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WMAR > SEC Filings for WMAR > Form 10-K on 12-Mar-2014All Recent SEC Filings

Show all filings for WEST MARINE INC

Form 10-K for WEST MARINE INC


12-Mar-2014

Annual Report


ITEM 7-MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis is based upon our financial statements as of the dates and for the periods presented in this section. You should read this discussion and analysis in conjunction with the financial statements and supplementary data in Item 8 of this annual report on Form 10-K. Forward-Looking Statements
The statements in this Form 10-K that relate to future plans, events, expectations, objectives or performance (or assumptions underlying such matters) are forward-looking statements that involve a number of risks and uncertainties. These forward-looking statements include, among other things, statements that relate to our future plans, expectations, objectives, performance and similar projections, such as:
future earnings and growth in sales and profitability;

our efforts to reposition West Marine from a boating equipment and accessories retailer to a water life outfitter with a broader product offering targeting a larger customer base, which requires the success of our key growth strategies: eCommerce expansion, store optimization, and merchandise expansion; and

our ability to continue to manage our expenses and execute on our growth strategies in a relatively flat boating equipment market, as well as facts and assumptions underlying these statements or projections.

These forward-looking statements may involve known and unknown risks, uncertainties and other factors that may cause our actual results and performance in future periods to be materially different from any future results or performance suggested by the forward-looking statements in this report. Although we believe the expectations reflected in such forward-looking statements are based upon reasonable assumptions, we can give no assurance that actual results will not differ materially from these expectations. These risks, uncertainties and other factors are discussed under risk factors in Item 1A of this report.
Readers are cautioned not to place undue reliance on forward-looking statements, which are based only upon information available as of the date of this report. We do not undertake, and specifically disclaim any obligation, to publicly release the result of any revisions that may be made to any forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements even if experience or future changes make it clear that any projected results expressed or implied therein will not be realized.
Overview
We are the largest omni-channel specialty retailer exclusively offering boating supplies, gear, apparel and footwear to anyone who enjoys recreational time on or around the water with 2013 net revenues of $663.2 million and net income of $7.8 million. Providing great customer experiences and a consistent brand is important to us regardless of the sales channel the customer uses. Our 287 stores open at the end of 2013 are located in 38 states, Puerto Rico and Canada and together with our eCommerce website reaching domestic and international customers, we are recognized as the dominant waterlife outfitter for cruisers, sailors, anglers and paddle sports enthusiasts.
We have focused on the following key growth strategies during 2013 and will continue to focus on and invest in these strategies in 2014 (for additional information refer to Item 1. Business of this report):
eCommerce

store optimization

merchandise expansion

We have and will continue to invest significant resources in support of these key growth strategies. This will include additional capital investments to continue to improve our eCommerce websites and to upgrade our information technology infrastructure to further support our omni-channel retail model, designed to provide a seamless customer experience across all shopping channels. We will also incur additional investments in staffing to support execution in key areas, such as information technology and eCommerce. In addition, there will be incremental investments in marketing which, along with a reallocation of some of our traditional media spending, is intended to attract a more diverse group of customers and, thereby, grow our customer base. These strategies and investments are expected to better position us to deliver incremental sales and operating margin improvement over time.
We have corrected immaterial errors in our prior period financial statements primarily related to vendor cash consideration for advertising and other selling expenses as described in Item 8, Note 1 to our consolidated financial reports of this report. Please refer to Note 1 to our consolidated financial statements in Item 8 of this annual report on Form 10-K for additional information on the corrections.


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Results of Operations
The following table sets forth certain income statement components expressed as a percent of net revenues:

                                              2013      2012       2011
Net revenues                                 100.0 %   100.0 %   100.0  %
Cost of goods sold                            71.1 %    69.3 %    69.9  %
Gross profit                                  28.9 %    30.7 %    30.1  %
Selling, general and administrative expense   26.5 %    27.0 %    26.6  %
Store closures and other restructuring costs     - %       - %       -  %
Impairment of long-lived assets                  - %       - %       -  %
Income from operations                         2.4 %     3.7 %     3.5  %
Interest expense                               0.1 %     0.1 %     0.1  %
Income before income taxes                     2.3 %     3.6 %     3.4  %
Provision (benefit) for income taxes           1.1 %     1.4 %    (1.7 )%
Net income                                     1.2 %     2.2 %     5.1  %


Fiscal 2013 compared with Fiscal 2012
Revenues

Net revenues for 2013 were $663.2 million, a decrease of $12.2 million or 1.8%, compared to net revenues of $675.3 million for 2012. This decrease primarily was due to a $11.5 million or 1.8% decrease in comparable store sales. Comparable store sales changes during the first, second, third and fourth quarters of 2013 were (6.6)%, (2.7)%, 0.9% and 0.5%, respectively.
Core products, which represented 83.5% and 84.7% of our total revenues for 2013 and 2012, respectively, were down 2.9% during 2013 as compared to the same period last year, primarily as a result of reduced boat usage. These reductions year-over-year were partially offset by increased sales from promotional activity and successes in our three key growth strategies, which remain a relatively small portion of our overall business and are discussed below. As compared to the same period last year, we saw positive sales growth from our three key strategies: eCommerce; merchandise expansion; and store optimization. Sales through our direct-to-consumer channel, driven by domestic eCommerce growth, increased by 15.7%. The direct-to-consumer channel represented 6.5% of our 2013 revenues, as compared to 5.5% last year. Sales in our merchandise expansion categories (including footwear, apparel, clothing accessories, fishing products and paddle sports equipment) were up 6.1%. Merchandise expansion products represented 16.5% of our 2013 revenues, as compared to 15.3% last year. Finally, with respect to our store optimization strategy, sales from stores in our optimized markets, where we have moved to a larger format store from multiple, smaller locations, were up 4.4%, during 2013. We also experienced increased sales to professional customers during 2013, primarily through our store locations, which we believe resulted from our ongoing efforts to better serve this group of customers through our store locations. Gross profit
Gross profit decreased by $15.9 million, or 7.6%, to $191.6 million in 2013, compared to $207.5 million for 2012, primarily due to lower sales. Gross profit decreased as a percentage of net revenues to 28.9% in 2013, compared to 30.7% in 2012. This was driven by lower raw product margin rate, which decreased by 1.1%, primarily due to promotional offers and a shift in balance of sales from our retail customers, where transaction counts were down due to less boat usage and reduced commissioning activities, and a shift toward sales from professional customers given the success of our wholesale growth strategy. Professional customers receive discounts on products based on purchase volumes that are not consistently offered to retail customers. Gross profit rate was also lower by 0.5% due to higher occupancy expenses during the year, primarily due to store closure reserves recorded as a result of our store optimization strategy and by 0.2% primarily due to higher inventory shrinkage. Selling, general and administrative ("SG&A") expense SG&A expense for 2013 was $175.9 million, a decrease of $6.2 million, or 3.4%, compared to $182.1 million last year. SG&A decreased as a percentage of revenues to 26.5% in 2013, compared to 27.0% in 2012. Drivers of lower SG&A expense included: a $4.4 million reduction in bonus expense due to increased bonus target thresholds that were not achieved; a $1.9 million reduction in store payroll expense; a $1.7 million reduction in support expense; and a $1.2 million reduction related to Chief Executive Officer transition costs incurred in 2012. This was partially offset by a $2.9 million increase in support expense related to our key growth strategies, which includes investments in information technology infrastructure and our eCommerce website.


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Interest expense
Interest expense was $0.4 million in 2013, down from $0.8 million in 2012. This expense consists primarily of the amortization of commitment fees, as our borrowings were minimal in 2013. Cash provided by operating activities funded property and equipment investments.
Net Income
Net income for 2013 was $7.8 million compared to net income for 2012 of $14.7 million. Our effective income tax rate for 2013 was 48.8%, compared to 39.8% in 2012. The year-over-year change in our effective tax rate was primarily due to the change in gross valuation allowance against state tax credits in the amount of $2.2 million; this change increased our annual effective tax rate by 9.3%. Our effective tax rate is subject to change based on the mix of income from different state and foreign jurisdictions that tax at different rates, as well as the change in status or outcome of uncertain tax positions. Our foreign earnings are not indefinitely reinvested outside the U.S. and are subject to current U.S. income tax. For more information, see Note 8 to our consolidated financial statements.
Fiscal 2012 compared with Fiscal 2011
Revenues
Net revenues for 2012 were $675.3 million, an increase of 4.9%, compared to net revenues of $643.4 million for 2011. This increase was primarily due to a $16.7 million, or 3.1%, increase in comparable store sales.
Core products, which represented 84.8% and 86.1% of our total revenues for 2012 and 2011, respectively, and tend to be dependent upon boat-usage, were up 3.5% during 2012 as compared to the same period last year. These increases year-over-year were driven by an earlier than normal start to the boating season in the Northeast and Great Lakes regions, as well as favorable boating conditions throughout the year for other areas of the country. Additionally, we continued to see successes in our three key growth strategies which remain a relatively small portion of our overall business and are discussed below. As compared to the same period in the prior year, we saw positive sales growth from our three key strategies in 2012: eCommerce; merchandise expansion; and store optimization. Sales through our direct-to-consumer channel, driven by domestic eCommerce growth, increased by 4.4%. The direct-to-consumer channel represented 5.5% of our 2012 revenues, as compared to 5.4% of 2011 revenues. Sales in our merchandise expansion categories (including footwear, apparel, clothing accessories, fishing products and paddle sports equipment) were up 15.2%. Merchandise expansion products represented 15.3% of our 2012 revenues, as compared to 13.9% in 2011. Finally, with respect to our store optimization strategy, sales from stores in our optimized markets, where we have moved to a larger format store from multiple, smaller locations, were up 22.0%, during 2012. We also experienced increased sales to professional customers during 2012, primarily through our store locations, which we believe resulted from our ongoing efforts to better serve this group of customers through our store locations.
Gross profit
Gross profit increased by $13.8 million, or 7.1%, to $207.5 million in 2012, compared to $193.7 million for 2011, primarily due to higher sales. Gross profit increased as a percentage of net revenues by 0.6% to 30.7% in 2012, compared to 30.1% in 2011, primarily due to the leveraging of occupancy expense by 0.5% on higher sales and a 0.1% improvement in shrink. These improvements were partially offset by a 0.1% increase in unit buying and distribution costs. Selling, general and administrative expense SG&A expense for 2012 was $182.1 million, an increase of $11.2 million, or 6.6%, compared to $170.9 million for last year. SG&A increased as a percentage of revenues to 27.0% in 2012, compared to 26.6% in 2011. Drivers of higher SG&A expense included: a $3.2 million increase in support expense related to our key growth strategies, which includes investments in information technology infrastructure and the eCommerce website; $3.1 million in higher store project expense reflecting the opening of ten stores this year compared to six stores last year; $1.4 million in higher training costs including West Marine University, our biennial Company-wide training event and store associate training programs; $1.3 million in higher advertising to support additional circulation of marketing materials, to perform market tests and for Grand Openings at our new locations; and $1.2 million in additional expense related to our Chief Executive Officer transition.
Interest expense
Interest expense was $0.8 million in 2012, slightly down from $0.9 million in 2011. This expense consists primarily of the amortization of commitment fees, as our borrowings were minimal in 2012. Cash provided by operating activities funded property and equipment investments with excess cash being used to pay down our seasonal use of debt. This was the primary driver of the outstanding bank borrowings in 2012.
Net Income


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Net income for 2012 was $14.7 million compared to net income for 2011 of $32.8 million. Lower net income in 2012 was primarily attributable to the release of substantially all of our valuation allowance in 2011. Our effective income tax rate for 2012 was a provision of 39.8%, compared to a benefit of 49.8% in 2011. The year-over-year change in our effective tax rate was primarily due to the release of substantially all of our valuation allowance during the second quarter of 2011, resulting in a $18.4 million benefit in that year. For more information, see Note 8 to our consolidated financial statements. Liquidity and Capital Resources
Our cash was used to fund working capital, operating expenses, debt service, share repurchases and capital expenditures, primarily related to the build-out of new stores and improvements in our information technology infrastructure, which support our store optimization and eCommerce strategic growth strategies. Funds generated by operating activities, available cash and our credit facility are our largest sources of cash. At the end of both 2013 and 2012, we were debt free. However, we may borrow against our credit facility during the first half of each year as we build inventory levels in preparation for the key boating season.
Working capital, the excess of current assets over current liabilities, increased to $223.0 million at the end of 2013, compared to $217.8 million at the end of 2012. The increase in working capital primarily was attributable to a $13.7 million higher merchandise inventory balance which is in support of our growth strategy of merchandise expansion and a reduction of $3.4 million in accrued expenses at the end of 2013. Partially offsetting these improvements in working capital were a $4.3 million reduction in assets held for sale, and an $8.1 million lower cash balance.
Operating Activities
During 2013, our primary source of liquidity was cash flow from operations. Net cash provided by operating activities decreased year-over-year by $12.4 million, to $13.6 million in 2013, compared to $26.0 million last year. The decrease in cash provided by operating activities was due primarily to changes in operating assets and liabilities, including increases of merchandise inventories compared to the prior year, and decreases in accounts payable resulting from the timing of payments to vendors. Additionally, we experienced net income of $7.8 million in 2013 versus net income of $14.7 million in 2012. Non-cash charges to earnings in 2013 included depreciation and amortization of $15.0 million, stock-based compensation of $3.2 million and deferred income taxes of $3.5 million. During 2012, our primary source of liquidity was cash flow from operations. Net cash provided by operating activities decreased year-over-year by $10.7 million to $26.0 million in 2012, compared to $36.7 million in 2011. The decrease in cash provided by operating activities was due primarily to changes in operating assets and liabilities, including increases of prepayments and other receivables compared to the prior year and decreases in accounts payable resulting from the timing of payments to vendors. Prepayments and other receivables increased due to payments for sales taxes and bank fees. Additionally, we experienced net income of $14.7 million in 2012 versus net income of $32.8 million in 2011. Non-cash charges to earnings in 2012 included depreciation and amortization of $15.3 million, stock-based compensation of $3.1 million and deferred income taxes of $4.6 million.
During 2011, our primary source of liquidity was cash flow from operations. Net cash provided by operating activities increased year-over-year by $11.8 million to $36.7 million in 2011, compared to $24.9 million in 2010. The increase in cash provided by operating activities was due primarily to increases in cash provided by net income and reduced inventory levels, partially offset by an increase in cash used for accrued expenses. Cash used for inventory was lower due primarily to our continued focus on inventory management and ensuring the correct product assortment in each store based on customer demographics. Cash used for accrued expenses partially offset the increase in cash primarily as a result of lower accrued bonus expense given our increased bonus target thresholds in 2011 as compared to accrued bonus and related thresholds in fiscal 2010.
Investing Activities
In 2013, our capital expenditures were $24.2 million, primarily for new stores, store remodels, eCommerce website, information technology and investment in supply chain efficiencies. We opened 11 new stores and remodeled one store in 2013. During 2014, we expect to increase capital spending, primarily in support of strategic growth initiatives which include store optimization and our eCommerce website. Additionally, we will continue to invest in enhancements to our information technology infrastructure. We intend to fund our expansion through cash generated from operations and, if necessary, credit facility borrowings.
In 2012 and 2011, our capital expenditures were $17.8 million and $17.2 million, respectively, mostly for new stores, store remodels, information technology and investment in supply chain efficiencies. We opened 10 new stores and remodeled four stores in 2012 and in 2011, we opened six new stores and remodeled four stores.
Financing Activities
Net cash provided by financing activities was $2.4 million in 2013, primarily consisting of a $6.5 million increase in cash from associate share-based compensation plans, partially offset by $4.0 million in cash used toward share repurchases. Net cash


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provided by financing activities was $4.4 million in 2012, primarily consisting of a $4.9 million increase in cash from associate share-based compensation plans, partially offset by $0.6 million in cash used to pay loan costs associated with the first amendment to our amended and restated loan agreement. Net cash provided by financing activities was $2.4 million in 2011, attributed entirely to an increase in cash related to associate share-based compensation plans.
Credit Agreement
Our current loan and security agreement, as amended, with Wells Fargo Bank, National Association and the other lenders signatory thereto provides a maximum available borrowing capacity of $120.0 million. In addition, at our option and subject to certain conditions, we may increase our borrowing capacity up to an additional $25.0 million. The amount available to be borrowed is based on a percentage of our inventory (excluding capitalized indirect costs) and accounts receivable.
The revolving credit facility is available for general working capital and general corporate purposes. At our election, borrowings under the revolving credit facility will bear interest at one of the following options:
1.The prime rate, which is defined in the loan agreement as the highest of:
a.Federal funds rate, as in effect from time to time, plus one-half of one percent;
b.LIBOR rate for a one-month interest period plus one percent; or
c.The rate of interest in effect for such day as publicly announced from time to time by Wells Fargo as its "prime rate," or
2.The LIBOR rate quoted by the British Bankers Association for the applicable interest period. In each case, the applicable interest rate is increased by a margin imposed by the loan agreement. The applicable margin for any date will depend upon the amount of available credit under the revolving credit facility. The margin range for option (1) above is between 0.5% and 1.0% and for option (2) above is between 1.5% and 2.0%. The loan agreement also imposes a fee on the unused portion of the revolving credit facility available. For 2013, 2012 and 2011, the weighted-average interest rate on all of our outstanding borrowings was 3.8%, 4.7% and 3.1%, respectively. Although the loan agreement contains customary covenants, including, but not limited to, restrictions on our ability to incur liens, make acquisitions and investments, pay dividends and sell or transfer assets, it does not contain debt or other similar financial covenants, such as maintaining certain specific leverage, debt service or interest coverage ratios. Instead, our loan is asset-based (which means our lenders maintain a security interest in our inventory and accounts receivable which serve as collateral for the loan), and the amount we may borrow under our revolving credit facility at any given time is determined by the estimated value of these assets as determined by the lenders' appraisers. Additionally, we must maintain a minimum revolving credit availability equal to the greater of $7 million or 10% of the borrowing base. In addition, there are customary events of default under our loan agreement, including failure to comply with our covenants. If we fail to comply with any of the covenants contained in the loan agreement, an event of default occurs which, if not waived by our lenders or cured within the applicable time periods, results in the lenders having the right to accelerate repayment of all outstanding indebtedness under the loan agreement before the stated maturity date and the revolving credit facility could be terminated. As of December 28, 2013, we were in compliance with the covenants under our loan agreement. At the end of 2013 and 2012, there were no amounts outstanding under our revolving credit facilities, and we had $98.8 million and $91.7 million, respectively, available for future borrowings. At the end of 2013 and 2012, we had $4.6 million and $5.1 million, respectively, of outstanding commercial and stand-by letters of credit. We strategically manage our debt over the course of our fiscal year. We incur seasonal fluctuations in our cash flows and, therefore, we incur debt as we build up our inventories for spring in order to maintain stock levels sufficient to fulfill customer needs and maximize sales during the main boating season. Additionally, we hire a significant number of temporary associates during the summer, our peak selling season. Our weighted-average outstanding balances for the first quarters of 2013 and 2012 were less than $0.1 million and $0.1 million, respectively. For our second quarters of 2013 and 2012, the weighted-average outstanding balances were not material and $0.1 million, respectively, and the third quarter weighted-average outstanding balances for both 2013 and 2012 were not material. The fourth quarter weighted-average outstanding balances for both 2013 and 2012 were not material. We may borrow against our aggregate borrowing base up to the maximum revolver amount, which was $120.0 million at both year-end 2013 and 2012. Our borrowing base at each of our last two fiscal year-ends consisted of the following (in millions):

                                   2013        2012
Accounts receivable availability $   5.1     $  4.4
Inventory availability             115.6      108.3
Less: reserves                      (6.0 )     (5.4 )
Less: minimum availability         (11.5 )    (10.7 )
Total borrowing base             $ 103.2     $ 96.6


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Our aggregate borrowing base was reduced by the following obligations (in millions):

Ending loan balance/(overpayment) $ (0.2 )   $ (0.2 )
Outstanding letters of credit        4.6        5.1
Total obligations                 $  4.4     $  4.9

Accordingly, our availability as of fiscal year end 2013 and 2012, respectively, was (in millions):

Total borrowing base $ 103.2     $ 96.6
Less: obligations       (4.4 )     (4.9 )
Total availability   $  98.8     $ 91.7

Contractual obligations
Aggregate information about our unconditional contractual obligations as of December 28, 2013 is presented in the following table (in thousands).

                                                         Payments due by period
                                               Less than                                       More than
                                 Total          1 year         1-3 years       3-5 years        5 years
Contractual cash obligations:
Operating leases(1)           $  291,863     $    48,902     $    85,070     $    58,186     $    99,705
Purchase commitments(2)           70,476          69,776             700               -               -
Bank letters of credit             4,235           4,235               -               -               -
Other long-term liabilities        4,403           2,833           1,570               -               -
                              $  370,977     $   125,746     $    87,340     $    58,186     $    99,705

(1) Operating lease amounts in this table represent minimum amounts due under existing agreements and exclude costs of insurance, taxes, repairs and maintenance.

(2) All but a limited number of our purchase commitments are cancelable by us without penalty; however, we do intend to honor these commitments.

We are party to various arrangements that are conditional in nature and obligate . . .

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