscal years ended December 31, 2005 and December 30, 2006, all quarters for fiscal year 2006 and the first three quarters of fiscal year 2007. Please see Note 2 to our condensed consolidated financial statements for the unaudited restated interim period financial statement line item data for the 13-week and 39-week periods ended September 29, 2007. The determination to restate was made on managements recommendation following the identification of errors related to: (i) the reserves for estimated workers compensation claims which were understated; (ii) several other errors that individually were not material but, in the aggregate, required correction relating to, among other things, inventory reserves, vendor allowances, capitalized indirect costs, sales and use tax accruals, sales return reserves, software development costs, software asset impairments, foreign currency translation gains/losses, deferred income taxes and share-based compensation; (iii) certain items that were incorrectly presented on a net basis in our consolidated statements of cash flows, including changes in merchandise inventories, repayments and borrowings on our line of credit, and the non-cash portion of fixed assets purchases; and (iv) our segment information disclosure, as required information regarding assets, capital expenditures and depreciation for our reportable segments was incorrectly excluded. The following discussion reflects restated results for the 13-week and 39-week periods ended September 29, 2007.
Recent Accounting Pronouncements
See Note 1 to the condensed consolidated financial statements in Item 1 of this report.
Critical Accounting Policies and Estimates
Our unaudited financial statements and accompanying notes are prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information pursuant to Regulation S-X. Preparing financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses. These estimates and assumptions are affected by managements application of accounting policies. We have identified certain policies that require the application of significant judgment by management. Our most critical accounting policies are those related to inventory valuations including allowances, reserves and capitalization of indirect costs, vendor allowances receivable, costs associated with exit activities (e.g. store closures), impairment of long-lived assets, uncertain tax positions, deferred tax assets and applicable valuation allowance, liabilities for self-insurance and share-based compensation. Goodwill is no longer included as a critical accounting policy item due to the total impairment of the balance at December 29, 2007. These critical accounting policies are described in Item 7, Managements Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year ended December 29, 2007 (the 2007 Form 10-K). This discussion and analysis should be read in conjunction with such discussion and with our condensed consolidated financial statements and related notes included in Part I, Item 1 of this report.
14
Results of Operations
The following table sets forth certain statement of operations components expressed as a percent of net revenues:
13 Weeks Ended | 39 Weeks Ended | |||||||||||
September 27, 2008 |
September 29, 2007 |
September 27, 2008 |
September 29, 2007 |
|||||||||
Net revenues |
100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | ||||
Cost of goods sold |
72.4 | 69.3 | 71.0 | 69.5 | ||||||||
Gross profit |
27.6 | 30.7 | 29.0 | 30.5 | ||||||||
Selling, general and administrative expense |
24.4 | 24.8 | 26.9 | 25.3 | ||||||||
Store closures and other restructuring costs |
0.9 | 0.0 | 0.3 | 0.0 | ||||||||
Impairment of long-lived assets |
0.1 | 0.0 | 0.5 | 0.1 | ||||||||
Income from operations |
2.2 | 5.9 | 1.3 | 5.1 | ||||||||
Interest expense, net |
0.2 | 0.3 | 0.3 | 0.5 | ||||||||
Income before income taxes |
2.0 | 5.6 | 1.0 | 4.6 | ||||||||
Income taxes |
0.1 | 2.3 | 2.9 | 1.8 | ||||||||
Net income (loss) |
1.9 | % | 3.3 | % | (1.9 | )% | 2.8 | % | ||||
Three Months Ended September 27, 2008 Compared to Three Months Ended September 29, 2007
Net revenues for the third quarter of 2008 were $180.2 million, a decrease of $8.1 million, or 4.3%, compared to net revenues of $188.4 million in the third quarter of 2007, primarily due to a $7.5 million decrease in comparable store sales. Net income for the third quarter of 2008 was $3.4 million compared to net income of $6.2 million in the third quarter of 2007.
Net revenues attributable to our Stores division decreased $7.5 million to $159.8 million in the third quarter of 2008, a 4.5% decrease compared to the third quarter of 2007, primarily due to a $7.5 million decrease in comparable store sales. Comparable store sales decreased 4.7% in the third quarter of 2008, compared to a comparable store sales increase of 0.3% in the third quarter last year. We believe decreased comparable store sales were driven primarily by the weak economy and higher fuel prices. We continued to experience lower year-over-year sales of core boating products and discretionary items, which continues the trend of reduced boat usage and cautious customer spending on large-ticket items. We had 361 stores open at the end of the third quarter of 2008 compared to 372 stores at the end of the third quarter of 2007. Wholesale (Port Supply) net sales through our distribution centers decreased $0.2 million, or 1.6%, to $10.0 million in the third quarter of 2008 compared to 2007, primarily due to lower sales to boat dealers. Net sales at our Direct Sales division decreased $0.4 million, or 4.0%, to $10.5 million in the third quarter of 2008 compared to 2007, primarily due to lower sales performance on catalog mailings and less promotional offers this year.
Gross profit decreased by $8.2 million, or 14.1%, to $49.7 million in the third quarter of 2008, compared to $57.9 million for the same period last year. Gross profit decreased as a percentage of net revenues to 27.6% in the third quarter of 2008, a 310 basis point decrease compared to 30.7% for the same period last year. Gross profit as a percentage of revenues decreased primarily due to lower raw product margin, down 108 basis points, driven by promotional activity and store closing clearance sales. Gross profit was also lower as a percentage of sales by 80 basis points due to occupancy expense. Occupancy is our largest fixed expense and its impact on gross margin is driven by sales results and the fixed nature of the expense. Buying and distribution costs contributed to a decrease of 72 basis points and recognized vendor allowances also de-leveraged, down 54 basis points, driven by the reduced inventories and reduced purchases in line with lower sales.
Selling, general and administrative expenses decreased $3.0 million, or 6.4%, to $43.9 million in the third quarter of 2008, compared to $46.8 million for the same period last year, and decreased as a percentage of sales to 24.4% in the third quarter of 2008, compared to 24.8% for the same period last year. The decrease in selling, general and administrative expenses was primarily due to $2.8 million in lower payroll, marketing and other variable expense, reflecting lower sales, reduced store count and lower professional services expenses for information technology projects. We also received a $0.4 million benefit related to the timing of professional services.
Impairment of long-lived assets was $0.2 million in the third quarter of 2008 and related to four stores. Last year, impairment for information technology products was less than $0.1 million.
As previously disclosed, we anticipated closing a small number of stores this year, which we originally estimated to be in the range of 10 to 15 locations. These closures were primarily due to relocation, or consolidation of smaller stores into fewer, larger stores to better serve our markets. During the second quarter, management conducted a more detailed analysis of store operations, particularly in light of deteriorating boating market conditions, and concluded that additional underperforming stores should be closed, bringing the total to between 25 and 30 stores. The stores identified for closure are spread across several major boating markets. We used specific criteria to identify these stores, including cash flow projections by store as compared to the net book value of long-lived assets by store. During the third quarter, management also decided to close our distribution center located in Hagerstown, Maryland, and our call center located in Largo, Florida. We recognized restructuring expenses of $1.7 million consisting of $0.9 million for store closures, $0.1 million for Port Supply, $0.5 million for the distribution center, and severance costs of $0.2 million for reductions in force at the Watsonville Support Center. We expect to recognize approximately $14.0 million in total restructuring charges during 2008.
Interest expense decreased $0.2 million, or 36.5%, to $0.3 million in the third quarter of 2008, compared to $0.5 million for the same period last year. The decrease in interest expense was due to both lower interest rates and lower average outstanding bank borrowings in the third quarter of 2008, compared to the same period last year.
Our effective tax rate is subject to change based on the mix of income from different state jurisdictions that tax at different rates, as well as the change in status or outcome of uncertain tax positions. We evaluate our effective income tax rate on a quarterly basis and update our estimate of the full-year effective income tax rate as necessary. Our effective tax rate for the third quarter of 2008 was 7.2%, compared with 41.5% for the same period last year. The change in our effective tax rate was due to managements decision to establish a full valuation allowance during the second quarter on the net deferred tax assets. For more information, see Note 3 to our consolidated financial statements.
15
Nine Months Ended September 27, 2008 Compared to Nine Months Ended September 29, 2007
Net revenues for the first nine months of 2008 were $520.2 million, a decrease of $41.1 million, or 7.3%, compared to net revenues of $561.3 million in the first nine months of 2007, primarily due to a decrease of $33.3 million in comparable store sales and $6.9 million in sales attributable to stores that were closed in 2007. Net loss for the first nine months of 2008 was $9.8 million compared to net income of $15.6 million in the first nine months of 2007.
Net sales attributable to our Stores division decreased $36.1 million to $456.5 million in the first nine months of 2008, a 7.3% decrease compared to the first nine months of 2007, primarily due to a $33.3 million decrease in comparable store sales. Comparable store sales decreased 7.1% in the first nine months of 2008, compared to a comparable store sales decrease of 1.7% in the first nine months last year. Comparable store sales for the first nine months were driven primarily by the weak economy and higher fuel prices. For the first nine months of the year, purchases of core products and discretionary items declined, continuing the trend of reduced boat usage and cautious customer spending on large-ticket items. Wholesale (Port Supply) net sales through our distribution centers decreased $2.1 million, or 6.1%, to $31.8 million in the first nine months of 2008 compared with 2007, primarily due to increased sales to Port Supply customers through our store locations, which are included in Stores sales. Net sales through the Port Supply division were also impacted by lower sales to boat dealers. Net sales of our Direct Sales division decreased $2.9 million, or 8.3%, to $31.9 million in the first nine months of 2008 compared to 2007, primarily due to lower sales performance on catalog mailings, less promotional offers during the first nine months of this year, and fewer catalog mailings in 2007 that had an impact on first quarter 2008 sales.
Gross profit decreased by $20.3 million, or 11.9%, to $150.6 million in the first nine months of 2008, compared to $170.9 million for the same period last year. Gross profit decreased as a percentage of net revenues to 29.0% in the first nine months of 2008, a 150 basis point decrease compared to 30.5% for the same period last year. Gross profit as a percentage of revenues decreased primarily due to occupancy expense and lower vendor allowances recognized. Occupancy is our largest fixed expense and its impact on gross margin is largely driven by sales results, and the fixed nature of the expense de-leveraged gross margin by 96 basis points due to the year-over-year decline in sales. Reduced vendor allowances contributed to a decrease of 44 basis points and was due to reduced purchases in line with lower sales.
Selling, general and administrative expenses decreased $2.1 million, or 1.5%, to $139.5 million in the first nine months of 2008, compared to $141.7 million for the same period last year, and increased as a percentage of revenues to 26.9% in the first nine months of 2008, compared to 25.3% for the same period last year. The decrease in selling, general, and administrative expenses is primarily due to a decrease of $7.2 million in payroll, marketing and variable expenses. These reductions, which were driven by lower sales and the reduction in store count, were partially offset by $2.1 million associated with cooperating with the ongoing SEC investigation and $0.5 million expense related to West Marine associate training held in February 2008.
Impairment of long-lived assets was $2.4 million in the first nine months of 2008, compared to $0.4 million impairment for the same period last year. In addition to the third quarter 2008 store impairments discussed above, we impaired 36 stores during the first six months of this year. The impairment charge noted for last year was recorded for information technology assets that were superseded by the launch of new e-commerce assets. During the third quarter of this year, management also decided to close our distribution center located in Hagerstown, Maryland, and our call center located in Largo, Florida. We recognized restructuring expenses of $1.7 million consisting of $0.9 million for store closures, $0.1 million for Port Supply, $0.5 million for the distribution center, and severance costs of $0.2 million for reductions in force at the Watsonville Support Center.
Interest expense decreased $1.3 million, or 39.7%, to $1.9 million in the first nine months of 2008, compared to $3.2 million for the same period last year. The decrease in interest expense was due to both lower interest rates and lower average outstanding bank borrowings in the first nine months of 2008, compared to the same period last year.
Our effective tax rate is subject to change based on the mix of income from different state jurisdictions that tax at different rates, as well as the change in status or outcome of uncertain tax positions. We evaluate our effective income tax rate on a quarterly basis and update our estimate of the full-year effective income tax rate as necessary. Our effective income tax expense rate for the nine months of 2008 was 293.5%, compared with 39.0% for the same period last year. The change in our effective tax rate was largely due to managements decision to place a full valuation allowance on the net deferred tax assets.
Liquidity and Capital Resources
Our cash needs primarily are for working capital to support our inventory requirements and capital expenditures for new and remodeled stores. We believe our existing credit facility and cash flow from operations will be sufficient to satisfy our liquidity needs over the next 12 months.
Operating Activities
During the first nine months of 2008, net cash provided by operating activities was $34.0 million, compared to $49.8 million for the same period last year. The decline is driven by lower operating results and we expect this trend to continue through the fourth quarter. The net cash provided by operating activities this year includes an $8.2 million increase in accounts payable due to timing of payments and a $3.3 million decrease in other current assets due to timing of tax payments. This was partially offset by a decrease in accrued expenses and other of $3.6 million for the change in gift card liabilities consistent with seasonal activity and an increase in accounts receivable of $1.6 million also due to seasonal sales activity.
Investing Activity
We spent $11.5 million on capital expenditures during the first nine months of 2008, a $3.3 million decrease from the prior year, primarily due to lower spending on information technology projects partially offset by investment in building and production improvements at our distribution centers. We expect to spend between $15.0 million and $18.0 million on capital expenditures during 2008, mainly for store development activities, including new stores, a flagship store, remodels and expansions, and information technology. We have opened three stores and expect to open one additional store during fiscal year 2008. We intend to fund our investments through cash generated from operations and bank borrowings.
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Financing Arrangements
Net cash used in financing activities was $22.6 million for the first nine months of 2008, representing net repayments under our credit facility. We received a de minimis amount from the exercise of vested stock options during the first nine months of 2008, compared to $2.9 million received for the same period last year.
We have a $225.0 million credit agreement with a group of lenders that expires in December 2010. Borrowing availability is based on a percentage of our inventory and accounts receivable. At our option, subject to certain conditions and restrictions, the agreement provides up to $25.0 million in additional financing during the term. The credit facility is guaranteed by West Marine and its subsidiaries and is secured by a security interest in all of the accounts receivable and inventory of West Marine and its subsidiaries, certain other assets related thereto, and all proceeds thereof. The credit facility includes a $50.0 million sub-facility available for the issuance of commercial and stand-by letters of credit and a sub-limit of up to $20.0 million for same-day advances.
At our election, borrowings under the loan facility will bear interest at one of the following rates: the prime rate announced by Wells Fargo Bank, National Association at its principal office in San Francisco, California; or the interest rate per annum at which deposits in U.S. dollars are offered by reference lenders to prime banks in designated markets located outside the U.S. 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 loan facility. The loan agreement also imposes a commitment fee on the unused portion of the revolving loan facility. For the third quarter of 2008, the weighted-average interest rate on all of our outstanding borrowings was 3.8%.
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. Additionally, minimum revolving credit availability equal to the lesser of $15.0 million or 7.5% of the borrowing base must be maintained. As of September 27, 2008, we were in compliance with our bank covenants.
At September 27, 2008, borrowings under this credit facility were $29.3 million, bearing interest at rates ranging from 3.5% to 5.0%, and $98.8 million was available to be borrowed. At September 29, 2007, borrowings under this credit facility were $30.3 million, bearing interest at rates ranging from 6.4% to 8.3%. At September 27, 2008, we had $4.7 million of outstanding stand-by letters of credit and $1.0 million of outstanding commercial letters of credit, compared to $6.0 million outstanding stand-by letters of credit and $0.3 million of outstanding commercial letters of credit at the end of the third quarter last year.
Off-Balance Sheet Arrangements
Substantially all of the real property used in our business is leased under operating lease agreements, as described in Item 2 Properties and Note 9 to the consolidated financial statements in the 2007 Form 10-K.
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 consolidated revenues and net income are higher in the second and third quarters and decrease in the first and fourth quarters of the fiscal year. In 2007, 64% of our net revenues 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 retail markets.
Business Trends
Our research indicates that the U.S. boating industry currently is experiencing a down cycle, as evidenced by lower sales trends in each of our business segments compared to last year, lower new and used boat sales, and declining boat registrations in key states. We have been and are responding to this challenging industry climate by:
| controlling our operating expenses and emphasizing specialized and localized product assortments in our stores; |
| opening a small number of stores, closing 25 to 30 stores and remodeling, expanding or significantly re-merchandising up to 25 stores; |
| reducing overhead by re-engineering and streamlining business processes; |
| closing our Maryland distribution center by year-end; |
| implementing service model changes in the Port Supply business which emphasizes growing sales profitably; |
| moving to a shared services model; |
| closing our call center in Largo, Florida by year-end and moving to a virtual call center structure, enabling our associates to operate from their homes for maximum flexibility and optimization of customer service levels; |
| continuing to invest in our e-commerce business in order to ensure customers are provided with better than expected customer service; and |
| further exploring franchising and other growth vehicles to drive domestic and international sales and market presence. |
We believe worsening economic conditions and turmoil in the financial markets may have further adversely impacted discretionary consumer spending in an already challenging climate for the boating industry. It is unclear the extent to which these circumstances will persist and what overall impact they will have on future discretionary consumer spending.
During the third quarter of 2008, we incurred restructuring charges of $0.9 million for store closures, $0.1 million for Port Supply restructuring, and $0.5 million related to closing our Maryland distribution center. We also incurred severance costs of $0.2 million for reductions in force at the Watsonville Support Center. We expect costs for store closures in the fourth quarter of 2008 to be between $4.1 million and $6.8 million, most of which will be cash charges for lease terminations. We also expect to incur costs associated with the closure of our Largo, Florida call center between $1.0 million and $2.0 million. Finally, we expect to record additional charges of approximately $2.4 million to $3.5 million related to closing of our Maryland distribution center.
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Internet Address and Access to SEC Filings
Our Internet address is www.westmarine.com. Interested readers may access our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and any amendments to those reports filed or furnished pursuant to Section 13(a) of the Securities Exchange Act of 1934, as amended, in the Investor Relations portion of our website as well as through the Securities and Exchange Commissions website, www.sec.gov.
Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995
This report contains forward-looking statements within the safe harbor provisions of the Section 21E of the Securities Exchange Act of 1934, as amended (the Exchange Act). All statements other than those that are purely historical are forward-looking statements. Words such as expect, anticipate, believe, estimate, plan, project, and similar expressions also identify forward-looking statements. These forward-looking statements include, among other things, statements that relate to West Marines future plans, expectations, objectives, performance and similar projections, as well as facts and assumptions underlying these statements or projections. Actual results may differ materially from the results expressed or implied in these forward-looking statements due to various risks, uncertainties or other factors.
West Marines operations could be adversely affected if unseasonably cold weather, prolonged winter-like conditions, natural disasters such as hurricanes, or extraordinary amounts of rainfall occur during the peak boating season in the second and third quarters. Risk factors that may affect our earnings in the future include the risk factors set forth in the 2007 Form 10-K, and those risks which may be described from time to time in West Marines other filings with the Securities and Exchange Commission. Except as required by applicable law, West Marine assumes no responsibility to update any forward-looking statements as a result of new information, future events or otherwise.
ITEM 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We do not undertake any specific actions to diminish our exposure to interest rate risk, and we are not a party to any interest 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 2007 Form 10-K.
Based on our operating results for the year ended December 29, 2007, a 66 basis point change in the interest rate (10% of our weighted-average interest rate) affecting our floating financial instruments would have an effect of reducing our pretax income and cash flows by approximately $0.4 million over the next year, and would have an immaterial effect on the fair value of our fixed-rate financial instruments (see Note 7 to the Notes to Consolidated Financial Statements in our 2007 Form 10-K).
ITEM 4 CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
West Marines management, including the Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act. Based on this review, management, including the Chief Executive Officer and the Chief Financial Officer, has concluded that our disclosure controls and procedures were not effective as of September 27, 2008, due to the existence of the material weaknesses described below. A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis.
| We did not maintain sufficient accounting resources with adequate training in the application of generally accepted accounting principles (GAAP) commensurate with our financial reporting requirements and the complexity of our operations and transactions. |
| Monitoring and oversight controls over the preparation of significant accounting estimates were not effective. |
Despite the existence of these material weaknesses, management believes that the financial statements included in this report fairly present, in all material respects, our financial condition, results of operations and cash flows for the periods presented.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the third quarter of fiscal year 2008 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. We have previously undertaken remediation measures in the first and second quarter of 2008, but do not expect the material weaknesses identified above to be fully remediated until management has tested our internal controls over financial reporting and found them to be operating effectively. We expect to complete this process during our annual testing for fiscal 2008.
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On March 21, 2008, a former hourly associate filed a lawsuit in the California Superior Court, County of Orange. The suit alleges, among other things, that we engaged in unfair business practices and failed to provide meal and rest periods, correct itemized statements, and appropriately pay discharged associates in violation of certain applicable sections of the California Labor Code and the California Business and Professions Code. The plaintiff seeks to represent himself and all similarly situated current and former hourly-paid associates employed by West Marine in the State of California. The plaintiff seeks reimbursement of wages, penalties and interest allegedly owed under the relevant California code sections, as well as an unspecified amount of damages and attorneys fees and costs recoverable by law. We filed an answer denying all charges and have served discovery. We believe that we have meritorious defenses to this lawsuit and we continue to vigorously defend it, including plaintiffs efforts to certify a California class action. Additionally, we are involved in various other legal proceedings, claims and litigation including the SEC investigation discussed in our 2007 Form 10-K, as well as those arising in the ordinary course of business. Based on the facts currently available, we do not believe that the disposition of matters that are pending or asserted 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 results of operations in any given period.
We have included in Part I, Item 1A of our 2007 Form 10-K and Part II, Item 1A of our Form 10-Q for the quarter ended June 28, 2008, a description of certain risks and uncertainties that could affect the companys business, future performance or financial condition, referred to as Risk Factors. These risk factors have not materially changed other than as set forth below. Investors should consider these Risk Factors prior to making an investment decision with respect to our common stock.
Worsening economic conditions and financial market turmoil could adversely affect our business and results of operations.
Worsening economic conditions and turmoil in the financial markets may adversely impact consumer spending, particularly in discretionary areas, such as boating. Uncertainty about current and future economic conditions may cause consumers to refrain from discretionary purchases in response to tighter credit, decreased cash availability and declining consumer confidence. If these circumstances persist or continue to worsen, our future operating results could be adversely affected as compared to our current expectations.
ITEM 2 UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
None.
ITEM 3 DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
None.
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3.1 | Certificate of Incorporation of West Marine, Inc., as amended (incorporated by reference to Exhibit 3.1 to West Marines Annual Report on Form 10-K filed March 18, 2004). | |
3.2 | Bylaws of West Marine, Inc., as amended (incorporated by reference to Exhibit 3.1 to West Marines Annual Report on Form 10-K filed March 13, 2007). | |
4.1 | Specimen Common Stock Certificate (incorporated by reference to Exhibit 4.1 to West Marines Registration Statement on Form S-1 (Registration No. 33-69604)). | |
15.1 | Letter regarding Unaudited Interim Financial Information. | |
31.1 | Certification of Chief Executive Officer Pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934, as amended. | |
31.2 | Certification of Chief Financial Officer Pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934, as amended. | |
32.1 | Certification of Chief Executive Officer and Chief Financial Officer Pursuant to Rule 13a-14(b) under the Securities Exchange Act of 1934, as amended. |
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Date: November 4, 2008 | WEST MARINE, INC. | |||||||
By: | /s/ Geoffrey A. Eisenberg | |||||||
Geoffrey A. Eisenberg | ||||||||
Chief Executive Officer | ||||||||
By: | /s/ Thomas R. Moran | |||||||
Thomas R. Moran | ||||||||
Chief Financial Officer |
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