UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q/A
(Amendment No.1)
| x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended September 30, 2006
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)
Registrant’s 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, or a non-accelerated filer. See the definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer ¨ Accelerated filer x Non-accelerated filer ¨
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 24, 2006, the number of shares outstanding of the registrant’s common stock was 21,457,085.
Explanatory Note
This Form 10-Q/A is being filed to restate the financial statements and certain disclosure items related to management’s review of its inventory accounting practices and reevaluation of various indirect costs included in inventory cost. In connection with this review, management determined that the inclusion of a portion of store occupancy costs and certain other indirect costs in inventory was an error requiring correction by restating West Marine’s previously-issued financial statements.
The consolidated balance sheets as of September 30, 2006 and October 1, 2005 and the consolidated statements of income for the 13 weeks and 39 weeks ended September 30, 2006 and October 1, 2005 and consolidated statement of cash flows for the 39 weeks ended September 30, 2006 and October 1, 2005 presented in this report have been restated. All financial information included in this report is based on our restated financial statements. See Note 2 to our consolidated financial statements in Item 1 for additional information regarding the restatement.
This amendment does not reflect events occurring after the original filing of the quarterly report on October 30, 2006, except to reflect the restatement as described above, or modify or update those disclosure items presented in the original Form 10-Q and not contained in this amendment. Amendments to the quarterly reports on Form 10-Q for the quarterly periods ended April 1, 2006 and July 1, 2006 are being filed concurrently with this filing.
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PART I – FINANCIAL INFORMATION
CONDENSED CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, 2006, DECEMBER 31, 2005 AND OCTOBER 1, 2005
(Unaudited and in thousands, except share data)
As Restated | December 31, 2005 | As Restated (Note 2) October 1, 2005 | ||||||||
| ASSETS | ||||||||||
Current assets: | ||||||||||
Cash | $ | 6,940 | $ | 13,058 | $ | 6,274 | ||||
Trade receivables, net | 7,543 | 6,125 | 7,132 | |||||||
Merchandise inventories | 265,008 | 277,932 | 293,271 | |||||||
Deferred income taxes | 5,276 | 5,384 | 6,934 | |||||||
Other current assets | 20,396 | 29,376 | 26,262 | |||||||
Total current assets | 305,163 | 331,875 | 339,873 | |||||||
Property and equipment, net | 74,592 | 82,787 | 90,625 | |||||||
Goodwill | 56,905 | 56,905 | 56,905 | |||||||
Intangibles | 239 | 268 | 2,319 | |||||||
Other assets | 3,604 | 3,534 | 3,550 | |||||||
| TOTAL ASSETS | $ | 440,503 | $ | 475,369 | $ | 493,272 | ||||
| LIABILITIES AND STOCKHOLDERS’ EQUITY | ||||||||||
Current liabilities: | ||||||||||
Accounts payable | $ | 44,987 | $ | 37,589 | $ | 49,671 | ||||
Accrued expenses | 40,101 | 35,549 | 35,320 | |||||||
Total current liabilities | 85,088 | 73,138 | 84,991 | |||||||
Long-term debt | 63,995 | 117,000 | 99,000 | |||||||
Deferred items and other non-current obligations | 8,330 | 9,630 | 13,362 | |||||||
Total liabilities | 157,413 | 199,768 | 197,353 | |||||||
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; 21,454,666 shares issued and 21,435,510 shares outstanding at September 30, 2006; 21,204,533 shares issued and outstanding at December 31, 2005; and 21,146,789 shares issued and outstanding at October 1, 2005 | 22 | 21 | 21 | |||||||
Treasury stock | (282 | ) | — | — | ||||||
Additional paid-in capital | 162,753 | 159,891 | 159,147 | |||||||
Accumulated other comprehensive income (loss) | (95 | ) | 182 | 69 | ||||||
Retained earnings | 120,692 | 115,507 | 136,682 | |||||||
Total stockholders’ equity | 283,090 | 275,601 | 295,919 | |||||||
| TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY | $ | 440,503 | $ | 475,369 | $ | 493,272 | ||||
See notes to condensed consolidated financial statements.
3
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited and in thousands, except per share data)
| 13 Weeks Ended | 39 Weeks Ended | |||||||||||
As Restated (Note 2) 2006 | As Restated (Note 2) October 1, 2005 | As Restated (Note 2) September 30, 2006 | As Restated (Note 2) October 1, 2005 | |||||||||
Net sales | $ | 195,605 | $ | 188,574 | $ | 592,793 | $ | 567,459 | ||||
Cost of goods sold | 137,150 | 131,103 | 413,333 | 386,054 | ||||||||
Gross profit | 58,455 | 57,471 | 179,460 | 181,405 | ||||||||
Selling, general and administrative expense | 50,982 | 50,872 | 159,016 | 146,552 | ||||||||
Store closure costs | 1,528 | — | 5,060 | — | ||||||||
Income from operations | 5,945 | 6,599 | 15,384 | 34,853 | ||||||||
Interest expense | 1,211 | 1,321 | 5,280 | 4,580 | ||||||||
Income before income taxes | 4,734 | 5,278 | 10,014 | 30,273 | ||||||||
Income taxes | 1,820 | 1,998 | 4,919 | 11,412 | ||||||||
Net income | $ | 2,914 | $ | 3,280 | $ | 5,185 | $ | 18,861 | ||||
Net income per share: | ||||||||||||
Basic | $ | 0.14 | $ | 0.16 | $ | 0.24 | $ | 0.90 | ||||
Diluted | $ | 0.14 | $ | 0.15 | $ | 0.24 | $ | 0.88 | ||||
Weighted average common and common equivalent shares outstanding: | ||||||||||||
Basic | 21,420 | 21,126 | 21,297 | 21,045 | ||||||||
Diluted | 21,549 | 21,421 | 21,449 | 21,414 | ||||||||
See notes to condensed consolidated financial statements.
4
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited and in thousands)
| 39 Weeks Ended | ||||||||
As Restated (Note 2) September 30, 2006 | As Restated (Note 2) October 1, 2005 | |||||||
| OPERATING ACTIVITIES: | ||||||||
Net income | $ | 5,185 | $ | 18,861 | ||||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||
Depreciation and amortization | 16,542 | 17,195 | ||||||
Asset impairment charge | 3,532 | — | ||||||
Stock-based compensation | 1,646 | — | ||||||
Tax benefit from exercise of stock options | 198 | 949 | ||||||
Excess tax benefit from stock-based compensation | (220 | ) | — | |||||
Provision for doubtful accounts | 317 | 145 | ||||||
Loss on asset disposals | 278 | 138 | ||||||
Provision for deferred income taxes | (37 | ) | (34 | ) | ||||
Changes in assets and liabilities: | ||||||||
Accounts receivable | (1,735 | ) | (1,068 | ) | ||||
Merchandise inventories | 12,923 | 18,950 | ||||||
Prepaid expenses and other current assets | 8,980 | 2,894 | ||||||
Other assets | (464 | ) | (568 | ) | ||||
Accounts payable | 7,487 | (15,980 | ) | |||||
Accrued expenses | 4,552 | 7,175 | ||||||
Deferred items | (44 | ) | (241 | ) | ||||
Net cash provided by operating activities | 59,140 | 48,416 | ||||||
INVESTING ACTIVITIES: | ||||||||
Purchases of property and equipment | (13,125 | ) | (25,071 | ) | ||||
Proceeds from sale of property | 14 | — | ||||||
Net cash used in investing activities | (13,111 | ) | (25,071 | ) | ||||
| FINANCING ACTIVITIES: | ||||||||
Net repayments on line of credit | (53,004 | ) | (25,064 | ) | ||||
Payment of loan costs | (100 | ) | (264 | ) | ||||
Proceeds from exercise of stock options | 411 | 2,121 | ||||||
Proceeds from sale of common stock pursuant to Associate Stock Purchase Plan | 607 | 677 | ||||||
Excess tax benefit from stock-based compensation | 220 | — | ||||||
Treasury shares purchased | (281 | ) | — | |||||
Net cash used in financing activities | (52,147 | ) | (22,530 | ) | ||||
| NET INCREASE (DECREASE) IN CASH | (6,118 | ) | 815 | |||||
| CASH AT BEGINNING OF PERIOD | 13,058 | 5,459 | ||||||
| CASH AT END OF PERIOD | $ | 6,940 | $ | 6,274 | ||||
See notes to condensed consolidated financial statements.
5
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Thirteen and Thirty-nine Weeks Ended September 30, 2006 and October 1, 2005
(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 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) necessary to fairly present the financial position at September 30, 2006 and October 1, 2005, and the interim results of operations for the 13-week and the 39-week periods and cash flows for the 39-week period then ended have been included.
The condensed consolidated balance sheet at December 31, 2005, presented herein, has been derived from the audited consolidated financial statements of the Company as restated for the year then ended and were included in West Marine’s Annual Report on Form 10-K for the year ended December 30, 2006.
Accounting policies followed by the Company are described in Note 1 to its audited consolidated financial statements for the year ended December 31, 2005. Certain information and disclosures normally included in the notes to annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been omitted for purposes of the condensed consolidated interim financial statements presented herein. These condensed consolidated interim financial statements should be read in conjunction with the audited consolidated financial statements, including the notes thereto, which were included in the Company’s Annual Report on Form 10-K for the year ended December 30, 2006.
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the 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 30, 2006 are not necessarily indicative of the results to be expected for any other interim period or for the fiscal year ending December 30, 2006.
The terms “2005” and “2006” refer to the Company’s fiscal years ended December 31, 2005 and December 30, 2006, respectively.
Comprehensive income consists of net income and other comprehensive income (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.
NOTE 2. Restatement of Prior Periods
The condensed consolidated financial statements for the third quarters of 2006 and 2005 presented in this amended report are restated to correct certain indirect costs erroneously capitalized in inventory. In light of recent changes in the Company’s business model, management reviewed its inventory accounting practices and reevaluated various indirect costs included in inventory cost. In connection with this review, management determined that the inclusion of a portion of store occupancy costs and certain other indirect costs in inventory was an error requiring correction by restating the Company’s previously-issued financial statements.
Additionally, during the course of this review, an error was identified in the Company’s reporting of the adoption of Emerging Issues Task Force Issue No. 02-16, “Accounting by a Customer (Including a Reseller) for Certain Consideration Received from a Vendor,” in 2003, requiring correction by separately reporting the cumulative effect of a change in accounting principle in the Company’s previously-issued financial statements.
As a result, the Company has restated its consolidated financial statements for fiscal years 2002, 2003, 2004 and 2005, for each quarter in fiscal year 2005 and for the first three quarters in fiscal year 2006. The effect of the restatement on the condensed consolidated statements of income, condensed consolidated balance sheets and condensed consolidated statements of cash flows for the quarter ended September 30, 2006 and October 1, 2005 are presented in the following tables.
6
Condensed Consolidated Balance Sheets
(in thousands)
| September 30, 2006 | October 1, 2005 | |||||||||||||||||||
| As Reported | Restatement Adjustments | As Restated | As Reported | Restatement Adjustments | As Restated | |||||||||||||||
| Assets | ||||||||||||||||||||
Merchandise inventories | $ | 299,465 | $ | (34,457 | ) | $ | 265,008 | $ | 328,449 | $ | (35,178 | ) | $ | 293,271 | ||||||
Deferred income taxes | — | 5,276 | 5,276 | — | 6,934 | 6,934 | ||||||||||||||
Total current assets | 334,344 | (29,181 | ) | 305,163 | 368,117 | (28,244 | ) | 339,873 | ||||||||||||
Total assets | 469,684 | (29,181 | ) | 440,503 | 521,516 | (28,244 | ) | 493,272 | ||||||||||||
| Liabilities | ||||||||||||||||||||
Deferred current liabilities | 8,304 | (8,304 | ) | — | 6,913 | (6,913 | ) | — | ||||||||||||
Total current liabilities | 93,392 | (8,304 | ) | 85,088 | 91,904 | (6,913 | ) | 84,991 | ||||||||||||
Total liabilities | 165,717 | (8,304 | ) | 157,413 | 204,266 | (6,913 | ) | 197,353 | ||||||||||||
| Stockholders’ Equity | ||||||||||||||||||||
Retained earnings | 141,569 | (20,877 | ) | 120,692 | 158,013 | (21,331 | ) | 136,682 | ||||||||||||
Total stockholders’ equity | 303,967 | (20,877 | ) | 283,090 | 317,250 | (21,331 | ) | 295,919 | ||||||||||||
Total liabilities and stockholders’ equity | 469,684 | (29,181 | ) | 440,503 | 521,516 | (28,244 | ) | 493,272 | ||||||||||||
Condensed Consolidated Statements of Income
(in thousands, except per share data)
13 Weeks Ended September 30, 2006 | 13 Weeks Ended October 1, 2005 | |||||||||||||||||||
| As Reported | Restatement Adjustments | As Restated | As Reported | Restatement Adjustments | As Restated | |||||||||||||||
Cost of goods sold | $ | 140,382 | $ | (3,682 | ) | $ | 137,150 | $ | 133,177 | $ | (2,074 | ) | $ | 131,103 | ||||||
Gross profit | 54,773 | 3,682 | 58,455 | 55,397 | 2,074 | 57,471 | ||||||||||||||
Income from operations | 2,263 | 3,682 | 5,945 | 4,525 | 2,074 | 6,599 | ||||||||||||||
Income before income taxes | 1,052 | 3,682 | 4,734 | 3,204 | 2,074 | 5,278 | ||||||||||||||
Income taxes | 676 | 1,144 | 1,820 | 1,182 | 816 | 1,998 | ||||||||||||||
Net income | 376 | 2,538 | 2,914 | 2,022 | 1,258 | 3,280 | ||||||||||||||
Net income per share—basic | $ | 0.02 | $ | 0.12 | $ | 0.14 | $ | 0.10 | $ | 0.06 | $ | 0.16 | ||||||||
Net income per share—diluted | $ | 0.02 | $ | 0.12 | $ | 0.14 | $ | 0.09 | $ | 0.06 | $ | 0.15 | ||||||||
39 Weeks Ended September 30, 2006 | 39 Weeks Ended October 1, 2005 | |||||||||||||||||||
| As Reported | Restatement Adjustments | As Restated | As Reported | Restatement Adjustments | As Restated | |||||||||||||||
Cost of goods sold | $ | 413,541 | $ | (208 | ) | $ | 413,333 | $ | 385,318 | $ | 736 | $ | 386,054 | |||||||
Gross profit | 179,252 | 208 | 179,460 | 182,141 | (736 | ) | 181,405 | |||||||||||||
Income from operations | 15,176 | 208 | 15,384 | 35,589 | (736 | ) | 34,853 | |||||||||||||
Income before income taxes | 9,896 | 208 | 10,104 | 31,009 | (736 | ) | 30,273 | |||||||||||||
Income taxes | 4,854 | 65 | 4,919 | 11,701 | (289 | ) | 11,412 | |||||||||||||
Net income | 5,042 | 143 | 5,185 | 19,308 | (447 | ) | 18,861 | |||||||||||||
Net income per share—basic | $ | 0.24 | $ | — | $ | 0.24 | $ | 0.92 | $ | (0.02 | ) | $ | 0.90 | |||||||
Net income per share—diluted | $ | 0.24 | $ | — | $ | 0.24 | $ | 0.90 | $ | (0.02 | ) | $ | 0.88 | |||||||
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Condensed Consolidated Statements of Cash Flows
(in thousands)
39 Weeks Ended September 30, 2006 | 39 Weeks Ended October 1, 2005 | ||||||||||||||||||||||
| As Reported | Restatement Adjustments | As Restated | As Reported | Restatement Adjustments | As Restated | ||||||||||||||||||
| Operating Activities | |||||||||||||||||||||||
Net income | $ | 5,042 | $ | 143 | $ | 5,185 | $ | 19,308 | $ | (447 | ) | $ | 18,861 | ||||||||||
Changes in assets and liabilities: | |||||||||||||||||||||||
Merchandise inventories | 13,131 | (208 | ) | 12,923 | 18,214 | 736 | 18,950 | ||||||||||||||||
Benefit from deferred income taxes | (102 | ) | 65 | (37 | ) | 255 | (289 | ) | (34 | ) | |||||||||||||
Net cash provided by operating activities | 59,140 | — | 59,140 | 48,416 | — | 48,416 | |||||||||||||||||
NOTE 3. Stock-based Compensation
Prior to January 1, 2006, the Company accounted for stock-based compensation using the intrinsic-value-based recognition method prescribed by Accounting Principles Board Opinion (APB) No. 25, “Accounting for Stock Issued to Employees,” and Statement of Financial Accounting Standards (SFAS) No. 123, “Accounting for Stock-Based Compensation.” As awards were granted at an exercise price equal to the market value of the underlying common stock on the date of grant, no stock-based employee compensation cost was reflected in net income prior to January 1, 2006. Effective January 1, 2006, the Company adopted SFAS 123(R) “Share-Based Payment” and began recognizing compensation expense for its stock-based payments based on the fair value of the awards under the modified prospective application method. Stock-based payments consists of stock option grants, restricted share awards and stock purchase plan issuances, each as described further below. Stock-based compensation expense for the third quarter and nine months ended September 30, 2006 was approximately $0.4 million and $1.6 million, respectively.
Under the modified prospective application method adopted by the Company, results for periods prior to January 1, 2006 have not been restated to reflect the effects of implementing SFAS 123(R). The following pro forma information is presented for comparative purposes and illustrates the pro forma effect on net income and earnings per share for the 13-week and 39-week periods ended October 1, 2005, as if the Company had applied the fair value recognition provisions of SFAS 123 to the stock-based compensation for that period (dollars in thousands, except per share amounts):
| 13 Weeks Ended October 1, 2005 | 39 weeks Ended October 1, 2005 | |||||||
Net income, as restated | $ | 3,280 | $ | 18,861 | ||||
Add: total stock-based compensation expense included in net income, net of related tax effects | — | — | ||||||
Deduct: total stock-based compensation expense determined under fair value based method for all awards, net of related tax effects | (1,098 | ) | (3,173 | ) | ||||
Pro forma net income | $ | 2,182 | $ | 15,688 | ||||
Earnings per share, basic: | ||||||||
As restated | $ | 0.16 | $ | 0.90 | ||||
Pro forma | $ | 0.10 | $ | 0.75 | ||||
Earnings per share, diluted: | ||||||||
As restated | $ | 0.15 | $ | 0.88 | ||||
Pro forma | $ | 0.10 | $ | 0.73 | ||||
SFAS 123(R) requires that stock-based compensation expense be calculated and recognized as follows: (a) grant date fair value calculated in accordance with the original provisions of SFAS 123 for unvested awards granted prior to January 1, 2006; (b) grant date fair value calculated in accordance with the provisions of SFAS
123(R) for unvested awards granted subsequent to January 1, 2006; and (c) fair value of the shares purchased by employees from the Company’s stock purchase plan subsequent to January 1, 2006. On December 22, 2005, the Board of Directors of the Company, upon the recommendation of the Board’s Governance and Compensation Committee, approved the acceleration of vesting of all stock options then held by current employees, making all of the outstanding stock options at December 31, 2005 vested and exercisable, primarily to avoid recognition of compensation expense in future periods. Therefore, all compensation expense recognized for stock options in the 13-week and 39-week periods ended September 30, 2006 was related to options granted after December 31, 2005. The additional pre-tax expense that, absent the accelerated vesting, would have been reflected in the Company’s consolidated statements of income in the 13-week and 39-week periods ended September 30, 2006, is approximately $1.6 million and $4.8 million, respectively.
8
The Company grants options to purchase common stock to eligible associates and directors under its Omnibus Equity Incentive Plan (the “Plan”). The Company estimates the fair value of stock option awards by applying the Black-Scholes Merton option pricing valuation model. In determining the fair value of options granted in the 13 week periods ended September 30, 2006 and October 1, 2005, the following assumptions and methodology were used:
| 13-Weeks Ended | ||||||
| September 30, 2006 | October 1, 2005 | |||||
Expected price volatility | 40 | % | 60 | % | ||
Risk-free interest rate | 5.0 | % | 2.6-4.3 | % | ||
Weighted-average expected lives (years) | 3.8 | 6.2 | ||||
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 daily 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. Common shares are authorized by the Company’s board of directors, subject to stockholder approval, for issuance under the Plan and are managed by the plan administrators. Subject to adjustment, the maximum number of shares currently available for grant under the Plan may not exceed 7,300,000 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 historical experience using the weighted-average of the vesting period and the full contractual term. An increase in the expected term would increase compensation expense.
Dividend yield: The Company historically has not made any dividend payments nor does it expect to pay dividends in the foreseeable future. An increase in the dividend yield would decrease compensation expense.
A summary of the Company’s stock option activity for the 39 weeks ended September 30, 2006 is as follows:
| Number of Shares | Weighted Average Exercise Price Per Share | Weighted Average Remaining Contractual Term (years) | Aggregate Intrinsic Value (in thousands) | ||||||||
Outstanding at January 1, 2006 | 3,037,375 | $ | 18.99 | ||||||||
Granted | 486,436 | 14.38 | |||||||||
Exercised | (80,439 | ) | 6.11 | ||||||||
Canceled | (162,791 | ) | 22.18 | ||||||||
Outstanding at September 30, 2006 | 3,280,581 | 18.46 | 5.5 | $ | 3,317 | ||||||
Outstanding and exercisable at September 30, 2006 | 2,794,145 | 19.17 | 5.7 | 3,192 | |||||||
Aggregate intrinsic value at September 30, 2006 is based on the closing stock price of $14.00 on the preceding day. The total intrinsic value of options exercised in the 13 weeks ended September 30, 2006 was $0.6 million.
At September 30, 2006, 343,250 shares were authorized for future issuance under the Plan. For the 13-week period ended September 30, 2006, the weighted-average grant date fair value of options granted was $4.50, and no options were vested. At September 30, 2006, total compensation cost related to non-vested awards not yet recognized was $1.9 million after adjustment for expected forfeitures, with a weighted-average expense recognition period of 3.6 years.
Restricted Share Awards
The Plan also provides for awards of stock to eligible associates and directors that are subject to restrictions on transfer for a period of time (commonly referred to as “restricted shares”). For the 13-week period ended September 30, 2006, compensation expense for restricted share awards was approximately $0.1 million. As of September 30, 2006, compensation expense adjusted for forfeitures of $0.6 million has not yet been recognized for unvested restricted share awards.
A summary of restricted share activity for the 39 weeks ended September 30, 2006 is as follows:
| Number of Shares | Weighted Average Grant Date Fair Market Value | Weighted Average Remaining Vesting Period | ||||||
Unvested at January 1, 2006 | 107,893 | $ | 16.62 | |||||
Granted | 9,699 | 14.61 | ||||||
Vested | (58,461 | ) | 16.52 | |||||
Forfeited | (9,867 | ) | 16.58 | |||||
Unvested at September 30, 2006 | 49,264 | 16.34 | 2.4 | |||||
9
Associate Stock Purchase Plan
The Company has an Associate Stock Purchase Plan (the “Purchase Plan”) covering all eligible associates. Participating associates purchase stock twice a year at 85% of the lower of the closing price on the grant date or the purchase date. On April 28, 2006, 52,652 shares were purchased under the Purchase Plan, for which $0.2 million in compensation expense was recognized. Additionally, based on grant date subscription levels, it is estimated that 56,263 shares will be purchased during the fourth quarter of 2006, for which $0.2 million in compensation expense has been recognized year to date as of September 30, 2006. At September 30, 2006, 113,912 shares were authorized for future issuance under the Purchase Plan. Assumptions used in determining the fair value of shares to be purchased under the Purchase Plan in the fourth quarter of 2006 were as follows:
| 13 Weeks Ended September 30, 2006 | |||
Expected price volatility | 41 | % | |
Risk-free interest rate | 4.6 | % | |
Weighted-average expected lives (years) | 0.5 | ||
Dividend yield | — |
The Company recognized excess tax benefits in additional paid-in capital under SFAS 123(R) in the 39-week period ended September 30, 2006 of $0.2 million, classified as financing cash flows. The Company realized tax benefits on options exercised, restricted shares vested and disqualifying sales of shares purchased under the Purchase Plan of $0.5 million in the 39-week period ending September 30, 2006. The effect of the adoption of SFAS 123(R) on future results will depend, among other things, on levels of stock-based payments granted in the future, actual forfeiture rates and the timing of option exercises.
NOTE 4. Segment Information
The Company has three divisions—Stores, Port Supply (wholesale) and Direct Sales (catalog and Internet)—all of which sell aftermarket recreational boating supplies directly to customers. The Company’s customer base overlaps between its Stores and Port Supply divisions and between its Stores and Direct Sales divisions. All processes for the three divisions within the supply chain are commingled, including purchases from merchandise vendors, distribution center activity and customer delivery.
Assets are not presented by segment, as the Company’s assets overlap among segments. Contribution is defined as net sales, less product costs and direct expenses. The following is financial information related to the Company’s business segments (in thousands):
| 13 Weeks Ended | 39 Weeks Ended | |||||||||||||||
| As restated | As restated | |||||||||||||||
September 30, 2006 | October 1, 2005 | September 30, 2006 | October 1, 2005 | |||||||||||||
Net sales: | ||||||||||||||||
Stores | $ | 173,817 | $ | 165,406 | $ | 523,768 | $ | 494,282 | ||||||||
Direct Sales | 11,187 | 11,186 | 34,542 | 34,351 | ||||||||||||
Port Supply | 10,601 | 11,982 | 34,483 | 38,826 | ||||||||||||
Consolidated net sales | $ | 195,605 | $ | 188,574 | $ | 592,793 | $ | 567,459 | ||||||||
Contribution: | ||||||||||||||||
Stores | $ | 23,106 | $ | 17,618 | $ | 59,635 | $ | 64,734 | ||||||||
Direct Sales | 1,275 | 1,357 | 4,703 | 5,717 | ||||||||||||
Port Supply | 656 | 1,650 | 4,021 | 6,197 | ||||||||||||
Consolidated contribution | $ | 25,037 | $ | 20,625 | $ | 68,359 | $ | 76,648 | ||||||||
Reconciliation of consolidated contribution to net income: | ||||||||||||||||
Consolidated contribution | $ | 25,037 | $ | 20,625 | $ | 68,359 | $ | 76,648 | ||||||||
Less: | ||||||||||||||||
Indirect costs of goods sold not included in consolidated contribution | (9,143 | ) | (6,448 | ) | (22,290 | ) | (19,203 | ) | ||||||||
Store closure costs | (1,528 | ) | — | (5,060 | ) | — | ||||||||||
General and administrative expense | (8,421 | ) | (7,578 | ) | (25,625 | ) | (22,592 | ) | ||||||||
Interest expense | (1,211 | ) | (1,321 | ) | (5,280 | ) | (4,580 | ) | ||||||||
Income taxes | (1,820 | ) | (1,998 | ) | (4,919 | ) | (11,412 | ) | ||||||||
Net income | $ | 2,914 | $ | 3,280 | $ | 5,185 | $ | 18,861 | ||||||||
NOTE 5. Store Closure Costs
The Company’s condensed consolidated financial statements for the 13-week period ended September 30, 2006 include a $1.5 million charge for expenses related to store closures, primarily for lease termination costs and severance benefits. The Company’s condensed consolidated financial statements for the 39-week period ended September 30, 2006 includes a $1.5 million charge for store closure costs and a $3.5 million non-cash asset impairment charge as a component of store closure costs to reduce the carrying value of long-lived assets—primarily leasehold improvements, fixtures and equipment at under-performing stores the Company expects to close—to their fair value, based on management’s analysis of expected future cash flows of certain store locations.
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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 as of September 30, 2006 and October 1, 2005, and the related condensed consolidated statements of income for the 13-week and 39-week periods ended September 30, 2006 and October 1, 2005, and cash flows for the 39-week periods ended September 30, 2006 and October 1, 2005. These interim financial statements are the responsibility of West Marine’s 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 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 31, 2005, and the related consolidated statements of operations, stockholders’ equity, and cash flows for the year then ended (not presented herein, as restated); and in our report dated March 27, 2007, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of December 31, 2005 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
October 30, 2006 (March 27, 2007 as to the effects of the restatement discussed in Note 2)
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ITEM 2 - 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 notes thereto found in Item 1 of this Form 10-Q/A and our consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2005. All references to the third quarter and first nine months of 2006 mean the 13-week and 39-week periods, respectively, ended September 30, 2006, and all references to the third quarter and first nine months of 2005 mean the 13-week and 39-weeks periods, respectively, ended October 1, 2005. Unless the context otherwise requires, “West Marine,” “we,” “us” and “our” refer to West Marine, Inc. and its subsidiaries.
Restatement
The condensed consolidated financial statements for the 13 weeks and 39 weeks ended September 30, 2006 and October 1, 2005 presented in this report are restated to correct certain indirect costs erroneously capitalized in inventory. The restatement had the effect of increasing net income for the 13 weeks ended September 30, 2006 and October 1, 2005 by $2.5 million and $1.3 million, respectively, increasing net income for the 39 weeks ended September 30, 2006 by $0.1 million and decreasing net income for the 39 weeks ended October 1, 2005 by $0.4 million. For more information, see Note 2 to our consolidated financial statements in Item 1 of this report. All information in this Item 2 gives effect to the restatement.
General
West Marine is one of the largest boating supplies retailers in the world. We have three divisions — 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 2006, we offered our products through 402 stores in 38 states, Puerto Rico and Canada; on the Internet ( www.westmarine.com and www.boatus-store.com ); and through catalogs. We are also engaged, through our Port Supply division, our stores and 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.
Recent Accounting Pronouncements
In June 2006, the Financial Accounting Standards Board (FASB) issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (FIN 48), effective for fiscal years beginning after December 15, 2006. This interpretation clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with Statement of Financial Accounting Standards (SFAS) No. 109, “Accounting for Income Taxes,” including the recognition threshold and measurement attributes for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. West Marine will adopt FIN 48 on December 31, 2006, as required. The impact of FIN 48 on our financial statements is not yet known or reasonably estimable.
In June 2006, the FASB ratified the consensuses reached by the Emerging Issues Task Force in Issue No. 06-3, “How Taxes Collected from Customers and Remitted to Governmental Authorities Should be Presented in the Income Statement (That is, Gross Versus Net Presentation).” Issue No. 06-3 requires disclosure of an entity’s accounting policy regarding the presentation of taxes assessed by a governmental authority that are directly imposed on a revenue-producing transaction between a seller and a customer, including sales, use, value added and some excise taxes. We present such taxes on a net basis (excluded from revenues and costs). The adoption of Issue No. 06-3, which is effective for interim and annual reporting periods beginning after December 15, 2006, will have no impact on our consolidated financial statements.
Critical Accounting Policies and Estimates
Management’s discussion and analysis of West Marine’s financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in conformity with accounting principles generally accepted in the United States of America. Our accounting policies and estimates periodically are reevaluated and adjustments are made when facts and circumstances dictate a change. Our accounting policies are more fully described in Note 1 to the financial statements included in our Annual Report on Form 10-K for the fiscal year ended December 30, 2006. We have identified certain critical accounting policies which are described below.
Lease accounting. Our accounting practices and policies with respect to leasing transactions include: recording rent expense starting on the date we gain possession of leased property, conforming the lease term used in calculating straight-line rent expense with the term used to amortize improvements on leased property; and recording tenant improvement allowances received from landlords as an adjustment to deferred rent, reducing straight-line rent expense. Certain of our 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, we recognize rent expense on a straight-line basis over the expected minimum life of the lease, generally about ten years, including periods of free rent, and record the difference between the amount charged to rent expense and the rent paid as deferred rent. Tenant improvement allowances received from landlords generally are treated as deferred rent adjustments, reducing straight-line rent expense over the life of the lease.
Revenue recognition. We recognize revenue at the time the products are received by the customers in accordance with the provisions of Staff Accounting Bulletin (“SAB”) No. 101, “Revenue Recognition in Financial Statements” as amended by SAB 104, “Revenue Recognition.” Revenue is recognized for store sales at the point at which the customer receives and pays for the merchandise at the register. For direct sales, revenue is recognized at the time the customer receives the product. Customers typically receive goods within three days of shipment. Shipping charges billed to customers are included in net sales.
We record a reserve for estimated product returns based on historical return trends. If actual returns are greater than those projected, additional sales returns may be recorded in the future. Discounts offered to customers consist primarily of point of sale markdowns and are recorded at the time of the related sale as a reduction of revenue. Gift cards sold or issued for store credit in exchange for returned goods are carried as a liability and revenue is recognized as amounts under the gift card are redeemed. The value of points and awards under our loyalty programs are recorded as a liability and deducted from revenue at the time the points and awards are earned, based on historical conversion and redemption rates. The associated revenue is recognized when the rewards are redeemed or expire.
Stock-based compensation. Effective January 1, 2006, we adopted Statement of Financial Accounting Standard (“SFAS”) 123(R) “Share-Based Payment” and began recognizing compensation expense for its stock-based payments based on the fair value of the awards under the modified prospective application method. Stock-based payments consist of stock option grants, restricted share awards and stock purchase plan issuances. The effect of the adoption of SFAS 123(R) on future results will depend, among other things, on levels of stock-based payments granted in the future, actual forfeiture rates and the timing of option exercises. For more information, see Note 3 to our condensed consolidated financial statements, in Item 1 of this report.
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Merchandise inventories and vendor allowances. Our merchandise inventories are carried at the lower of cost or market on a first-in, first-out basis. 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 selling locations and operating costs of our merchandising, replenishment and distribution activities. Indirect costs included in inventory value at the end of the third quarter of 2006 and 2005 were $26.3 million and $28.3 million, respectively. We recognize indirect costs included in inventory value as an increase in cost of goods sold as the related products are sold.
We make certain assumptions based upon historical experience and current information to adjust inventory value for estimated shrinkage and to adjust inventory value to the lower of cost or market. Inventories are 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 inventory sold below cost.
We receive consideration from a variety of vendor-sponsored programs and arrangements such as volume rebates, markdown allowances, promotions and payment terms discounts. Vendor allowances related to merchandise purchases are treated as a reduction of inventory value and recognized as a reduction in cost of goods sold as the related products are sold.
We establish a receivable for income generated from vendor-sponsored programs 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 and diversity of the individual agreements with vendors, we perform detailed analyses and review historical trends to determine an appropriate level of the receivable.
Impairment of long-lived assets. In accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” we evaluate the recoverability of long-lived assets annually or whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. An impairment loss is recorded, if required, for the portion of the asset’s carrying value that exceeds the asset’s estimated fair value. We may also accelerate depreciation over the asset’s revised useful life, if appropriate. When evaluating long-lived assets for potential impairment, we group and evaluate assets at the lowest level at which individual cash flows can be identified.
We group and evaluate store assets for impairment at the individual store level. We compare asset carrying values to the store’s estimated future cash flows. We believe that store asset carrying values and useful lives are appropriate at the present time.
Asset retirement obligations and facility closing costs. In accordance with SFAS No. 143, “Accounting for Asset Retirement Obligations,” we estimate the fair value of our obligations to clean-up and restore leased properties under our agreements with landlords and record the amount as a liability when incurred. We account for closed store and warehouse lease termination costs in accordance with SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.” In the period we close a store or warehouse, we write off the book value of any abandoned leasehold improvements and record as an obligation the present value of estimated costs that will not be recovered. These costs include future lease payments, less any expected sublease income. These costs could increase or decrease based upon general economic conditions, circumstances in specific locations, our ability to sublease facilities and the accuracy of our related estimates.
Self insurance. We are self-insured for certain losses related to employee medical claims, workers’ compensation and general liability. Our reserve is developed based on historical claims data and includes an assessment of self-insured losses that are incurred but not reported as of the end of the period. The resulting estimate is recorded as a liability. Our assumptions are reviewed periodically and compared with actual claims experience and external benchmarks to ensure that our reserves are appropriate.
Income taxes. We record a valuation allowance to reduce our deferred tax assets to the amount we believe is more likely than not to be realized. While we have considered future taxable income, state tax apportionment and ongoing prudent and feasible tax planning strategies in assessing the need for the valuation allowance, in the event we were to determine that we would not be able to realize all or part of our net deferred tax assets in the future, an adjustment to the deferred tax assets would be charged to income in the period such determination was made. Likewise, should we determine that we would be able to realize our deferred tax assets in the future in excess of our recorded amount, an adjustment to the deferred tax assets would increase income in the period such determination was made.
Our tax filings are subject to audit by authorities in the jurisdictions where we conduct business, which may result in assessments of additional taxes, penalties and interest. We believe we have adequately provided for obligations that would result from these legal and/or tax proceedings that result from these audits where it is probable we will pay some amounts and the amounts can be estimated; in some cases, however, it is too early to predict a final outcome.
Results of Operations
The following table sets forth certain statement of operations components expressed as a percent of net sales:
| 13 Weeks Ended | 39 Weeks Ended | |||||||||||
| September 30, 2006 | October 1, 2005 | September 30, 2006 | October 1, 2005 | |||||||||
Net sales | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | ||||
Cost of goods sold | 70.1 | 69.5 | 69.7 | 68.0 | ||||||||
Gross profit | 29.9 | 30.5 | 30.3 | 32.0 | ||||||||
Selling, general and administrative expense | 26.1 | 27.0 | 26.8 | 25.9 | ||||||||
Store closure costs | 0.8 | 0.0 | 0.9 | 0.0 | ||||||||
Income from operations | 3.0 | 3.5 | 2.6 | 6.1 | ||||||||
Interest expense | 0.6 | 0.7 | 0.9 | 0.8 | ||||||||
Income before income taxes | 2.4 | 2.8 | 1.7 | 5.3 | ||||||||
Income taxes | 0.9 | 1.1 | 0.8 | 2.0 | ||||||||
Net income | 1.5 | 1.7 | 0.9 | 3.3 | ||||||||
Store Closure Costs
On August 4, 2006, our board of directors approved management’s recommendation to close between 30 and 40 stores that management identified as having no reasonable expectation of significant positive cash flow over the near term. In the second quarter of 2006, we recorded a $3.5 million non-cash asset impairment charge to reduce the carrying value of the long-lived assets associated with certain retail stores—primarily leasehold improvements, fixtures and equipment in underperforming stores that we intend to close—to their fair value based on an analysis of expected future cash flows. During the third quarter of 2006, we closed eight stores and incurred related expenses of approximately $1.5 million, primarily for lease termination costs and severance benefits. During the fourth quarter of 2006, we expect to incur additional expenses ranging from approximately $7.0 million to $9.0 million before tax in conjunction with store closings. Approximately $6.0 million to $7.0 million of these costs relate to lease termination costs. We also expect to incur other costs of approximately $1.0 million to $2.0 million, including severance benefits and inventory writedowns. See “Critical Accounting Policies and Estimates—Impairment of long-lived assets” and “—Asset retirement obligations and facility closing costs” for more information.
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Three Months Ended September 30, 2006 Compared to Three Months Ended October 1, 2005
Net sales for the third quarter of 2006 were $195.6 million, an increase of $7.0 million, or 3.7%, compared to net sales of $188.6 million in the third quarter of 2005. Net income for the third quarter of 2006 was $2.9 million, or $0.14 per diluted share, compared to net income of $3.3 million, or $0.15 per diluted share, in the third quarter of 2005.
Net sales attributable to our Stores division increased $8.4 million to $173.8 million in the third quarter of 2006, a 5.1% increase compared to the third quarter of 2005, primarily due to new store openings, as well as higher sales in stores open for more than a year. Comparable store sales increased 2.4% in the third quarter of 2006 compared to the same period a year ago, mainly due to improved sales in the southeast and Gulf states, which were heavily impacted by Hurricanes Katrina and Rita last year, and improved sales on the west coast, which benefited from store selling and merchandising initiatives, including a focus on boating lifestyle products, partially offset by weather-related sales decreases in many of our northeast and mid-Atlantic stores. Wholesale (Port Supply) net sales through our distribution centers decreased $1.4 million, or 11.5%, to $10.6 million in the third quarter of 2006 compared with 2005, primarily because wholesale customers purchased more merchandise through our store locations, which are included in Stores sales. Direct Sales net sales remained relatively flat at $11.2 million compared to the same period last year.
Gross profit increased by $1.0 million, or 1.7 %, to $58.5 million in the third quarter of 2006, compared to $57.5 million for the same period last year. Gross profit decreased as a percentage of net sales to 29.9% in the third quarter of 2006, a 60 basis point decrease compared to 30.5% for the same period last year, mainly due to a 141 basis point decrease in capitalized indirect costs, including occupancy, buying and distribution costs, which decreased gross profit as the related products were sold, partially offset by increased vendor allowances, lower inventory shrinkage and a shift in sales mix toward higher-margin boating lifestyle products, versus lower-margin electronics items.
Selling, general and administrative expenses increased $0.1 million, or 0.2%, to $51.0 million in the third quarter of 2006, compared to $50.9 million for the same period last year, and decreased as a percentage of sales to 26.1% in the third quarter of 2006, compared to 27.0% for the same period last year, mainly due to lower store labor costs, partially offset by stock-based compensation expense of $0.4 million in 2006, compared to none last year.
Interest expense decreased $0.1 million, or 8.3%, to $1.2 million in the third quarter of 2006, compared to $1.3 million for the same period last year. The decrease in interest expense primarily was due to lower average outstanding bank debt in the third quarter of 2006, compared to the same period last year. The decrease in average outstanding bank debt primarily was attributable to an increase in cash provided by operations and lower capital expenditures.
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 rate for the third quarter of 2006 was approximately 38.4%, compared with approximately 37.8% for the same period last year. The change in our effective tax rate was largely due to the impact of store closure costs, nondeductible compensation related to our associate stock purchase plan and state tax benefits that expired during the third quarter of 2006.
Nine Months Ended September 30, 2006 Compared to Nine Months Ended October 1, 2005
Net sales for the first nine months of 2006 were $592.8 million, an increase of $25.3 million, or 4.5%, compared to net sales of $567.5 million for the first nine months of 2005. Net income for the first nine months of 2006 was $5.2 million, or $0.24 per share, compared to net income of $18.9 million, or $0.88 per share, for the first nine months of 2005.
Net sales attributable to our Stores division increased $29.5 million to $523.8 million in the first nine months of 2006, a 6.0% increase compared to the first nine months of 2005, primarily due to new store openings, as well as higher sales in stores open for more than a year. Comparable store sales increased 2.8% in the first nine months of 2006 compared to the same period a year ago, mainly due to improved weather in the highly seasonal northeast, mid-Atlantic and Great Lakes areas throughout most of the period, improved sales in the southeast and Gulf states, which were heavily impacted by Hurricanes Katrina and Rita last year, and increased sales of discretionary items, especially boating lifestyle products. Wholesale (Port Supply) net sales through our distribution centers decreased $4.3 million, or 11.2%, to $34.5 million in the first nine months of 2006 compared with 2005, primarily because wholesale customers purchased more merchandise through our store locations, which are included in Stores sales. Direct Sales net sales increased $0.2 million, or 0.6% to $34.5 million in the first nine months of 2006 compared with 2005, primarily due to improvements in our West Marine Internet shopping website, offset by reduced sales in areas where we have opened new stores.
Gross profit decreased by $1.9 million, or 1.1%, to $179.5 million in the first nine months of 2006, compared to $181.4 million for the same period last year. Gross profit decreased as a percentage of net sales to 30.3% for the first nine months of 2006, a 170 basis point decrease compared to 32.0% for the same period last year, mainly due to a 112 basis point decrease in capitalized indirect costs, including occupancy, buying and distribution costs, which decreased gross profit as the related products were sold.
Selling, general and administrative expenses increased $12.5 million, or 8.5%, to $159.0 million in the first nine months of 2006, compared to $146.6 million for the same period last year, and increased as a percentage of sales to 26.8% in the first nine months of 2006, compared to 25.9% for the same period last year, mainly due to additional operating costs for new stores and continued investments in store selling, direct sales and wholesale business initiatives, as well as stock-based compensation expense of $1.6 million in 2006, compared to none last year.
Interest expense increased $0.7 million, or 15.3%, to $5.3 million in the first nine months of 2006, compared to $4.6 million for the same period last year. The increase in interest expense primarily was due to higher interest rates paid in the first nine months of 2006 compared to last year.
Our effective income 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 rate for the first nine months of 2006 was approximately 49.1%, compared with approximately 37.7% for the same period last year. The change in our effective tax rate was largely due to the impact of store closure costs and nondeductible compensation related to our associate stock purchase plan. At the end of the third quarter, our estimated effective income tax rate for the full year 2006 was approximately 30.4%. The tax rate applicable to store closure costs included in our estimated full-year effective rate was approximately 36.6%.
Liquidity and Capital Resources
Our cash needs primarily are for working capital to support our inventory requirements and capital expenditures, lease termination costs, termination benefits and certain other exit costs associated with planned store closures in the third and fourth quarters of 2006, pre-opening expenses and beginning inventory for new stores and remodeling or relocating older stores, as well as investments in business initiatives as described under “Business Trends.” We also may require additional capital in the event we choose to pursue acquisition opportunities. We believe our existing credit facility and cash flow from operations will be sufficient to satisfy our liquidity needs over the next 12 months.
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Operating Activities
During the first nine months of 2006, net cash provided by operating activities was $59.1 million, primarily due to $25.3 million from net income excluding depreciation, amortization and asset impairment charges, as well as a decrease in merchandise inventories of $12.9 million. Inventory value decreased by 9.6% and inventory per square foot decreased by 12.5% at the end of the third quarter of 2006, compared to the same period last year, primarily due to the implementation of inventory management initiatives.
Investing Activity
We spent $13.1 million on capital expenditures during the first nine months of 2006, a $12.0 million decrease from $25.1 million spent during the same period in the prior year, primarily due to a reduction in new store openings and reduced spending for information systems software development projects. We expect to spend a total of $16.0 million to $18.0 million on capital expenditures during 2006, primarily for new and remodeled stores and information systems improvements. We expect to open a total of eight stores during fiscal year 2006, seven of which we have already opened. We intend to pay for our expansion through cash generated from operations and bank borrowings.
Financing Arrangements
Net cash used in financing activities was $52.1 million for the first nine months of 2006, primarily consisting of $53.0 million of net repayments under our credit facility, attributable to improved cash flows from operations. We received $1.0 million from the exercise of vested stock options granted under our omnibus equity incentive plan and from the sales of common stock pursuant to our associate stock purchase plan during the first nine months of 2006, compared to $2.8 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. The credit facility also includes 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: (1) the prime rate announced by Wells Fargo Bank, National Association at its principal office in San Francisco, California or (2) 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 2006, the weighted average interest rate on all of our outstanding borrowings was 7.0%.
The loan agreement contains customary covenants, including but not limited to, restrictions on the ability of West Marine and its subsidiaries to incur liens, make acquisitions and investments, pay dividends and sell or transfer assets. As of September 30, 2006 we were in compliance with our bank covenants. Additionally, a minimum revolving credit availability equal to the lesser of $15.0 million or 7.5% of the borrowing base must be maintained.
At September 30, 2006, borrowings under this credit facility were $64.0 million, bearing interest at rates ranging from 5.7% to 8.3%, and $161.0 million was available to be borrowed. At October 1, 2005, borrowings under our previous credit facility were $99.0 million, bearing interest at rates ranging from 5.6% to 7.3%. At September 30, 2006, we had $5.5 million of outstanding stand-by letters of credit and $0.1 million of outstanding commercial letters of credit, compared to $5.2 million and $0.3 million, respectively, outstanding 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 5 to the Consolidated Financial Statements in our Annual Report on Form 10-K for the year ended December 31, 2005.
We do not participate in transactions that generate relationships with unconsolidated entities or financial partnerships, such as special purpose entities or variable interest entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other limited purposes. As of September 30, 2006, we were not involved in any unconsolidated special purpose entities or variable interest entities.
Seasonality
Historically, our business has been highly seasonal. In 2005, 64% of our net sales and all of our net income occurred during the second and third quarters, principally during the period from April through July, 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. In addition, the boating supplies market is heavily influenced by uncontrollable external events, such as fuel prices, weather and other factors. In light of business trends and market characteristics, and in order to sustain an acceptable level of earnings and grow shareholder value over the long-term, we intend to close between 22 and 32 unprofitable stores and reduce operating expenses during the fourth quarter of 2006. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Store Closure Costs” for more information.
Previously, we announced a number of key business initiatives, including store sales training, specialized stores, direct sales growth, wholesale sales growth and inventory reduction, among other targeted efforts. We intend to continue to invest in these long-term initiatives. However, due to the mixed results we have experienced to date, we intend to suspend some aspects of these initiatives, monitor the results of our strategic investments and adjust our business tactics accordingly.
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 Commission’s website,www.sec.gov.
“Safe Harbor” Statement Under the Private Securities Litigation Reform Act of 1995
This Quarterly Report on Form 10-Q/A contains forward-looking statements within the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995. 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 Marine’s future plans, expectations, objectives, performance, and similar projections, as well as facts and assumptions underlying these statements or projections.
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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 Marine’s 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 West Marine’s Annual Report on Form 10-K for the fiscal year ended December 31, 2005 and its Quarterly Report for the fiscal quarter ended July 1, 2006, and those risks which may be described from time to time in West Marine’s 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 4 – CONTROLS AND PROCEDURES
In the course of a company-initiated review of its accounting for capitalized indirect inventory costs, which began during the fourth quarter of 2005 and concluded during the financial closing process in connection with the preparation of its Annual Report on Form 10-K for the fiscal year ended December 30, 2006, West Marine determined that a portion of store occupancy costs had been capitalized in error, resulting in the restatement of previously-issued financial statements. The error originated from a change in accounting policy that occurred in fiscal year 2003. Management initiated the review of accounting for capitalized indirect inventory costs based on information detected by internal controls designed and maintained to monitor existing accounting policies for compliance with generally accepted accounting principles.
Management, including the Chief Executive Officer and the Chief Financial Officer, performed an evaluation of the effectiveness and design and operation of our disclosure controls and procedures as of September 30, 2006. Based on that evaluation, our management, including the Chief Executive Officer and Chief Financial Officer, concluded that our disclosure controls and procedures were effective as of September 30, 2006. As part of this evaluation, management considered the controls which were designed and in place in 2005 that identified the matter that resulted in the restatement described and reflected in this amended report. For more information, see Note 2 to our condensed consolidated financial statements in Item 1 of this report.
There were no changes in our internal control over financial reporting that occurred during the third quarter of fiscal year 2006 that materially affected, or were reasonably likely to materially affect, our internal control over financial reporting.
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| 3.1 | Certificate of Incorporation of West Marine, Inc., as amended (incorporated by reference to Exhibit 3.1 to West Marine’s Annual Report of Form 10-K filed March 18, 2004). | |
| 3.2 | Bylaws of West Marine, Inc., as amended (incorporated by reference to Exhibit 3.2 to West Marine’s Annual Report of Form 10-K filed March 18, 2004). | |
| 4.1 | Specimen Common Stock Certificate (incorporated by reference to Exhibit 4.1 to West Marine’s Registration Statement on Form S-1 (Registration No. 33-69604)). | |
| 10.1 | Loan and Security Agreement, dated as of December 29, 2005, among West Marine Products, Inc., each of the persons identified as borrowers on the signature pages thereof, each of the persons identified as guarantors on the signature pages thereof, the financial institutions from time to time party thereto as lenders, Wells Fargo Bank, National Association, as Issuing Lender, and Wells Fargo Retail Finance, LLC, as Agent for the lenders (incorporated by reference to Exhibit 10.1 to West Marine’s Current Report on Form 8-K dated December 29, 2005 and filed on January 4, 2006). | |
| 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: May 8, 2007 | WEST MARINE, INC. | |||
| By: | /s/ Peter L. Harris | |||
| Peter L. Harris | ||||
| Chief Executive Officer | ||||
| By: | /s/ Thomas R. Moran | |||
| Thomas R. Moran | ||||
| Senior Vice President and Chief Financial Officer | ||||
| By: | /s/ Peter Van Handel | |||
| Peter Van Handel | ||||
| Vice President and Chief Accounting Officer | ||||
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