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: OCTOBER 2, 2004
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
------------
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 .
--- ---
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes No X .
----- -----
1,252,546 shares of $1 par value common stock were outstanding on November 12,
2004.
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
WELLCO ENTERPRISES, INC.
CONSOLIDATED FINANCIAL STATEMENTS FILED WITH FORM 10-Q
FOR THE FISCAL QUARTER ENDED OCTOBER 2, 2004
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.
-2-
WELLCO ENTERPRISES, INC.
CONSOLIDATED BALANCE SHEETS
OCTOBER 2, 2004 AND JULY 3, 2004
(in thousands)
ASSETS
(unaudited)
OCTOBER 2, JULY 3,
2004 2004
---------------------------
CURRENT ASSETS:
Cash and cash equivalents .................. $ 57 $ 58
Receivables, net ........................... 4,629 6,070
Inventories-
Finished goods ......................... 3,774 2,228
Work in process ........................ 3,008 2,771
Raw materials .......................... 5,972 6,064
-------- --------
Total .................................. 12,754 11,063
Deferred income taxes and
prepaid expenses ........................... 548 324
-------- --------
Total ...................................... 17,988 17,515
-------- --------
MACHINERY LEASED TO LICENSEES,
Net of accumulated depreciation ............ 15 17
PROPERTY, PLANT AND EQUIPMENT:
Land ....................................... 107 107
Buildings .................................. 1,439 1,439
Machinery and equipment .................... 9,920 9,553
Office equipment ........................... 808 797
Automobiles ................................ 188 188
Leasehold improvements ..................... 809 809
-------- --------
Total cost ................................. 13,271 12,893
Less accumulated depreciation and
amortization ............................ (8,108) (7,802)
-------- --------
Net Property Plant and Equipment ........... 5,163 5,091
-------- --------
INTANGIBLE ASSETS:
Intangible pension asset ................... 19 19
-------- --------
TOTAL ............................................ $ 23,185 $ 22,642
======== ========
(continued on next page)
-3-
WELLCO ENTERPRISES, INC.
CONSOLIDATED BALANCE SHEETS
OCTOBER 2, 2004 AND JULY 3, 2004
(in thousands except share data)
LIABILITIES AND STOCKHOLDERS' EQUITY
(unaudited)
OCTOBER 2, JULY 3,
2004 2004
---------------------------
CURRENT LIABILITIES:
Short-term borrowing from bank
(Note 2) ................................. $ 3,660 $ 3,780
Accounts payable ......................... 4,332 3,659
Accrued compensation ..................... 1,311 1,374
Accrued income taxes ..................... 884 1,048
Other liabilities ........................ 550 604
-------- --------
Total .................................... 10,737 10,465
-------- --------
LONG-TERM LIABILITIES:
Pension obligation ....................... 1,337 1,337
Notes payable ............................ 224 222
Deferred income taxes .................... 88 88
Deferred revenues ........................ 76 78
STOCKHOLDERS' EQUITY:
Common stock, $1.00 par value ............ 1,253 1,245
Additional paid-in capital ............... 1,081 1,027
Retained earnings ........................ 9,708 9,499
Accumulated other comprehensive
loss ..................................... (1,319) (1,319)
-------- --------
Total .................................... 10,723 10,452
-------- --------
TOTAL .......................................... $ 23,185 $ 22,642
======== ========
See Notes to Consolidated Financial Statements.
-4-
WELLCO ENTERPRISES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE FISCAL THREE MONTHS ENDED
OCTOBER 2, 2004 AND SEPTEMBER 27, 2003
(in thousands except per share and number of shares)
(unaudited)
OCTOBER 2, SEPTEMBER 27,
2004 2003
----------------------------
REVENUES ..................................... $ 10,621 $ 8,617
----------- -----------
COSTS AND EXPENSES:
Cost of sales and services ............. 9,387 7,490
General and administrative
expenses ............................... 688 634
----------- -----------
Total .................................. 10,075 8,124
----------- -----------
GRANT INCOME ................................. -- 20
----------- -----------
OPERATING INCOME ............................. 546 513
INTEREST EXPENSE ............................. (48) (26)
INTEREST INCOME .............................. -- 1
----------- -----------
INCOME BEFORE INCOME TAXES ................... 498 488
PROVISION FOR INCOME TAXES ................... 101 72
----------- -----------
NET INCOME ................................... $ 397 $ 416
=========== ===========
BASIC EARNINGS PER SHARE (Note 3)
based on weighted average
number of shares outstanding ........... $ 0.32 $ 0.35
=========== ===========
Shares used in computing basic
earnings per share ..................... 1,247,650 1,185,746
=========== ===========
DILUTED EARNINGS PER SHARE (Note 3)
based on weighted average number
of shares outstanding and dilutive
stock options .......................... $ 0.31 $ 0.35
=========== ===========
Shares used in computing diluted
earnings per share ..................... 1,299,415 1,199,611
=========== ===========
DIVIDENDS DECLARED PER SHARE ................. $ 0.15 $ 0.10
=========== ===========
See Notes to Consolidated Financial Statements.
-5-
WELLCO ENTERPRISES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE FISCAL THREE MONTHS ENDED
OCTOBER 2, 2004 AND SEPTEMBER 27, 2003
(in thousands)
(unaudited)
OCTOBER 2, SEPTEMBER 27,
2004 2003
-------------------------
CASH FLOWS FROM OPERATING
ACTIVITIES:
Net income .................................... $ 397 $ 416
------- -------
Adjustments to reconcile net income to
net cash provided (used) by
operating activities:
Depreciation and amortization ........... 308 252
Non-cash grant income recognized ........ -- (20)
Non-cash reduction in
deferred revenue ........................ (2) (2)
Non-cash interest expense ............... 2 2
(Increase) decrease in-
Receivables ........................ 1,441 (565)
Inventories ........................ (1,691) (908)
Prepaid expenses ................... (272) (199)
Increase (decrease) in-
Accounts payable ................... 673 (994)
Accrued compensation ............... (63) 133
Accrued income taxes ............... (164) 74
Pension obligation ................. 48 (57)
Other current liabilities .......... (54) (42)
------- -------
Total adjustments ............................. 226 (2,326)
------- -------
NET CASH PROVIDED (USED) BY
OPERATING ACTIVITIES .......................... 623 (1,910)
------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of plant and equipment .............. (378) (720)
------- -------
CASH USED BY INVESTING ACTIVITIES .................. (378) (720)
------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from (repayment of)
short-term borrowings ......................... (120) 2,695
Cash dividends paid ........................... (188) (119)
Stock options exercised ....................... 62 --
------- -------
NET CASH PROVIDED (USED) BY
FINANCING ACTIVITIES .......................... (246) 2,576
------- -------
NET DECREASE IN CASH ............................... (1) (54)
CASH AT BEGINNING OF PERIOD ........................ 58 133
------- -------
CASH AT END OF PERIOD .............................. $ 57 $ 79
======= =======
(continued on next page)
-6-
WELLCO ENTERPRISES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE FISCAL THREE MONTHS ENDED
OCTOBER 2, 2004 AND SEPTEMBER 27, 2003
(in thousands)
(unaudited)
OCTOBER 2, SEPTEMBER 27,
2004 2003
-------------------------
SUPPLEMENTAL DISCLOSURE OF CASH
FLOW INFORMATION:
Cash paid for-
Interest ............................... $ 48 $ 26
Income taxes ........................... $265 $ (2)
==== ====
See Notes to Consolidated Financial Statements.
-7-
WELLCO ENTERPRISES, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
FOR THE FISCAL THREE MONTHS ENDED
OCTOBER 2, 2004
(in thousands except number of shares and per share)
(unaudited)
Common Stock Additional
----------------------
Par Paid-In Retained
Shares Value Capital Earnings
-----------------------------------------------
BALANCE AT JULY 3, 2004 1,245,046 $ 1,245 $ 1,027 $ 9,499
Net income for the fiscal three
months ended October 2, 2004 397
Exercise of stock options 7,500 8 54
Cash dividend ($.15 per share) (188)
-----------------------------------------------
BALANCE AT OCTOBER 2, 2004 1,252,546 $ 1,253 $ 1,081 $ 9,708
===============================================
Accumulated
Other
Comprehensive
Loss
----------------
ADDITIONAL PENSION LIABILITY,
NET OF TAX, BALANCE
AT JULY 3, 2004 $ (1,319)
Change for the fiscal three
months ended October 2, 2004 -
----------------
BALANCE AT OCTOBER 2, 2004 $ (1,319)
================
See Notes to Consolidated Financial Statements.
-8-
WELLCO ENTERPRISES, INC.
-----------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
-----------------------------------------------------
FOR THE FISCAL THREE MONTHS ENDED OCTOBER 2, 2004
-------------------------------------------------
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 DSCP 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.
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 solicitation.
2. LINE OF CREDIT:
Due to the Company's increased accounts receivable from shipping DMS boots
under surge, and to increased inventories, caused by both surge and the
initial production of the ICB boot, the Company increased its line of
credit during the 2004 fiscal year to $10,000,000 and was reduced to
$5,000,000 by September 1, 2004. This line of credit is secured by a
blanket lien on all machinery and equipment and all accounts receivable
and inventory. At October 2, 2004, borrowings on this line of credit were
$3,660,000 with $1,340,000 available in additional borrowings. 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 October 2, 2004.
Subsequently, on October 21, 2004, the Company increased its line of
credit to $7,500,000 and the line, which expires January 31, 2005, can be
renewed annually at the bank's discretion.
3. 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:
-9-
For the Three Months Ended 10/2/04
-----------------------------------
Net Income Shares Per-Share
(Numerator) (Denominator) Amount
--------------------------------------
Basic EPS Available to Shareholders $ 397,000 1,247,650 $ 0.32
- --------------------------------------------------------------------------------
Effect of Dilutive Stock-based
Compensation Arrangements 51,765
- --------------------------------------------------------------------------------
Diluted EPS Available to Shareholders $ 397,000 1,299,415 $ 0.31
- --------------------------------------------------------------------------------
For the Three Months Ended 9/27/03
-----------------------------------
Net Income Shares Per-Share
(Numerator) (Denominator) Amount
--------------------------------------
Basic EPS Available to Shareholders $ 416,000 1,185,746 $ 0.35
- --------------------------------------------------------------------------------
Effect of Dilutive Stock-based
Compensation Arrangements 13,865
- --------------------------------------------------------------------------------
Diluted EPS Available to Shareholders $ 416,000 1,199,611 $ 0.35
- --------------------------------------------------------------------------------
4. STOCK-BASED COMPENSATION:
The Company uses Accounting Principles Board Opinion No. 25 (APB 25) to
account for stock options granted to employees. Under APB 25, no
compensation cost is reflected in net income for stock option awards as
all options granted had an exercise price equal to or in excess of the
market value of the underlying common stock on the date of grant.
Under SFAS No. 123 and No. 148, a company that uses APB 25 to account for
stock options must disclose the effect on reported net income of using a
fair value based method of accounting for stock- based employee
compensation.
The following table summarizes the effect on net income and earnings per
share had the accounting for employee stock options been based on the fair
value method.
For the Three Months Ended
October 2, September 27,
2004 2003
- -----------------------------------------------------------------------------
Net income:
- -----------------------------------------------------------------------------
As reported $ 397,000 $ 416,000
- -----------------------------------------------------------------------------
Compensation expense, net of tax 6,000 6,000
- -----------------------------------------------------------------------------
Pro forma $ 391,000 $ 410,000
- -----------------------------------------------------------------------------
- -----------------------------------------------------------------------------
-10-
For the Three Months Ended
October 2, September 27,
2004 2003
- -----------------------------------------------------------------------------
Basic earnings per share:
- -----------------------------------------------------------------------------
As reported $ 0.32 $ 0.35
- -----------------------------------------------------------------------------
Compensation expense, net of tax 0.01 0.01
- -----------------------------------------------------------------------------
Pro forma $ 0.31 $ 0.34
- -----------------------------------------------------------------------------
- -----------------------------------------------------------------------------
Diluted earnings per share:
- -----------------------------------------------------------------------------
As reported $ 0.31 $ 0.35
- -----------------------------------------------------------------------------
Compensation expense, net of tax 0.01 0.01
- -----------------------------------------------------------------------------
Pro forma $ 0.30 $ 0.34
- -----------------------------------------------------------------------------
5. PENSION PLANS:
The Company has two non-contributory, defined benefit plans. The
components of pension expense, included in Cost of Sales and Services in
the Consolidated Statements of Operations are as follows:
For the Three Months Ended
October 2, September 27,
2004 2003
- ------------------------------------------------------------------------------
Benefits Earned for Service in the
Current Period $ 36,600 $ 32,200
- ------------------------------------------------------------------------------
Interest on the Projected Benefit
Obligation 87,000 88,700
- ------------------------------------------------------------------------------
Expected Return on Plan Assets (78,100) (74,300)
- ------------------------------------------------------------------------------
Amortization of: Unrecognized Net
Pension Obligation at July 1, 1987; Cost
of Benefit Changes Since That Date; and
Gains and Losses Against Actuarial 15,200 29,000
Assumptions
- ------------------------------------------------------------------------------
Pension Expense $ 60,700 $ 75,600
- ------------------------------------------------------------------------------
-11-
6. PUERTO RICAN GOVERNMENT REFUND:
The majority of the Company's boot manufacturing operations occur at the
factory of a wholly-owned subsidiary located in Puerto Rico. The Company
is participating in a Puerto Rico government program under which it is
reimbursed for part of the compensation paid to certain employees. On
September 23, 2004, that subsidiary received a reimbursement of $780,000
for compensation paid employees in the 2004 fiscal year. The Consolidated
Statements of Operations for the three months ended October 2, 2004
include the $780,000 as a reduction of Cost of Sales and Services.
The Company has filed an reimbursement for $560,000 for compensation paid
employees through September 30, 2004. The Company's policy is to record
these reimbursements in the fiscal period in which they are received.
-12-
PART I. FINANCIAL INFORMATION
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
RESULTS OF OPERATIONS
=====================
Critical Accounting Policies:
- ----------------------------
The Consolidated Financial Statements have been prepared in accordance with
generally accepted accounting principles which require the Company to make
estimates and assumptions that affect the reported amounts of assets and
liabilities at the date of the Consolidated Financial Statements, and revenues
and expenses during the periods reported. Actual results could differ from those
estimates. The Company believes the following are the critical accounting
policies which could have the most significant effect on the Company's reported
results and require the most difficult, subjective or complex judgements by
management.
o Impairment of Long-Lived Assets:
The Company reviews its long-lived assets for impairment whenever
events or circumstances indicate that the carrying amount of an
asset may not be recoverable. If the sum of the expected cash
flows, undiscounted and without interest, is less than the
carrying amount of the asset, an impairment loss is recognized as
the amount by which the carrying amount of the asset exceeds its
fair value. The Company makes estimates of its future cash flows
related to assets subject to impairment review. One of the most
critical estimates is future demand, primarily through U. S.
Department of Defense contracts, for the Company's products.
Changes to this and other estimates could result in an impairment
charge in future periods.
o Inventory Valuation:
Raw materials and supplies are valued at the lower of first-in,
first-out cost or market. Finished goods and work in process are
valued at the lower of actual cost, determined on a specific
identification basis, or market. The Company estimates which
materials may be obsolete and which products in work in process
or finished goods may be sold at less than cost, and adjusts its
inventory value accordingly. Future periods could include either
income or expense items if estimates change and for differences
between the estimated and actual amount realized from the sale of
inventory.
o Income Taxes:
The Company records a liability for potential tax assessments
based on its estimate of the potential exposure. Due to the
subjectivity and complex nature of the underlying issues, actual
payments or assessments may differ from estimates. Income tax
expense in future periods could be adjusted for the difference
between actual payments and the Company's recorded liability
based on its assessments and estimates.
The Company has recorded a valuation allowance equal to a
significant part of its deferred tax assets. The valuation
allowance is based on an evaluation of the uncertainty of future
taxable income from certain jurisdictions. An adjustment could be
required if circumstances and events cause the Company to change
these estimates.
Since July 3, 2004, the end of the 2004 fiscal year, there have been no changes
in the nature of the estimates and assumptions related to these critical
accounting policies.
-13-
Comparing the Three Months Ended October 2, 2004 and September 27, 2003:
- -----------------------------------------------------------------------
OVERVIEW
--------
The most significant event occurring in this fiscal quarter is the integration
into manufacturing of a new boot for the Defense Supply Center Philadelphia
(DSCP). Excess costs were incurred in training employees and establishing
manufacturing procedures and methods. While this level of activity has increased
income, significant excess costs have been incurred.
Comparative results for these two periods is as follows:
Current Period Prior Period
Three Months Ended Three Months Ended % of
(Amounts in thousands) October 2, 2004 September 27, 2003 Change Change
- --------------------------------------------------------------------------------
Revenues $ 10,621 $ 8,617 $ 2,004 23%
- -------------------------------------------------------------------------------
Cost of Sales 9,387 7,490 1,897 25%
- -------------------------------------------------------------------------------
Gross Profit 1,234 1,127 107 10%
- -------------------------------------------------------------------------------
Administrative Expenses 688 634 54 9%
- -------------------------------------------------------------------------------
Grant Income - 20 (20)
- -------------------------------------------------------------------------------
Operating Income 546 513 33 6%
- -------------------------------------------------------------------------------
Interest Expense, Net 48 25 23
- -------------------------------------------------------------------------------
Income Taxes 101 72 29
- -------------------------------------------------------------------------------
Net Income $ 397 $ 416 $ (19)
- -------------------------------------------------------------------------------
For the three months ended October 2, 2004 (current period), Wellco had net
income of $397,000 compared to a net income of $416,000 in the prior year three
month period ended September 27, 2003 (prior period). The major reasons for the
decrease in net income are:
o Compared to the prior period, total revenues in the current
period increased by $2,004,000. In the current period the Company
shipped 40,000 pairs of the Infantry Combat Boot (ICB). The prior
period did not contain any ICB boot sales. Also in the current
period, the Company sold 6,000 fewer pairs of other boots than in
the prior period.
o Cost of Sales and Services in the current year increased by
$1,897,000, which resulted in an increase in gross profit of only
$107,000. The Company's three major U.S. Department of Defense
contracts have lower profit margins than those historically
earned under prior contracts. The shrinking base of U. S. boot
manufacturers has increased the emphasis on price when responding
to DSCP boot solicitations .
In the past year, the Company has more than doubled its rate of
boot production. This increase was in response to the need for
boots in Iraq as well as new contracts. This necessitated the
hiring of more than 400 new employees and significant purchases
of equipment. Significant excess costs have been incurred in
training these employees and in expanding production lines.
-14-
This also has adversely affected profit margins.
In September 2004, Hurricane Jeanne interrupted power at the
Puerto Rico factory for approximately one week and it took almost
another week for all employees to return to work and normal
production to resume. No damage was done to the factory building
or its contents. However, the interruption resulted in
inefficiencies in production and the air freighting of materials.
In the current period, the Company was changing its production
operations from boots with a solid rubber sole to boots with the
contract required three layer sole, which is a more complicated
and costly construction. This caused certain delays and
inefficiencies in production.
The majority of the Company's boot manufacturing operations occur
at the factory of a wholly- owned subsidiary located in Puerto
Rico. The Company is participating in a Puerto Rican government
program under which it is reimbursed for part of the compensation
paid to certain employees. On September 23, 2004, that subsidiary
received a reimbursement of $780,000 for compensation paid
employees in the 2004 fiscal year. The Company's policy is to
record these reimbursements in the fiscal period in which they
are received, and this amount was recorded as a reduction in cost
of sales in the current period.
o During the current period, the $54,000 increase in general and
administrative expenses was primarily caused by increases in
heath insurance costs. The Company has a self-funded plan and
health insurance costs can vary.
o The Consolidated Statements of Operations for the prior period
included grant income of $20,000. This grant required the Company
to maintain operations in Puerto Rico for its five fiscal years
2000 through 2004. This income was all recognized by the end of
fiscal year 2004.
o Interest expense increased $23,000 because of increased
borrowings under a bank line of credit.
The income tax rate (the percent of Provision for Income Taxes to the Income
Before Income Taxes) for the current period was 20% compared to 15% for the
prior period. The income tax rate increase is primarily due to an increase in
the proportion of total Income Before Income Taxes which is subject to full
federal tax.
Forward Looking Information:
- ---------------------------
Below is a summary of the Company's current boot contracts with DSCP.
In October 2004, DSCP exercised the first option term under the DMS
contract mentioned above. The maximum pairs that DSCP can order under this
option is less than that of the base contract year. The first option term
is for the period October 2004 through September 2005.
In July 2004, DSCP exercised the first year option under one of the
Company's ICB boot contracts, which will be for July 2004 through June
2005. The initial order under this option has been issued for 51,000
pairs.
On March 10, 2004, DSCP awarded a new contract to the Company to supply
110,010 pairs of the ICB boot in the desert tan color. The contract has a
delivery period of August 2004 through April 2005.
-15-
The Company has substantially completed shipping all boots which are under
surge orders to meet the Iraq need. When compared to fiscal year 2004,
fiscal year 2005 revenues will be less. The Company cannot reasonably
estimate how much the decrease will be.
The majority of the Company's boot manufacturing operations occur at the factory
of a wholly-owned subsidiary located in Puerto Rico. The Company is
participating in a Puerto Rican government program under which it is reimbursed
for part of the compensation paid to certain employees. The Company's policy is
to record these reimbursements in the fiscal period in which they are received.
The Company has filed for reimbursement of $560,000 for compensation paid
employees through September 30, 2004. On September 23, 2004, that subsidiary
received a reimbursement of $780,000 for compensation paid employees in the 2004
fiscal year.
DSCP temporarily suspended shipments under the above-mentioned DMS contract
until it definitized and completed certain contract modifications (see the
Liquidity and Capital Resources section below). On November 9, 2004, replacement
purchase orders were issued and the suspension has been lifted, and the Company
will soon resume shipments. This will not affect the total pairs Wellco will
ship under this contract. However, this is adversely affecting the Company's
liquidity.
On December 31, 2004, agreements under which the Company earns fees for
providing certain equipment and related services to other boot manufacturers
expire. The Company intends to negotiate an extension of these agreements. The
effect on future operating results could be adverse if the negotiations do not
result in an extension or continuation of the agreements under terms presently
in effect today.
The business of providing boots to DSCP is very competitive, as U. S. boot
manufacturers attempt to replace commercial U. S. production lost to low-cost
foreign-made boots.
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)
October 2, 2004 July 3, 2004
- -------------------------------------------------------------------------
Cash and Cash Equivalents $57 $58
- -------------------------------------------------------------------------
Unused Line of Credit 1,340 3,220
- -------------------------------------------------------------------------
Total $1,397 $3,278
- -------------------------------------------------------------------------
The decrease in total liquidity was primarily caused by a scheduled $2,000,000
reduction in the total amount available under the bank line of credit. At July
3, 2004, the available borrowings were $7,000,000 and at October 2, 2004, the
amount was $5,000,000.
The following table summarizes the major sources (uses) of cash for the three
months ended October 2, 2004:
-16-
(in thousands)
October 2, 2004
- ------------------------------------------------------------------------
Income Before Depreciation and Other Non-cash
Adjustments $705
- ------------------------------------------------------------------------
Net Change in Accounts Receivable, Inventories,
Accounts Payable, and Accrued Compensation 360
- ------------------------------------------------------------------------
Net Change in Income Taxes, Pension Obligation,
and Other (442)
- ------------------------------------------------------------------------
Net Cash Provided by Operations 623
- ------------------------------------------------------------------------
Cash Used to Purchase Plant and Equipment (378)
- ------------------------------------------------------------------------
Repayment of Line of Credit (120)
- ------------------------------------------------------------------------
Stock Options Exercised 62
- ------------------------------------------------------------------------
Cash Dividends Paid (188)
- ------------------------------------------------------------------------
Net Decrease in Cash and Cash Equivalents ($1)
- ------------------------------------------------------------------------
In the three months ended October 2, 2004, cash provided by operations was
$623,000. Net income of $397,000, depreciation and amortization of $308,000, and
a $1,441,000 reduction in accounts receivable were the main operating sources of
cash. The main use of operating cash were an increase in inventories of
$1,691,000.
Cash from operations and borrowings from the line of credit was primarily used
to purchase equipment, pay cash dividends, and fund the increase in raw
materials and work in process inventories for the production required for the
new Tan ICB boot.
The following table shows aggregated information about contractual obligations
as of October 2, 2004:
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 801,000 $158,000 $333,000 $310,000 -
- --------------------------------------------------------------------------------
Total $1,101,000 $158,000 $333,000 $310,000 $300,000
- --------------------------------------------------------------------------------
Based on estimates provided by the Company, DSCP, in fiscal year 2004, made
certain changes to existing boot delivery orders under the Company's major boot
contract. However, a delay in the Company's sourcing a material component
resulted in these estimates being impossible to meet. Approximately two months
ago, DSCP subsequently suspended the Company's shipments under this contract
until they could definitize the changes and issue contract modifications
reversing the previously made changes. In addition, this caused the payment of
certain invoices to be delayed. The total of invoices not paid and the invoice
value of finished boots waiting for invoicing is currently $3,700,000. On
November 9, 2004, DSCP issued the needed contract modifications.
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In addition, Wellco has paid $1,300,000 of air freight charges to meet DSCP's
surge need in Iraq. These payments occurred primarily in May through August,
2004. Throughout the surge period, Wellco has paid the air freight and received
reimbursement from DSCP several months later. However, the current amount is
more than double previous amounts. DSCP has told Wellco that this amount is
approved and that this item is close to having funding allocated to it.
Because of these two events, Wellco's bank, in October 2004, increased its
maximum line of credit from $5,000,000 to $7,500,000. Typically, the Company
gets paid thirty days after issuing its invoice and it will take a few weeks to
have all the finished boots inspected and invoiced. Currently, the Company has
borrowed almost all funds available under the line, and it is now clear that the
Company will need a further increase in the bank line of credit. The Company
will soon negotiate with its bank.
The Company cannot absolutely predict the success of such negotiations. However,
since the need comes from obligations of DSCP, the Company believes that the
bank will agree to the needed increase. If the bank does not increase the line,
or does not adequately increase the line, the Company's operations would be
adversely affected. Other than this, Wellco does not know of any 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.
The bank line of credit will expire and be subject to renewal on January 31,
2005. 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; and,
receiving government contracts that do not provide enough revenues to provide
adequate liquidity. The Company expects continued need of this line of credit
after January 31, 2005, and would be adversely affected if the line is not
renewed.
Loan agreements related to the line of credit contain covenants requiring the
Company to maintain at the end of each fiscal quarter a certain level of working
capital and tangible new worth. The Company met these requirements at October 2,
2004.
There was borrowing of $3,660,000 under the line of credit at October 2, 2004.
Because of surge and the investment in inventory for manufacture of the ICB
boot, the Company expects significant use of the line of credit in the next few
months.
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. Except for the
delay discussed above and based on information available to date, the Company
believes that such events should not occur in its fiscal year 2005.
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 January 31, 2005, 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:
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o Having a current ratio less than that prescribed by the bank.
o Having tangible net worth less than that prescribed by the bank.
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.
CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING INFORMATION
Statements throughout this report that are not historical facts are
forward-looking statements. These statements are based on current expectations
and beliefs, and involve numerous risks and uncertainties. Many factors could
affect the Company's actual results, causing results to differ materially from
those expressed in any such forward-looking information.
These factors include, but are 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 July 3, 2004. 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.
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.
(a) Evaluation of Disclosure Controls and Procedures
Disclosure controls and procedures are controls and other procedures that are
designed to ensure that information required to be disclosed in the reports that
are filed or submitted under the Exchange Act is recorded, processed, summarized
and reported, within the time periods specified in the Securities and Exchange
Commissions's rules and forms. Disclosure controls and procedures include,
without limitation, controls and procedures designed to ensure that information
required to be disclosed in the reports that are filed under the Exchange Act is
accumulated and communicated to management, including the chief executive
officer and chief financial officer, as appropriate to allow timely decisions
regarding required disclosure. Under the supervision of and with the
participation of management, including the chief executive officer and chief
financial officer, the Company has evaluated the effectiveness of the design and
operation of its disclosure controls and procedures as of October 2, 2004, and
based on its evaluation, our chief executive officer and chief financial officer
have concluded that these controls and procedures are effective.
(b) Changes in Internal Controls
There have been no significant changes in internal controls or in other factors
that could significantly affect these controls subsequent to the date of the
evaluation described above, including any corrective actions with regard to
significant deficiencies and material weaknesses.
-19-
PART II. OTHER INFORMATION
Item 1. Legal Proceedings. N/A
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds. N/A
Item 3. Defaults Upon Senior Securities. N/A
Item 4. Submission of Matters to a Vote of Security Holders. N/A
Item 5. Other Information. N/A
Item 6. Exhibits.
(31) Certifications of the Chief Executive Officer and
Chief Financial Officer under Section 302 of the
Sarbanes-Oxley Act of 2002, filed herewith.
(32) Certifications of the Chief Executive Officer and
Chief Financial Officer under Section 906 of the
Sarbanes-Oxley Act of 2002, filed herewith.
-20-
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 Chief
and President Financial Officer
(Principal Executive Officer)
November 16, 2004
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Exhibit 31
WELLCO ENTERPRISES, INC.
FORM 10-Q FOR THE THREE MONTHS ENDED OCTOBER 2, 2004
CERTIFICATION OF CHIEF EXECUTIVE OFFICER PURSUANT TO
18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 302
OF THE SARBANES-OXLEY ACT OF 2002
I, David Lutz, certify that:
1. I have reviewed this report on Form 10-Q of Wellco Enterprises, Inc.(the
registrant);
2. Based on my knowledge, this 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 report;
3. Based on my knowledge, the financial statements, and other financial
information included in this 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 report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-15(e) and 15d- 15(e)) for the registrant and have:
(a) Designed such disclosure controls and procedures, or caused
such disclosure controls and procedures to be designed under our
supervision, 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 report is being prepared;
(b) Evaluated the effectiveness of the registrant's disclosure
controls and procedures and presented in this report our
conclusions about the effectiveness of the disclosure controls
and procedures, as of the end of the period covered by this
report based on such evaluation; and
(c) Disclosed in this report any change in the registrant's
internal controls over financial reporting that occurred during
the registrant's first fiscal quarter that has materially
affected, or is reasonably likely to materially affect, the
registrant's internal control over financial reporting; and
5. The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation of internal control over financial reporting, to the
registrant's auditors and the audit committee of the registrant's board of
directors (or persons performing the equivalent functions):
(a) All significant deficiencies and material weaknesses in the
design or operation of internal control over financial reporting
which are reasonably likely to adversely affect the registrant's
-22-
ability to record, process, summarize and report financial
information; and
(b) Any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal control over financial reporting.
Date: November 16, 2004
/s/ David Lutz
By: David Lutz, Chief Executive Officer and President
(Chief Executive Officer)
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WELLCO ENTERPRISES, INC.
FORM 10-Q FOR THE THREE MONTHS ENDED OCTOBER 2, 2004
CERTIFICATION OF CHIEF FINANCIAL OFFICER PURSUANT TO
18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 302
OF THE SARBANES-OXLEY ACT OF 2002
I, Tammy Francis, certify that:
1. I have reviewed this report on Form 10-Q of Wellco Enterprises, Inc.(the
registrant);
2. Based on my knowledge, this 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 report;
3. Based on my knowledge, the financial statements, and other financial
information included in this 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 report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-15(e) and 15d- 15(e)) for the registrant and have:
(a) Designed such disclosure controls and procedures, or caused
such disclosure controls and procedures to be designed under our
supervision, 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 report is being prepared;
(b) Evaluated the effectiveness of the registrant's disclosure
controls and procedures and presented in this report our
conclusions about the effectiveness of the disclosure controls
and procedures, as of the end of the period covered by this
report based on such evaluation; and
(c) Disclosed in this report any change in the registrant's
internal controls over financial reporting that occurred during
the registrant's first fiscal quarter that has materially
affected, or is reasonably likely to materially affect, the
registrant's internal control over financial reporting; and
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation of internal control over financial reporting,
to the registrant's auditors and the audit committee of the registrant's
board of directors (or persons performing the equivalent functions):
(a) All significant deficiencies and material weaknesses in the
design or operation of internal control over financial reporting
which are reasonably likely to adversely affect the registrant's
-24-
ability to record, process, summarize and report
financial information; and
(b) Any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal control over financial reporting.
Date: November 16, 2004
/s/ Tammy Francis
By: Tammy Francis, Controller and Treasurer
(Chief Financial Officer)
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Exhibit 32
----------
WELLCO ENTERPRISES, INC.
FORM 10-Q FOR THE THREE MONTHS ENDED OCTOBER 2, 2004
CERTIFICATION OF CHIEF EXECUTIVE OFFICER 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 three months ended
October 2, 2004, 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 containing the financial statements
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: November 16, 2004
/s/ David Lutz
By: David Lutz, Chief Executive Officer and President
(Chief Executive Officer)
A signed original of this written statement required by Section 906 has been
provided to the Company and will be retained by Wellco Enterprises Inc. and
furnished to the Securities and Exchange Commission or its staff upon request.
This certification will not be deemed "filed" for purposes of Section 18 of the
Securities Exchange Act of 1934, or otherwise subject to the liability of that
section. This certification will not be deemed to be incorporated by reference
into any filing under the Securities Act of 1933 or the Securities Exchange Act
of 1934 even if the document with which it is submitted to the Securities and
Exchange Commission is so incorporated by reference.
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WELLCO ENTERPRISES, INC.
FORM 10-Q FOR THE THREE MONTHS ENDED OCTOBER 2, 2004
CERTIFICATION OF CHIEF FINANCIAL OFFICER 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 chief financial officer of Wellco Enterprises, Inc.
2. Attached to this certification is Form 10-Q for the three months ended
October 2, 2004, 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 containing the financial statements
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: November 16, 2004
/s/ Tammy Francis
By: Tammy Francis, Controller and Treasurer
(Chief Financial Officer)
A signed original of this written statement required by Section 906 has been
provided to the Company and will be retained by Wellco Enterprises Inc. and
furnished to the Securities and Exchange Commission or its staff upon request.
This certification will not be deemed "filed" for purposes of Section 18 of the
Securities Exchange Act of 1934, or otherwise subject to the liability of that
section. This certification will not be deemed to be incorporated by reference
into any filing under the Securities Act of 1933 or the Securities Exchange Act
of 1934 even if the document with which it is submitted to the Securities and
Exchange Commission is so incorporated by reference.
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