West Marine (WMAR)

NOTE 2: INCOME TAXES

The Company calculates its interim income tax provision in accordance with Accounting Principles Board Opinion No. 28, “Interim Financial Reporting” and FASB Interpretation No. 18, “Accounting for Income Taxes in Interim Periods.” At the end of each interim period, the Company estimates the annual effective tax rate and applies that rate to its year-to-date ordinary earnings. The tax expense or benefit related to significant, unusual or extraordinary items that will be separately reported or reported net of their related tax effect are individually computed and recognized in the interim period in which those items occur. In addition, the effect of changes in enacted tax laws or rates or tax status is recognized in the interim period in which the change occurs.

The computation of the annual estimated effective tax rate at each interim period requires certain estimates and significant judgment including, but not limited to, the expected operating income (loss) for the year, projections of the proportion of income earned and taxed in foreign jurisdictions, permanent and temporary differences as a result of differences between amounts measured and recognized in accordance with tax laws and financial accounting standards, and the likelihood of recovering deferred tax assets generated in the current year. The accounting estimates used to compute the provision (benefit) for income taxes may change as new events occur, additional information is obtained or as the tax environment changes.

The Company’s income tax rate was a provision for state taxes of 2.6% resulting in expense of $0.4 million for the thirteen weeks ended April 4, 2009, and the effective tax rate of 30.6% resulted in a benefit of $7.8 million for the thirteen weeks ended March 29, 2008. The change in the effective tax rate was primarily due to the Company’s decision in the second quarter of 2008 to record a full valuation allowance against its net deferred tax assets

The fiscal 2008 adjustment had no impact on the Company’s cash flow or future prospects, nor did it alter the Company’s ability to utilize the underlying tax net operating loss and credit carryforwards in the future, the utilization of which is limited to achieving future taxable income.

Under GAAP, when the Company’s results demonstrate a pattern of future profitability and reverse the current cumulative loss trend, the Company’s valuation allowance may be adjusted and may result in the reinstatement of all or a part of the net deferred tax assets.

Income taxes

Our effective income tax rate for 2008 was a provision of 53.5%, compared to a benefit of 9.2% in 2007. The change in our effective tax rate was due to management’s decision to establish a full valuation allowance of $23.2 million on the net deferred tax assets. For more information, see Note 8 to our consolidated financial statements.

Income taxes

Our effective income tax rate for 2007 was a benefit of 9.2%, compared to a benefit of 29.2% in 2006. The lower benefit rate in 2007 was primarily attributable to the non-deductible portion of goodwill impairment changes, which reduced tax benefits by $14.1 million. In addition, during 2007 we recorded valuation allowances against our California enterprise zone credit and state net operating loss carryforwards of $3.6 million and $0.8 million, respectively.

Income taxes

FACE="Times New Roman" SIZE="2">Our effective income tax rate for 2008 was a provision of 53.5%, compared to a benefit of 9.2% in 2007. The change in our effective tax rate was due to management’s decision to establish a full valuation
allowance of $23.2 million on the net deferred tax assets. For more information, see Note 8 to our consolidated financial statements.

Income
taxes

Our effective income tax rate for 2007 was a benefit of 9.2%, compared to a benefit of 29.2% in 2006. The lower benefit rate in
2007 was primarily attributable to the non-deductible portion of goodwill impairment changes, which reduced tax benefits by $14.1 million. In addition, during 2007 we recorded valuation allowances against our California enterprise zone credit
and state net operating loss carryforwards of $3.6 million and $0.8 million, respectively.

NOTE 3: INCOME TAXES

The Company calculates its interim income tax provision in accordance with Accounting Principles Board Opinion No. 28, “Interim Financial Reporting,” and FASB Interpretation No. 18, “Accounting for Income Taxes in Interim Periods.” At the end of each interim period, the Company estimates the annual effective tax rate and applies that rate to its year-to-date ordinary earnings. The tax expense or benefit related to significant, unusual or extraordinary items that will be separately reported or reported net of their related tax effect, are individually computed and recognized in the interim period in which those items occur. In addition, the effect of changes in enacted tax laws or rates or tax status is recognized in the interim period in which the change occurs.

The computation of the annual estimated effective tax rate at each interim period requires certain estimates and significant judgment including, but not limited to, the expected operating income (loss) for the year, projections of the proportion of income earned and taxed in foreign jurisdictions, permanent and temporary differences as a result of differences between amounts measured and recognized in accordance with tax laws and financial accounting standards, and the likelihood of recovering deferred tax assets generated in the current year. The accounting estimates used to compute the provision (benefit) for income taxes may change as new events occur, additional information is obtained or as the tax environment changes.

The Company’s income tax expense and effective tax rate were $14.9 million and 293.5%, respectively, for the thirty-nine weeks ended September 27, 2008, and $10.0 million and 39.0%, respectively, for the thirty-nine weeks ended September 29, 2007.

Each quarter, management is required to evaluate changes in assumptions about valuation allowances. In the second quarter of 2008, the Company recorded a charge of $14.6 million to provide a full valuation allowance against the Company’s net deferred tax assets.

At year-end 2007 and for the first quarter of 2008, management forecasted sufficient income in future years to fully utilize all of the Company’s net deferred tax assets. However, in the second quarter of 2008, with lower projected earnings in the near term, management’s assumptions about the Company’s ability to use these assets changed. In making the determination to record the valuation allowance in the second quarter, management noted that SFAS No. 109 paragraph 17 requires a valuation allowance if, based on all available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized. The valuation allowance should be sufficient to reduce the deferred tax assets to the amount that is more likely than not to be realized. Cumulative losses are a form of objective negative evidence that carries more weight than subjective positive evidence, such as forecasts. After examining all of the available evidence, both positive and negative, including evidence that circumstances did not improve in the third quarter, the Company determined a full valuation allowance was appropriate.

This fiscal 2008 adjustment will have no impact on the Company’s cash flow or future prospects, nor does it alter the Company’s ability to utilize the underlying net operating losses and credit carryforwards for income tax purposes in the future, the utilization of which is limited to achieving future taxable income.

Under GAAP, when the Company’s results demonstrate a pattern of future profitability and reverse the current cumulative loss trend, this valuation allowance may be adjusted and may result in the reinstatement of all or a part of the net deferred tax assets.

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NOTE 3: INCOME TAXES

The Company calculates its interim income tax provision in accordance with Accounting Principles Board Opinion No. 28, “Interim Financial Reporting” and FASB Interpretation No. 18, “Accounting for Income Taxes in Interim Periods.” At the end of each interim period, the Company estimates the annual effective tax rate and applies that rate to its year-to-date ordinary earnings. The tax expense or benefit related to significant, unusual, or extraordinary items that will be separately reported or reported net of their related tax effect, are individually computed and recognized in the interim period in which those items occur. In addition, the effect of changes in enacted tax laws or rates or tax status is recognized in the interim period in which the change occurs.

The computation of the annual estimated effective tax rate at each interim period requires certain estimates and significant judgment including, but not limited to, the expected operating income (loss) for the year, projections of the proportion of income earned and taxed in foreign jurisdictions, permanent and temporary differences as a result of differences between amounts measured and recognized in accordance with tax laws and financial accounting standards, and the likelihood of recovering deferred tax assets generated in the current year. The accounting estimates used to compute the provision (benefit) for income taxes may change as new events occur, additional information is obtained or as the tax environment changes.

The Company’s income tax expense and effective tax rate were $14.6 million and 1,059.4%, respectively, for the twenty six weeks ended June 28, 2008, and $5.6 million and 37.3%, respectively, for the twenty six weeks ended June 30, 2007. In the second quarter of 2008, the Company recorded a non-cash charge of $14.6 million to provide a full valuation allowance against our net deferred tax assets.

Each quarter, management is required to evaluate changes in assumptions about valuation allowances. As disclosed in the 2007 Form 10-K, at the end of 2007, management determined that there should be a valuation allowance established on certain state and foreign tax assets which totaled $4.2 million and which brought the total valuation allowance against the Company’s net deferred tax assets to $7.6 million. However, at the 2007 year end and for the first quarter of 2008, the Company’s forecasted earnings and the history of its ability to fully utilize the remaining deferred tax assets precluded recording a full valuation allowance. Management believes that a full valuation allowance is required as of June 28, 2008 due to events and developments that occurred during the second quarter of 2008 as a result of a significant decline in the Company’s 2008 annual forecasted income as compared to prior projections. This decline in pre-tax income is due to lower than expected sales volume and is consistent with unfavorable macro economic conditions.

In conducting the Company’s second quarter 2008 analysis, management used a consistent approach which considered the Company’s history of pre-tax losses for the past three years, as well as the Company’s forecasted income in the near term as it related to the Company’s ability to use its net deferred tax assets in future years. At year-end 2007 and for the first quarter of 2008, management forecasted sufficient income in future years to fully utilize all of the Company’s net deferred tax assets. However, in the second quarter of 2008, with lower projected earnings in the near term, management’s assumptions about the Company’s ability to use these assets changed. In making the determination to record this valuation allowance, management noted that SFAS No. 109 paragraph 17 requires a valuation allowance if, based on all available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized. The valuation allowance should be sufficient to reduce the deferred tax assets to the amount that is more likely than not to be realized. Cumulative losses are a form of objective negative evidence that carries more weight than subjective positive evidence, such as forecasts. After examining all of the available evidence, both positive and negative, the Company determined a full valuation allowance was appropriate.

This fiscal 2008 adjustment will have no impact on the Company’s cash flow or future prospects, nor does it alter the Company’s ability to utilize the underlying tax net operating loss and credit carryforwards in the future, the utilization of which is limited to achieving future taxable income.

Under GAAP, when the Company’s results demonstrate a pattern of future profitability and reverse the current cumulative loss trend, this valuation allowance may be adjusted and may result in the reinstatement of all or a part of the net deferred tax assets.

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NOTE 3: INCOME TAXES

West Marine calculates its interim income tax provision in accordance with Accounting Principles Board Opinion No. 28, “Interim Financial Reporting” and FASB Interpretation No. 18, “Accounting for Income Taxes in Interim Periods.” At the end of each interim period, the Company estimates the annual effective tax rate and applies that rate to its ordinary quarterly earnings. The tax expense or benefit related to significant, unusual, or extraordinary items that will be separately reported or reported net of their related tax effect, are individually computed and recognized in the interim period in which those items occur. In addition, the effect of changes in enacted tax laws or rates or tax status is recognized in the interim period in which the change occurs.

The computation of the annual estimated effective tax rate at each interim period requires certain estimates and significant judgment including, but not limited to, the expected operating income (loss) for the year, projections of the proportion of income earned and taxed in foreign jurisdictions, permanent and temporary differences as a result of differences between amounts measured and recognized in accordance with tax laws and financial accounting standards, and the likelihood of recovering deferred tax assets generated in the current year. The accounting estimates used to compute the provision (benefit) for income taxes may change as new events occur, additional information is obtained or as the tax environment changes.

The Company’s income tax benefit and effective tax rate was $7.8 million and 30.6%, respectively, for the thirteen weeks ended March 29, 2008, and $7.0 million and 38.3%, respectively, for the thirteen weeks ended March 31, 2007. The change in the effective tax rate is primarily due to differences year-over-year in the Company’s annual estimated pre-tax income and the relative impact of permanent differences on pre-tax income. When the Company’s annual estimated income tax rate changes, the year-to-date effect of the change is recorded in the current period, which can cause fluctuations in effective tax rates in interim periods.

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Income taxes

Our effective income tax benefit rate of 29.2% for 2006 compared to a benefit of 61.0% in 2005, primarily due to changes in our estimation of state income tax liabilities, which increased tax benefits in 2005 by approximately $0.9 million. In addition, during 2006 we recorded $1.0 million in valuation allowances against our state net operating loss carryforwards.

Income taxes

SIZE="2">Our effective income tax benefit rate of 29.2% for 2006 compared to a benefit of 61.0% in 2005, primarily due to changes in our estimation of state income tax liabilities, which increased tax benefits in 2005 by approximately $0.9 million.
In addition, during 2006 we recorded $1.0 million in valuation allowances against our state net operating loss carryforwards.

NOTE 2: INCOME TAXES

In June 2006, the Financial Accounting Standards Board (“FASB”) issued interpretation No. 48 (“FIN 48”), “Accounting for Uncertainty in Income Taxes,” 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.” FIN 48 prescribes a recognition threshold and measurement attribute criteria for the financial statement recognition and measurement of a tax position taken, or expected to be taken, in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition.

West Marine adopted FIN 48 on December 31, 2006, and as a result, the Company determined that approximately $3.2 million of tax benefits previously recognized should be considered uncertain tax positions, of which $1.9 million would impact the Company’s effective tax rate, if recognized. Prior to adoption of FIN 48, the Company’s income tax contingency reserves were $1.7 million. Accordingly, the Company recorded a $0.2 million reduction to retained earnings as of December 31, 2006 (the beginning of fiscal year 2007). The difference of $1.3 million between the total amount of uncertain tax positions and the amount that would impact the effective tax rate consists of items that are offset by deferred tax assets and the federal tax benefit of state income tax items, and therefore, no financial statement recognition was required.

Upon adoption, the Company’s balance sheet reflected a FIN 48 liability of $1.6 million, consisting of $0.6 million classified as a current liability and $1.0 million classified as a non-current liability. The difference of $0.3 million between the FIN 48 liability and the amount that would impact the effective tax rate primarily consists of unrecognized tax benefits.

As of December 31, 2006, the Company had $0.1 million of accrued interest and $0.1 million of accrued penalties related to uncertain tax positions. The Company’s policy is to recognize interest and penalties related to uncertain tax positions as part of its provision for income taxes.

During the first nine months of 2007, the Company reduced its FIN 48 liability by $0.8 million primarily as a result of the expiration of federal and various state statutes of limitations for the 2003 tax year and the settlement of various state tax liabilities, partially offset by a $0.4 million increase resulting from additional information concerning existing federal and state tax contingencies and the estimated impact of state audits that commenced during the period.

As of September 29, 2007, the Company’s balance sheet reflected a FIN 48 liability of $1.2 million, classified as $0.2 million in current liabilities and $1.0 million in deferred items and other non-current liabilities. These balances include $0.1 million of accrued interest and $0.1 million of accrued penalties related to the Company’s uncertain tax positions. The amount classified as a current liability represents the Company’s anticipated payment of cash in settlement of uncertain tax positions within one year.

The Company and its subsidiaries file income tax returns in the U.S. federal jurisdiction, various states, Puerto Rico and Canada. Generally, the statute of limitations for income tax return examinations is three years for U.S. federal, four years for Puerto Rico, seven years for Canada and varies among state and local jurisdictions.

NOTE 2: INCOME TAXES

In June 2006, the Financial Accounting Standards Board (“FASB”) issued interpretation No. 48 (“FIN 48”), “Accounting for Uncertainty in Income Taxes,” 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.” FIN 48 prescribes a recognition threshold and measurement attribute criteria for the financial statement recognition and measurement of a tax position taken, or expected to be taken, in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition.

West Marine adopted FIN 48 on December 31, 2006, and as a result, the Company determined that approximately $3.2 million of tax benefits previously recognized should be considered uncertain tax positions, of which $1.9 million would impact the Company’s effective tax rate, if recognized. The difference between the total amount of uncertain tax positions and the amount that would impact the effective tax rate consists of items that are offset by deferred tax assets, and the federal tax benefit of state income tax items. Accordingly, the Company recorded a $0.2 million reduction to retained earnings as of December 31, 2006 (the beginning of fiscal year 2007). As of December 31, 2006, the Company had $0.2 million of accrued interest and penalties related to uncertain tax positions. The Company’s policy is to recognize interest and penalties related to uncertain tax positions as part of its provision for income taxes.

The Company reduced unrecognized tax benefits by $0.6 million during the first six months of 2007, primarily as a result of the settlement of various state tax liabilities. As of June 30, 2007, $0.1 million in current liabilities and $0.9 million in deferred items and other non-current liabilities related to uncertain tax positions were reflected on the Company’s consolidated balance sheet. The amount classified as a current liability represents the Company’s anticipated payment of cash in settlement of uncertain tax positions within one year.

The Company and its subsidiaries file income tax returns in the U.S. federal jurisdiction, various states, Puerto Rico and Canada. Generally, the statute of limitations for income tax return examinations is three years for U.S. federal, four years for Puerto Rico, seven years for Canada and varies among state and local jurisdictions.

NOTE 2: INCOME TAXES

In June 2006, the Financial Accounting Standards Board (“FASB”) issued interpretation No. 48 (“FIN 48”), “Accounting for Uncertainty in Income Taxes”, 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”. FIN 48 prescribes a recognition threshold and measurement attribute criteria for the financial statement recognition and measurement of a tax position taken, or expected to be taken, in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition.

West Marine adopted FIN 48 on December 31, 2006, and as a result, the Company determined that approximately $3.2 million of tax benefits previously recognized should be considered uncertain tax positions, of which $1.9 million would impact the Company’s effective tax rate, if recognized. The difference between the total amount of uncertain tax positions and the amount that would impact the effective tax rate consists of items that are offset by deferred tax assets, and the federal tax benefit of state income tax items. Accordingly, the Company recorded a $0.2 million reduction to retained earnings as of December 31, 2006 (the beginning of fiscal year 2007). As of December 31, 2006, the Company had $0.2 million of accrued interest and penalties related to uncertain tax positions. There were no significant changes to any relevant amounts during the first quarter of 2007. The Company’s policy is to recognize interest and penalties related to unrecognized tax positions as part of its provision for income taxes.

As of March 31, 2007, $0.6 million in current liabilities and $1.0 million in deferred items and other non-current liabilities related to uncertain tax positions were reflected on the Company’s consolidated balance sheet. The amount classified as a current liability represents the Company’s anticipated payment of cash in settlement of uncertain tax positions within one year.

The Company and its subsidiaries file income tax returns in the U.S. federal jurisdiction, various states, Puerto Rico and Canada. The statute of limitations for income tax return examinations is three years for U.S. federal, four years for Puerto Rico, seven years for Canada and varies by state and local jurisdiction.

Income taxes

Our income tax rate of 51.8% of pre-tax loss in 2005 improved from 34.6% of pre-tax income in 2004, primarily due to a state tax benefit in 2005 relating to enterprise zone credits.

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Income taxes

Our 2004 income tax rate of 35.3% of pre-tax income decreased from 38.0% in the prior year, primarily due to a $0.8 million tax benefit in the fourth quarter relating to current and prior years’ state enterprise zone tax credits.

Income taxes

Our 2003 income tax rate of 38.0% of pre-tax income decreased from 39.5% in the prior year, primarily due to a $0.3 million benefit for enterprise zone tax credits.