FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(X) QUARTERLY REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT
OF 1934
FOR THE QUARTERLY PERIOD ENDED: DECEMBER 30, 2006
COMMISSION FILE NUMBER: 1-5555
WELLCO ENTERPRISES, INC.
------------- -------------------------
(Exact name of registrant as specified in charter)
NORTH CAROLINA 56-0769274
- ------------------- ----------------------------------------------
(State of Incorporation) (I.R.S. Employer Identification No.)
150 Westwood Circle, P.O. Box 188, Waynesville, NC 28786
(Address of Principal Executive Office)
Registrant's telephone number, including area code 828-456-3545
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Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No .
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Act). Yes __No X . ------ -----
Indicate by check mark whether the Registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer (as defined in Exchange Act Rule
12b-2 of the Act). ___Large accelerated filer __Accelerated filer
_X_Non-accelerated filer
1,270,746 common shares (all voting) were outstanding as of February 13, 2007.
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
WELLCO ENTERPRISES, INC.
CONSOLIDATED FINANCIAL STATEMENTS FILED WITH FORM 10-Q
FOR THE FISCAL QUARTER ENDED DECEMBER 30, 2006
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
CONSOLIDATED BALANCE SHEETS
DECEMBER 30, 2006 AND JULY 1, 2006
(in thousands)
ASSETS
(unaudited) *
DECEMBER 30, JULY 1,
2006 2006
---------------------------
CURRENT ASSETS:
Cash and cash equivalents .................. $ 34 $ 44
Receivables, net ........................... 3,661 3,559
Inventories-
Finished goods ......................... 4,290 4,470
Work in process ........................ 2,521 1,509
Raw materials .......................... 3,668 3,432
-------- --------
Total .................................. 10,479 9,411
Deferred taxes ............................ 415 184
Prepaid expenses ........................... 603 455
-------- --------
Total ...................................... 15,192 13,653
-------- --------
MACHINERY LEASED TO LICENSEES,
Net of accumulated depreciation ............ 3 5
PROPERTY, PLANT AND EQUIPMENT:
Land ....................................... 107 107
Buildings .................................. 1,439 1,439
Machinery and equipment .................... 11,580 11,239
Office equipment ........................... 997 886
Automobiles ................................ 251 235
Leasehold improvements ..................... 968 823
-------- --------
Total cost ................................. 15,342 14,729
Less accumulated depreciation and
amortization ............................ (10,910) (10,243)
-------- --------
Net Property Plant and Equipment ........... 4,432 4,486
-------- --------
INTANGIBLE ASSETS:
Intangible pension asset ................... 6 6
-------- --------
TOTAL ............................................ $ 19,633 $ 18,150
======== ========
* Derived from audited financial statements
(continued on next page)
3
WELLCO ENTERPRISES, INC.
CONSOLIDATED BALANCE SHEETS
DECEMBER 30, 2006 AND JULY 1, 2006
(in thousands except share data)
LIABILITIES AND STOCKHOLDERS' EQUITY
(unaudited) *
DECEMBER 30, JULY 1,
2006 2006
---------------------------
CURRENT LIABILITIES:
Short-term borrowing from bank ............... $ 2,800 $ 625
Accounts payable ............................. 1,788 1,716
Accrued compensation ......................... 573 769
Dividend payable ............................. 127 --
Accrued income taxes ......................... 677 407
Other liabilities ............................ 304 366
-------- --------
Total ........................................ 6,269 3,883
-------- --------
LONG-TERM LIABILITIES:
Pension obligation ........................... 1,013 1,013
Notes payable ................................ 246 241
Other accrued liabilities .................... 341 363
Deferred taxes .............................. 172 172
Deferred grant income ........................ 206 206
Deferred revenues ............................ 54 59
STOCKHOLDERS' EQUITY:
Common stock, $1.00 par value ................ 1,271 1,271
Additional paid-in capital ................... 1,319 1,319
Retained earnings ............................ 9,749 10,630
Accumulated other comprehensive loss ......... (1,007) (1,007)
-------- --------
Total ........................................ 11,332 12,213
-------- --------
TOTAL .............................................. $ 19,633 $ 18,150
======== ========
See Notes to Consolidated Financial Statements.
* Derived from audited financial statements
4
WELLCO ENTERPRISES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE FISCAL SIX MONTHS ENDED
DECEMBER 30, 2006 AND DECEMBER 31, 2005
(in thousands except per share and number of shares)
(unaudited)
DECEMBER 30, DECEMBER 31,
2006 2005
-----------------------------
REVENUES ..................................... $ 11,584 $ 19,359
----------- -----------
COSTS AND EXPENSES:
Cost of sales and services ............. 10,894 18,529
General and administrative expenses .... 1,373 1,245
----------- -----------
Total .................................. 12,267 19,774
----------- -----------
GRANT INCOME ................................. -- 85
MERGER COSTS ................................. 135 --
----------- -----------
OPERATING LOSS ............................... (818) (330)
NET INTEREST EXPENSE ......................... (40) (109)
----------- -----------
LOSS BEFORE INCOME TAXES .................... (858) (439)
BENEFIT FOR INCOME TAXES ..................... (231) (18)
----------- -----------
NET LOSS ..................................... $ (627) $ (421)
=========== ===========
BASIC LOSS PER SHARE
Based on weighted average number of
shares outstanding ..................... $ (0.49) $ (0.33)
=========== ===========
Shares used in computing basic
loss per share ......................... 1,270,746 1,270,746
=========== ===========
DILUTED LOSS PER SHARE
Based on weighted average number of
shares outstanding and dilutive
stock options .......................... $ (0.49) $ (0.33)
=========== ===========
Shares used in computing diluted
loss per share ......................... 1,270,746 1,270,746
=========== ===========
DIVIDENDS DECLARED PER SHARE ................. $ 0.20 $ 0.30
=========== ===========
See Notes to Consolidated Financial Statements.
5
WELLCO ENTERPRISES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE FISCAL THREE MONTHS ENDED
DECEMBER 30, 2006 AND DECEMBER 31, 2005
(in thousands except per share and number of shares)
(unaudited)
DECEMBER 30, DECEMBER 31,
2006 2005
---------------------------
REVENUES ....................................... $ 6,255 $ 11,041
----------- -----------
COSTS AND EXPENSES:
Cost of sales and services ............... 5,747 10,127
General and administrative expenses ...... 736 636
----------- -----------
Total .................................... 6,483 10,763
----------- -----------
GRANT INCOME ................................... -- 23
MERGER COSTS ................................... 135
----------- -----------
OPERATING INCOME (LOSS) ........................ (363) 301
NET INTEREST EXPENSE ........................... (26) (66)
----------- -----------
INCOME (LOSS) BEFORE INCOME TAXES .............. (389) 235
PROVISION (BENEFIT) FOR INCOME TAXES ........... (133) 10
----------- -----------
NET INCOME (LOSS) .............................. $ (256) $ 225
=========== ===========
BASIC EARNINGS PER SHARE (Notes 4 and 5)
based on weighted average number of
shares outstanding ....................... $ (0.20) $ 0.18
=========== ===========
Shares used in computing basic
earnings per share ....................... 1,270,746 1,270,746
=========== ===========
DILUTED EARNINGS PER SHARE (Notes 4 and 5)
based on weighted average number of
shares outstanding and dilutive stock
options .................................. $ (0.20) $ 0.17
=========== ===========
Shares used in computing diluted
earnings per share ....................... 1,270,746 1,292,157
=========== ===========
DIVIDENDS DECLARED PER SHARE ................... $ 0.10 $ 0.15
=========== ===========
See Notes to Consolidated Financial Statements.
6
WELLCO ENTERPRISES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE FISCAL SIX MONTHS ENDED
DECEMBER 30, 2006 AND DECEMBER 31, 2005
(in thousands)
(unaudited)
DECEMBER 30, DECEMBER 31,
2006 2005
--------------------------
CASH FLOWS FROM OPERATING
ACTIVITIES:
Net loss .......................................... $ (627) $ (421)
------- -------
Adjustments to reconcile net loss
to net cash provided (used) by operating
activities:
Depreciation and amortization ................ 669 705
Non-cash reduction in deferred revenue ....... (5) (5)
Non-cash interest expense .................... 5 5
(Increase) decrease in-
Receivables ............................ (102) (1,870)
Inventories ............................ (1,068) (1,758)
Prepaid expenses ....................... (148) (394)
Increase (decrease) in-
Accounts payable ....................... 72 1,117
Accrued compensation ................... (196) (311)
Accrued income taxes ................... 270 (138)
Deferred taxes ......................... (231) --
Other liabilities ..................... (84) (36)
------- -------
Total adjustments ................................. (818) (2,685)
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NET CASH USED BY
OPERATING ACTIVITIES .............................. (1,445) (3,106)
------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of plant and equipment .................. (613) (315)
------- -------
CASH USED BY INVESTING ACTIVITIES ...................... (613) (315)
------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net advances of line of credit borrowings ......... 2,175 3,680
Cash dividends paid ............................... (127) (191)
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NET CASH PROVIDED BY
FINANCING ACTIVITIES .............................. 2,048 3,489
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NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS ... (10) 68
CASH AND CASH EQUIVALENTS
AT THE BEGINNING OF THE PERIOD .................... 44 34
------- -------
CASH AND CASH EQUIVALENTS AT END OF PERIOD ............ $ 34 $ 102
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(continued on next page)
7
WELLCO ENTERPRISES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE FISCAL SIX MONTHS ENDED
DECEMBER 30, 2006 AND DECEMBER 31, 2005
(in thousands)
(unaudited)
DECEMBER 30, DECEMBER 31,
2006 2005
--------------------------
SUPPLEMENTAL DISCLOSURE OF CASH
FLOW INFORMATION:
Cash paid for-
Interest................................... $ 38 $ 104
Income taxes paid (refund)................ $ (269) $ 120
======= =======
See Notes to Consolidated Financial Statements.
8
WELLCO ENTERPRISES, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
FOR THE FISCAL SIX MONTHS ENDED
DECEMBER 30, 2006
(in thousands except number of shares and per share amounts)
(unaudited)
Common Stock Additional
Par Paid-In Retained
Shares Value Capital Earnings
--------------------------------------------
BALANCE AT JULY 1, 2006 1,270,746 $ 1,271 $ 1,319 $ 10,630
Net loss for the fiscal six
months ended December 30, 2006 (627)
Cash dividend ($.20 per share) (254)
---------------------------------------------
BALANCE AT DECEMBER 30, 2006 1,270,746 $ 1,271 $ 1,319 $ 9,749
=============================================
Accumulated
Other
Comprehensive
Loss
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ADDITIONAL PENSION LIABILITY,
NET OF TAX, BALANCE
AT JULY 1, 2006 $ (1,007)
Change for the fiscal six
months ended December 30, 2006 -
-------------
BALANCE AT DECEMBER 30, 2006 $ (1,007)
=============
See Notes to Consolidated Financial Statements.
9
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
------------------------------------------------------
FOR THE FISCAL SIX MONTHS ENDED DECEMBER 30, 2006
-------------------------------------------------
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. RECENT FINANCIAL ACCOUNTING STANDARDS:
In July 2006, the FASB issued FASB Interpretation No. 48, Accounting for
Uncertainty in Income Taxes--an interpretation of FASB Statement No. 109
('FIN 48"), which clarifies the accounting for uncertainty in tax
positions. This Interpretation requires that we recognize in our financial
statements, the impact of a tax position, if that position is more likely
than not of being sustained on audit, based on the technical merits of the
position. The provisions of FIN 48 are effective as of the beginning of our
2007 fiscal year, with the cumulative effect of the change in accounting
principle recorded as an adjustment to opening retained earnings. The
Company will begin to evaluate whether FIN 48 has any impact on the
Company's financial statements prior to its effective date.
In June 2006, the FASB ratified the Emerging Issues Task Force ("EITF")
position EITF 06-3, How Taxes Collected from Customers and Remitted to
Governmental Authorities Should Be Presented in the Income Statement (That
is Gross versus Net Presentation), that addresses disclosure requirements
for taxes assessed by a governmental authority that is both imposed on and
concurrent with a specific revenue-producing transaction between a seller
and a customer, and may include, but is not limited to, sales, use, value
added, and some excise taxes. EITF 06-3 requires disclosure of the method
of accounting for the applicable assessed taxes, and the amount of assessed
taxes that are included in revenues if they are accounted for under the
gross method. The provisions of EITF 06-3 are effective for interim and
annual reporting periods beginning after December 15, 2006 with earlier
application permitted. The adoption of EITF 06-3 is not expected to have a
material impact on the Company's consolidated financial statements.
In September 2006, the FASB issued SFAS No. 158, Employers' Accounting for
Defined Benefit Pension and Other Postretirement Plans -- An Amendment of
FASB Statements No. 87, 88, 106, and 132R requires an employer to: (a)
recognize in its statement of financial position an asset for a plan's
overfunded status or a liability for a plan's underfunded status; (b)
measure a plan's assets and its obligations that determine its funded
status as of the end of the employer's fiscal year (with limited
10
exceptions); and (c) recognize changes in the funded status of a defined
benefit postretirement plan in the year in which the changes occur. Those
changes will be reported in comprehensive income. The requirement to
recognize the funded status of a benefit plan and the disclosure
requirements are effective as of the end of the fiscal year ending after
December 15, 2006. The requirement to measure plan assets and benefit
obligations as of the date of the employer's fiscal year-end statement of
financial position is effective for fiscal years ending after December 15,
2008. The Company is in the process of evaluating the impact of FAS 158.
3. LINE OF CREDIT:
The Company maintains a $7,500,000 bank line of credit. The Company's line
of credit was scheduled to renew on December 31, 2006. However, the line of
credit was extended until March 31, 2007. On March 31, 2007, the line of
credit can be renewed until December 31, 2007 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 December 30, 2006,
borrowings on this line of credit were $2,800,000 with $4,700,000 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 as of December 30, 2006.
4. 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 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 (loss) 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.
For the Six Months Ended 12/30/06
---------------------------------
Net Loss Shares Per-Share
(Numerator) (Denominator) Amount
------------------------------------------------------------------------
Basic EPS Available to
Shareholders $ (627,000) 1,270,746 $ (0.49)
------------------------------------------------------------------------
Effect of Dilutive Stock-based
Compensation Arrangements
(Note: N/A - Anti-dilutive)
------------------------------------------------------------------------
Diluted EPS Available to
Shareholders $ (627,000) 1,270,746 $ (0.49)
------------------------------------------------------------------------
For the Six Months Ended 12/31/05
---------------------------------
Net Loss Shares Per-Share
(Numerator) (Denominator) Amount
------------------------------------------------------------------------
Basic EPS Available to
Shareholders $ (421,000) 1,270,746 $ (0.33)
------------------------------------------------------------------------
Effect of Dilutive Stock-based
Compensation Arrangements
(Note: N/A - Anti-dilutive)
------------------------------------------------------------------------
Diluted EPS Available to
Shareholders $ (421,000) 1,270,746 $ (0.33)
------------------------------------------------------------------------
11
For the Three Months Ended 12/30/06
-----------------------------------
Net Loss Shares Per-Share
(Numerator) (Denominator) Amount
------------------------------------------------------------------------
Basic EPS Available to
Shareholders $ (256,000) 1,270,746 $ (0.20)
------------------------------------------------------------------------
Effect of Dilutive Stock-based
Compensation Arrangements
(Note: N/A - Anti-dilutive)
------------------------------------------------------------------------
Diluted EPS Available to
Shareholders $ (256,000) 1,270,746 $ (0.20)
------------------------------------------------------------------------
For the Three Months Ended 12/31/05
-----------------------------------
Net Income Shares Per-Share
(Numerator) (Denominator) Amount
------------------------------------------------------------------------
Basic EPS Available to
Shareholders $ 225,000 1,270,746 $ 0.18
------------------------------------------------------------------------
Effect of Dilutive Stock-based
Compensation Arrangements 21,411
------------------------------------------------------------------------
Diluted EPS Available to
Shareholders $ 225,000 1,292,157 $ 0.18
------------------------------------------------------------------------
5. STOCK-BASED COMPENSATION:
Effective July 3, 2005, the Company adopted Statement of Financial
Accounting Standards No. 123R (revised 2004), "Share-Based Payment,"
("SFAS No. 123R") which was issued by the FASB in December 2004. SFAS No.
123R revises SFAS No. 123 "Accounting for Stock Based Compensation," and
supersedes APB No. 25, "Accounting for Stock Issued to Employees,"
(APB No. 25) and its related interpretations. SFAS No.123R requires
recognition of the cost of employee services received in exchange for
an award of equity instruments in the financial statements over the
period the employee is required to perform the services in exchange for the
award (presumptively the vesting period). SFAS No. 123R also requires
measurement of the cost of employee services received in exchange for an
award based on the grant-date fair value of the award. SFAS No. 123R also
amends SFAS No. 95 "Statement of Cash Flows," to require that excess tax
benefits be reported as financing cash inflows, rather than as a reduction
of taxes paid, which is included within operating cash flows.
The Company adopted SFAS No.123R using the modified prospective application
as permitted under SFAS No. 123R. Accordingly, prior period amounts have
not been restated. Under this application, the Company is required to
record compensation expense for all awards granted after the date of
adoption and for the unvested portion of previously granted awards that
remain outstanding at the date of adoption. As of the date of adoption, the
Company had no unvested previously granted awards and has not granted any
awards after July 1, 2006. There have been no options exercised during the
interim periods ended December 30, 2006and December 31, 2005. Therefore,
the new standard has had no impact on the consolidated statements of
operations and cash flows, or earnings per share of the Company during the
current reporting periods.
As of December 30, 2006, the Company had 52,500 options outstanding and
exercisable at a weighted average exercise price of $ 10.65 per share.
12
The Company currently has two share-based compensation plans in effect at
December 30, 2006 and information about them is contained in the notes to
the consolidated financial statements filed as part of the Company's 2006
annual report on Form 10-K. This quarterly report should be read in
conjunction with such annual report.
6. 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 Six Months Ended
--------------------------------------------------------------------------
December 30, December 31,
2006 2005
--------------------------------------------------------------------------
Benefits Earned for Service
in the Current Period $76,600 $93,000
--------------------------------------------------------------------------
Interest on the Projected
Benefit Obligation 165,200 158,000
--------------------------------------------------------------------------
Expected Return on Plan Assets (171,200) (162,200)
--------------------------------------------------------------------------
Amortization of: Unrecognized Net
Pension Obligation at July 1,
1987; Cost of Benefit Changes Since
That Date; and Gains and
Losses Against Actuarial Assumptions 17,400 47,200
--------------------------------------------------------------------------
Pension Expense $88,000 $136,000
--------------------------------------------------------------------------
For the Three Months Ended
--------------------------------------------------------------------------
December 30, December 31,
2006 2005
--------------------------------------------------------------------------
Benefits Earned for Service
in the Current Period $38,300 $46,500
--------------------------------------------------------------------------
Interest on the Projected
Benefit Obligation 82,600 79,000
--------------------------------------------------------------------------
Expected Return on Plan Assets (85,600) (81,100)
--------------------------------------------------------------------------
Amortization of: Unrecognized Net
Pension Obligation at July 1,
1987; Cost of Benefit Changes Since
That Date; and Gains and
Losses Against Actuarial Assumptions 8,700 23,600
--------------------------------------------------------------------------
Pension Expense $44,000 $68,000
--------------------------------------------------------------------------
13
7. 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
employees. The Consolidated Statements of Operations for the six months
and three months ended December 30, 2006 include $340,000 and $181,000,
respectively, as revenues. The Consolidated Statements of Operations for
the six months and three months ended December 31, 2005 include $381,000
as revenues.
The Company has an outstanding uncollected reimbursement claim for
$491,000 for compensation paid employees and expensed through December 30,
2006. The Company's policy is to recognize reimbursements as revenue in
the period that they are received.
8. GRANT MONEY RECEIVED:
The Company has received to date approximately $442,000 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 monies it has received. 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 Company did not recognize any grant
income for the six months or three months ended December 30, 2006 due to
the level of employment being below the required level in the grant
document. As of December 30, 2006, the Company has approximately $206,000
of deferred grant income reported in its consolidated balance sheet. Until
a determination of whether any potential refunds will be required, the
Company will not recognize any remaining portion of this deferred grant
income. The Consolidated Statements of Operations for the six-month period
ended December 31, 2005 recognized $85,000 as grant income including
$41,000 that related to grant periods prior to fiscal year 2006. The
Consolidated Statements of Operations for the three-month period ended
December 31, 2005 recognized $23,000 as grant income.
9. 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.
10. PROPOSED MERGER AGREEMENT AND ASSOCIATED MERGER COSTS:
On February 7, 2007, the Company announced a definitive merger agreement
to be acquired in an all-cash transaction valued at $14.00 per share by
14
Golden Gate Capital. As a result of the Merger, each holder of the
Company's common stock will be entitled to receive $14.00 per share in
cash. In addition, the Merger Agreement provides that each holder of an
outstanding option to purchase shares of the Company common stock issued
under the Company stock option plans will be entitled to receive cash in
an amount per share to the difference between $14.00 and the exercise
price of the option contingent upon the holder entering into an
acknowledgement canceling the options upon consummation of the Merger.
The proposed merger agreement has received unanimous approval from a
committee of independent directors of the Company and its Board of
Directors. Soles Brower Smith & Co. advised the independent committee and
provided it and the Board of Directors with a fairness opinion. The
parties anticipate closing the transaction in the first half of calendar
2007. The closing is subject to certain customary closing conditions,
including receipt of required regulatory approvals and the Company's
shareholder approval. Also, part of the merger agreement is a restriction
prohibiting the Company from paying any further dividends on its common
stock.
The Company has agreed to file a proxy statement in connection with the
proposed merger agreement and related transactions. The proxy statement
will be mailed to the shareholders of the Company and they are urged to
read the proxy statement and other relevant materials when they become
available.
As a result of the planned Merger, the Consolidated Statements of
Operations for the six month and three month period ended December 30,
2006 include $135,000 in costs directly related to the Merger as a
component of operating loss.
15
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 judgments by
management.
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.
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.
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.
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
16
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 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 1, 2006, the end of the 2006 fiscal year, there have been no changes
in the nature of the estimates and assumptions related to these critical
accounting policies.
Comparing the Six Months Ended December 30, 2006 and December 31, 2005:
- ----------------------------------------------------------------------
OVERVIEW
--------
The most significant events occurring in the six months ended December 30, 2006
(current period) compared to the six months ended December 31, 2005 (prior
period) are:
1. 44% decrease in total pairs of boots sold under contracts with the U.S.
Department of Defense (DOD).
2. The Company incurred $135,000 in merger related costs.
Comparative results for these two periods is as follows:
- --------------------------------------------------------------------------------
Current Period Prior Period
Six Months Ended Six Months Ended
December 30, December 31, Change % of Change
(Amounts in thousands) 2006 2005
- --------------------------------------------------------------------------------
Revenues $11,584 $19,359 $(7,775) (40%)
- --------------------------------------------------------------------------------
Cost of Sales 10,894 18,529 (7,635) (41%)
- --------------------------------------------------------------------------------
Gross Profit 690 830 (140) (17%)
- --------------------------------------------------------------------------------
Administrative Expenses 1,373 1,245 (128) (10%)
- --------------------------------------------------------------------------------
Grant Income - 85 (85) (100%)
- --------------------------------------------------------------------------------
Merger Costs 135 - (135) (100%)
- --------------------------------------------------------------------------------
Operating Loss (818) (330) (488) (148%)
- --------------------------------------------------------------------------------
Interest Expense, Net 40 109 69 63%
- --------------------------------------------------------------------------------
Benefit from Income Taxes 231 18 213 1183%
- --------------------------------------------------------------------------------
Net Loss $(627) $(421) $(206) (49%)
- --------------------------------------------------------------------------------
For the current period, Wellco had a net loss of $627,000 from revenues of
$11,584,000 compared to a net loss of $421,000 from revenues of $19,359,000 in
the prior period.
17
In the current period the Company shipped 118,000 pairs of boots under contract
with the U.S. Department of Defense as compared to 211,000 pairs in the prior
period, a decrease of 93,000 pairs.
The Company's primary customer is the Defense Supply Center Philadelphia (DSCP),
the DOD agency with which the Company contracts for the manufacture of boots
used by U. S. Armed Forces personnel. Revenues decreased by $7,775,000. The
primary reason for the decrease was a 44% reduction of total pairs of boots
shipped to the U.S. government due to DSCP reducing inventories of certain
boots.
Revenues from technical assistance fees and equipment rentals from licensees,
which vary with their shipments, decreased $172,000 because the Company's boot
manufacturing licensees were also affected by the DOD's reduction in inventories
of certain boots.
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. During the
current period, the Company received $340,000 of reimbursement under this
program, which is included in revenues. In the prior period, the Company
received $381,000 of reimbursement. The Company's policy is to recognize the
reimbursements as revenue in the period in which it is received, and not when
the related compensation is paid.
Gross profit for the six months ended December 30, 2006 was $690,000 on much
lower sales volume as compared to a gross profit of $830,000 for the prior
period. During the current period, the gross profit margin was 6% of revenues
due to an extremely low level of production and sales volume. Fixed costs (such
as depreciation, insurance and rent) and semi-variable costs did not decrease
proportionately to the decrease in the production and sales volume. In addition,
the Company retained critical operating personnel assuming the low level of
production would be temporary.
During the prior six-month period, the gross profit was 4.3% of revenues. 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 rate of boot production was reduced due to the
limited supply of this component. After this supplier solved its quality
problem, the rate of production continued to be impaired, as it took that
supplier several weeks to reestablish full production. The supplier agreed to
reimburse certain excess manufacturing costs and this reimbursement has been
reflected in the Cost of Sales and Services for the six months ending December
31, 2005. However, some of the excess costs could not be recouped from the
supplier.
During the current period, the $128,000 increase in general and administrative
expenses was primarily caused by increase in administrative salaries,
professional fees and health care costs. The Company's employee group health
insurance costs vary with actual health care costs incurred because the Company
is self-funded.
The amount of grant income recognized in the current period under the Puerto
Rico Special Incentives Contract was $0 as compared to $85,000 during the prior
18
period. 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. During the current
period, the Company's level of employment was below the level of employment
required in the grant document. Thus, for the current period, the Company did
not recognize grant revenues. Until the level of employment surpasses the level
required in the grant document or until the Puerto Rican Government indicates
that a refund will not be requested, the Company will not recognize any further
portion of its deferred grant income. As of December 30, 2006, the Company has
approximately $206,000 of deferred grant income reported in its consolidated
balance sheet.
As a result of the planned Merger, the Consolidated Statements of Operations for
the six-month period ended December 30, 2006 include $135,000 in costs directly
related to the Merger as a component of operating loss. The costs include
professional fees for investment advisors, attorneys and environmental studies.
Interest expense decreased $69,000 because of less borrowing on the bank line of
credit. In addition, the current bank line of credit charges an unused fee for
the amount not borrowed on the line.
For the current period, the Company reflected income tax benefit of $231,000 on
a pretax loss of $858,000 at an effective benefit rate of 26%. For fiscal year
2007, the Company will file a consolidated federal income tax return that will
include the subsidiary in Puerto Rico. Fiscal year 2006 was the last year that
the Company received a federal tax credit for income earned at its subsidiary in
Puerto Rico which was able to file a separate federal income tax return. For the
prior period, the effective income tax benefit was 4% of a pretax loss of
$439,000. For the prior period, the benefit rate of 4% is less than the U.S.
federal tax statutory rate of 34% because the majority of the loss was from its
operations in Puerto Rico, which was substantially exempt from U.S. income tax.
Comparing the Three Months Ended December 30, 2006 and December 31, 2005:
- ------------------------------------------------------------------------
OVERVIEW
--------
The most significant events occurring in the three months ended December 30,
2006 (current period) compared to the three months ended December 31, 2005
(prior period) are:
1. 47% decrease in total pairs of boots sold under contracts with the U.S.
Department Defense (DOD).
2. In the current period, the Company received and recognized as revenues
$181,000 from the Government of Puerto Rico under its program, which
reimburses the Company for part of the compensation paid to certain
employees. The prior period included $381,000 reimbursement. These
payments are recorded as revenues in the period received.
3. The Company incurred $135,000 in merger related costs.
Comparative results for these two periods is as follows:
19
- --------------------------------------------------------------------------------
Current Period Prior Period
Six Months Ended Six Months Ended
December 30, December 31, Change % of Change
(Amounts in thousands) 2006 2005
- --------------------------------------------------------------------------------
Revenues $6,255 $11,041 $(4,786) (43%)
- --------------------------------------------------------------------------------
Cost of Sales 5,747 10,127 (4,380) (43%)
- --------------------------------------------------------------------------------
Gross Profit 508 914 (406) (44%)
- --------------------------------------------------------------------------------
Administrative Expenses 736 636 (100) (16%)
- --------------------------------------------------------------------------------
Grant Income - 23 (23) (100%)
- --------------------------------------------------------------------------------
Merger Costs 135 - (135) (100%)
- --------------------------------------------------------------------------------
Operating Income (Loss) (363) 301 (664) (221%)
- --------------------------------------------------------------------------------
Interest Expense, Net 26 66 40 61%
- --------------------------------------------------------------------------------
Income Taxes (Benefit) (133) 10 143 1430%
- --------------------------------------------------------------------------------
Net Income (Loss) $(256) $225 $(481) (214%)
- --------------------------------------------------------------------------------
For the current period, Wellco had a net loss of $256,000 from revenues of
$6,255,000 compared to a net income of $225,000 from revenues of $11,041,000 in
the prior period.
Revenues in the current period decreased by $4,786,000. The primary reason for
the decrease was a 47% reduction of total pairs of boots shipped to the U.S.
government due to DSCP reducing inventories of certain boots. In the current
period the Company shipped 63,000 pairs of boots under contract with the U.S.
Department of Defense as compared to 119,000 pairs in the prior period, a
decrease of 56,000 pairs.
Revenues from technical assistance fees and equipment rentals from licensees,
which vary with their shipments, decreased $83,000 because the Company's boot
manufacturing licensees were also affected by the DOD's reduction in inventories
of certain boots.
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. During the
current period, the Company received $181,000 of reimbursement under this
program, which is included in revenues. In the prior period, the Company
received $381,000 of reimbursement. The Company's policy is to recognize the
reimbursements as revenue in the period in which it is received, and not when
the related compensation is paid.
Gross profit for the three months ended December 30, 2006 was $508,000 as
compared to gross profit of $914,000 for the prior period. During the current
period, the gross profit margin was only 8.1% of revenues due to an extremely
low level of production and sales volume.
20
During the current period, the $100,000 increase in general and administrative
expenses was primarily caused by an increase in administrative salaries,
professional fees and health care costs.
The amount of grant income recognized in the current period under the Puerto
Rico Special Incentives Contract was $0 as compared to $23,000 during the prior
period. 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. During the current
period, the Company's level of employment was below the level of employment
required in the grant document. Thus, for the current period, the Company did
not recognize grant revenues. Until the level of employment surpasses the level
required in the grant document or until the Puerto Rican Government indicates
that a refund will not be requested, the Company will not recognize any further
portion of its deferred grant income.
Interest expense decreased $40,000 because of limited use of the bank line of
credit. With the current bank line of credit, there is an unused fee for the
amount not borrowed on the line.
For the current period, the Company reflected income tax benefit of $133,000 on
a pretax loss of $389,000 at an effective benefit rate of 34%. For fiscal year
2007, the Company will file a consolidated federal income tax return that will
include the subsidiary in Puerto Rico. Fiscal year 2006 was the last year that
the Company received a federal tax credit for income earned at its subsidiary in
Puerto Rico which was able to file a separate federal income tax return. For the
prior period, the effective income tax rate was 4% on a pretax income of
$235,000. For the prior period, the tax rate of 4% is less than the U.S. federal
tax statutory rate of 34% because the operations in Puerto Rico had net income,
which was substantially exempt from U.S. income tax.
Forward Looking Information:
- ---------------------------
In early February 2006, Department of Defense extended the delivery dates for
two boot orders under its contracts. The original delivery dates for boot
shipments in April through June 2006 were extended to May through August 2006.
The Company was informed the Army's current usage of boots was lower than the
rate projected when the orders were issued. Consequently, DOD has issued much
smaller orders for Hot Weather and Temperate Weather boots.
Due to the reduced orders from DOD, approximately 70,000 pairs will be shipped
during the third fiscal quarter of 2007 compared to 166,000 pairs shipped during
the third quarter of 2006.For the third fiscal quarter of 2007, the reduction in
boot shipments will have a negative effect on margins when compared to the third
fiscal quarter of 2006.
On February 2, 2007, the Natick Contracting Division of DOD awarded the Company
a one-year contract to supply the Hot Weather Flame Resistant boot with a
minimum 20,000 pairs and a maximum 65,000 pairs to be ordered. The first
delivery order has been issued for 25,000 pairs. The Hot Weather Flame Resistant
contract is a new product for the Company.
Below is a summary of the Company's current boot contracts with the Defense
Department. The Company's Defense Department boot contracts are indefinite
21
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. In
late September 2006, DOD extended the Hot Weather contract period until
September 29, 2006 so they could place one more delivery order under
the contract before it expired. At December 30, 2006, the Company had a
backlog of 15,000 of Hot Weather Boots and this is the final order
under this Hot Weather contract.
On July 7, 2006, the Defense Department exercised the third option year
under the Company's Temperate Weather boot contract. For the third
option year, the minimum pairs are 10,000 and the maximum are 227,000.
Pairs ordered to date under the third option year are 64,000.This
contract has one more option year outstanding. The exercise of any
contract option is the unilateral decision of the Defense Department.
On April 13, 2006, the Company received a Department of Defense
contract to supply the U.S. Army with Extreme Cold Weather boots. This
contract is for a one-year period, with four one-year options, which
are exercisable at the government's discretion. The base year is for a
minimum of 5,000 pairs and a maximum of 29,000 pairs. Pairs ordered to
date under the base year are 4,700 pairs. DOD has issued their letter
of intent to exercise the first option under the Mukluk contract.
On August 2, 2006, the Company submitted a proposal for the new Hot Weather boot
solicitation, which will replace the Hot Weather contract that expired on
September 29, 2006. The solicitation is for an indefinite quantity contract with
a base year and four one-year option periods. DSCP was to award the contract
within 180 days. However, they recently requested that we extend our bid
proposal until February 28, 2007 to allow them more time to award the contract
and we granted the extension. DSCP intends to make five awards, of which three
will be restricted to contractors who meet the criteria for being a small
business, and two contracts will be awarded without the small business
restriction. The Company is not a small business. Bidding on government
solicitations is very competitive, and the Company cannot confidently predict
its success in receiving a contract award from any solicitation. If the Company
does not receive a contract from this solicitation, future operating results and
liquidity will be adversely affected.
The Company also submitted a bid for a new solicitation for a boot known as the
Intermediate Cold Weather Boot. This particular boot will have a minimum 29,000
pairs with a maximum of 90,000 pairs per base year and four option years
available. The Company has also submitted a bid for a boot known as the Flight
Deck Safety Boot. This product is a new item for Wellco in the bid process. The
contract calls for minimum 37,000 pairs with maximum potential of 88,000 pairs
in the base year with four option years. In late December, the Company submitted
a proposal to supply the Safety Hot Weather Boot. The contract will have a
minimum 24,000 pairs with a maximum of 69,000 pairs per base year and four
option years. All three solicitations are for new products and the Company
cannot predict its success in receiving a contract award from these
solicitations.
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
22
for part of the compensation paid to certain employees in training. As of
December 30, 2006, $491,000 has been filed for, but has not been received or
recorded as revenues, reimbursement under this program. 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 $491,000. In the past
four fiscal years, the Company has received and recorded as revenues a total of
$2,644,000 under this program.
In December 2005, the Company was one of two contract awardees for the
development of the US Army Modular Boot System. This award was the result of the
Company's response to the Modular Boot System solicitation that required
submission of data and product demonstration models illustrating the Company's
concept of the modular boot system. This contract provides the development of a
Modular Boot System 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. The contract's goal is to develop a
functional boot system to provide comfort in a temperature range of -60(0)F to
120(0)F. If successful, the new Modular Boot System would replace many of the
current boot styles.
The Department of Defense placed its first order under this contract for 580
pairs of the Modular Boot System and the boots were shipped in March 2006.
Recent feedback from the Natick Contracting Division of the U.S. Army was very
positive on the testing of the first order of boots. Recently, DOD exercised the
second option to supply the development of the Modular Boot System and issued an
order for 450 pairs of the MBS. The Company recently shipped the 450 pairs for
expanded testing. If the Wellco Modular Boot System is successful through all
phases of development and testing, the contract provides for Wellco to
manufacture 160,000 pairs of this boot for issuance to military personnel. As
with any contract, there is no assurance that Wellco will be successful in
receiving the contract to manufacture the 160,000 pairs.
The Company is actively bidding on solicitations for footwear contracts with the
U.S. military for new products. At the same time, we are very focused on
building our commercial wholesale and retail business.
Income earned by the Company's Puerto Rico subsidiary has for many years been
fully exempt from U. S. income taxes. Fiscal year 2006 was the last year in
which this subsidiary has any exemption from U. S. income taxes. For fiscal year
2007 and forward, the Company and all its subsidiaries including Puerto Rico
will be taxed at the regular U.S. federal tax rates and as a result, any Company
profits will be impacted by higher effective tax rates than in the past.
On February 7, 2007, the Company announced a definitive merger agreement to be
acquired in an all-cash transaction valued at $14.00 per share by Golden Gate
Capital. As a result of the Merger, each holder of the Company's common stock
will be entitled to receive $14.00 per share in cash. In addition, the Merger
Agreement provides that each holder of an outstanding option to purchase shares
of the Company common stock issued under the Company stock option plans will be
entitled to receive cash in an amount per share to the difference between $14.00
and the exercise price of the option contingent upon the holder entering into an
acknowledgement canceling the options upon consummation of the Merger.
The proposed merger agreement has received unanimous approval from a committee
of independent directors of the Company and its Board of Directors. Soles Brower
Smith & Co. advised the independent committee and provided it and the Board of
Directors with a fairness opinion. The parties anticipate closing the
transaction in the first half of calendar 2007. The closing is subject to
23
certain customary closing conditions, including receipt of required regulatory
approvals and the Company's shareholder approval.Also, in the merger agreement
is a restriction prohibiting the Company from paying any further dividends on
its common stock.
If the merger agreement is closed, the Company will become privately owned and
will not be required to comply with Section 404 of the Sarbanes-Oxley Act of
2002. However, if the merger agreement does not close, 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
Company has received quotations from outside firms specializing in the review,
documentation and testing of internal controls. Based on these quotations and on
reported information about the costs other companies are incurring, the Company
estimates that the cost of the internal control review and audit will be between
$200,000 and $500,000. The Company cannot reasonably predict whether material
weaknesses will be found in its internal controls over financial reporting.
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.
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 six-month period
and the last fiscal year, the amounts of cash and unused line of credit:
(in thousands)
December 30, 2006 July 1, 2006
-------------------------------------------------------------
Cash and Cash Equivalents $34 $44
-------------------------------------------------------------
Unused Line of Credit 4,700 6,875
-------------------------------------------------------------
Total $4,734 $6,919
-------------------------------------------------------------
The following table summarizes the cash flow activities for the six-month period
ended December 30, 2006:
Cash provided by (used in): (in thousands)
----------------------------------------------------
Operating activities $(1,445)
----------------------------------------------------
Investing activities (613)
----------------------------------------------------
Financing activities 2,048
----------------------------------------------------
Net change in cash and cash equivalents $(10)
----------------------------------------------------
24
Operating Activities: In the six months ended December 30, 2006, cash used by
operations was $1,445,000. Depreciation of $669,000, an increase of $72,000 in
account payables, and a $39,000 increase in accrued income taxes were the main
operating sources of cash. The main uses of operating cash were the net loss of
$627,000, increases of $102,000 in accounts receivables, $1,068,000 in
inventories, and a decrease of $196,000 in accrued compensation and $84,000 in
other liabilities and an increase of $148,000 in prepaid expenses.
Investing Activities: In the six months ended December 30, 2006, purchases of
machinery, equipment and leasehold improvements was $613,000.
Financing Activities: In the six months ended December 30, 2006, the Company's
net cash provided by financing activities totaled $2,048,000. Cash was provided
through additional borrowings of $2,175,000 from the line of credit. $127,000
was used to pay quarterly dividend payments to stockholders.
The following table shows aggregated information about contractual obligations
as of December 30, 2006:
Payments Due by Period
Total Less Than 1 Year 1-3 Years 4-5 Years After 5 Years
- --------------------------------------------------------------------------------
Notes Payable $300,000 $300,000 -
- --------------------------------------------------------------------------------
Building Lease 705,000 275,000 $430,000 -
- --------------------------------------------------------------------------------
Total $1,005,000 $275,000 $430,000 $300,000 -
- --------------------------------------------------------------------------------
In addition, during the six month period ended December 30, 2006, the Company
paid $38,000 in interest expense and $169,000 in contributions to its pension
plans. The Company received a tax refund of $270,000 during the six-month period
ended December 30, 2006.
On February 7, 2007, the Company announced a definitive merger agreement to be
acquired in an all-cash transaction valued at $14.00 per share by Golden Gate
Capital. As a result of the Merger, each holder of the Company's common stock
will be entitled to receive $14.00 per share in cash.
The parties anticipate closing the transaction in the second half of fiscal
2007. The closing is subject to certain customary closing conditions, including
receipt of required regulatory approvals, the Company's shareholder approval,
and a restriction prohibiting the Company from paying any further dividends on
its common stock. As a result of the planned Merger, the Consolidated Statements
of Operations for the six month and three month period ended December 30, 2006
include $135,000 in costs directly related to the Merger as a component of
operating loss. During the remaining six months of fiscal year 2007, additional
merger costs are estimated to be between $400,000 to $500,000 for professional
fees and other direct merger costs. In addition, according to the definitive
agreement, after closing there will be stay bonuses paid to certain executives
for approximately $1,700,000.
25
The Company maintains a $7,500,000 bank line of credit. Borrowings under the
line of credit at December 30, 2006 were $2,800,000.
The bank line of credit will expire and be subject to renewal on March 31, 2007.
Historically, the bank has always renewed the line of credit. Under conditions
of substantial reduction in operations, and in the event there is little basis
for projecting a reversal of such reduction, it is possible that the bank could
terminate or 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 March 31, 2007, and would be
adversely affected if the line were 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 December
30, 2006.
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 March 31, 2007, 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.
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
26
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 1, 2006. 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 December 30, 2006 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.
27
PART II. OTHER INFORMATION
--------------------------
Item 1. Legal Proceedings. N/A
Item 1(A). Risk Factors. There have been no material changes to our
risk factors as disclosed in Item 1A. "Risk Factors" in
our Annual Report on Form 10-K for the year ended July 1,
2006.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
N/A
Item 3. Defaults Upon Senior Securities. N/A
Item 4. The 2006 Annual Stockholders Meeting of Wellco Enterprises,
Inc. was on November 14, 2006. The only matter voted on
at that meeting was the election of directors. The results of
the voting were.
Directors were elected as follows:
Nominee for Director Shares Voted For Shares Withheld
Claude Abernethy 1,069,583 62,093
Katherine J. Emerson 1,076,018 55,658
Lee Ferguson 1,124,280 7,396
George Henson 1,068,718 62,958
Rolf Kaufman 1,070,418 61,258
David Kemper 1,076,018 55,658
John D. Lovelace 1,064,398 67,278
Sarah E. Lovelace 1,064,398 67,278
Fred K. Webb, Jr. 1,070,418 61,258
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.
28
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\
- ------------------------------------------ -------------------------------------
Lee Ferguson, Chief Executive Officer and Tammy Francis, Vice President of
President (Principal Executive Officer) Finance and Treasurer (Chief
Financial Officer)
- --------------------------------------------------------------------------------
February 13, 2007
29
Exhibit 31
----------
WELLCO ENTERPRISES, INC.
FORM 10-Q FOR THE SIX MONTHS ENDED DECEMBER 30, 2006
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, Lee Ferguson, 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
30
(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: February 13, 2007
/s/ Lee Ferguson
By: Lee Ferguson, Chief Executive Officer and President
(Chief Executive Officer)
31
WELLCO ENTERPRISES, INC.
FORM 10-Q FOR THE SIX MONTHS ENDED DECEMBER 30, 2006
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
32
(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: February 13, 2007
/s/ Tammy Francis
By: Tammy Francis, Vice President of Finance and Treasurer
(Chief Financial Officer)
33
Exhibit 32
----------
WELLCO ENTERPRISES, INC.
FORM 10-Q FOR THE SIX MONTHS ENDED DECEMBER 30, 2006
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, Lee Ferguson, certify that:
1. I am the chief executive officer of Wellco Enterprises, Inc.
2. Attached to this certification is Form 10-Q for the six months ended
December 30, 2006, 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 the
periodic report containing the financial statements fully complies with
the requirements of Section 13(a) or 15(d) of the Exchange Act, and the
information in the periodic report fairly presents, in all material
respects, the financial condition and results of operations of the
issuer for the periods presented.
Date: February 13, 2007
/s/ Lee Ferguson
By: Lee Ferguson, 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.
34
WELLCO ENTERPRISES, INC.
FORM 10-Q FOR THE SIX MONTHS ENDED DECEMBER 30, 2006
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 six months ended
December 30, 2006, 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 the
periodic report containing the financial statements fully complies with
the requirements of Section 13(a) or 15(d) of the Exchange Act, and the
information in the periodic report fairly presents, in all material
respects, the financial condition and results of operations of the
issuer for the periods presented.
Date: February 13, 2007
/s/ Tammy Francis
By: Tammy Francis, Vice President of Finance 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.
35