================================================================================ SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 --------------------------- FORM 10-Q (Mark One) [ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 for the period ended September 30, 1997 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 for the transition period from ____________________ To ____________________ Commission File Number: 1-8984 WEDGESTONE FINANCIAL (Exact Name of Registrant as Specified in its Charter) Massachusetts 04-26950000 (State or other jurisdiction (I.R.S. Employer of incorporation) Identification Number) 5200 N. Irwindale Avenue Suite 168 Irwindale, California 91706 (818) 338-3555 (Address, including zip code and telephone number, including area code of registrant's principal executive offices) --------------------------- Indicate by check mark whether the registrant has (1) 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 such shorter period that the registrant was required to file such reports and (2) has been subject to filing requirements for the past 90 days. [ X ] Yes [ ] No Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Section 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. [ X ] Yes [ ] No As of November 14, 1997, 21,885,668 shares of beneficial interest were outstanding. Total number of pages in this document: 14 ================================================================================ WEDGESTONE FINANCIAL & SUBSIDIARIES TABLE OF CONTENTS Page PART I FINANCIAL INFORMATION Item 1 Financial Statements Consolidated Balance Sheets - September 30, 1997 (unaudited) and December 31, 1996.........................................................................2 Consolidated Statements of Operations (unaudited) for the Three Months and Nine Months Ended September 30, 1997 and 1996........................3 Consolidated Statements of Shareholders' Equity (unaudited) for the Nine Months Ended September 30, 1997 and 1996.........................................4 Consolidated Statements of Cash Flows (unaudited) for the Three Months and Nine Months Ended September 30, 1997 and 1996........................5 Notes to Unaudited Consolidated Financial Statements......................................6 Item 2 Management's Discussion and Analysis of Financial Condition and Results of Operations.................................................................8 PART II OTHER INFORMATION Item 1 Legal Proceedings........................................................................12 Item 2 Changes in Securities....................................................................12 Item 3 Defaults upon Senior Securities..........................................................12 Item 4 Submission of Matters to a Vote of Security Holders......................................12 Item 5 Other Information........................................................................12 Item 6 Exhibits and Reports on Form 8-K.........................................................12 Signatures.................................................................................................13 -1- WEDGESTONE FINANCIAL AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS As of September 30, 1997 and December 31, 1996 (Amounts in Thousands - except share data) (Unaudited) 1997 1996 ---- ---- ASSETS Current Assets: Cash $ 91 $ 344 Accounts and other receivables - (net of allowances of $263 and $222 in 1997 and 1996, respectively) 7,319 7,282 Inventories 6,084 4,619 Prepaid expenses and other current assets 347 565 Deferred income taxes 500 476 -------- -------- Total Current Assets 14,341 13,286 -------- -------- Notes receivable - net 1,801 81 Real estate acquired by foreclosure - net 196 1,086 Property, plant and equipment - net 3,582 3,237 Goodwill 97 130 Deferred income taxes 1,357 2,196 Other assets 228 334 -------- -------- 7,261 7,064 -------- -------- Total Assets $ 21,602 $ 20,350 ======== ======== LIABILITIES AND SHAREHOLDERS' EQUITY Current Liabilities: Revolving credit line and current portion of long-term debt $ 537 $ 1,952 Accounts payable 4,559 3,882 Accrued payroll and related expenses 617 593 Other accrued expenses 1,431 1,535 -------- -------- Total Current Liabilities 7,144 7,962 Long-term debt 5,318 5,269 -------- -------- Total Liabilities 12,462 13,231 Commitments and contingencies Shareholders' Equity: Shares of Beneficial Interest-par value $1.00 per share: authorized - unlimited shares: issued and outstanding - 21,885,668 shares 21,886 21,886 Additional paid-in capital 31,396 31,396 Accumulated deficit (44,142) (46,163) -------- -------- Total Shareholders' Equity 9,140 7,119 -------- -------- Total Liabilities and Shareholders' Equity $ 21,602 $ 20,350 ======== ======== <FN> See notes to consolidated financial statements. </FN> -2- WEDGESTONE FINANCIAL AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS For the Three Months and Nine Months Ended September 30, 1997 and 1996 (Unaudited) (Amounts in Thousands - except per share data) Three Months Ended September 30, Nine Months Ended September 30, 1997 1996 1997 1996 ---- ---- ---- ---- Net sales $ 12,826 $ 11,441 $ 37,751 $ 34,389 Cost of sales 8,163 7,401 24,380 23,460 -------- -------- -------- -------- Gross profit 4,663 4,040 13,371 10,929 Selling, general and administrative expenses 3,429 3,254 10,059 8,867 -------- -------- -------- -------- Operating income 1,234 786 3,312 2,062 Goodwill amortization 11 11 33 38 Other income -- -- (418) -- Interest expense 176 267 648 876 -------- -------- -------- -------- Income before taxes 1,047 508 3,049 1,148 Provision for income taxes 287 98 1,028 300 -------- -------- -------- -------- Net income $ 760 $ 410 $ 2,021 $ 848 ======== ======== ======== ======== Net income per share of beneficial interest $ .03 $ .02 $ .09 $ .04 ======== ======== ======== ======== Weighted average number of shares outstanding 21,886 21,886 21,886 21,886 ======== ======== ======== ======== <FN> See notes to consolidated financial statements. </FN> -3- WEDGESTONE FINANCIAL AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY For the Nine Months Ended September 30, 1997 and 1996 (Unaudited) (Amounts in Thousands) Additional Shares of Beneficial paid-in Accumulated Interest capital deficit Total ------------------------ ---------- ----------- -------- Shares Amount Balance at December 31, 1995 21,886 $ 21,886 $ 31,396 ($47,535) $ 5,747 Net income 848 848 -------- -------- -------- -------- -------- Balance at September 30, 1996 21,886 $ 21,886 $ 31,396 ($46,687) $ 6,595 ======== ======== ======== ======== ======== Balance at December 31, 1996 21,886 $ 21,886 $ 31,396 ($46,163) $ 7,119 Net income 2,021 2,021 -------- -------- -------- -------- -------- Balance at September 30, 1997 21,886 $ 21,886 $ 31,396 ($44,142) $ 9,140 ======== ======== ======== ======== ======== <FN> See notes to consolidated financial statements. </FN> -4- WEDGESTONE FINANCIAL AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS For the Three Months and Nine Months Ended September 30, 1997 and 1996 (Unaudited) (Amounts in Thousands) Three Months Ended September 30 Nine Months Ended September 30 1997 1996 1997 1996 ---- ---- ---- ---- Cash Flows from Operating Activities: Net income $ 760 $ 410 $ 2,021 $ 848 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Depreciation and amortization 217 198 651 671 Gain on sale of real estate -- -- (418) -- Gain on disposal of assets -- (2) -- (204) Deferred income taxes 216 -- 815 52 Changes in operating assets and liabilities: Accounts and other receivables (460) 85 (37) (1,273) Inventories (512) (1,025) (1,465) (1,359) Prepaid expenses and other current assets 255 85 218 (43) Accounts payable 854 102 677 823 Accrued payroll and related expenses 187 93 24 76 Other accrued expenses 24 83 (104) (352) Other assets (8) (35) 16 (36) ------- ------- ------- ------- Net cash provided by (used in) operating activities 1,533 (6) 2,398 (797) ------- ------- ------- ------- Cash Flows from Investing Activities: Proceeds from sale of equipment -- 2 -- 234 Proceeds from sale of real estate -- -- 1,328 -- Capital expenditures (547) (249) (963) (595) Investment in notes receivable -- -- (1,650) -- Investment in real estate -- -- -- 5 ------- ------- ------- ------- Net cash used in investing activities (547) (247) (1,285) (356) ------- ------- ------- ------- Cash Flows from Financing Activities: Borrowings on term debt -- -- 841 -- Repayments of term debt (121) (697) (300) (1,134) Net borrowings (repayments) on revolving debt (930) 616 (1,907) 2,044 ------- ------- ------- ------- Net cash provided by (used in) financing activities (1,051) (81) (1,366) 910 ------- ------- ------- ------- Net decrease in cash (65) (334) (253) (243) Cash at beginning of period 156 456 344 365 ------- ------- ------- ------- Cash at end of period $ 91 $ 122 $ 91 $ 122 ======= ======= ======= ======= <FN> See notes to consolidated financial statements. </FN> -5- WEDGESTONE FINANCIAL AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS For the Three Months and Nine Months Ended September 30, 1996 and 1995 NOTE 1. Background and Basis of Presentation Background - Wedgestone Financial ("Wedgestone" or the "Company") was formed in 1980 as a real estate investment trust ("REIT") and, on August 9, 1991, filed for bankruptcy. Wedgestone's plan of reorganization (the "Plan") became effective on August 3, 1992. Wedgestone's primary business is now the manufacture and distribution of automotive aftermarket products for the light duty truck market. Its principal products include rear bumpers; tubular products such as grille guards, push bars, and step rails; and various other related aftermarket products. The Company's automotive products are marketed in traditional, original equipment dealer and retail automotive aftermarkets. The automotive segment manufactures and sells its products at two locations in California, and one in Minnesota. Sales are also made from distribution centers in Texas and Utah. Acquisitions - Since May 1992, Wedgestone has acquired three manufacturing operations. On June 15, 1992, Wedgestone acquired St. James Automotive Corp. ("St. James") in exchange for 6,795,220 shares of beneficial interest of Wedgestone and accounted for this acquisition as a purchase. On November 18, 1994, Wedgestone acquired the Automotive Segment of Standun, Inc. ("Standun"), which consisted of the Fey Automotive Products Division ("Fey") and Sigma Plating Co., Inc. ("Sigma") in exchange for 6,795,223 shares of beneficial interest of Wedgestone and the assumption of approximately $1,104,000 of outstanding debt due to a related party of Wedgestone, and certain other liabilities. The shareholders of Standun owned, directly or indirectly, approximately 48% of Wedgestone prior to the acquisition and, as a result, this acquisition was accounted for as a "put-together" which is similar to the pooling of interest method of accounting. As a result of the acquisition, Standun owned 31% of the outstanding shares of beneficial interest of Wedgestone. On January 9, 1995, Wedgestone acquired substantially all of the assets of Hercules Bumpers, Inc. ("Hercules"). The purchase price for the assets acquired was the assumption of certain debt and other liabilities approximating $5.1 million. In addition, certain debt was guaranteed jointly and severally by Charles W. Brady ("Brady"), the former principal shareholder of Hercules, and Chattahoochee Leasing Corporation ("CLC"), a corporation controlled by Brady. In exchange for this guarantee, Brady received a promissory note in the amount of $300,000 and 1,200,000 shares of beneficial interest of Wedgestone. In consideration for an agreement to pay a liability of Hercules, CLC received a promissory note for $100,000 which was secured by 100,000 shares of beneficial interest of Wedgestone. In June, 1995, the Company exercised its right under the CLC Agreement and acquired the note by issuing these shares to CLC. (See Note 3 - - Sale of Subsidiary.) Basis of Presentation and Principles of Consolidation The consolidated financial statements include the accounts of Wedgestone and its wholly owned subsidiaries. All significant intercompany transactions have been eliminated in consolidation. The financial statements included in this Form 10-Q have been prepared by the Company, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed, or omitted, pursuant to such rules and regulations. These financial statements should be read in conjunction with the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1996. The results of operations for the interim periods shown in this report are not necessarily indicative of results to be expected for the fiscal year. In the opinion of management, the information contained herein reflects all adjustments necessary to make the results of operations for the interim periods a fair statement of such operations. Income Per Share of Beneficial Interest - Income per share of beneficial interest is calculated based on weighted average outstanding shares of beneficial interest. NOTE 2. Inventories -6- Inventories consist of the following: (In Thousands) September 30, December 31, 1997 1996 ---- ---- Finished goods $ 3,352 $ 2,474 Work in progress 1,368 1,239 Raw materials 1,512 1,025 ------- ------- 6,232 4,738 Less allowances (148) (119) ------- ------- $ 6,084 $ 4,619 ======= ======= NOTE 3. Sale of Subsidiary On March 5, 1996, Hercules closed its manufacturing plant in Pelham, Georgia. The market for the bumpers produced in the Pelham facility significantly changed during 1995. Historically, a significant percentage of Hercules business was for sales to dealers of domestic original equipment manufacturers. A new program implemented by one of these manufacturers in late 1994 made it extremely difficult for Hercules to remain competitive in this market segment. Hercules incurred a net loss of $125,000 in 1995 and continued to incur losses in 1996 through the date of sale totaling $966,000. As a result, management determined that closing the Pelham facility was appropriate. On April 18, 1996, the Board of Directors authorized and completed the sale of the Company's stock ownership in Hercules to MBC Corporation for $1.00 and the assumption of certain debt and other liabilities approximating $4.5 million, pursuant to a Stock Purchase Agreement. -7- Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Background On June 15, 1992, Wedgestone acquired St. James Automotive Corp. This subsidiary manufactures and sells tubular products for the light-duty truck market such as grille guards, push bars and step bars. On November 18, 1994, Wedgestone acquired the Automotive Segment of Standun, Inc. ("Standun") which consisted of Sigma and the Fey Automotive Products division. The assets of the Fey division, which included the stock of Sigma, were merged into Wedgestone's wholly owned subsidiary Fey Automotive Products, Inc. In conjunction with the acquisition of the Automotive Segment of Standun, Wedgestone placed St. James, Fey and Sigma under the common ownership of its wholly owned subsidiary, Wedgestone Automotive. Collectively, these companies comprise Wedgestone Automotive. On January 5, 1995, Wedgestone Automotive, through its wholly owned subsidiary Hercules Automotive Products, Inc. acquired substantially all of the assets of Hercules Bumpers, Inc., a Georgia company. This acquisition was intended to provide access to a new business segment for Wedgestone Automotive. The segment, known as dealer direct, involves the sale of rear step bumpers for light-duty trucks to new vehicle dealers as an alternative to the factory supplied bumper. Hercules Bumpers, Inc., was the largest domestic supplier in this dealer direct segment offering dealers a line of specialty bumpers. During 1994, a major OE manufacturer initiated a program to secure a greater portion of rear step bumper sales. The program, which involved severe price competition and program buying, eroded a substantial portion of Hercules' sales base and placed Hercules in a loss position for the fourth quarter of 1995. In response to the likely prospect of continued losses, Wedgestone Automotive ceased manufacturing operations at Hercules on March 5, 1996. In a further decision to exit this segment, Wedgestone Automotive sold its ownership in Hercules to MBC Corporation for $1.00 and the assumption of certain debt and other liabilities approximating $4.5 million pursuant to a Stock Purchase Agreement. The Pelham manufacturing plant along with its inventory and accounts receivable constituted all of the material assets of Hercules. Since 1994 the Company has operated solely within the automotive aftermarket, serving both OE manufacturers and aftermarket customers with bumpers and tubular steel accessories. Since 1996, an erosion of Wedgestone's bumper sales has occurred due to a desire on the part of truck manufacturers to integrate the design of rear step bumpers into their current designs for light duty pick-up trucks and sport utility vehicles. New vehicle dealers who might choose Wedgestone's bumpers instead of the factory equivalent due to advantages in either price or greater tow capacity are returning to the factory bumper due to the incompatibility of the Company's current bumper line with current vehicle designs. For the near term, sales of Wedgestone bumpers to the crash replacement market will continue, however, unless the Company invests in new designs, its current line will not support the long term demands of the crash replacement market for aftermarket bumpers. In the past, the expected return on investment for updating the Company's bumper line was based on both crash replacement and aftermarket sales for new vehicles. Sales in both of these markets is used to justify the cost of new tooling. Since 1995, however, there has been a significant effort on the part of the OE manufacturers to improve dealer loyalty for their products. These efforts, which have been promoted through the use of pricing strategies designed to enhance dealer profits, have significantly eroded the Company's sales of bumpers to new vehicle dealers. As a result of the success of OE campaigns to enhance dealer loyalty, the Company does not believe there would be a sufficient return on investment to support the estimated $2 million required to develop new tooling to replicate current OE bumper designs. The Company is looking at alternative methods to lower the cost of this investment, including avoiding the investment through the import of components that more closely conform to the appearance of the new OE bumpers. In recent years, particulary with the development of their new truck designs, the OE manufacturers have increased their own line of aftermarket truck accessories. These accessories are being offered to their dealer networks in an effort to enhance OE profitability by participating in the more profitable aspects of the accessory aftermarket for their light duty trucks and sport utility vehicles. The sale of OE accessories has significantly benefitted from the OE programs designed to promote dealer loyalty. Wedgestone's line of tubular accessories has also benefitted from the OE accessory programs in that the Company has been able to secure supplier agreements from several OE manufacturers for Step Bars, Grille Guards, Light Bars, Push Bars and Combo Bars. These accessories are all tubular in nature and represent one consistent style of product. The Company's ability to rely on the sales of these products in the future is entirely dependant on the consumer's continued acceptance of these types of accessories. Due to the vulnerability of continued earnings stemming from a decline in bumper sales and the Company's dependancy on tubular products for its OE programs, Wedgestone intends to seek additional products and markets. While remaining committed to its core competency of metal fabrication and finishing, and maintaining its commitment to the light duty pickup and sport utility aftermarket, Wedgestone intends to reduce its dependancy on this market as the sole source of return on invested capital. This expansion of product and -8- markets will require significant investments in tooling, processes and product design. The Company expects this expansion to take several years and will involve a significant financial commitment to procure equipment and finance the acquisition of companies that would assist and accelerate Wedgestone's penetration of market segments compatible with its core competency. Liquidity and Capital Resources To date, Wedgestone has financed its business activities through cash flows from operations. Additional debt has been incurred primarily for working capital and acquisitions. For the nine months ended September 30, 1997, cash flows from operations totaling $3,069,000 were supplemented by additional advances from unsecured creditors totaling $597,000 and a reduction in prepaid expenses and other assets totaling $218,000 and $16,000, respectively. These funds were used to acquire $1,465,000 in additional inventories and $37,000 in trade receivables, resulting in net cash provided by operations totaling $2,398,000 for the first nine months of 1997 compared to cash consumed by operations totaling $797,000 for this same period in 1996. Net cash flows from operations were further supplemented during the period by net proceeds from the sale of real estate totaling $1,328,000 and net borrowings on long-term debt totaling $541,000. During 1997, the Company invested $963,000 in new equipment, invested in notes receivable from a related party totaling $1,650,000 and made payments on revolving debt totaling $1,907,000 resulting in a net decrease in cash for the nine months ended September 30, 1997 totaling $253,000 compared to a $243,000 decrease in cash for the same period in 1996. In November 1994 Wedgestone entered into a three-year, $7.5 million credit facility, which provided for a revolving credit line and term loan with CIT / Credit Finance ("CIT"), and was collateralized by substantially all of the assets of the Company. On March 18, 1997, the Company amended and restated the agreement with CIT resulting in a five-year $10 million credit facility providing a revolving credit line and term loan under terms substantially similar to the original agreement. The amended and restated agreement provides for borrowings based on a percentage of inventory and receivables and includes an equipment term loan, at the lender's prime rate plus 1.375% (10% at September 30, 1997). On May 20, 1997 Wedgestone advanced Stockwood, LLC. ("Stockwood") $1,650,000 under a one year secured note with interest at 12 percent. The note is secured by 3,500,000 shares of beneficial interest of Wedgestone Financial with principal and interest due at maturity. Stockwood is a related party through common ownership by certain Wedgestone Financial shareholders. Capital projects to increase production capacity have been authorized totaling approximately $1,000,000 in response to new production awards. These expenditures will culminate by the end of the first quarter of 1998. The Company has secured satisfactory financing arrangements for these capital expenditures in the form of third party operating leases. Management is continuing to review the capital needs of the Company in light of its long and short term business strategy. The Company continues to actively seek acquisition opportunities in the Automotive Products Business Segment and other market segments unrelated to the automotive industry. Management believes such acquisitions to be critical to the Company's long-term prospects. To the extent that Wedgestone expands its operations and makes additional acquisitions, it will need to obtain additional funding from institutional lenders and other sources. Wedgestone's ability to use equity in pursuing acquisitions may be limited by its desire to preserve certain tax attributes including its net operating loss carry forwards. Results Of Operations Three Months Ended September 30, 1997 Compared to Three Months Ended September 30, 1996 Net sales increased $1,385,000 or 12% to $12,826,000 for the three months ended September 30, 1997 compared to $11,441,000 for the same period in 1996. This reflects a decrease of $1,039,000 or 18% in sales of bumpers offset by a $2,424,000 or 43% increase in the sales of tubular and other products. The increase in tubular sales reflects a continuing acceptance of the Company's line of Westin tubular truck accessories in the light duty pickup and sport utility aftermarket. The decline in bumper sales reflects a general decline in the demand for aftermarket bumpers. This decline is mostly due to efforts of the original equipment ("OE") manufacturers to -9- integrate the rear step bumpers on light duty pickup trucks into the overall design of each new vehicle. With the release of new OE bumper designs on 1997 models the Company is losing its competitive advantage afforded by its current line of aftermarket bumpers. Management believes that the Company will continue to experience significant erosion in bumper sales in the remaining three months of 1997 and that the decline in bumper sales will accelerate in 1998 as new OE light duty truck models are released. Slowing this decline will be a continued demand for Wedgestone bumpers in the crash replacement market. The crash replacement business, however, will also decline unless the Company makes significant investments in new tooling to replicate the new OE bumper designs. The Company is currently examining alternatives to these tooling investments, including the import of components that more closely conform to the appearance of the OE bumpers. Sales of bumpers for the year ended December 31, 1996 represented 48% or $21,688,000 of total Company sales. The Company continues to pursue sales of its products directly to the OE manufacturers. For the quarter ended September 30, 1997 sales to OE customers increased 126% to $1,239,000 compared to $546,000 for the same period in 1996. In response to OE quality requirements the Company received its ISO 9001 / QS 9000 rating on June 9, 1997. During the quarter ended June 30, 1997, the Company received new production awards from Mercedes Benz, Subaru, and Nissan for products to be made in its Irwindale, California facility. Initial sales on these agreements totaled $988,000 for the quarter ended September 30, 1997. The Company also received a production award from Ford in the quarter ended June 30, 1997 for product to be delivered in 1998. An investment approximating $1,000,000 in equipment will be required to fulfill this award. Purchase commitments for a majority of this equipment have been made. All of the OE production awards are for tubular products. These products are generally not a functional part of the vehicle. Future procurement of such products by the OE manufacturers is conditional upon market acceptance of the products as designed and upon the public's continued interest in the general appearance of these types of accessories. Gross margins increased $633,000 or 15% to $4,663,000 or 36% of sales for the three months ended September 30, 1997 compared to $4,040,000 or 35% of sales in 1996. Sales and marketing costs decreased by $177,000 or 9% to $1,860,000 or 15% of sales for the three months ended September 30, 1997 compared to $2,037,000 or 19% of sales in 1996. The decrease is due to lower advertising and promotional costs incurred by the Company in response to lower sales of aftermarket bumpers. Administrative costs increased by $352,000 or 28% to $1,569,000 for the three months ended September 30, 1997 compared to $1,217,000 in 1996. Product design and development costs account for this increase. Included in these costs are salaries, benefits and overhead costs for additions to the Company's engineering staff. The Company believes that its future competitive position in the automotive aftermarket will require significant increases in engineering and development costs over the next several years. Interest expense decreased $91,000 or 34% to $176,000 for the three months ended September 30, 1997 compared to $267,000 in 1996. This decrease is attributable to the decrease in interest rates in 1997 compared to 1996. Interest rates were further reduced in the quarter as a result of the amended and restated CIT credit facility. Nine Months Ended September 30, 1997 Compared to Nine Months Ended September 30, 1996 Net sales increased $3,362,000 or 9% to $37,751,000 for the nine months ended September 30, 1997 compared to $34,389,000 for the same period in 1996. This reflects a decrease of $1,816,000 or 11% in sales of bumpers offset by a $5,178,000 or 29% increase in the sales of tubular and other products. The increase in tubular sales reflects a continuing acceptance of the Company's line of Westin tubular truck accessories in the light duty pickup and sport utility aftermarket. The decline in bumper sales reflects a general decline in the demand for aftermarket bumpers. This decline is mostly due to efforts of the original equipment ("OE") manufacturers to integrate the rear step bumpers on light duty pickup trucks into the overall design of each new vehicle. With the release of new OE bumper designs on 1997 models the Company is losing its competitive advantage afforded by its current line of aftermarket bumpers. Management believes that the Company will continue to experience significant erosion in bumper sales in the remaining three months of 1997 and that the decline in bumper sales will accelerate in 1998 as new OE light duty truck models are released. Slowing this decline will be a continued demand for Wedgestone bumpers in the crash replacement market. The crash replacement business, however, will also decline unless the Company makes significant investments in new tooling to replicate the new OE bumper designs. The Company is currently examining alternatives to these tooling investments, including the import of components that more closely conform to the appearance of the OE bumpers. Sales of bumpers for the year -10- ended December 31, 1996 represented 48% or $21,688,000 of total Company sales. Bumper sales for the first nine months of 1997 totaled $14,663,000 compared to $16,479,000 in 1996. The Company continues to pursue sales of its products directly to the OE manufacturers. For the nine months ended September 30, 1997 sales to OE customers increased 48% to $2,473,000 compared to $1,667,000 for the same period in 1996. In response to OE quality requirements the Company received its ISO 9001 / QS 9000 rating on June 9, 1997. During the quarter ended June 30, 1997, the Company received new production awards from Mercedes Benz, Subaru, and Nissan for products to be made in its Irwindale, California facility. Initial sales on these agreements totaled $988,000 in sales for the quarter ended September 30, 1997. The Company also received a production award from Ford in the quarter ended June 30, 1997 for product to be delivered in 1998. An investment approximating $1,000,000 in equipment will be required to fulfill this award. Purchase commitments for a majority of this equipment have been made. All of the OE production awards are for tubular products. These products are generally not a functional part of the vehicle. Future procurement of such products by the OE manufacturers is conditional upon market acceptance of the products as designed and upon the public's continued interest in the general appearance of these types of accessories. Gross margins increased $2,442,000 or 22% to $13,371,000 or 35% of sales for the nine months ended September 30, 1997 compared to $10,929,000 or 32% of sales in 1996 which included $609,000 in gross margin losses on the sales of Hercules' products. Sales and marketing costs increased by $323,000 or 6% to $5,518,000 or 15% of sales for the nine months ended September 30, 1997 compared to $5,195,000 or 15% of sales in 1996. The increase is due to additional advertising and promotional costs incurred by the Company to further penetrate the traditional and retail market segments for Westin tubular products. The Company believes that further expenditures in this area are required to maintain the market growth achieved and expand these markets further. Administrative costs increased by $869,000 or 24% to $4,541,000 for the nine months ended September 30, 1997 compared to $3,672,000 in 1996. Product design and development costs account for this increase. Included in these costs are salaries, benefits and overhead costs for additions to the Company's engineering staff. The Company believes that its future competitive position in the automotive aftermarket will require significant increases in engineering and development costs over the next several years. Other income for the nine months ended September 30, 1997 consists of the gain on the sale of the Company's 21 acres of land known as the College Point property. Interest expense decreased $228,000 or 26% to $648,000 for the nine months ended September 30, 1997 compared to $876,000 in 1996. This decrease is attributable to the decrease in debt associated with Hercules and to the decrease in interest rates in 1997 compared to 1996. Interest rates were further reduced in the second quarter as a result of the amended and restated CIT credit facility. Forward Looking Information Information contained in this Form 10-Q contains "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995, which can be identified by the use of forward-looking terminology such as "may", "will", "expect", "plan", "anticipate", "estimate or "continue" or the negative thereof or other variations thereon or comparable terminology. There are certain important factors that could cause results to differ materially from those anticipated by some of these forward-looking statements. Investors are cautioned that all forward-looking statements involve risks and uncertainty. The factors, among others, that could cause actual results to differ materially include: pricing and merchandising policies from the major automotive manufacturers; the Company's ability to execute its business plan; the acceptance of the Company's merchandising strategies by its target customers; competitive pressures on sales and pricing; and increases in other costs which cannot be recovered through improved pricing of merchandise. -11- PART II OTHER INFORMATION Item 1. Legal Proceedings None. Item 2. Changes in Securities None. Item 3. Defaults upon Senior Securities None. Item 4. Submission of Matters to a Vote of Security Holders None. Item 5. Other Information None. Item 6. Exhibits and Reports on Form 8-K (a) Exhibits: None. (b) Reports on Form 8-K: None. -12- PART II SIGNATURES Pursuant to the requirements of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Wedgestone Financial Date: November 14, 1997 By: /s/ Eric H. Lee -------------------- Chief Financial Officer (Principal Financial Officer) The name "Wedgestone Financial" (Formerly Wedgestone Realty Investors Trust) is the designation of the Trustees under a Declaration of Trust dated March 12, 1980, as amended, and in accordance with such Declaration of Trust notice is hereby given that all persons dealing with Wedgestone Financial by so acting acknowledge and agree that such persons must look solely to the Trust property for the enforcement of any claims against Wedgestone Financial and that neither Trustees, Officers, employees, agents nor shareholders assume any personal liability for claims against the Trust or obligations entered into on behalf of Wedgestone Financial, and that respective properties shall not be subject to claims of any other person in respect of any such liability. -13-