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 1, 2005
COMMISSION FILE NUMBER: 1-5555
WELLCO ENTERPRISES, INC.
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(Exact name of registrant as specified in charter)
NORTH CAROLINA 56-0769274
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(State of Incorporation) (I.R.S. Employer Identification No.)
150 Westwood Circle, P.O. Box 188, Waynesville, NC 28786
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(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 .
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes No X .
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Act). Yes No X .
1,270,746 common shares (all voting) were outstanding as of November 15, 2005.
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
WELLCO ENTERPRISES, INC.
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CONSOLIDATED FINANCIAL STATEMENTS FILED WITH FORM 10-Q
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FOR THE FISCAL QUARTER ENDED OCTOBER 1, 2005
--------------------------------------------
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 1, 2005 AND JULY 2, 2005
(in thousands)
ASSETS
(unaudited) *
OCTOBER 1, JULY 2,
2005 2005
--------------------------
CURRENT ASSETS:
Cash and cash equivalents .................. $ 233 $ 34
Receivables, net ........................... 3,257 3,205
Inventories-
Finished goods ......................... 3,433 4,853
Work in process ........................ 3,194 2,880
Raw materials .......................... 3,589 3,924
-------- --------
Total .................................. 10,216 11,657
Deferred taxes ............................ 266 266
Prepaid expenses ........................... 726 304
-------- --------
Total ...................................... 14,698 15,466
-------- --------
MACHINERY LEASED TO LICENSEES,
Net of accumulated depreciation ............ 10 11
PROPERTY, PLANT AND EQUIPMENT:
Land ....................................... 107 107
Buildings .................................. 1,439 1,439
Machinery and equipment .................... 10,891 10,846
Office equipment ........................... 869 851
Automobiles ................................ 235 208
Leasehold improvements ..................... 809 809
-------- --------
Total cost ................................. 14,350 14,260
Less accumulated depreciation and
amortization ............................ (9,295) (8,943)
-------- --------
Net Property Plant and Equipment ........... 5,055 5,317
-------- --------
INTANGIBLE ASSETS:
Intangible pension asset ................... 10 10
-------- --------
TOTAL ............................................ $ 19,773 $ 20,804
======== ========
* Derived from audited financial statements
(continued on next page)
-3-
WELLCO ENTERPRISES, INC.
CONSOLIDATED BALANCE SHEETS
OCTOBER 1, 2005 AND JULY 2, 2005
(in thousands except share data)
LIABILITIES AND STOCKHOLDERS' EQUITY
(unaudited) *
OCTOBER 1, JULY 2,
2005 2005
--------------------------
CURRENT LIABILITIES:
Short-term borrowing from bank ............... $ 2,120 $ 1,720
Accounts payable ............................. 2,505 2,912
Accrued compensation ......................... 869 1,016
Accrued income taxes ......................... 601 649
Other liabilities ............................ 276 285
-------- --------
Total ........................................ 6,371 6,582
-------- --------
LONG-TERM LIABILITIES:
Pension obligation ........................... 1,485 1,485
Notes payable ................................ 233 231
Other accrued liabilities .................... 425 425
Deferred taxes .............................. 128 128
Deferred grant income ........................ 141 124
Deferred revenues ............................ 67 69
STOCKHOLDERS' EQUITY:
Common stock, $1.00 par value ................ 1,271 1,271
Additional paid-in capital ................... 1,319 1,319
Retained earnings ............................ 9,809 10,646
Accumulated other comprehensive loss ......... (1,476) (1,476)
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Total ........................................ 10,923 11,760
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TOTAL .............................................. $ 19,773 $ 20,804
======== ========
See Notes to Consolidated Financial Statements.
* Derived from audited financial statements
-4-
WELLCO ENTERPRISES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE FISCAL THREE MONTHS ENDED
OCTOBER 1, 2005 AND OCTOBER 2, 2004
(in thousands except per share and number of shares)
(unaudited)
OCTOBER 1, OCTOBER 2,
2005 2004
---------------------------
REVENUES ..................................... $ 8,318 $ 11,401
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COSTS AND EXPENSES:
Cost of sales and services ............. 8,402 10,167
General and administrative expenses .... 609 688
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Total .................................. 9,011 10,855
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GRANT INCOME ................................. 62 --
----------- -----------
OPERATING INCOME (LOSS) ...................... (631) 546
INTEREST EXPENSE ............................. (43) (48)
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INCOME (LOSS) BEFORE INCOME TAXES ........... (674) 498
PROVISION (BENEFIT) FOR INCOME TAXES ......... (28) 101
----------- -----------
NET INCOME (LOSS) ............................ $ (646) $ 397
=========== ===========
BASIC EARNINGS (LOSS) PER SHARE
Based on weighted average
number of shares outstanding ........... $ (0.51) $ 0.32
=========== ===========
Shares used in computing basic
earnings per share ..................... 1,270,746 1,247,650
=========== ===========
DILUTED EARNINGS (LOSS) PER SHARE
Based on weighted average number
of shares outstanding and dilutive
stock options .......................... $ (0.51) $ 0.31
=========== ===========
Shares used in computing diluted
earnings per share ..................... 1,270,746 1,299,415
=========== ===========
DIVIDENDS DECLARED PER SHARE ................. $ 0.15 $ 0.15
=========== ===========
See Notes to Consolidated Financial Statements.
-5-
WELLCO ENTERPRISES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE FISCAL THREE MONTHS ENDED
OCTOBER 1, 2005 AND OCTOBER 2, 2004
(in thousands)
(unaudited)
OCTOBER 1, OCTOBER 2,
2005 2004
----------------------
CASH FLOWS FROM OPERATING
ACTIVITIES:
Net income (loss) ................................. $ (646) $ 397
------- -------
Adjustments to reconcile net income (loss)
to net cash provided (used) by
operating activities:
Depreciation and amortization ................ 352 308
Non-cash reduction in deferred revenue ....... (2) (2)
Non-cash interest expense .................... 2 2
(Increase) decrease in-
Receivables ............................ (52) 1,441
Inventories ............................ 1,441 (1,691)
Prepaid expenses ....................... (422) (272)
Increase (decrease) in-
Accounts payable ....................... (407) 673
Accrued compensation ................... (147) (63)
Accrued income taxes ................... (48) (164)
Other liabilities ..................... 9 (6)
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Total adjustments ................................. 726 226
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NET CASH PROVIDED (USED) BY
OPERATING ACTIVITIES .............................. 80 623
------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of plant and equipment .................. (90) (378)
------- -------
CASH USED BY INVESTING ACTIVITIES ...................... (90) (378)
------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from (repayment of)
short-term borrowings ............................. 400 (120)
Cash dividends paid ............................... (191) (188)
Stock options exercised ........................... -- 62
------- -------
NET CASH PROVIDED (USED) BY
FINANCING ACTIVITIES .............................. 209 (246)
------- -------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS ... 199 (1)
CASH AND CASH EQUIVALENTS
AT THE BEGINNING OF THE PERIOD .................... 34 58
------- -------
CASH AND CASH EQUIVALENTS AT END OF PERIOD ............. $ 233 $ 57
======= =======
(continued on next page)
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WELLCO ENTERPRISES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE FISCAL THREE MONTHS ENDED
OCTOBER 1, 2005 AND OCTOBER 2, 2004
(in thousands)
(unaudited)
OCTOBER 1, OCTOBER 2,
2005 2004
----------------------
SUPPLEMENTAL DISCLOSURE OF CASH
FLOW INFORMATION:
Cash paid for-
Interest ................................. $ 41 $ 46
Income taxes ............................. $ 20 $265
==== ====
See Notes to Consolidated Financial Statements.
-7-
WELLCO ENTERPRISES, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
FOR THE FISCAL THREE MONTHS ENDED
OCTOBER 1, 2005
(in thousands except number of shares and per share)
(unaudited)
Common Stock Additional
Par Paid-In Retained
Shares Value Capital Earnings
----------------------------------------------
BALANCE AT JULY 2, 2005 1,270,746 $ 1,271 $ 1,319 $ 10,646
Net loss for the fiscal three
months ended October 1, 2005 (646)
Cash dividend ($.15 per share) (191)
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BALANCE AT October 1, 2005 1,270,746 $ 1,271 $ 1,319 $ 9,809
===============================================
Accumulated
Other
Comprehensive
Loss
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ADDITIONAL PENSION LIABILITY,
NET OF TAX, BALANCE
AT JULY 2, 2005 $ (1,476)
Change for the fiscal three
months ended October 1, 2005 -
----------------
BALANCE AT October 1, 2005 $ (1,476)
================
See Notes to Consolidated Financial Statements.
-8-
WELLCO ENTERPRISES, INC.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
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FOR THE FISCAL THREE MONTHS ENDED OCTOBER 1, 2005
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1. BUSINESS:
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:
The Company maintains a $7,500,000 bank line of credit. The Company's line
of credit expires on December 31, 2005 and can be renewed annually at the
bank's discretion. This line of credit is secured by a blanket lien on all
machinery and equipment and all accounts receivable and inventory. At
October 1, 2005, borrowings on this line of credit were $2,120,000 with
$5,380,000 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 1, 2005.
3. EARNINGS (LOSS) PER SHARE:
The Company computes its basic and diluted earnings (loss) per share
amounts in accordance with Statement of Financial Accounting Standards No.
128 (SFAS 128), "Earnings (Loss)per Share." Basic earnings (loss) per
share is computed by dividing net earnings (loss) by the weighted average
number of common shares outstanding during the period. Diluted earnings
per share is computed by dividing net earnings (loss) 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 10/01/05
-------------------------------------
Net Loss Shares Per-Share
(Numerator) (Denominator) Amount
----------------------------------------
Basic EPS Available to
Shareholders $ (646,000) 1,270,746 $ (0.51)
- --------------------------------------------------------------------------------
Effect of Dilutive Stock-based
Compensation Arrangements
(Note: N/A - Anti-dilutive)
- --------------------------------------------------------------------------------
Diluted EPS Available to
Shareholders $ (646,000) 1,270,746 $ (0.51)
- --------------------------------------------------------------------------------
For the Three Months Ended 10/02/04
-------------------------------------
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
- --------------------------------------------------------------------------------
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 Company's stock options were all vested by July 2, 2005, the end of
the 2005 fiscal year. The following table summarizes the effect on net
income and earnings (loss) per share had the accounting for employee stock
options been based on the fair value method.
For the Three Months Ended
October 1, October 2,
2005 2004
- ----------------------------------------------------------------------
Net income (loss):
- ----------------------------------------------------------------------
As reported $ (646,000) $ 397,000
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Compensation expense, net of tax - 6,000
- ----------------------------------------------------------------------
Pro forma $ (646,000) $ 391,000
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-10-
October 1, October 2,
2005 2004
- ---------------------------------------------------------------------
Basic earnings (loss) per share:
- ---------------------------------------------------------------------
As reported $ (0.51) $ 0.32
- ---------------------------------------------------------------------
Compensation expense, net of tax - 0.01
- ---------------------------------------------------------------------
Pro forma $ (0.51) $ 0.31
- ---------------------------------------------------------------------
Diluted earnings (loss) per share:
As reported $ (0.51) $ 0.31
- ---------------------------------------------------------------------
Compensation expense, net of tax - 0.01
- ---------------------------------------------------------------------
Pro forma $ (0.51) $ 0.30
- ---------------------------------------------------------------------
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 1, October 2,
2005 2004
- ---------------------------------------------------------------------
Benefits Earned for Service in the
Current Period $ 46,500 $ 36,600
- ---------------------------------------------------------------------
Interest on the Projected Benefit
Obligation 79,000 87,000
- ---------------------------------------------------------------------
Expected Return on Plan Assets (81,100) (78,100)
Amortization of: Unrecognized Net
Pension Obligation at July 1, 1987; Cost
of Benefit Changes Since That Date; and
Gains and Losses Against Actuarial
Assumptions 23,600 15,200
- ---------------------------------------------------------------------
Pension Expense $ 68,000 $ 60,700
- ---------------------------------------------------------------------
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 Rican government program to assist
manufacturers in the training of new or expanded work force under which
the Company is reimbursed for part of the compensation paid to certain
-11-
employees. There was no reimbursement received during the quarter ended
October 1, 2005. On September 23, 2004, that subsidiary received a
reimbursement of $780,000 for compensation paid employees in the 2004
fiscal year and was recognized as a revenue in the quarter ended October
2, 2004.
The Company has filed a reimbursement claim for $996,000 for compensation
paid employees and expensed through October 1, 2005. Subsequently, on
October 17, 2005, that subsidiary received a reimbursement of $234,000
that will be included as Revenues for the second 2006 fiscal quarter ended
December 31, 2005. The Company's policy is to recognize reimbursements as
a revenue in the period that they are received.
7. GRANT MONEY RECEIVED:
The Company received approximately $280,000 in December 2004, $43,000 in
April 2005 and $99,000 in September 2005 from the government of Puerto
Rico under a Special Incentives Contract related to creating new job
opportunities in its boot manufacturing operations in Puerto Rico. The
grant is for a five year period (fiscal years 2004 through 2008) and
requires the Company to maintain a certain level of employment in Puerto
Rico over the grant period. If this requirement is not met, the Company
may be required to refund a pro-rata portion of the total grant. The grant
is for a maximum of $526,000 and monies are disbursed based upon certain
expenditures made by the Company. The Company's policy is to recognize
grant monies pro-rata over the five year grant period, with grant income
first recognized in the period in which it is received. The Consolidated
Statements of Operations for the three-month period ended October 1, 2005
recognized $62,000 as grant income including $41,000 that related to grant
periods prior to fiscal year 2006.
8. GOVERNMENT BOOT CONTRACT REVENUES:
From time to time, the Company records estimates of revenues or costs
associated with certain contract actions before the amount of such actions
are settled with the DSCP. Any differences between these estimates and the
actual amounts agreed to are included in the period of settlement.
9. RECLASSIFICATIONS:
Certain reclassifications have been made in the prior year's financial
statements to conform to classifications used in the current year.
-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 Recognition of Contract Adjustments:
From time to time, contract price adjustments will occur which
require the Company to compute and present to the Defense
Department for audit its calculation of such adjustments. If the
adjustment is one of a recurring nature, the Company will record
its calculation in the period the change occurred. For other
adjustments, the adjustment is not recorded until the period in
which the Company and the government agree on the amount of
adjustment.
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
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these estimates.
Since July 2, 2005, the end of the 2005 fiscal year, there have been no
changes in the nature of the estimates and assumptions related to these
critical accounting policies.
Comparing the Three Months Ended October 1, 2005 and October 2, 2004:
--------------------------------------------------------------------
OVERVIEW
--------
The most significant events occurring in the three months ended October 1,
2005 (current period) compared to the three months ended October 2, 2004
(prior period):
1. A 38% decrease in total pairs of boots sold under contracts with
the U.S. Department of Defense (DOD).
2. A 63% decrease in production of boots under contract with the
DOD.
3. In the current period, the Company did not receive any
reimbursement from the Government of Puerto Rico under its program
which reimburses the Company for part of the compensation paid to
certain employees. In the prior period, the Company received and
recognized as income $780,000 under this program.
Comparative results for these two periods is as follows:
Current Period Prior Period
Three Months Three Months
Ended October 1, Ended October 2, % of
(Amounts in thousands) 2005 2004 Change Change
- --------------------------------------------------------------------------------
Revenues $ 8,318 $ 11,401 $(3,083) -27%
- --------------------------------------------------------------------------------
Cost of Sales 8,402 10,167 (1,765) -17%
- --------------------------------------------------------------------------------
Gross Profit (Loss) (84) 1,234 (1,318) -107%
- --------------------------------------------------------------------------------
Administrative Expenses 609 688 (79) -12%
- --------------------------------------------------------------------------------
Grant Income 62 - 62
- --------------------------------------------------------------------------------
Operating Income (Loss) (631) 546 (1,177) -235%
- --------------------------------------------------------------------------------
Interest Expense, Net 43 48 (5)
- --------------------------------------------------------------------------------
Income Tax Expense
(Benefit) (28) 101 (129)
- --------------------------------------------------------------------------------
Net Income (Loss) $ (646) $ 397 $(1,043)
- --------------------------------------------------------------------------------
For the three months ended October 1, 2005 (current period), Wellco had a net
loss of $646,000 compared to net income of $397,000 in the prior year three
month period ended October 2, 2004 (prior period).
o Compared to the prior period, total revenues in the
current period decreased by $3,083,000. During the current
quarter, the Company shipped 38% fewer pairs of boots
-14-
under its DOD contracts. The decrease in sales is less
than the 63% decrease in production because of a decrease
in the inventory of finished boots in the current period.
In early August 2005 the only U.S. supplier of a DOD
required component had a quality problem that was not
substantially resolved until late September. This
supplier's quality problem severely limited the supply of
this component material and contributed to the reduction
in sales to DOD. In the July through September, 2005
period, the Company received new DOD orders totaling
187,000 pairs of boots. However, the component quality
problem prevented the Company from producing and selling
a significant quantity of these boots in the current
period. More information about this is in the below
discussion of Cost of Sales and Services.
In the prior period, delivery orders issued by the DOD
under which the Company was shipping Hot Weather boots
incorporated a "surge" requirement to meet the need in
Iraq. The "surge" requirement was substantially completed
in the first quarter of the prior period.
Since October 1, 2004, the Company's allocation percent
for Hot Weather boots under a DOD contract has been 15% of
the total need. For the October 1, 2003 to October 1,
2004, the Company's allocation was 30% of the total need.
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 to
assist manufacturers in the training of new and expanded
work force under which the Company is reimbursed for part
of the compensation paid to certain employees. Under this
program, the Company did not received any reimbursement
from this program for the current period. However, during
the prior period, the Company received $780,000 of
reimbursement under this program and this amount is
included in Revenues for the fiscal quarter ended October
2, 2004. The Company's policy is to recognize the
reimbursements as a revenue in the period that it is
received. Subsequent to October 1, 2005 the Company
received $234,000 under this program. This amount, plus
any other amounts received, will be recognized as revenues
in the second quarter of fiscal year 2006.
o Cost of Sales and Services in the current year decreased
by only $1,765,000. Production of boots under contract
with the DOD during the current quarter was 63% less than
the prior quarter. Fixed costs and semi-variable costs did
not decrease proportionately to this 63% decrease in
production. Of the above factors that contributed to the
reduction in revenues, the primary factor that caused the
reduced rate of production was the component supplier's
quality problem.
In early August 2005, the only U.S. supplier of a DOD
required component had a significant quality problem.
Fortunately, the Company's quality system found
this problem when it first occurred. In order to assure
that defective product did not get into boots, the Company
had to perform additional quality checks and time
consuming repairs. The supplier has agreed to reimburse
excess manufacturing costs and the current period costs
have been reduced by the amount invoiced for these excess
costs through October 1, 2005.
In the July through September, 2005 period, the Company
received new DOD orders totaling 187,000 pairs of boots.
However, the component quality problem prevented the
Company from producing a significant quantity of these
boots in the current period.
-15-
Over the past two years, because of surge and a new DOD
contract, the Company has more than doubled its production
capacity. Because it had information indicating that
consumption of military boots was more than what DOD was
ordering, the Company decided to maintain, at least
temporarily, this increased production capacity. If
production capacity was sharply reduced and DOD orders
increased significantly, increasing production capacity
would be time consuming and expensive. From August through
October, 2005, the Company received DOD delivery orders
totaling 280,000 pairs of boots, with delivery due from
November 2005 through June 2006. Of this total, 155,000
pairs are due in December 2005 through February 2006.
Maintaining a production capacity higher that actually
needed is expensive. However, the Company will need all of
its capacity to meet deliveries under the new orders,
especially those deliveries due December 2005 through
February 2006.
o During the current period, general and administrative
expenses decreased by $79,000, caused primarily by a
reduction in the number of administrative employees and a
reduction in profit-based bonuses.
o The amount of grant income recognized in the current period
under the Puerto Rico Special Incentives Contract is
$62,000 including $41,000 that related to grant periods
prior to fiscal year 2006. The prior year did not contain
grant income.
The rate of tax benefit for income taxes for the quarter ended October 1,
2005 was 4% compared to a 20% rate of tax for the quarter ended October 2,
2004 This benefit rate is less than the U. S. federal tax rate of 34% because
the majority of the loss is from operations in Puerto Rico, which is
substantially exempt from U. S. income tax.
Forward Looking Information:
----------------------------
Below is a summary of the Company's current boot contracts with Defense
Department. The Company's Defense Department boot contracts are indefinite
quantity contracts. This means that each contract specifies a minimum number
of pairs that must be ordered from a contractor and a maximum number of pairs
that may be ordered.
On September 23, 2005, the Defense Department exercised the second and
final option year under the Company's Hot Weather boot contract. For
the first option year, the minimum pairs were 41,000 and the maximum
was 323,000. A total of 163,000 pairs were actually ordered in the
first option year. For the second option year, the minimum pairs is
41,000 and the maximum is 256,000. Pairs ordered to date under the
second option year are 43,000. The second option year is for the period
October 2005 through September 2006. The Company expects the Defense
Department to issue a new solicitation for contracts to supply the Hot
Weather boot starting in November 2006. The Company cannot confidently
predict its success in receiving a contract award.
On July 8, 2005, the Defense Department exercised the second option
year under the Company's Temperate Weather boot contract. For the first
option year, the minimum pairs were 51,000 and the maximum was 227,000.
A total of 176,000 pairs were actually ordered in the first option
year. For the second option year, the minimum pairs are 13,000 and the
maximum are 227,000. Pairs ordered to date under the second option year
are 221,000. This contract has two more option years outstanding. The
exercise of any contract option is the unilateral decision of the
Defense Department.
-16-
The Hot Weather boot contract was awarded to four contractors. Each contractor
was awarded a percent allocation of all Hot Weather boots to be ordered. One
contractor got 35%, Wellco got 30%, one contractor got 20% and the fourth
contractor got 15%.
This Hot Weather boot contract also provides that, after the exercise of each
option, contractor allocation must be the same as that originally awarded for
the minimum number of pairs ordered in that option year. The contract further
provides that, during each option year and after the minimum pairs have been
ordered at the awarded allocation percent, the Defense Department can, based on
the contractor's option price and performance during the prior contract year,
change a contractor's allocation percentage.
In September 2005, Wellco was informed that its allocation percentage for the
first option year, which started in October 2004 and ends September 30, 2005,
had decreased from 30% to 15%. Wellco asked but was not told the specific
factor(s) that resulted in this decrease. Wellco believes that the reduction in
its allocation percentage was due to its not supplying all pairs under surge
delivery orders by the specified delivery date.
When Wellco submitted its solicitation response that resulted in this contract,
the price offered for the 15% allocation was higher than the 30% allocation.
Shipments during the first option have been invoiced and revenues recognized
using the lower 30% allocation price. Wellco believes that its invoice price for
pairs above the minimum should be adjusted to the higher 15% allocation price.
Wellco understands that the Defense Department's interpretation of the contract
is that pairs shipped at the lower percentage are to be invoiced at the lower
30% price. Wellco is consulting its legal counsel about this issue.
As previously discussed, in early August 2005, the sole supplier of a major boot
component had a quality problem. Although this problem has been substantially
resolved, the Company is continuing additional, time consuming, quality
procedures. While the rate of production in the second quarter is improved, the
necessary additional quality procedures, and repairs resulting from these
procedures, continues to restrict production.
The majority of the Company's boots 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 in training. As of
October 1, 2005, $996,000 has been filed for, but has not been received or
recorded as revenues, reimbursement under this program. Subsequently, on October
17, 2005, that subsidiary received a reimbursement of $234,000 that will be
included as revenues for the second 2006 fiscal quarter ended December 31, 2005.
The government of Puerto Rico recently suspended new contracts for this program.
The Company understands that this suspension will not affect its collection of
the remaining balance due of $762,000. In the past two fiscal years, the Company
has received and recorded as revenues a total of $1,700,000 under this program.
In September 2005 the Company submitted a response to a solicitation for the
research and development of a Modular Boot System (MBS) for the U. S. military.
Presently, the Department of Defense buys four different boot styles to meet the
varied climatic conditions encountered by military personnel. This solicitation
calls for bidders to submit concepts and models of a MBS that would result in a
functional boot system that would provide comfort in a temperature range of
- -60(0)F to 120(0)F. If successful, the MBS would replace many, if not all, of
the current boot styles.
After review of solicitations, the Defense Department will make up to two
contract awards, or, the Defense Department may determine not to award any
contracts. The Company cannot confidently predict if it will receive a contract
from this solicitation.
The Company has submitted solicitation responses to supply machinery and
assistance for the upgrade of boot manufacturing machinery to factories in three
foreign countries. Two of the three solicitations are judged to be significant.
The Company cannot confidently predict if it will receive a contract from any of
these solicitations.
Income earned by the Company's Puerto Rico subsidiary has for many years been
fully exempt from U. S. income taxes and is currently partially exempt. Fiscal
year 2006 is the last year in which this subsidiary will have any exemption from
U. S. income taxes.
-17-
The requirements of Section 404 of the Sarbanes-Oxley Act of 2002 will first
apply to the Company's 2008 fiscal year. Section 404 requires the Company to
document, test, and issue an opinion as to the adequacy of their internal
controls over financial reporting. In addition, Section 404 requires the
Company's Independent Accountants to review the Company's internal control
documentation and testing results, and to issue its opinion as to the
correctness of the Company's opinion as to the adequacy of their internal
controls over financial reporting. The Securities and Exchange Commission is
presently evaluating the effect of Section 404 on smaller public companies.
Unless this evaluation results in a significant reduction in requirements for
small public companies, the Company will incur significant costs in complying
with Section 404.
The Company relies heavily on boot contracts from the DOD for most of its
operations. The business of providing boots to the U. S. Defense Department is
very competitive. With more than 98% of U. S. footwear sales being of foreign
manufacture, the manufacture of boots for DOD, which must all be done in the U.
S., is one way of using domestic capacity.
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 1, 2005 July 2, 2005
- ---------------------------------------------------------------------
Cash and Cash Equivalents $233 $34
- ---------------------------------------------------------------------
Unused Line of Credit 5,380 5,780
- ---------------------------------------------------------------------
Total $5,613 $5,814
- ---------------------------------------------------------------------
The following table summarizes the cash flow activities for the three month
period ended October 1, 2005:
Cash provided by (used in): (in thousands)
- ---------------------------------------------------------------
Operating activities $80
- ---------------------------------------------------------------
Investing activities (90)
- ---------------------------------------------------------------
Financing activities 209
- ---------------------------------------------------------------
Net change in cash and cash equivalents $199
- ---------------------------------------------------------------
Operating Activities: In the three months ended October 1, 2005, cash provided
by operations was $80,000. Depreciation of $352,000 and a $1,441,000 decrease in
inventories were the main operating sources of cash. The main uses of operating
cash were the net loss of $646,000, decreases of $407,000 in accounts
payable,$147,000 in accrued compensation, $48,000 in accrued taxes and an
increase of $422,000 in prepaid expenses and $52,000 in accounts receivable.
-18-
Investing Activities: In the three months ended October 1, 2005, purchases of
machinery and other equipment was $90,000.
Financing Activities: In the three months ended October 1, 2005, the Company's
net cash from financing activities totaled $209,000. Cash was provided through
additional borrowings of $400,000 from the line of credit. $191,000 was used to
pay quarterly dividend payments to stockholders.
The following table shows aggregated information about contractual obligations
as of October 1, 2005:
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 793,000 $202,000 $425,000 $166,000 -
- --------------------------------------------------------------------------------
Total $1,093,000 $202,000 $425,000 $166,000 $300,000
- --------------------------------------------------------------------------------
In addition, during the three month period ended October 1, 2005, the Company
paid $43,000 in interest expense, $20,000 in income tax payments and $90,000 in
contributions to its pension plans.
The Company maintains a $7,500,000 bank line of credit. Borrowings under the
line of credit at October 1, 2005 were $2,120,000.
The bank line of credit will expire and be subject to renewal on December 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, not receiving
future 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 December 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 net worth. The Company met these requirements at October 1,
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 December 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:
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.
-19-
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 2, 2005. 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.
We are exposed to interest rate changes primarily as a result of our line of
credit which we use to maintain liquidity and to fund capital expenditures and
expansion. Our market risk exposure with respect to this debt is to changes in
LIBOR. Our line of credit provides for interest on outstanding borrowings at
rates tied to LIBOR. We do not enter into derivative or interest rate
transactions for speculative purposes.
In the normal course of business and consistent with established policies and
procedures we use the necessary financial instruments to manage the fluctuations
in interest rates. The Company does not have any foreign currency risk.
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
Commission'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 1, 2005, 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 changes in internal controls during the last fiscal quarter
that materially affected, or are reasonably likely to materially affect, the
Company's internal control over financial reporting.
-20-
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.
A) N/A
B) 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.
-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 Chief
and President Financial Officer
(Principal Executive Officer)
November 15, 2005
-22-
Exhibit 31
----------
WELLCO ENTERPRISES, INC.
FORM 10-Q FOR THE THREE MONTHS ENDED OCTOBER 1, 2005
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 current 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
ability to record, process, summarize and report financial
information; 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 control over financial reporting.
Date: November 15, 2005
/s/ David Lutz
By: David Lutz, Chief Executive Officer and President
(Chief Executive Officer)
-24-
WELLCO ENTERPRISES, INC.
FORM 10-Q FOR THE THREE MONTHS ENDED OCTOBER 1, 2005
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 current 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
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
-25-
registrant's internal control over financial reporting.
Date: November 15, 2005
/s/ Tammy Francis
By: Tammy Francis, Controller and Treasurer
(Chief Financial Officer)
-26-
Exhibit 32
----------
WELLCO ENTERPRISES, INC.
FORM 10-Q FOR THE THREE MONTHS ENDED OCTOBER 1, 2005
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 1, 2005, 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 15, 2005
/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.
-27-
WELLCO ENTERPRISES, INC.
FORM 10-Q FOR THE THREE MONTHS ENDED OCTOBER 1, 2005
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 1, 2005, 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 15, 2005
/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.
-28-