FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(X) QUARTERLY REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF
1934
FOR THE QUARTERLY PERIOD ENDED: DECEMBER 28, 2002
COMMISSION FILE NUMBER: 1-5555
WELLCO ENTERPRISES, INC.
-------------------------
(Exact name of registrant as specified in charter)
NORTH CAROLINA 56-0769274
- ------------------- ------------------------------------
(State of Incorporation) (I.R.S. Employer Identification No.)
150 Westwood Circle, P.O. Box 188, Waynesville, NC 28786
(Address of Principal Executive Office)
Registrant's telephone number, including area code 828-456-3545
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Indicate by 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 .
--- ---
1,185,746 shares of $1 par value common stock were outstanding on February 11,
2003.
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
WELLCO ENTERPRISES, INC.
CONSOLIDATED FINANCIAL STATEMENTS FILED WITH FORM 10-Q
FOR THE FISCAL QUARTER ENDED DECEMBER 28, 2002
The attached unaudited financial statements reflect all adjustments which are,
in the opinion of management, necessary to reflect a fair statement of the
financial position, results of operations, and cash flows for the interim
periods presented. All significant adjustments are of a normal recurring nature.
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WELLCO ENTERPRISES, INC.
CONSOLIDATED BALANCE SHEETS
DECEMBER 28, 2002 AND JUNE 29, 2002
(in thousands)
ASSETS
(unaudited)
DECEMBER 28, JUNE 29,
2002 2002
------------ --------
CURRENT ASSETS:
Cash and cash equivalents .................... $ 423 $ 270
Receivables, net ............................. 1,963 1,374
Inventories-
Finished goods ........................... 1,742 2,509
Work in process .......................... 1,236 1,268
Raw materials ............................ 2,159 2,463
-------- --------
Total .................................... 5,137 6,240
Deferred taxes and prepaid expenses .......... 556 381
Assets held for sale (Note 5) ................ 25 70
-------- --------
Total ........................................ 8,104 8,335
-------- --------
MACHINERY LEASED TO LICENSEES,
net of accumulated depreciation .............. 26 28
PROPERTY, PLANT AND EQUIPMENT:
Land ......................................... 107 107
Buildings .................................... 1,176 1,176
Machinery and equipment ...................... 6,958 6,727
Office equipment ............................. 759 747
Automobiles .................................. 185 220
Leasehold improvements ....................... 758 735
-------- --------
Total cost ................................... 9,943 9,712
Less accumulated depreciation and
amortization .............................. (6,229) (5,786)
-------- --------
Net Property Plant and Equipment ............. 3,714 3,926
-------- --------
INTANGIBLE ASSETS:
Excess of cost over net assets of
subsidiary at acquisition (Note 2) ........ 228 228
Intangible pension asset ..................... 21 21
-------- --------
Total ........................................ 249 249
DEFERRED TAXES ..................................... 391 391
-------- --------
TOTAL .............................................. $ 12,484 $ 12,929
======== ========
(continued on next page)
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WELLCO ENTERPRISES, INC.
CONSOLIDATED BALANCE SHEETS
DECEMBER 28, 2002 AND JUNE 29, 2002
(in thousands except share data)
LIABILITIES AND STOCKHOLDERS' EQUITY
(unaudited)
DECEMBER 28, JUNE 29,
2002 2002
------------ --------
CURRENT LIABILITIES:
Accounts payable ............................. $ 967 $ 1,306
Accrued compensation ......................... 562 892
Accrued income taxes ......................... 851 769
Other liabilities ............................ 484 587
-------- --------
Total ........................................ 2,864 3,554
-------- --------
LONG-TERM LIABILITIES:
Pension obligation ........................... 1,028 1,028
Notes payable ................................ 209 205
Deferred revenues ............................ 91 95
STOCKHOLDERS' EQUITY:
Common stock, $1.00 par value ................ 1,186 1,183
Additional paid-in capital ................... 357 336
Retained earnings ............................ 7,468 7,247
Accumulated other comprehensive loss ......... (719) (719)
-------- --------
Total ........................................ 8,292 8,047
-------- --------
TOTAL .............................................. $ 12,484 $ 12,929
======== ========
See Notes to Consolidated Financial Statements.
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WELLCO ENTERPRISES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE FISCAL SIX MONTHS ENDED
DECEMBER 28, 2002 AND DECEMBER 29, 2001
(in thousands except per share and number of shares)
(unaudited)
DECEMBER 28, DECEMBER 29,
2002 2001
------------ ------------
REVENUES ....................................... $ 10,506 $ 9,960
----------- -----------
COSTS AND EXPENSES:
Cost of sales and services ............... 8,809 8,456
Unrecovered contract preparation
costs (Note 5) ........................... 45 --
General and administrative expenses ...... 1,136 1,303
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Total .................................... 9,990 9,759
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GRANT INCOME ................................... 40 40
----------- -----------
OPERATING INCOME ............................... 556 241
INTEREST EXPENSE ............................... (16) (24)
INTEREST INCOME (Note 6) ....................... 5 254
----------- -----------
INCOME BEFORE INCOME TAXES ..................... 545 471
PROVISION FOR INCOME TAXES ..................... 87 31
----------- -----------
NET INCOME ..................................... $ 458 $ 440
=========== ===========
BASIC EARNINGS PER SHARE (Note 4)
based on weighted average number of
shares outstanding ....................... $ 0.39 $ 0.38
=========== ===========
Shares used in computing basic
earnings per share ....................... 1,183,857 1,165,313
=========== ===========
DILUTED EARNINGS PER SHARE (Note 4) based
on weighted average number of shares
outstanding and dilutive stock
options ................................. $ 0.38 $ 0.37
=========== ===========
Shares used in computing diluted
earnings per share ....................... 1,216,723 1,200,610
=========== ===========
See Notes to Consolidated Financial Statements.
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WELLCO ENTERPRISES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE FISCAL THREE MONTHS ENDED
DECEMBER 28, 2002 AND DECEMBER 29, 2001
(in thousands except per share and number of shares)
(unaudited)
DECEMBER 28, DECEMBER 29,
2002 2001
------------ ------------
REVENUES ....................................... $ 5,248 $ 6,390
----------- -----------
COSTS AND EXPENSES:
Cost of sales and services ............... 4,579 5,249
Unrecovered contract preparation
costs (Note 5) ........................... 25 --
General and administrative expenses ...... 580 713
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Total .................................... 5,184 5,962
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GRANT INCOME ................................... 20 20
----------- -----------
OPERATING INCOME ............................... 84 448
INTEREST EXPENSE ............................... (12) (20)
INTEREST INCOME (Note 6) ....................... 3 243
----------- -----------
INCOME BEFORE INCOME TAXES ..................... 75 671
PROVISION FOR INCOME TAXES .................... 11 26
----------- -----------
NET INCOME ..................................... $ 64 $ 645
=========== ===========
BASIC EARNINGS PER SHARE (Note 4)
based on weighted average number of
shares outstanding ....................... $ 0.05 $ 0.55
=========== ===========
Shares used in computing basic
earnings per share ....................... 1,184,931 1,167,312
=========== ===========
DILUTED EARNINGS PER SHARE (Note 4) based
on weighted average number of shares
outstanding and dilutive stock
options ................................. $ 0.05 $ 0.53
=========== ===========
Shares used in computing diluted
earnings per share ....................... 1,212,891 1,219,485
=========== ===========
See Notes to Consolidated Financial Statements.
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WELLCO ENTERPRISES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE FISCAL SIX MONTHS ENDED
DECEMBER 28, 2002 AND DECEMBER 29, 2001
(in thousands)
(unaudited)
DECEMBER 28, DECEMBER 29,
2002 2001
------------ -------------
CASH FLOWS FROM OPERATING
ACTIVITIES:
Net income .................................... $ 458 $ 440
------- -------
Adjustments to reconcile net income
to net cash provided by (used in)
operating activities:
Depreciation and amortization ........... 480 433
Non-cash asset impairment ............... 45 --
Non-cash grant income recognized ........ (40) (40)
Non-cash reduction in deferred revenue... (4) (2)
Non-cash interest expense ............... 4 (236)
(Increase) decrease in-
Receivables ........................ (589) 120
Inventories ........................ 1,103 (469)
Other current assets ............... (107) (134)
Increase (decrease) in-
Accounts payable ................... (339) 606
Accrued compensation ............... (330) (158)
Accrued income taxes ............... 82 (17)
Pension obligation ................. (88) (59)
Other .............................. (43) (35)
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Total adjustments ............................. 174 9
------- -------
NET CASH PROVIDED BY
OPERATING ACTIVITIES .......................... 632 449
------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of plant and equipment .............. (266) (322)
------- -------
CASH USED IN INVESTING ACTIVITIES .................. (266) (322)
------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Cash dividends paid ........................... (237) --
Stock option exercised ........................ 24 120
------- -------
NET CASH PROVIDED BY (USED IN)
FINANCING ACTIVITIES .......................... (213) 120
------- -------
NET INCREASE IN CASH ............................... 153 247
CASH AT BEGINNING OF PERIOD ........................ 270 653
------- -------
CASH AT END OF PERIOD .............................. $ 423 $ 900
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(continued on next page)
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WELLCO ENTERPRISES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE FISCAL SIX MONTHS ENDED
DECEMBER 28, 2002 AND DECEMBER 29, 2001
(in thousands)
(unaudited)
DECEMBER 28, DECEMBER 29,
2002 2001
------------ -------------
SUPPLEMENTAL DISCLOSURE OF CASH
FLOW INFORMATION:
Cash paid for-
Interest ................................ $16 $ 4
Income taxes ............................ $ 5 $40
=== ===
See Notes to Consolidated Financial Statements.
-8-
WELLCO ENTERPRISES, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
FOR THE FISCAL SIX MONTHS ENDED
DECEMBER 28, 2002
(in thousands except number of shares)
(unaudited)
Common Stock Additional
Par Paid-In Retained
Shares Value Capital Earnings
-----------------------------------------------
BALANCE AT JUNE 29, 2002 1,182,746 $ 1,183 $ 336 $ 7,247
Net income for the fiscal six
months ended December 28, 2002 458
Exercise of stock options 3,000 3 21
Cash dividend ($.20 per share) (237)
------------------------------------------------
BALANCE AT DECEMBER 28, 2002 1,185,746 $ 1,186 $ 357 $ 7,468
================================================
Accumulated
Other
Comprehensive
Loss
----------------
ADDITIONAL PENSION LIABILITY,
NET OF TAX, BALANCE
AT JUNE 29, 2002 $ (719)
Change for the fiscal six
months ended December 28, 2002 -
----------------
BALANCE AT DECEMBER 28, 2002 $ (719)
================
See Notes to Consolidated Financial Statements.
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WELLCO ENTERPRISES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE FISCAL SIX MONTHS ENDED DECEMBER 28, 2002
1. BUSINESS AND ORGANIZATION:
Substantially all of the Company's operating activity is from the sale of
military and other rugged footwear, the sale of specialized machinery and
materials for the manufacture of this type of footwear and the rendering
of technical assistance and other services to licensees for the
manufacture of this type of footwear. The majority of revenues were from
sales to the U. S. government, primarily the Defense Supply Center
Philadelphia (DSCP), under contracts for the supply of boots used by the
United States Armed Forces. The loss of this customer would have a
material adverse effect on the Company.
Bidding on U. S. government boot solicitations is open to any qualified U.
S. manufacturer. Bidding on contracts is very competitive. U. S. footwear
manufacturers have been adversely affected by sales of footwear made in
low labor cost countries. This has significantly affected the competition
for contracts to supply boots to U. S. Armed Forces, which by law must
be made in the United States.
There are presently two outstanding U. S. government boot solicitations to
which the Company responded. If a contract is awarded to Wellco from only
one of these solicitations, or if Wellco does not receive a contract from
either solicitation, future operating results will be adversely affected
and certain assets may be impaired.
Most boot contracts are for multi-year periods. Therefore, a bidder not
receiving an award from a significant solicitation could be adversely
affected for several years. In addition, current boot contracts contain
options for additional pairs that are exercisable at the government's
discretion. The Company cannot predict with certainty its success in
receiving a contract from any of the above solicitations.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
New Accounting Pronouncements
On June 29, 2001,SFAS No. 142, "Goodwill and Other Intangible Assets" was
approved by the FASB. SFAS No. 142 changes the accounting for goodwill
from an amortization method to an impairment approach. Under SFAS No. 142,
if the carrying amount of goodwill exceeds its implied fair value, an
impairment loss is recorded equal to that excess. The Consolidated Balance
Sheets include $228,000 of goodwill ("Excess of cost over net assets of
subsidiary at acquisition") related to the Company's Ro-Search, Inc.
reporting unit. As this goodwill arose prior to 1970, it was not amortized
prior to the adoption of SFAS No. 142.
The Company adopted the provisions of SFAS No. 142 on June 30, 2002, the
beginning of the Company's 2003 fiscal year. The Company has completed
step one of the transitional impairment test and has determined that the
carrying amount of the reporting unit's net assets, including goodwill,
exceeds the fair value of the reporting unit. Management will proceed with
step two of the transitional impairment test to determine if an impairment
should be recorded. The Company expects to complete this analysis by no
later than the end of the Company's 2003 fiscal year.
In October 2001, SFAS No. 144, "Accounting for Impairment or Disposal of
Long-lived Assets" was issued specifying, among other things, the
financial accounting and reporting for the impairment or disposal of
long-lived assets. SFAS No.144 supersedes SFAS No. 121 and the accounting
-10-
and reporting provisions of APB 30 related to the disposal of a segment of
a business. The Statement is effective for the Company's 2003 fiscal year
which started June 30, 2002 and will be applied to long- lived assets
whenever events or circumstances indicate that their carrying amount may
not be recoverable. There was no effect on the Company's financial
statements from the adoption of this standard.
In January 2003, FASB Interpretation No. 45, "Guarantor's Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others" was issued to clarify the requirements for a
guarantor's accounting for and disclosures of certain guarantees issued
and outstanding. The inital recognition and measurement provisions are
effective for guarantees issued or modified after December 31, 2002. The
disclosure requirements are effective for the Company's fiscal quarter
ended December 28, 2002. The Company has not yet determined the impact,
if any, that the recognition and measurement provisions will have on its
consolidated financial position or results of operations.
3. LINE OF CREDIT:
The Company recently renewed its bank line of credit. Due to the Company's
increased cash from operations and its lack of need for a $3,000,000 line
of credit, on February 5, 2003 the line was reduced from $3,000,000 to
$1,500,000. The line, which expires December 31, 2003, can be renewed
annually at the bank's discretion. This line of credit is secured by a
blanket lien on all machinery and equipment (carrying value of $2,538,000)
and all non-governmental accounts receivable and inventory ($1,056,000).
At December 28, 2002, there was no borrowing on the line of credit.
The bank credit agreement contains, among other provisions, defined levels
of net worth and current ratio requirements. The Company was in compliance
with the loan covenants at December 28, 2002.
4. EARNINGS PER SHARE:
The Company computes its basic and diluted earnings per share amounts in
accordance with Statement of Financial Accounting Standards No. 128 (SFAS
128), "Earnings per Share." Basic earnings per share is computed by
dividing net earnings by the weighted average number of common shares
outstanding during the period. Diluted earnings per share is computed by
dividing net earnings by the weighted average number of common shares
outstanding during the period plus the dilutive potential common shares
that would have been outstanding upon the assumed exercise of dilutive
stock options.
The following is the reconciliation of the numerators and denominators of
the basic and diluted earnings per share computations:
For the Six Months Ended 12/28/02
----------------------------------
Net Income Shares Per-Share
(Numerator) (Denominator) Amount
Basic EPS Available to Shareholders $458,000 1,183,857 $0.39
Effect of Dilutive Stock-based
Compensation Arrangements 32,866
---------------------------------------
Diluted EPS Available to Shareholders $458,000 1,216,723 $0.38
-11-
For the Six Months Ended 12/29/01
----------------------------------
Net Income Shares Per-Share
(Numerator) (Denominator) Amount
Basic EPS Available to Shareholders $440,000 1,165,313 $0.38
Effect of Dilutive Stock-based
Compensation Arrangements 35,297
--------------------------------------
Diluted EPS Available to Shareholders $440,000 1,200,610 $0.37
For the Three Months Ended 12/28/02
-----------------------------------
Net Income Shares Per-Share
(Numerator) (Denominator) Amount
Basic EPS Available to Shareholders $ 64,000 1,184,931 $ 0.05
Effect of Dilutive Stock-based
Compensation Arrangements 27,960
----------------------------------------
Diluted EPS Available to Shareholders $ 64,000 1,212,891 $ 0.05
For the Three Months Ended 12/29/01
------------------------------------
Net Income Shares Per-Share
(Numerator) (Denominator) Amount
Basic EPS Available to Shareholders $645,000 1,167,312 $0.55
Effect of Dilutive Stock-based
Compensation Arrangements 52,173
---------------------------------------
Diluted EPS Available to Shareholders $645,000 1,219,485 $0.53
5. UNRECOVERED CONTRACT PREPARATION COSTS:
In October, 2001, Wellco submitted a solicitation response to a U. S.
government procurement for berets to be used by U. S. Army personnel.
Wellco did not have any prior experience in manufacturing berets or
similar knitted products. Since submitting its response, certain costs
were incurred in order to learn beret manufacturing operations and
procedures, and to demonstrate to the government that Wellco had the
capability to manufacture and deliver berets within the government's
required delivery schedule. In July 2002, the government announced
contract awards and Wellco was not awarded a contract. In the 2002 fiscal
year, beret manufacturing machinery was written down by $159,000 to an
amount equal to the estimated amount for which this machinery could be
sold. At December 28, 2002 based on revised estimates of the resale value,
the beret manufacturing machinery was further written down by $25,000 and
is shown as Unrecovered Contract Preparation Costs in the Consolidated
Statements of Operations for the fiscal three months ended December 28,
2002. Unrecovered Contract Preparation Costs in the Consolidated
Statements of Operations for the fiscal six months ended December 28, 2002
include a write down of $45,000 for the beret manufacturing machinery. The
revised estimated amount for which this machinery could be sold is
included in the Consolidated Balance Sheets as Assets Held For Sale.
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6. NOTE PAYABLE:
On December 29, 1995 Wellco repurchased from Coronet Insurance Company and
some of its affiliates (Coronet and Affiliates) 1,531,272 shares of Wellco
common stock, which represented 57.69% of total shares outstanding at that
time. This repurchase provided for certain additional payments, without
interest, to be made if cumulative net income for the six fiscal years
1997 through 2002 exceeded a defined amount. Generally accepted accounting
principles required that an obligation be reflected in the Consolidated
Balance Sheets for the estimated additional payments that would be made.
Actual cumulative net income through fiscal year 2002 was less than the
defined amount that cumulative net income had to exceed and therefore the
Company has no obligation under this arrangement.
Since its stock repurchase, Wellco, had accrued imputed interest expense
on the estimated additional contingent payment. At December 29, 2001, the
previously accrued $234,000 interest liability was reversed in connection
with the elimination of the Note Payable and accordingly, interest income
for this amount was recognized in the Consolidated Statements of
Operations for the fiscal six months ended December 29, 2001.
-13-
PART I. FINANCIAL INFORMATION
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
RESULTS OF OPERATIONS
=====================
Comparing the Six Months Ended December 28, 2002 and December 29, 2001:
- ------------------------------------------------------------------------
For the six months ended December 28, 2002 (current period), Wellco had net
income of $458,000 compared to a net income of $440,000 in the prior year six
month period ended December 29, 2001 (prior period). The major reasons for the
increase in net income are:
o Total Revenues in the current period increased by $546,000 as
compared to the prior period. The major reason for this increase
was a 4% increase in pairs of Direct Molded Soled (DMS) boots
sold to the Defense Supply Center Philadelphia (DSCP). The
Company also began shipping under a small contract with DSCP to
supply the Extreme Cold Weather (Mukluk) boots.
o Cost of Sales and Services in the current period increased by
$353,000, resulting in a $193,000 increase in gross profit.
o The current period includes $45,000 of unrecovered contract
preparation costs. In October, 2001, Wellco submitted a
solicitation response to a U. S. government procurement for
berets to be used by U.S. Army personnel. Wellco did not have any
prior experience in manufacturing berets or similar knitted
products. Since submitting its response, certain machinery was
purchased and certain costs were incurred in order to learn beret
manufacturing operations and procedures, and to demonstrate to
the government that Wellco had the capability to manufacture and
deliver berets within the government's required delivery
schedule. In July 2002, the government announced contract awards
and Wellco was not awarded a contract. In the 2002 fiscal year,
beret manufacturing machinery was written down by $159,000 to an
amount equal to the estimated amount for which this machinery
could be sold. Based on revised estimates of the resale value,
the beret manufacturing machinery was further written down by
$45,000 and is shown as Unrecovered Contract Preparation Costs
in the Consolidated Statements of Operations for the six months
ended December 28, 2002. The revised estimated amount for which
this machinery can be sold is included in the Consolidated
Balance Sheets as Assets Held For Sale.
o Lower total administrative personnel salary cost and lower legal
cost were the primary reasons general and administrative expenses
decreased $167,000 in the current period.
o The Consolidated Statements of Operations for the current period
and the prior period include grant income of $40,000. This grant
requires the Company to maintain operations in Puerto Rico for
its five fiscal years 2000 through 2004, and the grant income is
being recognized on a straight line basis over this five year
period.
o Net income in the prior period includes interest income of
$234,000 which represents the reversal of previously accrued
imputed interest related to a December 29, 1995 repurchase by
Wellco of 1,531,272 shares of its common stock (see Note 6). This
repurchase provided for certain additional payments, without
interest, to be made if cumulative net income for the six fiscal
years 1997 through 2002 exceeded certain defined amounts. Since
its stock repurchase, Wellco, using generally accepted accounting
principles, accrued imputed interest for estimated additional
payments. At December 29, 2001, Wellco projected that no
additional payments were due and the previously accrued interest
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expense, as well as the previously accrued liability for these
payments, were reversed.
The income tax rate (the percent of Provision for Income Taxes to the Income
Before Income Taxes) for the current period was 16% compared to 7% for the prior
period. The Small Business Job Protection Act (Act) terminated the federal tax
credit on income earned from operations in Puerto Rico. Under the Act, the
amount of the Company's fiscal year 2003 through 2006 income subject to this
credit is limited, and the credit is entirely eliminated starting with fiscal
year 2007. The current period income tax rate is higher because fiscal year 2003
income from Puerto Rico operations is estimated to exceed the amount subject to
the credit, thereby resulting in the excess not being subject to the federal tax
credit.
Comparing the Three Months Ended December 28, 2002 and December 29, 2001:
- --------------------------------------------------------------------------
For the three months ended December 28, 2002 (current period), Wellco had net
income of $64,000 compared to a net income of $645,000 in the prior year three
month period ended December 29, 2001 (prior period). The major reasons for the
decrease in net income are:
o Total Revenues in the current period decreased by $1,142,000 as
compared to the prior period. During the prior period and after
the terrorist attacks on September 11, 2001, Wellco received
larger than normal boot orders from the U. S. Department of
Defense along with a request to expedite production of these
orders. In response, Wellco increased its production rate through
December, 2001 to a level approximately double the rate prior to
these orders.
o Although Revenues during the current period decreased by
$1,142,000 (18%), Cost of Sales and Services in the current
period only decreased by $670,000 (13%). Gross margin in the
prior period was significantly higher because as sales increased,
fixed costs such as depreciation and certain semi-variable costs
such as fringe benefits and maintenance expenses did not increase
proportionately.
o The current quarter includes $25,000 of unrecovered contract
preparation costs. In October, 2001, Wellco submitted a
solicitation response to a U. S. government procurement for
berets to be used by U. S. Army personnel. Wellco did not have
any prior experience in manufacturing berets or similar knitted
products. Since submitting its response, certain machinery was
purchased and certain costs were incurred in order to learn beret
manufacturing operations and procedures, and to demonstrate to
the government that Wellco had the capability to manufacture and
deliver berets within the government's required delivery
schedule. In July 2002, the government announced contract awards
and Wellco was not awarded a contract. In the 2002 fiscal year,
beret manufacturing machinery was written down by $159,000 to an
amount equal to the estimated amount for which this machinery
could be sold. Based on revised estimates of the resale value,
the beret manufacturing machinery was further written down by
$25,000 this quarter and is shown as Unrecovered Contract
Preparation Costs in the Consolidated Statements of Operations
for the fiscal three months ended December 28, 2002. The revised
estimated amount for which this machinery could be sold is
included in the Consolidated Balance Sheet as Assets Held For
Sale.
o As stated above in the six month comparison, grant income is
being recognized on a straight line basis over the fiscal years
2000 through 2004.
o Net income in the prior period includes interest income of
$234,000 which represents the reversal of previously accrued
imputed interest related to a December 29, 1995 repurchase by
Wellco of 1,531,272 shares of its common stock (see Note 6). This
repurchase provided for certain additional payments, without
-15-
interest, to be made if cumulative net income for the six fiscal
years 1997 through 2002 exceeded certain defined amounts. Since
its stock repurchase, Wellco, using generally accepted accounting
principles, accrued imputed interest for estimated additional
payments. At December 29, 2001, Wellco projected that no
additional payments were due and the previously accrued interest
expense, as well as the previously accrued liability for these
payments, were reversed.
The income tax rate (the percent of Provision for Income Taxes to the Income
Before Income Taxes) for the current period was 15% compared to 4% for the prior
period. The Small Business Job Protection Act (Act) terminated the federal tax
credit on income earned from operations in Puerto Rico. Under the Act, the
amount of the Company's fiscal year 2003 through 2006 income subject to this
credit is limited, and the credit is entirely eliminated starting with fiscal
year 2007. The current period income tax rate is higher because fiscal year 2003
income from Puerto Rico operations is estimated to exceed the amount subject to
the credit, thereby resulting in the excess not being subject to the federal tax
credit.
Forward Looking Information:
- ----------------------------
Since April 19, 2002, the DSCP has twice issued Wellco a contract modification
extending its contract for Direct Molded Sole (DMS) combat and hot-weather
boots, and has subsequently ordered 183,000 pairs (103,000 in April 2002 and
80,000 in October 2002) under these extensions. This contract was originally
scheduled to expire on April 15, 2002. On January 28, 2003, the DSCP issued a
letter stating its intent to again extend the contract and purchase a minimum of
94,000 pairs. Under this extension, DSCP can purchase up to a maximum of 195,000
pairs.
At the beginning of the fiscal quarter that will end March 29, 2003, Wellco had
a small shipping backlog of DMS boots remaining from the first two extensions.
Shipments against the third extension will begin late in the fiscal quarter
ending March 29, 2003. However, they are not expected to be significant enough
to offset the negative effect on operations for the fiscal quarter ending March
29, 2003 of having a small shipping backlog at the beginning of this quarter.
The majority of boots from the minimum pairs of the third extension will be
shipped during the quarter ending June 28, 2003.
On March 19, 2002, Wellco submitted a response to a new DSCP solicitation for
DMS boots. The scheduled award date is presently not later than April 1, 2003.
Contracts will be for a base period of one year, with two one-year options. This
solicitation provides for up to four contracts with the quantities to be
purchased from each contractor being 35%, 30%, 20% and 15% of DSCP total boot
purchases. Under its current contract, Wellco is supplying 25% of total DSCP
purchases. The total minimum and maximum pairs DSCP will buy under contracts
issued from the new solicitation are lower than those under current contracts
for the reasons stated below.
The U. S. Army has approved replacing its all-leather combat boot, one of the
three DMS boots supplied by Wellco under its current contract, with the Infantry
Combat Boot (ICB), which is presently used only by the Marine Corps. In July
2002, DSCP received solicitation responses, including one from Wellco, for the
ICB boot, and the scheduled award date is presently February 28, 2003. The
solicitation provides for three contract awards, with first delivery
approximately eight months after contract award, with a base period of one year
and four one-year options thereafter.
The ICB solicitation provides that within 90 days after contract award, each
contractor is required to manufacture and submit for testing 2,000 pairs of
boots. If testing of these 2,000 pairs of boots is not satisfactory, it is
possible that the contractor will not receive any additional delivery orders
under this contract.
The DSCP's evaluation of solicitation offers is a time consuming process, and
many times they ask for an extension of offers. Therefore, contract awards from
-16-
the DMS and ICB boot solicitations may be later than the dates stated above.
Bidding on government solicitations is very competitive, and the Company cannot
predict with certainty its success in receiving a contract from any of the above
solicitations.
Wellco believes that, if it is awarded a contract from both the DMS and ICB boot
solicitations, any adverse effect on future operating results, related to the
Army's replacement of the all-leather combat boot with the ICB boot, will not be
substantial. If a contract is awarded Wellco from only one of these
solicitations, or if Wellco does not receive a contract from either
solicitation: future operating results and liquidity would be adversely
affected; use of the bank line of credit would likely increase; and, the bank
line of credit may be cancelled or may not be renewed (see further discussion in
the Liquidity and Capital Resources section). In addition, if contracts are not
awarded to Wellco, the carrying amount of certain long-lived assets may become
impaired. If some or all of these negative events were to occur, Wellco believes
that the effects would not occur until the Company's fiscal year 2004.
The Company is attempting to sell the previously mentioned beret manufacturing
machinery, which has a carrying value in the Consolidated Balance Sheets at
December 28, 2002 of $25,000. Future write down of this amount may be necessary
if the estimated or actual resale value is less than this amount.
In October 2001, SFAS No. 144, "Accounting for Impairment or Disposal of
Long-lived Assets" was issued specifying, among other things, the financial
accounting and reporting for the impairment or disposal of long- lived assets.
SFAS No.144 supersedes SFAS No. 121 and the accounting and reporting provisions
of APB 30 related to the disposal of a segment of a business. The Statement is
effective for the Company's 2003 fiscal year which started June 30, 2002 and
will be applied to long-lived assets whenever events or circumstances indicate
that their carrying amount may not be recoverable. There was no effect on the
Company's financial statements from the adoption of this standard.
On June 29, 2001,SFAS No. 142, "Goodwill and Other Intangible Assets" was
approved by the FASB. SFAS No. 142 changes the accounting for goodwill from an
amortization method to an impairment approach. Under SFAS No. 142, if the
carrying amount of goodwill exceeds its implied fair value, an impairment loss
is recorded equal to that excess. The Consolidated Balance Sheets include
$228,000 of goodwill ("Excess of cost over net assets of subsidiary at
acquisition") related to the Company's Ro-Search, Inc. reporting unit. As this
goodwill arose prior to 1970, it was not amortized prior to the adoption of SFAS
No. 142.
The Company adopted the provisions of SFAS No. 142 on June 30, 2002, the
beginning of the Company's 2003 fiscal year. The Company has completed step one
of the transitional impairment test and has determined that the carrying amount
of the reporting unit's net assets, including goodwill, exceeds the fair value
of the reporting unit. Management will proceed with step two of the transitional
impairment test to determine if an impairment should be recorded. The Company
expects to complete this analysis by no later than the end of the Company's 2003
fiscal year.
In January 2003, FASB Interpretation No. 45, "Guarantor's Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others" was issued to clarify the requirements for a guarantor's
accounting for and disclosures of certain guarantees issued and outstanding. The
inital recognition and measurement provisions are effective for guarantees
issued or modified after December 31, 2002. The disclosure requirements are
effective for the Company's fiscal quarter ended December 28, 2002. The Company
has not yet determined the impact, if any, that the recognition and measurement
provisions will have on its consolidated financial position or results of
operations.
Except for historical information, this form 10-Q includes forward looking
statements that involve risks and uncertainties, including, but not limited to,
the receipt of contracts from the U. S. government and the performance
thereunder, the ability to control costs under fixed price contracts, the
cancellation of contracts, and other risks detailed from time to time in the
Company's Securities and Exchange Commission filings, including Form 10-K for
the year ended June 29, 2002. Those statements include, but may not be limited
to, all statements regarding intent, beliefs, expectations, projections,
forecasts, and plans of the Company and its management. Actual results may
differ materially from management expectations. The Company assumes no
obligation to update any forward-looking statements.
-17-
LIQUIDITY AND CAPITAL RESOURCES
===============================
Wellco uses cash from operations and a bank line of credit to supply most of its
liquidity needs.
The following table summarizes, at the end of the most recent fiscal quarter and
the last fiscal year, the amounts of cash and unused line of credit:
(in thousands)
December 28, 2002 June 29, 2002
----------------- -------------
Cash and Cash Equivalents $423 $270
Unused Line of Credit 1,500* 3,000
------ ------
Total $1,923 $3,270
====== ======
* after reduction on February 5, 2003 from the previous amount of $3,000,000.
The increase in cash at December 28, 2002 resulted primarily from cash provided
by operations during the first six months of fiscal year 2003.
The following table summarizes the major sources (uses) of cash for the six
months ended December 28, 2002:
(in thousands)
December 28, 2002
-----------------
Income Before Depreciation and Other Non-cash
Adjustments $943
Net Change in Accounts Receivable, Inventories,
Accounts Payable, and Accrued Compensation (155)
Net Change in Income Taxes, Pension Obligation,
and Other (156)
----
Net Cash Provided by Operations 632
Cash Used to Purchase Plant and Equipment (266)
Cash Provided by Exercise of Stock Options 24
Cash Dividends Paid (237)
----
Net Increase in Cash and Cash Equivalents $153
====
In the six months ended December 28, 2002, cash provided by operations was
$632,000. Net income of $458,000, depreciation and amortization of $480,000, and
a reduction in inventories of $1,103,000 provided the main sources of operating
cash. The main uses of operating cash were to decrease accounts payable by
$339,000 and accrued compensation by $330,000, and also to fund an increase in
accounts receivable of $589,000. Because DSCP did not issue any boot orders in
the six month period, cash was provided by boot shipments from inventory that
were not replaced with boots produced.
Cash from operations was primarily used to purchase equipment, pay cash
dividends, and to invest in short- term interest earning instruments with
maturities of three months or less.
The following table shows aggregated information about contractual obligations
as of December 28, 2002:
-18-
Payments Due by Period
Total Less Than 1 1-3 Years 4-5 Years After 5 Years
Year
Notes Payable $300,000 $300,000
Building Lease 1,058,000 $143,000 $312,000 $336,000 267,000
---------------------------------------------------------------
Total $1,358,000 $143,000 $312,000 $336,000 $567,000
===============================================================
In addition to not receiving a contract from some of the solicitations mentioned
above, delays in U. S. government's contract awards and their issuance of
production orders under contracts could have an adverse effect on liquidity.
Wellco does not know of any other demands, commitments, uncertainties, or trends
that will result in or that are reasonablely likely to result in its liquidity
increasing or decreasing in any material way.
Prior to February 5, 2003, the bank line of credit provided for borrowings of up
to $3,000,000. Because of infrequent and limited line use, and in order to
reduce the bank's line maintenance charge, on February 5, 2003 the line was
reduced from $3,000,000 to $1,500,000. The line, which expires December 31,
2003, can be renewed annually at the bank's discretion. Historically, the bank
has always renewed the line of credit. Under conditions of substantial reduction
in operations, with little basis for projecting a reversal of such reduction, it
is possible that the bank would cancel the line of credit. Events that would
cause a substantial reduction in operations include: cancellation of existing
government contracts; not receiving future government contracts currently being
solicited; and, receiving government contracts that do not provide enough
revenues to provide adequate liquidity. Based on information available to date,
the Company believes that such events could not occur until its fiscal year
2004.
There was no borrowing under the line of credit at December 28, 2002 and the
Company was in compliance with the loan covenants at December 28, 2002. The
Company expects to use this bank line of credit from time to time. Since the
Company's first source of liquidity is cash from operations, a decrease in sales
of the Company's products would reduce this source of liquidity and result in
increased use of the bank line of credit. Based on information available to
date, the Company believes that such events could not occur until its fiscal
year 2004.
The Promissory Note, Loan Agreement and Security Agreement documenting the bank
line of credit provide that:
o All amounts borrowed shall become due and immediately payable
upon demand of the bank. o The bank's obligation to make advances
under the note shall terminate: if the bank makes a
demand for payment; if a default under any loan document occurs;
or, in any event, on December 31, 2003, unless the Note is
extended by the bank under terms satisfactory to the bank.
o All amounts borrowed shall become immediately payable if Wellco
commences or has commenced against it a bankruptcy or insolvency
proceeding, or in the event of default.
Events of default include:
o Having a current ratio less than that prescribed by the bank.
o Having tangible net worth less than that prescribed by the bank.
-19-
o Any failure to meet requirements under the Note, Loan Agreement
or Security Agreement.
Other than the above, Wellco does not know of any other demands, commitments,
uncertainties, or trends that will result in or that are reasonablely likely to
result in its liquidity increasing or decreasing in any material way.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
The Company does not have any derivative financial instruments, other financial
instruments, or derivative commodity instruments that require disclosures.
Item 4. Controls and Procedures.
The Company maintains disclosure controls and procedures that are designed to
ensure that information required to be disclosed in the Company's reports filed
pursuant to the Securities Exchange Act of 1934, as amended, is recorded,
processed, summarized and reported within the time periods specified in the
Securities and Exchange Commission's rules, regulations and related forms, and
that such information is accumulated and communicated to the Company's Chief
Executive Officer and Principal Financial Officer, as appropriate, to allow
timely decisions regarding required disclosure.
Within the 90 days prior to the filing date of this quarterly report, the
Company carried out an evaluation, under the supervision and with the
participation of the Company's management, including the Company's Chief
Executive Officer and the Principal Financial Officer, of the effectiveness of
the design and operation of the Company's disclosure controls and procedures.
Based on this evaluation, the Company's Chief Executive Officer and Principal
Financial Officer concluded that the Company's disclosure controls and
procedures were effective.
There have been no significant changes in the Company's internal controls or in
other factors that could significantly affect these controls and procedures
subsequent to the date the Company completed its evaluation. Therefore, no
corrective actions were required to be taken.
-20-
PART II. OTHER INFORMATION
- --------------------------
Item 1. Legal Proceedings. N/A
Item 2. Changes in Securities. N/A
Item 3. Defaults Upon Senior Securities. N/A
Item 4. Submission of Matters to a Vote of Security Holders:
The 2002 Annual Stockholders Meeting of Wellco Enterprises, Inc. was
held on November 19, 2002. The only matter voted on at that meeting
was the election of directors. The results of voting were:
Directors were elected as follows:
Nominee for Director Shares Voted For Shares Withheld From
- --------------------------------------------------------------------------------
James T. Emerson 1,132,784 18
David Lutz 1,132,784 18
Fred K. Webb, Jr. 1,132,784 18
Item 5. Other Information. N/A
Item 6. Exhibits and Reports on Form 8-K.
a). Exhibits: None
b). Reports on Form 8-K: None
-21-
SIGNATURE
---------
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.
Wellco Enterprises, Inc., Registrant
\s\ \s\
David Lutz, Chief Executive Officer Tammy Francis, Controller and Principal
and President Financial Officer
(Principal Executive Officer)
February 11, 2003
-22-
WELLCO ENTERPRISES, INC.
FORM 10-Q FOR THE SIX MONTHS ENDED DECEMBER 28, 2002
CERTIFICATION PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT
PRINCIPAL EXECUTIVE OFFICER
I, David Lutz, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Wellco Enterprises,
Inc.
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report.
3 Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report.
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we
have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant, including
its consolidated subsidiaries, is made known to us by others
within those entities, particularly during the period in which
this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date.
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
-23-
b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls.
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and
material weaknesses.
Date: February 11, 2003
/s/ David Lutz
By: David Lutz, Chief Executive Officer and President
(Principal Executive Officer)
-24-
WELLCO ENTERPRISES, INC.
FORM 10-Q FOR THE SIX MONTHS ENDED DECEMBER 28, 2002
CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
I, David Lutz, certify that:
1. I am the chief executive officer of Wellco Enterprises, Inc.
2. Attached to this certification is Form 10-Q for the six months ended
December 28, 2002, a periodic report (the "periodic report") filed by the
issuer with the Securities Exchange Commission pursuant to Section 13(a)
or 15(d) of the Securities Exchange Act of 1934 (the "Exchange Act:),
which contains financial statements.
3 I hereby certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002, that
o the periodic report fully complies with the requirements
of Section 13(a) or 15(d) of the Exchange Act, and
o the information in the periodic report fairly presents,
in all material respects, the financial condition and
results of operations of the issuer for the periods
presented.
Date: February 11, 2003
/s/ David Lutz
By: David Lutz, Chief Executive Officer and President
-25-
WELLCO ENTERPRISES, INC.
FORM 10-Q FOR THE SIX MONTHS ENDED DECEMBER 28, 2002
CERTIFICATION PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT
PRINCIPAL FINANCIAL OFFICER
I, Tammy Francis, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Wellco Enterprises,
Inc.
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report.
3 Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report.
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we
have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant, including
its consolidated subsidiaries, is made known to us by others
within those entities, particularly during the period in which
this quarterly report is being prepared; b) evaluated the
effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date
of this quarterly report (the "Evaluation Date"); and c)
presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date.
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
-26-
b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls.
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and
material weaknesses.
Date: February 11, 2003
/s/ Tammy Francis
By: Tammy Francis, Controller
(Principal Financial Officer)
-27-
WELLCO ENTERPRISES, INC.
FORM 10-Q FOR THE SIX MONTHS ENDED DECEMBER 28, 2002
CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
I, Tammy Francis, certify that:
1. I am the principal financial officer of Wellco Enterprises, Inc.
2. Attached to this certification is Form 10-Q for the six months ended
December 28, 2002, a periodic report (the "periodic report") filed by the
issuer with the Securities Exchange Commission pursuant to Section 13(a)
or 15(d) of the Securities Exchange Act of 1934 (the "Exchange Act:),
which contains financial statements.
3 I hereby certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002, that
o the periodic report fully complies with the requirements
of Section 13(a) or 15(d) of the Exchange Act, and
o the information in the periodic report fairly presents,
in all material respects, the financial condition and
results of operations of the issuer for the periods
presented.
Date: February 11, 2003
/s/ Tammy Francis
By: Tammy Francis, Controller
(Principal Financial Officer)
-28-