FORM 10-K
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
(X)ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended June 28, 2003
Commission file number 1-5555
WELLCO ENTERPRISES, INC.
(Exact name of Registrant as specified in charter)
North Carolina 56-0769274
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(State of incorporation) (I.R.S. employer identification no.)
Waynesville, North Carolina 28786
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code 828-456-3545
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Securities registered pursuant to Section 12(b) of the Act:
Common Capital Stock - $1 par value American Stock Exchange
(Title of class) (Name of exchange on which registered)
Securities registered pursuant to Section 12(g) of the Act:
Common Capital Stock - $1 par value
(Title of class)
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 if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. (X)
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes No X .
As of August 31, 2003, 1,185,746 common shares were outstanding, and the
aggregate market value of the common shares (based upon the closing price of
these shares on the American Stock Exchange on August 31, 2003) of Wellco
Enterprises, Inc. held by nonaffiliates was approximately $2,300,000.
Documents incorporated by reference:
Definitive Proxy Statement, to be dated October 17, 2003, in PART IV.
Form 8-K , dated March 17, 2003, in Item 4. Definitive Proxy Statement,
dated October 18, 2002, in PART IV. Definitive Proxy Statement, dated
October 13, 2000, in PART IV. Definitive Proxy Statement, dated October
17, 1997, in PART IV. Definitive Proxy Statement, dated October 18,
1996, in PART IV. Form 10-K for the Fiscal Year Ended July 1, 2000, in
Part IV. Form 10-K for the Fiscal Year Ended July 1, 1995, in PART IV.
Form 10-K for the Fiscal Year Ended July 3, 1982, in PART IV.
PART I
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Item 1. Business.
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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.
Footnote 15 to the Consolidated Financial Statements contains information about
revenues by similar sources and by geographic areas. The majority of revenues
($18,209,000 in 2003 and $14,875,000 in 2002) 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 U. S. Armed Forces. The loss of
this customer would have a material adverse effect on the Company.
For more than the last five years, the Company has manufactured and sold
military combat boots under firm fixed price contracts with DSCP. Boot products
are the general issue combat boot, the hot wet (jungle) boot and the hot dry
(desert) boot, all manufactured using the government specified Direct Molded
Sole (DMS) process and the Infantry Combat Boot (ICB). The Company has also
supplied the Intermediate Cold/Wet Boot (ICW) and anti-personnel mine protective
boots and overboots. The government awards fixed price boot contracts on the
basis of bids from several qualified U. S. manufacturers. The Company also sells
some of these same boot products to other customers, including customers located
in other countries.
The Company provides, primarily under long-term licensing agreements,
technology, assistance and related services for manufacturing military and
commercial footwear to customers in the United States and abroad. Under these
agreements licensees receive technology, services and assistance, and the
Company earns fees based primarily on the licensees' sales volume. In addition
to providing technical assistance, the Company also, from time to time, supplies
certain foreign military footwear manufacturers with some of their machinery and
material needs. The Company builds specialized footwear manufacturing equipment
for use in its own and its customers' manufacturing operations. This equipment
is usually sold, but in some cases it is leased.
Net income for the 2003 fiscal year was $823,000 ($0.68 diluted income per
share) compared to net income of $683,000 ($0.56 diluted income per share) for
the 2002 fiscal year. Income before cumulative effect of change in accounting
principle for goodwill for the 2003 fiscal year was $1,051,000 ($0.87 diluted
income per share before cumulative effect).
Compared to the prior year, total revenues in the current year increased by
$4,852,000. In late March, 2003, the Defense Supply Center Philadelphia (DSCP,
the Department of Defense Agency with whom the Company contracts for the
manufacture of combat boots) invoked its surge option under a contract. Invoked
in response to the need for desert boots used by U. S. Armed Forces personnel in
Iraq, the surge option requires Wellco to significantly increase its rate of
boot production. In the current year, the Company shipped 44,000 more pairs of
combat boots than in the prior year. Also during the 2003 fiscal year, the
Company began shipping under a small contract with DSCP to supply the Extreme
Cold Weather (Mukluk) boots. Sales from this contract for the current year were
$1,467,000.
In fiscal 2003, the Company's adopted Statement of Financial Accounting
Standards 142 (SFAS 142), "Goodwill and Other Intangible Assets". The Company's
Consolidated Balance Sheets have for many decades included $228,000 of goodwill
related to the acquisition of a subsidiary. This goodwill arose prior 1970 and,
under the guidance of Accounting Principles Board Opinion No. 17, had not been
amortized.
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SFAS No. 142 provides for a specific method to determine if goodwill is impaired
and the application of this method resulted in the $228,000 of goodwill being
deemed as impaired. As required under SFAS 142, the Company charged this
goodwill against the Consolidated Statements of Operations and Comprehensive
Income as the cumulative effect of change in accounting principle.
More information about these, and other events affecting Wellco's 2003 and 2002
operating results, are contained in the Management's Discussion and Analysis of
Results of Operations and Financial Condition section of the Company's 2003
Annual Report to Shareholders which is incorporated in Part II of this Form
10-K.
Bidding on U. S. government boot solicitations is open to any qualified U. S.
manufacturer. In addition to meeting very stringent manufacturing and quality
standards, contractors are required to comply with demanding delivery schedules
and a significant investment in specialized equipment is required for the
manufacture of certain types of boots.
The Company competes on U. S. government contracts with several other companies,
none of which dominates the industry. 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 U. S. 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 additional one-year options to purchase boots and the options are
exercisable at the government's discretion.
Many factors affect the government's demand for boots, therefore the quantity
purchased can vary from year to year. Contractors cannot influence the
government's boot needs. Price, quality, quick delivery and manufacturing
efficiency are the areas emphasized by the Company that strengthen its
competitive position. While the government's demand for boots varies from month
to month, the Company's business cannot be deemed seasonal.
The U. S. government usually evaluates bids received on solicitations for boots
using their "best value" system, under which bidders offering the best value to
the government are awarded the contract, or in the case of multiple contract
awards, a greater portion of total boots contracted. Best value usually involves
an evaluation of performance considerations, such as quality and delivery, with
the prices bid being equally important. As bidders become more equal in the best
value evaluation, price becomes more important.
Government contracts are subject to partial or complete termination under the
following circumstances:
(1) Convenience of the Government. The government's contracting
officer has the authority to partially or completely terminate
a contract for the convenience of the government only when it
is in the government's interest to terminate. The contracting
officer is responsible for negotiating a settlement with the
contractor.
(2) Default of the Contractor. The government's contracting
officer has the authority to partially or completely terminate
a contract because of the contractor's actual or anticipated
failure to perform his contractual obligations.
Under certain circumstances occasioned by the egregious conduct of a contractor,
contracts may be terminated and a contractor may be prohibited for a certain
period of time from receiving government contracts. The Company has never had a
contract either partially or completely terminated.
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Because domestic commercial footwear manufacturers are adversely affected by
imports from low labor cost countries, the Company targets its marketing of
technology and assistance primarily to military footwear manufacturers. The
Company competes against several other footwear construction methods commonly
used for heavy-duty commercial footwear. These methods include the Goodyear Welt
construction, as well as boots bottomed by injection molding. These methods are
used in work shoes, safety shoes, and hiking boots manufactured both in the U.
S. and abroad for the commercial market. Quality, service and reasonable
manufacturing costs are the most important features used to market the Company's
technology, assistance and services.
The Company has a strong research and development program. While not all
research and development results in successful new products or significant
revenues, the continuing development of new products and processes has been and
will continue to be a significant factor in growth and development. The Company
developed the desert combat boot, first used in Operation Desert Storm. In 1999
the Company completed a boot development research and development contract with
the U. S. Army that resulted in a 30% reduction in recruit lower extremity
injuries.
Of the total amount spent on research and development, a significant portion is
for personnel costs of mold engineers, rubber technicians, chemists, pattern
engineers and management, all of whom have many responsibilities in addition to
research and development. The Company estimates that the total cost of research
and development, the majority of which is company sponsored, for fiscal years
2003, 2002 and 2001 is $110,000, $180,000 and $98,000.
The Company's backlog of all sales, not including license fees and rentals, as
of August 31, 2003 was approximately $19,100,000 compared to $6,500,000 at
August 31, 2002. The Company estimates that substantially all of the current
year backlog will be shipped in the 2004 fiscal year. The current year's backlog
increased because in late March 2003, DSCP ordered the Company to accelerate its
rate of boot production by exercising a contract's surge option clause and the
Company was awarded a contract to supply the U.S. Army with the Infantry Combat
Boot (ICB).
Most of the raw materials used by the Company can be obtained from at least two
sources and are readily available. Because all materials in combat boots must
meet rigid government specifications and because quality is the first priority,
the Company purchases most of its raw materials from vendors who provide the
best materials at a reasonable cost. The loss of some vendors would cause some
difficulty for the entire industry, but the Company believes a suitable
replacement could be found in a reasonably short period of time. Major raw
materials include leathers, fabrics and rubber, and, by government regulation
all are from manufacturers in the United States.
Compliance with various existing governmental provisions relating to protection
of the environment has not had a material effect on the Company's capital
expenditures, earnings or competitive position.
The Company employed an average of 271 persons during the 2003 fiscal year.
Item 2. Properties.
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The Company has manufacturing, warehousing and office facilities in Waynesville,
North Carolina and Aguadilla, Puerto Rico. The building and land in North
Carolina are owned by the Company. The Puerto Rico building and land are leased.
In 1999, the Company consolidated its existing operations in Puerto Rico and the
operations transferred from its Waynesville, North Carolina factory into a
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larger leased building.
Management believes all its plants, warehouses and offices are in good condition
and are reasonably suited for the purposes for which they are presently used.
Item 3. Legal Proceedings.
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There are no material pending legal proceedings, other than ordinary routine
litigation incidental to the Company's business, to which the Company or any of
its subsidiaries are a party or of which any of their property is subject.
Management does not know of any director, officer, affiliate of the Company, nor
any stockholder of record or beneficial owner of more than 5% of the Company's
common stock, or any associate thereof who is a party to a legal proceeding that
is adverse to the Company or any of its subsidiaries.
Item 4. Submission of Matters to a Vote of Security Holders.
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There were not any submissions of matters to a vote of security holders during
the fourth quarter of fiscal year 2003.
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WELLCO(R)
ENTERPRISES, INC.
ANNUAL REPORT
2003
WELLCO ENTERPRISES, INC.
CONSOLIDATED SELECTED FINANCIAL DATA
(In Thousands Except for Per Share Amounts)
Fiscal Year Ended
June 28, June 29, June 30, July 1, July 3,
2003 2002 2001 2000 1999
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Revenues $ 24,833 $ 19,981 $ 19,417 $ 22,225 $ 21,312
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Net Income (Loss) (A) 823 683 1,153 711 (837)
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Basic Earnings (Loss)
per Share 0.70 0.58 0.99 0.61 (0.72)
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Diluted Earnings (Loss)
per Share 0.68 0.56 0.97 0.61 (0.72)
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Cash Dividends Declared
Per Share of Common Stock 0.40 0.40 0.40 0.25 0.20
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Total Assets at Year End 15,310 12,929 12,787 12,950 14,853
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Long-Term Liabilities at
Year End $ 1,972 $ 1,328 $ 1,532 $ 1,593 $ 1,721
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(A) After a $228,000 cumulative effect of a change in accounting principle
(See Note 21 in Consolidated Financial Statements). The cumulative
effect reduced both basic earnings and diluted earnings per share by
$0.19.
See the Management's Discussion and Analysis of Results and Operations and
Financial Condition section.
Independent Auditors
Crisp Hughes Evans LLP
Asheville, N.C.
Annual Meeting
November 18, 2003
Corporate Offices
Waynesville, N.C.
10-K Availability
The Company's Form 10-K (annual report filed with the Securities and Exchange
Commission) is available without charge to those who wish to receive a copy.
Write to: Corporate Secretary, Wellco Enterprises, Inc., Box 188, Waynesville,
N.C. 28786
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Dear Fellow Shareholders:
For fiscal year 2003, your company had net income of $823,000, equivalent to
basic earnings per share of $.70 (diluted $.68), from revenues of $24,833,000.
This compares with net income of $683,000, equivalent to basic earnings per
share of $.58 (diluted $.56) in the 2002 fiscal year.
The major events affecting operations and net income in fiscal year 2003 were:
1. In late March, 2003, and in response to the need for desert boots by our U.
S. Armed Forces personnel serving in Iraq, the Defense Supply Center
Philadelphia (DSCP) invoked the surge option clause under our contract. We
responded by significantly increasing our rate of production, and this is
the primary reason for the increase in revenues.
In the fourth quarter, we incurred $279,000 of additional costs related to
surge (overtime, new employee training loss, etc.). We believe that under
the related surge option contract clause, we are to submit a proposal for
reimbursement of these costs. DSCP has a different interpretation of this
clause. On the advice of our legal counsel, we took certain action in the
event we need to pursue legal avenues. The $279,000 is included in fiscal
year 2003 Cost of Sales and Services.
2. Production and shipment of boots to DSCP in fiscal year 2003 were under
three extensions of a contract that expired in fiscal year 2002. During the
year, we also had an outstanding response to a boot solicitation that
offered lower prices than those under the expired contract. When you have
current offered prices that are lower than those on an expired contract, it
is difficult to argue that your prices for a contract extension should not
be at the current offered prices . So, the extensions were at lower prices
and this reduced gross profit by $268,000.
3. Many decades ago, Wellco acquired Ro-Search, Inc. as a wholly-owned
subsidiary. The value of Wellco stock issued was $228,000 greater than the
value of the Ro-Search assets acquired, and has been reflected in the
Consolidated Balance Sheets under the caption "Excess of cost over net
assets of subsidiary at acquisition", which is commonly called goodwill.
Several years after Wellco acquired Ro-Search, an Accounting Principles
Board Opinion was issued requiring amortization of goodwill, but, because
Wellco's goodwill arose prior to that opinion, amortization was not
required.
Statement of Financial Accounting Standards 142 (SFAS 142), "Goodwill and
Other Intangible Assets", became effective for our 2003 fiscal year. SFAS
142 provides for a specific method to determine if goodwill is impaired,
and, as a result, the $228,000 of goodwill was charged against income in
fiscal year 2003.
4. In fiscal year 2002, we responded to a DSCP solicitation for the
manufacture of berets, but were not awarded a contract. Although we passed
a DSCP pre-award survey, a Canadian beret manufacturer, who had to
establish manufacturing in the U. S., was awarded the contract. In
anticipation of contract award, we purchased certain equipment which was
written down to $70,000 at the end of fiscal year 2002. In fiscal year 2003
and after being unsuccessful in finding a buyer for the equipment, this
remaining $70,000 was written off. However, in the past month we have found
a potential buyer, and hope to recover at least some of our investment.
5. We actively market to state prison systems installations for inmate
manufacture of work shoes. Prior to fiscal year 2003, we sold six
installations. In fiscal year 2003, we sold our seventh system to the State
of Pennsylvania.
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6. The income tax rate as shown in the Consolidated Statements of Operations
and Comprehensive Income (Loss) is 9% compared to 34% for fiscal year 2002.
The rate for 2002 reflects a $300,000 valuation allowance against
previously recorded deferred tax assets.
For a couple of years, our financial reports and releases have talked about the
Army replacing the all leather combat boot, one of the three Direct Molded Sole
boots we manufacture, with a new boot known as the Infantry Combat Boot (ICB).
The all leather combat boot was approximately 50% of our DSCP contract business.
We responded to the solicitation for the ICB boot and in March, 2003 we were one
of three manufacturers awarded a contract. Before getting production orders, we
manufactured 2,000 pairs which were inspected and tested. Our boots passed and
production orders have been issued. The contract is for one year with four,
one-year options. Incorporating this new boot while also being under surge has
not been easy, but we are meeting delivery dates.
In excess of a year, we have discussed the DSCP outstanding solicitation which
will result in contracts replacing the expired ones. On September 30, 2003, DSCP
announced contract awards. There were four expired contracts and ours was for
25% of total Direct Molded Sole (DMS) boots bought by DSCP. DSCP again awarded
four new contracts and ours is for 30% of total DMS boots. The other contractors
were awarded 35%, 20% and 15%. The contract is for one year with two, one-year
options.
Prices under our new DMS contract are substantially lower than those under the
expired contract. When evaluating solicitation responses for the expired
contract, DSCP specified that a contractor's technical rating (quality, timely
delivery, etc.) was much more important than price. However, for the new
contracts, a contractor's technical rating was evaluated as approximately equal
to price. This simply means that a lower bid price became much more important in
determining the percent awarded a contractor. Since the new contract does not
include the all leather combat boot, we wanted either the 35% or 30% award. Our
future operating results will be better with the 30% award and lower prices than
they would be with a 20% or 15% award at somewhat higher prices.
We were recently notified that surge will continue under the new DMS contract.
Continuing surge, combined with expanding manufacturing capacity for the ICB
boot will make for an interesting and busy 2004 fiscal year.
In the past year, I have learned that we are fortunate in having many talented,
dedicated and determined employees. Their tireless efforts are laying the
foundation for the future of Wellco.
David Lutz
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Chief Executive Officer and President
October 6, 2003
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL
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CONDITION
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RESULTS OF OPERATIONS
Critical Accounting Policies:
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The Consolidated Financial Statements have been prepared in accordance with
accounting principles generally accepted in the United States of America which
require the Company to make estimates and assumptions that affect the reported
amounts of assets and liabilities at the date of the Consolidated Financial
Statements, and revenues and expenses during the periods reported. Actual
results could differ from those estimates. The Company believes the following
are the critical accounting policies which could have the most significant
effect on the Company's reported results and require the most difficult,
subjective or complex judgements by management.
o Impairment of Long-Lived Assets:
The Company reviews its long-lived assets for impairment whenever
events or circumstances indicate that the carrying amount of an asset
may not be recoverable. If the sum of the expected cash flows,
undiscounted and without interest, is less than the carrying amount of
the asset, an impairment loss is recognized as the amount by which the
carrying amount of the asset exceeds its fair value. The Company makes
estimates of its future cash flows related to assets subject to
impairment review. One of the most critical estimates is future demand,
primarily through U. S. Department of Defense contracts, for the
Company's products. Changes to this and other estimates could result in
an impairment charge in future periods.
o Inventory Valuation:
Raw materials and supplies are valued at the lower of first-in,
first-out cost or market. Finished goods and work in process are valued
at the lower of actual cost, determined on a specific identification
basis, or market. The Company estimates which materials may be obsolete
and which products in work in process or finished goods may be sold at
less than cost, and adjusts their inventory value accordingly. Future
periods could include either income or expense items if estimates
change and for differences between the estimated and actual amount
realized from the sale of inventory.
o Income Taxes:
The Company records a liability for potential tax assessments based on
its estimate of the potential exposure. Due to the subjectivity and
complex nature of the underlying issues, actual payments or assessments
may differ from estimates. Income tax expense in future periods could
be adjusted for the difference between actual payments and the
Company's recorded liability based on its assessments and estimates.
The Company has recorded a valuation allowance equal to a significant
part of its deferred tax assets. The valuation allowance is based on an
evaluation of the uncertainty of future taxable income from certain
jurisdictions. An adjustment could be required if circumstances and
events cause the Company to change these estimates.
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Comparing the Fiscal Year ended June 28, 2003 to the Fiscal Year ended June 29,
2002:
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For the fiscal year ended June 28, 2003 ("current year"), Wellco had net income
after a cumulative effect of a change in accounting principle of $823,000
compared to a net income of $683,000 in the prior fiscal year ended June 29,
2002 ("prior year"). Income before cumulative effect of change in accounting
principle for goodwill for the fiscal year ended June 28, 2003 is $1,051,000.
The major reasons for the increase in net income are:
o Compared to the prior year, total revenues in the current year
increased by $4,852,000. In late March, 2003, the Defense Supply Center
Philadelphia (DSCP, the Department of Defense Agency with whom the
Company contracts for the manufacture of combat boots) invoked its
surge option under a contract. Invoked in response to the need for
desert boots used by U. S. Armed Forces personnel in Iraq, the surge
option requires Wellco to significantly increase its rate of boot
production. In the current year, the Company shipped 44,000 more pairs
of combat boots than in the prior year. Also during the 2003 fiscal
year, the Company began shipping under a small contract with DSCP to
supply the Extreme Cold Weather (Mukluk) boots. Sales from this
contract for the current year were $1,467,000. The sale of boot
manufacture equipment to a state prison caused an increase of $353,000
in sales of certain boot manufacturing equipment and materials.
o Cost of Sales and Services in the current year increased by $4,911,000.
Substantially all of combat boots sold to DSCP in the current period
were under three extensions of a contract which expired in April, 2002.
Prior to issuing these contract extensions and in the process of DSCP
negotiating extension prices, DSCP insisted that certain extension
prices be those offered by Wellco on an outstanding boot solicitation.
Prices offered by Wellco on the outstanding solicitation, and on the
subsequent new contract resulting from that solicitation, are lower
than those under the expired contract. These lower prices reduced gross
profit by $268,000 in the current year. The gross profit margin on boot
sales was also adversely affected by an increase in leather prices.
Cost of Sales and Services in the current year includes $279,000 of
cost incurred in the fourth quarter of the current year which
represents additional cost incurred because of the DSCP surge. Wellco
interprets the related surge option contract clause to require its
submitting and subsequently negotiating with DSCP a proposal for
reimbursement of these costs. DSCP has a different interpretation of
this clause. Based on the advice of its legal counsel, Wellco has
notified DSCP that when total additional costs incurred because of
surge are known, a request for reimbursement of these costs will be
submitted.
In addition, employee group health insurance, workers compensation
insurance and general property insurance costs increased $259,000
during the current year. Since Wellco's group health insurance is
self-funded, there was additional expense as a result of two employees'
major medical procedures.
o In fiscal year 2003, the Company's adopted Statement of Financial
Accounting Standards 142 (SFAS 142), "Goodwill and Other Intangible
Assets". The Company's Consolidated Balance Sheets have for many
decades included $228,000 of goodwill related to the acquisition of a
subsidiary. This goodwill arose prior to 1970 and, under the guidance
of Accounting Principles Board Opinion No. 17, had not been amortized.
SFAS No. 142 provides for a specific method to determine if goodwill is
impaired and the application of this method resulted in the $228,000 of
goodwill being deemed as impaired. As required under SFAS 142, the
Company charged this goodwill against the Consolidated Statements of
Operations and Comprehensive Income as the cumulative effect of
change in accounting principle.
-5-
o The current year includes $70,000 of unrecovered contract preparation
costs. In October, 2001, Wellco submitted a solicitation response to a
DSCP procurement for berets to be used by U. S. Army personnel. Wellco
did not have any prior experience in manufacturing berets or similar
knitted products. Since submitting its response, certain machinery was
purchased and certain costs were incurred in order to learn beret
manufacturing operations and procedures, and to demonstrate to
the government that Wellco had the capability to manufacture and
deliver berets within the government's required delivery schedule. In
July 2002, the government announced contract awards and Wellco was not
awarded a contract. In the 2002 fiscal year, beret manufacturing
machinery was written down by $159,000 to an amount equal to the
estimated amount for which this machinery could be sold ($70,000).
Based on revised estimates of the resale value, in the current year
beret manufacturing machinery was completely written off, and $70,000
is shown as Unrecovered Contract Preparation Costs in the Consolidated
Statements of Operations and Comprehensive Income for the fiscal year
ended June 28, 2003.
o Lower total administrative personnel salary cost and lower legal cost
were the primary reasons general and administrative expenses decreased
$161,000 in the current year.
o Interest income in the prior year includes $234,000 which represents
the reversal of previously accrued imputed interest related to a
December 29, 1995 repurchase by Wellco of 1,531,272 shares of its
common stock (see Note 12 to the Consolidated Financial Statements).
This repurchase provided for certain additional payments, without
interest, to be made if cumulative net income for the six fiscal years
1997 through 2002 exceeded a defined amount. Since its stock
repurchase, Wellco, using generally accepted accounting principles,
accrued imputed interest on the estimated additional payments. Since
cumulative income ultimately did not exceed the defined amount,
previously accrued imputed interest was reversed and recognized as
interest income.
The income tax rate (the percent of Provision for Income Taxes to the Income
Before Income Taxes) for fiscal year 2003 was 9% compared to 34% for the prior
year. The current year rate is lower, on the higher pretax income, because
during the prior period the Company recorded a valuation allowance of $300,000
to reflect the estimated amount of deferred tax assets that may not be realized.
Comparing the Fiscal Year ended June 29, 2002 to the Fiscal Year ended June 30,
2001:
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For the fiscal year ended June 29, 2002 ("current year"), Wellco had net income
of $683,000 compared to a net income of $1,153,000 in the prior fiscal year
ended June 30, 2001 ("prior year"). The major reasons for the decrease in net
income are:
o The current year includes $335,000 of unrecovered contract preparation
costs. In the current year, Wellco submitted a solicitation response to
a U. S. government procurement for berets to be used by U. S. Army
personnel. Contracts to be awarded under this solicitation would have
been significant to the Company's operations. Not previously having
manufactured berets, Wellco committed costs totaling $405,000 in order
to learn beret manufacturing operations and procedures, and to
demonstrate to the government that Wellco had the capability to
manufacture and deliver berets within the required delivery schedule.
In February, 2002 the government conducted a pre-award survey, the
purpose of which was to determine if Wellco had the manufacturing and
financial capability to successfully perform, should it be awarded the
contract. Wellco understood that from this survey it received the
"highest recommendation for award". However, subsequent to year-end,
other entities were awarded the contracts.
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At June 29, 2002, beret manufacturing machinery was written down by
$159,000 to an amount equal to the estimated amount for which this
machinery can be sold. This write-down, along with $176,000 of other
direct costs incurred (employee training and materials, consultant
fees, travel), totaling $335,000 and this is shown as Unrecovered
Contract Preparation Costs in the Consolidated Statements of Operations
and Comprehensive Income.
o The current year includes $300,000 in tax provision that resulted from
an increase in the valuation allowance for recorded deferred tax
assets.
o Compared to the prior year, total revenues in the current year
increased by $564,000. Since September 11, 2001, pairs of boots sold to
the U.S. Department of Defense have increased (revenue increase
$1,737,000). Somewhat offsetting this increase, sales of certain boot
manufacturing equipment and materials, which vary with the needs of
existing licensees and the licensing of new customers, were
significantly less in the current period (revenue decrease of
$672,000). In addition, total boot sales to customers other than the U.
S. Department of Defense in the prior year included sales to two
foreign militaries that did not occur in the current year.
o Cost of Sales and Services in the current year increased by $878,000.
The margin decrease that resulted from lower sales of boot
manufacturing equipment and materials more than offset the margin
increase that resulted from higher boot sales to the Defense
Department. In addition, prices of certain materials used in the
manufacture of boots have increased.
o General and Administrative expenses increased $57,000. This increase
was primarily caused by increased professional fees and administrative
personnel pension costs.
o Interest expense decreased $106,000 because of very limited use of the
bank line of credit in the current year and because the prior year
expense included the accrual of imputed interest (see below).
o The Consolidated Statements of Operations and Comprehensive Income for
the current year includes grant income of $80,000 and the prior year
included $160,000. In the prior period the Company received $100,000
representing partial payment from the government of Puerto Rico under a
Special Incentives Contract related to its 1999 consolidation of boot
manufacturing operations in Puerto Rico. After the Contract was
executed on May 23, 2001,final payment of $300,000 was received on
July 2, 2001. This grant requires the Company to maintain operations
in Puerto Rico for its five fiscal years 2000 through 2004. If this
requirement is not met, the Company is required to refund a pro-rata
portion of the total grant. Grant income was not recognized until the
$100,000 was received, and the prior period income includes this
amount as a cumulative catch-up adjustment. Subsequent to receiving
the final $300,000 payment, grant income is being recognized on a
straight line basis over this five year period at the rate of $20,000
per fiscal quarter. At June 29, 2002, $160,000 was remaining to be
amortized during fiscal years 2003 and 2004.
o Interest income in the current period includes $234,000 which
represents the reversal of previously accrued imputed interest related
to a December 29, 1995 repurchase by Wellco of 1,531,272 shares of its
common stock (see Note 12 to the Consolidated Financial Statements).
This repurchase provided for certain additional payments, without
interest, to be made if cumulative net income for the six fiscal years
1997 through 2002 exceeded a defined amount. Since its stock
-7-
repurchase, Wellco, using generally accepted accounting principles,
accrued imputed interest on the estimated additional payments. Since
cumulative income ultimately did not exceed the defined amount,
previously accrued imputed interest was reversed and recognized as
interest income.
The income tax rate (the percent of Provision for Income Taxes to the Income
Before Income Taxes) for fiscal year 2002 was 34% compared to 23% for the prior
year. The current year rate is higher, on the lower pretax income, because the
Company has recorded a valuation allowance of $300,000 to reflect the estimated
amount of deferred tax assets that may not be realized.
Forward Looking Information:
- ----------------------------
Wellco is presently shipping Direct Molded Sole (DMS) combat boots under the
third extension of a DSCP contract which was initially scheduled to expire in
April, 2002. In late March, 2003, DSCP invoked its surge option under this
contract. Under surge, a contractor is to make as many boots as fast as
reasonably possible. Based on information supplied by DSCP, surge is expected to
last throughout the first and second quarters of fiscal year 2004, which will
end December 27, 2003. Wellco estimates that it will ship approximately 105,000
pairs during the first quarter ending September 27, 2003 and between 85,000 and
100,000 pairs during the second quarter ending December 27, 2003, which is
significantly more than the corresponding quarters of the prior year.
On September 30, 2003, DSCP awarded Wellco a new contract for DMS combat boots.
Wellco's award is for 30% of DSCP total DMS boot purchases. The contract is for
a base period of one year, with two one- year options. Four contracts were
awarded and the quantities to be purchased from each contractor are 35%, 30%,
20% and 15% of DSCP total boot purchases. Under the old DMS contract mentioned
above, Wellco supplied 25% of total DSCP purchases. The total pairs DSCP will
buy under these new contracts will be lower than in the past because of the
Army's replacement of its all-leather DMS combat boot with the Infantry Combat
Boot (ICB), as discussed below. In addition, the new contract, as compared to
the old contract, has lower prices which will result in a lower profit margin
per pair of boots.
In 2002, the U. S. Army announced that it would replace its all-leather combat
boot, one of the three DMS boots supplied by Wellco, with the Infantry Combat
Boot (ICB). On March 11, 2003, Wellco, along with two other manufacturers, was
awarded a contract to supply the U.S. Army with this boot. This contract is for
a one year period, with four one year options which are exercisable at the
government's discretion.
If Wellco's future operating results and liquidity would be adversely affected
by the decreased prices in the new DMS contract; use of the bank line of credit
would likely increase; and, the bank line of credit may be cancelled or may not
be renewed (see further discussion in the Liquidity and Capital Resources
section).
The Company is continuing in its attempts to sell the previously mentioned beret
manufacturing machinery, which has no value in the Consolidated Balance Sheets
at June 28, 2003.
The Company recently received machinery orders from a customer totaling
$370,000. The Company estimates that delivery will be in the second and third
quarters of fiscal year 2004.
A 1% increase in the assumed discount rate used to compute the Company's pension
benefit obligation would decrease the obligation at June 30, 2003 by $552,000.
Conversely, a 1% decrease in the assumed discount rate would increase the
benefit obligation at June 30, 2003 by $662,000.
A 1% increase in the assumed discount rate used to compute the Company's retiree
health benefit obligation would decrease the benefit obligation at June 28, 2003
-8-
by $34,000. Conversely, a 1% decrease in the assumed discount rate would
increase the benefit obligation at June 28, 2003 by $40,000.
Except for historical information, this Annual Report includes forward looking
statements that involve risks and uncertainties, including, but not limited to,
the receipt of contracts from the U. S. government and the performance
thereunder, the ability to control costs under fixed price contracts, the
cancellation of contracts, and other risks detailed from time to time in the
Company's Securities and Exchange Commission filings, including Form 10-K for
the year ended June 28, 2003. 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.
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 each fiscal year
shown the Company's cash and funds available from the bank line of credit:
(in thousands)
2003 2002 2001
- ---------------------------------------------------------------------
Cash and Cash Equivalents $ 133 $ 270 $ 653
- ---------------------------------------------------------------------
Unused Bank Line of Credit * 910 3,000 3,000
- ---------------------------------------------------------------------
Total $ 1,043 $ 3,270 $ 3,653
- ---------------------------------------------------------------------
* Note: On September 18, 2003 the bank line of credit was increased to $4.5
million.
The following table summarizes the other major sources and (uses) of cash and
cash equivalents for the last three years:
(in thousands)
2003 2002 2001
- ------------------------------------------------------------------------------
Income Before Depreciation and Other Non-cash
Adjustments $ 2,080 $ 1,616 $ 2,049
- ------------------------------------------------------------------------------
Net Change in Accounts Receivable, Inventory,
Accounts Payable and Accrued Compensation (1,087) (629) 1,515
- ------------------------------------------------------------------------------
Net Change in Income Taxes, Pension Obligation,
and Other (87) (99) 186
- ------------------------------------------------------------------------------
Net Cash Provided By (Used In) Operations 906 888 3,750
- ------------------------------------------------------------------------------
Cash From Bank Line of Credit 995 370 -
- ------------------------------------------------------------------------------
Cash Used to Repay Bank Line of Credit (405) (370) (1,700)
- ------------------------------------------------------------------------------
-9-
2003 2002 2001
- ------------------------------------------------------------------------------
Cash From Note Payable - - 300
- ------------------------------------------------------------------------------
Cash Used to Repay Note Payable - - (36)
- ------------------------------------------------------------------------------
Cash Used to Purchase Plant and Equipment (1,183) (962) (1,269)
- ------------------------------------------------------------------------------
Cash Provided by Exercise of Stock Options 24 163 -
- ------------------------------------------------------------------------------
Cash Dividends Paid (474) (472) (465)
- ------------------------------------------------------------------------------
Net Increase (Decrease) in Cash and Cash
Equivalents $ (137) $ (383) $ 580
- ------------------------------------------------------------------------------
In 2003, cash provided by operations was $906,000. Net income of $823,000,
depreciation and amortization of $995,000 and a $1,832,000 increase in accounts
payable were the main sources of cash provided by operations. The main use of
cash for operations was an increase of $2,076,000 in accounts receivable and an
increase of $761,000 in inventory. The increase in accounts receivable and raw
materials inventory is a result of DSCP invoking the surge option and thus,
production was substantially increased. Cash from operations and $137,000 of
cash from the beginning of the fiscal year, along with $590,000 of borrowings
from the line of credit, provided the cash for purchases of equipment and the
payment of cash dividends. Purchases of plant and equipment were primarily for
equipment for manufacture of the ICB boot and to meet the increased demand of
DSCP for the DMS boot.
In 2002, cash provided by operations was $888,000. Net income of $683,000 and
depreciation and amortization of $856,000 were the main sources. $556,000 of
operating cash was provided by a reduction in accounts receivable. The main use
of cash for operations was a $1,101,000 increase in inventory, less the increase
in accounts payable. Cash from operations and $383,000 of cash from the
beginning of the fiscal year, along with $163,000 of cash from stock option
exercises, provided the cash for purchases of equipment and the payment of cash
dividends.
In 2001, cash provided by operations was $3,750,000. This primarily resulted
from net income plus depreciation and amortization, which totaled $1,878,000. A
$1,066,000 reduction in accounts receivable, primarily from completion of a
contract, and an increase in accounts payable and accrued liabilities of
$618,000, also provided operating cash.
The following table shows aggregated information about contractual obligations
as of June 28, 2003:
Payments Due by Period
Total Less Than 1 1-3 Years 4-5 Years After 5 Years
Year
- --------------------------------------------------------------------------------
Long -Term
Debt $300,000 - - - $300,000
- --------------------------------------------------------------------------------
Building Lease 990,000 $150,000 $318,000 $342,000 180,000
- --------------------------------------------------------------------------------
Total $1,290,000 $150,000 $318,000 $342,000 $480,000
- --------------------------------------------------------------------------------
-10-
The Company's remaining equipment need for ICB boot production is estimated to
be between $300,000 and $500,000. Other than this, Wellco does not know of any
other demands, commitments, uncertainties, or trends that will result in or that
are reasonablely likely to result in its liquidity increasing or decreasing in
any material way.
Prior to February 5, 2003, the bank line of credit provided for borrowings of up
to $3,000,000. Because of infrequent and limited line use, and in order to
reduce the bank's line maintenance charge, on February 5, 2003 the line was
reduced from $3,000,000 to $1,500,000. Due to increased accounts receivable from
shipping DMS boots under surge, and to increased inventories, caused by both
surge and the initial production of the ICB boot, the Company increased its line
of credit to $4,500,000 on September 18, 2003.
The bank line of credit, which provides for total borrowing of $4,500,000, will
expire on December 31, 2003 and will then be subject to renewal at the
discretion of the bank. Historically, the bank has always renewed the line of
credit. Under conditions of substantial reduction in operations, with little
basis for projecting a reversal of such reduction, it is possible that the bank
would cancel the line of credit. Events that would cause a substantial reduction
in operations include: cancellation of existing government contracts; and,
receiving government contracts that do not provide enough revenues to provide
adequate liquidity.
There was borrowing of $590,000 under the line of credit at June 28, 2003 and
the Company was in compliance with the loan covenants on that date. Because of
surge and the investment in inventory for manufacture of the ICB boot, the
Company expects significant use of the line of credit in the next few months.
Since the Company's first source of liquidity is cash from operations, a
decrease in sales of the Company's products would reduce this source of
liquidity and result in increased use of the bank line of credit. Based on
information available to date, the Company believes that such events should not
occur in its fiscal year 2004.
The Promissory Note, Loan Agreement and Security Agreement documenting the bank
line of credit provide that:
o All amounts borrowed shall become due and immediately payable upon
demand of the bank.
o The bank's obligation to make advances under the note shall terminate:
if the bank makes a demand for payment; if a default under any loan
document occurs; or, in any event, on December 31, 2003, unless the
Note is extended by the bank under terms satisfactory to the bank.
o All amounts borrowed shall become immediately payable if Wellco
commences or has commenced against it a bankruptcy or insolvency
proceeding, or in the event of default.
Events of default include:
o Having a current ratio less than that prescribed by the bank.
o Having tangible net worth less than that prescribed by the bank.
o Any failure to meet requirements under the Note, Loan Agreement or
Security Agreement.
-11-
WELLCO ENTERPRISES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
FOR THE FISCAL YEARS ENDED
JUNE 28, 2003, JUNE 29, 2002 AND JUNE 30, 2001
(in thousands except per share amounts)
JUNE 28, JUNE 29, JUNE 30,
2003 2002 2001
--------------------------------
REVENUES (Notes 5, 15 and 16) ............. $ 24,833 $ 19,981 $ 19,417
-------- -------- --------
COSTS AND EXPENSES
Cost of sales and services ........... 21,272 16,361 15,483
Unrecovered contract preparation costs
(Note 18) ............................ 70 335 --
General and administrative expenses .. 2,390 2,551 2,494
-------- -------- --------
Total ................................ 23,732 19,247 17,977
-------- -------- --------
GRANT INCOME (Note 17) ..................... 80 80 160
-------- -------- --------
OPERATING INCOME ........................... 1,181 814 1,600
INTEREST EXPENSE ........................... 30 32 138
DIVIDEND AND INTEREST INCOME (Note 12) ..... 9 260 28
-------- -------- --------
INCOME BEFORE INCOME TAXES ................. 1,160 1,042 1,490
PROVISION FOR INCOME TAXES (Note 11) ....... 109 359 337
-------- -------- --------
INCOME BEFORE CUMULATIVE EFFECT
OF CHANGE IN ACCOUNTING PRINCIPLE .... 1,051 683 1,153
CUMULATIVE EFFECT OF CHANGE IN
ACCOUNTING PRINCIPLE (Notes 2 and 21) 228 -- --
-------- -------- --------
NET INCOME ................................. 823 683 1,153
OTHER COMPREHENSIVE LOSS (Note 9):
Increase in additional minimum pension
liability, net of tax in 2001 ........ (924) (159) (130)
-------- -------- --------
COMPREHENSIVE INCOME (LOSS) ................ $ (101) $ 524 $ 1,023
======== ======== ========
EARNINGS PER SHARE (Note 14):
Basic, before cumulative effect ...... $ 0.89 $ 0.58 $ 0.99
Cumulative effect .................... (0.19) -- --
-------- -------- --------
Basic, after cumulative effect ....... $ 0.70 $ 0.58 $ 0.99
======== ======== ========
Diluted, before cumulative effect .... $ 0.87 $ 0.56 $ 0.97
Cumulative effect .................... (0.19) -- --
-------- -------- --------
Diluted, after cumulative effect ..... $ 0.68 $ 0.56 $ 0.97
======== ======== ========
See Notes to Consolidated Financial Statements.
-12-
WELLCO ENTERPRISES, INC.
CONSOLIDATED BALANCE SHEETS
JUNE 28, 2003 AND JUNE 29, 2002
(in thousands)
ASSETS
JUNE 28, JUNE 29,
2003 2002
---------------------
CURRENT ASSETS:
Cash and cash equivalents .................... $ 133 $ 270
Receivables, net (Notes 3 and 7) ............. 3,450 1,374
Inventories (Notes 4 and 7) .................. 7,001 6,240
Deferred taxes (Note 11) .................... 185 206
Prepaid expenses ............................. 290 175
Assets held for sale (Note 18) ............... -- 70
------- -------
Total ........................................ 11,059 8,335
------- -------
MACHINERY LEASED TO LICENSEES, net
(Notes 2 and 5) .............................. 23 28
PROPERTY, PLANT AND EQUIPMENT, net
(Notes 6 and 7) .............................. 4,119 3,926
INTANGIBLE ASSETS:
Excess of cost over net assets of
subsidiary at acquisition
(Notes 2 and 21) ............................. -- 228
Intangible pension asset (Note 9) ............ 29 21
------- -------
Total ........................................ 29 249
------- -------
DEFERRED TAXES (Note 11) ........................... 80 391
------- -------
TOTAL .............................................. $15,310 $12,929
======= =======
(continued on next page)
-13-
WELLCO ENTERPRISES, INC.
CONSOLIDATED BALANCE SHEETS
JUNE 28, 2003 AND JUNE 29, 2002
(in thousands except share data)
LIABILITIES AND STOCKHOLDERS' EQUITY
JUNE 28, JUNE 29,
2003 2002
---------------------
CURRENT LIABILITIES:
Short-term borrowing from bank (Note 7) ........ $ 590 $ --
Accounts payable ............................... 3,138 1,306
Accrued compensation ........................... 810 892
Accrued liabilities (Notes 8, 9, 10, and 17) ... 582 587
Accrued income taxes (Note 11) ................. 722 769
-------- --------
Total ...................................... 5,842 3,554
-------- --------
LONG-TERM LIABILITIES:
Pension obligation (Note 9) .................... 1,672 1,028
Notes payable (Note 12) ........................ 213 205
Deferred revenues (Note 12) .................... 87 95
COMMITMENTS (Note 20)
STOCKHOLDERS' EQUITY (Notes 9, 12 and 13):
Common stock, $1.00 par value; shares
authorized - 2,000,000; shares issued
and outstanding - 1,185,746 ................ 1,186 1,183
Additional paid-in capital ..................... 357 336
Retained earnings .............................. 7,596 7,247
Accumulated other comprehensive loss ........... (1,643) (719)
-------- --------
Total ...................................... 7,496 8,047
-------- --------
TOTAL ................................................ $ 15,310 $ 12,929
======== ========
See Notes to Consolidated Financial Statements.
-14-
WELLCO ENTERPRISES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE FISCAL YEARS ENDED
JUNE 28, 2003, JUNE 29, 2002 AND JUNE 30, 2001
(in thousands)
JUNE 28, JUNE 29, JUNE 30,
2003 2002 2001
------------------------------
CASH FLOWS FROM OPERATING
ACTIVITIES:
Net income .............................. $ 823 $ 683 $ 1,153
------- ------- -------
Adjustments to reconcile net income
to net cash provided by (used in)
operating activities:
Cumulative effect of change in
accounting principle .............. 228 -- --
Depreciation and amortization ....... 995 856 725
Deferred income taxes ............... 44 232 171
Non-cash reduction in accrued
interest .......................... -- (234) --
Non-cash asset impairment ........... 70 159 --
Non-cash grant income recognized .... (80) (80) --
Non-cash interest expense ........... 8 7
Non-cash reduction in deferred
revenues .......................... (8) (7) --
(Increase) decrease in-
Receivables ..................... (2,076) 556 1,066
Inventories ..................... (761) (1,230) 87
Other current assets ............ 57 (78) 15
Increase (decrease) in-
Accounts payable ................ 1,832 129 316
Accrued compensation ............ (82) (84) 46
Other accrued liabilites ........ 95 79 256
Accrued income taxes ............ (47) 37 103
Pension obligation .............. (192) (137) (188)
------- ------- -------
Total adjustments ....................... 83 205 2,597
------- ------- -------
NET CASH PROVIDED BY (USED IN)
OPERATING ACTIVITIES .................... 906 888 3,750
------- ------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of equipment .................. (1,183) (962) (1,269)
------- ------- -------
NET CASH PROVIDED BY (USED IN)
INVESTING ACTIVITIES ................... (1,183) (962) (1,269)
------- ------- -------
(continued on next page)
-15-
WELLCO ENTERPRISES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE FISCAL YEARS ENDED
JUNE 28, 2003, JUNE 29, 2002 AND JUNE 30, 2001
(in thousands)
JUNE 28, JUNE 29, JUNE 30,
2003 2002 2001
------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net advances (repayment) of line
of credit borrowings .................... 590 -- (1,700)
Proceeds from note payable .............. -- -- 300
Repayment of note payable ............... -- -- (36)
Cash dividends paid ..................... (474) (472) (465)
Stock option exercise ................... 24 163 --
------- ------- -------
NET CASH PROVIDED BY (USED IN)
FINANCING ACTIVITIES .................... 140 (309) (1,901)
------- ------- -------
NET INCREASE (DECREASE) IN CASH ............... (137) (383) 580
AND CASH EQUIVALENTS
CASH AND CASH EQUIVALENTS AT
BEGINNING OF YEAR ....................... 270 653 73
------- ------- -------
CASH AND CASH EQUIVALENTS AT
END OF YEAR ............................. $ 133 $ 270 $ 653
======= ======= =======
SUPPLEMENTAL DISCLOSURE OF CASH
FLOW INFORMATION:
Cash paid (received) for-
Interest ............................ $ 22 $ 32 $ 63
Income taxes ........................ 113 65 52
NONCASH INVESTING AND FINANCING
ACTIVITY:
Adjustment of stock repurchase note ........... (347) (355)
Increase in leasehold improvements ...... $ -- $ 112 $ --
======= ======= =======
See Notes to Consolidated Financial Statements.
-16-
WELLCO ENTERPRISES, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE FISCAL YEARS ENDED
JUNE 28, 2003, JUNE 29, 2002 AND JUNE 30, 2001
(in thousands except share data)
JUNE 28, JUNE 29, JUNE 30,
2003 2002 2001
--------------------------------
COMMON STOCK :
Balance at beginning of year ......... $ 1,183 $ 1,164 $ 1,164
Stock option exercise (Note 13) ...... 3 19 --
------- ------- -------
Balance at end of year .............. 1,186 1,183 1,164
------- ------- -------
ADDITIONAL PAID-IN CAPITAL:
Balance at beginning of year ......... 336 192 192
Stock option exercise (Note 13) ...... 21 144 --
------- ------- -------
Balance at end of year .............. 357 336 192
------- ------- -------
RETAINED EARNINGS:
Balance at beginning of year ......... 7,247 6,689 5,646
Adjustment of note payable
from stock repurchase (Note 12) ...... -- 347 355
Net income ........................... 823 683 1,153
Cash dividends (per share:
2003 - $.40, 2002 - $.40,
2001 - $.40) ....................... (474) (472) (465)
------- ------ -------
Balance at end of year ............... 7,596 7,247 6,689
------- ------ -------
ACCUMULATED OTHER COMPREHENSIVE LOSS
Additional minimum pension
liability, net of tax (Note 9):
Balance at beginning of year ......... (719) (560) (430)
Change for the year .................. (924) (159) (130)
------- ------- -------
Balance at end of year ............... (1,643) (719) (560)
------- ------- -------
TOTAL STOCKHOLDERS' EQUITY ................. $ 7,496 $ 8,047 $ 7,485
======= ======= =======
See Notes to Consolidated Financial Statements.
-17-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Fiscal Years Ended June 28, 2003, June 29, 2002, and June 30, 2001
- --------------------------------------------------------------------------
1. BUSINESS AND ORGANIZATION:
Substantially all of the Company's operating activity is from the sale of
military and other rugged footwear, the sale of specialized machinery and
materials for the manufacture of this type of footwear and the rendering of
technical assistance and other services to licensees for the manufacture of
this type of footwear. The majority of revenues ($18,209,000 in 2003,
$14,875,000 in 2002, and $13,962,000 in 2001) 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 U. S. Armed Forces. The loss
of this customer would have a material adverse effect on the Company.
Bidding on U. S. government boot solicitations is open to any qualified U.
S. manufacturer. Bidding on contracts is very competitive. U. S. footwear
manufacturers have been adversely affected by sales of footwear made in low
labor cost countries. This has significantly affected the competition for
contracts to supply boots to U. S. Armed Forces, which by law must be
made in the U. S.
Most boot contracts are for multi-year periods. Therefore, a bidder not
receiving an award from a significant solicitation could be adversely
affected for several years. In addition, current boot contracts contain
options for additional pairs that are exercisable at the government's
discretion. The Company cannot predict with certainty its success in
receiving a contract from any of the above solicitations.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Principles of Consolidation
The accompanying financial statements include the consolidated accounts
of the Company and its wholly-owned subsidiaries. Appropriate
eliminations have been made of all material intercompany transactions
and balances.
Cash and Cash Equivalents
Cash in excess of daily requirements is invested in short-term interest
earning instruments. The Company considers investments with original
maturities of three months or less to be cash equivalents.
Receivables
Accounts receivable from the sale of products or services are recorded
at net realizable value and the Company grants credit to customers on
an unsecured basis. The Company provides an allowance for doubtful
collections that is based upon a review of outstanding receivables,
historical collections information, and existing economic conditions.
Normal trade receivables are due 30 days after the issuance of the
invoice. Receivables past due more than 120 days are considered
delinquent. Delinquent receivables are written off based on individual
credit evaluations and specific circumstances of the customer.
Inventories
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.
-18-
Income Taxes
The provision for income taxes is based on taxes currently payable
adjusted for the net change in the deferred tax asset or liability
during the current year. A deferred tax asset or liability arises from
temporary differences between the carrying value of assets and
liabilities for financial reporting and income tax purposes. A
valuation allowance is recorded to reduce the carrying amounts of
deferred tax assets unless it is more likely than not that such assets
will be realized.
Fair Value of Financial Instruments
The carrying values of cash, receivables and accounts payable at June
28, 2003 and June 29, 2002 approximate fair value. The carrying value
of the notes payable (see Note 12 to the Consolidated Financial
Statements) is equal to the present value of estimated future cash
flows using a discount rate commensurate with the uncertainties
involved and thus approximates fair value.
Depreciation and Amortization
The Company uses the straight-line method to compute depreciation and
amortization on machinery leased to licensees and property, plant and
equipment used by the Company.
Machinery Leased to Licensees
Certain shoe-making machinery is leased to licensees under cancelable
operating leases. Such activity is accounted for by the operating
method whereby leased assets are capitalized and depreciated over their
estimated useful lives (5 to 10 years) and rentals, based primarily on
the volume of shoes produced or shipped by the lessees, are recorded
during the period earned.
Research and Development Costs
All research and development costs are expensed as incurred unless
subject to reimbursement. The amount charged against income was
approximately $110,000 in 2003 and $180,000 in 2002. Records to
determine the costs were not maintained during 2001.
Intangible Asset
The excess of the fair value (as determined by the Board of Directors)
of Wellco Enterprises, Inc. common stock issued over the net assets of
Ro-Search, Incorporated, a wholly owned subsidiary of Wellco, at
acquisition was not being amortized. This asset arose prior to 1970
and, in the opinion of management, there was not any diminution in its
value under the guidance of APB Opinion No. 17. Effective for the
Company's 2003 fiscal year, Statement of Financial Accounting Standards
No. 142 (SFAS 142), Goodwill and Other Intangible Assets, supersedes
APB Opinion No. 17.
Statement of Financial Accounting Standards No. 142 (SFAS 142,
"Goodwill and Other Intangible Assets) was effective with the Company's
2003 fiscal year. Under SFAS 142, this goodwill was deemed impaired and
was written off as a cumulative effect of change in accounting
principle, as explained in Footnote 21.
Revenue Recognition
On June 1, 2001, the government unilaterally modified the Company's
current boot contract to require a bill and hold procedure. Under bill
and hold, the government issues a specific boot production order which,
when completed and ready for shipment, is inspected and accepted by the
Quality Assurance Representative (QAR), thereby transferring ownership
to the government. Under this contract modification, after inspection
and acceptance by the QAR, the boots become "government-owned
property". Also, after QAR inspection and acceptance, Wellco invoices
and receives payment from the government, and warehouses and
-19-
distributes the related boots against government-issued requisition
orders, which Wellco receives five days per week. Government- owned
boots stored in Wellco's warehouse are complete, including packaging
and labeling. The bill and hold procedure requires physical segregation
and specific identification of government- owned boots and, because
they are owned by the government, Wellco cannot use them to fill any
other customers' orders. Wellco has certain custodial responsibilities
for these boots, including loss or damage, which Wellco insures. The
related insurance policies specifically provide that loss payment on
finished stock and sold personal property completed and awaiting
delivery is based on Wellco's selling price. The modification also
provides that at the end of any one-year term when an option is not
exercised, the government is to take final delivery of any and all of
its remaining inventory within six months. In accordance with guidance
issued under Securities and Exchange Commission Staff Accounting
Bulletin No. 101, Revenue Recognition in Financial Statements, revenues
from bill and hold transactions are recognized at the time of
acceptance by the QAR.
Certain shoe-making machinery is leased to licensees under twenty-year
cancelable operating leases. Lease payments are variable based on the
quantity of boots manufactured and sold by the lessee to its customers
and the contractual rental fee per pair of boots. There are no base
rental amounts or contingent rentals contained in the agreements.
Rental income is recognized by the Company when the lessee manufactures
and sells boots to the customer and is based upon the quantity of boots
manufactured or shipped by the lessee times the fixed rate per pair of
boots contained in the lease agreements.
The Company earns service fees for providing customers with technical
assistance in the manufacture of boots. The related agreements under
which these services are provided are for a fixed term and expire in
calendar years 2003-2007. The Company records service fee revenues at a
fixed rate per pair of boots times the quantity of boots manufactured
and sold by the customer when such boots are manufactured and sold by
the Company's customer.
Revenues from the sale of machinery and materials are recorded at the
time of shipment from our factory (FOB factory) or at the time of
receipt by the customer (FOB destination). Other than a one- year
warranty, the Company does not have any continuing responsibility
related to machines sold. Warranty costs are diminimus.
Shipping and Handling Costs
Shipping and handling costs are charged to Cost of Sales and Services
in the period incurred. Any amounts paid by customers for shipping and
handling are included in Revenues.
Impairment of Long-Lived Assets
The Company reviews its long-lived assets, including intangible 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 Consolidated Statements of Operations and Comprehensive
Income for the fiscal years 2003 and 2002 include a write-down of
$70,000 and $159,000 related to equipment purchased during contract
preparation for the manufacture of berets (see Note 18 to the
Consolidated Financial Statements).
Self-Funded Group Health Insurance
The cost of employee group health insurance is recorded in the period
in which the health care costs are incurred including an estimate of
the incurred but not reported claims. Third party administrator fees
-20-
are recorded in the month to which they apply. The cost of stop loss
insurance is recorded in the month to which it applies. The liability
for incurred but not reported insurance claims is accrued and included
in the Accounts Payable caption in the Consolidated Balance Sheets.
Fiscal Year
The Company's fiscal year ends on the Saturday closest to June 30.
Consequently, the 2003, 2002, and 2001 fiscal years contain 52 weeks of
operating results.
Estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions. These estimates and
assumptions affect the reported amounts of assets and liabilities, as
well as the disclosure of contingent assets and liabilities, at the
date of the financial statements. They also affect the reported amounts
of revenues and expenses during the reporting period. Actual results
could differ from those estimates.
Reclassifications
Certain reclassifications have been made in prior years' financial
statements to conform to classifications used in the current year.
Stock-Based Compensation Plans
The Company accounts for its stock-based compensation plans using the
compensation recognition provisions of Accounting Principles Board
Opinion 25 (APB 25), "Accounting for Stock Issued to Employees". The
Company also provides the disclosures required by Statement of
Financial Accounting Standards No. 123 (SFAS 123), "Accounting for
Stock-Based Compensation." Compensation expense under the APB 25 method
is recognized when there is a difference between the exercise price for
stock options and the stock's market price on the measurement date,
which for the Company, is normally the date of award.
New Accounting Pronouncements
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities", which addresses financial
accounting and reporting for costs associated with exit or disposal
activities and nullifies Emerging Issues Task Force (EITF) Issue No.
94-3, "Liability Recognition for Certain Employee Termination Benefits
and Other Costs to Exit an Activity (including Certain Costs Incurred
in a Restructuring)". This Statement applies to costs associated with
specific exit activities and requires a liability for a cost associated
with an exit or disposal activity to be recognized and measured
initially at its fair value in the period in which the liability is
incurred. A liability for a cost associated with an exit or disposal
activity is incurred when the definition of a liability is met. The
provisions of this statement are effective for exit or disposal
activities that are initiated after December 31, 2002. We adopted the
provisions of this statement on January 1, 2003 with no impact on our
financial position or results of operations.
In December 2002, SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure" was issued to amend
disclosure requirements of FASB Statement No. 123, "Accounting for
Stock-Based Compensation" to require disclosures in both annual and
interim financial statements about the method of accounting for
-21-
stock-based employee compensation and the effect of the method used on
reported results. The disclosure provisions for annual financial
information is effective for all periods presented in the financial
reports.
In November 2002, FASB Interpretation No. 45, "Guarantor's Accounting
and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others" was issued to clarify the
requirements for a guarantor's accounting for and disclosures of
certain guarantees issued and outstanding. The initial recognition and
measurement provisions are effective for guarantees issued or modified
after December 31, 2002. The Company has determined that it has no
guarantees issued and outstanding at June 28, 2003.
Other accounting standards that have been issued or proposed by the
FASB or other standards- setting bodies that do not require adoption
until a future date are not expected to have a material impact on our
consolidated financial statements upon adoption.
3. RECEIVABLES:
The majority of receivables at June 28, 2003 and June 29, 2002 are from the
U. S. Government. The Company's policy is to require either a confirmed
irrevocable bank letter of credit or advance payment on significant orders
from foreign customers. Allowances for doubtful accounts in 2003, 2002 and
2001 are not significant.
Receivables at June 28, 2003 and June 29, 2002 include $38,000 from the
Puerto Rican government for reimbursement of certain costs incurred by the
Company and related to leasehold improvements made to the Company's Puerto
Rican facility. At June 29, 2002, this receivable, which was initially
recorded at $150,000 in fiscal year 2000, was reduced by, and leasehold
improvements was increased by, $112,000, adjusting the receivable to the
amount the Puerto Rican government has agreed to pay at June 29, 2002. Any
additional reimbursements from the Puerto Rican government will be recorded
as a reduction in leasehold improvements.
4. INVENTORIES:
The components of inventories are:
(in thousands)
2003 2002
- ------------------------------------------------------
Finished Goods $ 1,247 $ 2,509
- ------------------------------------------------------
Work in Process 1,753 1,268
- ------------------------------------------------------
Raw Materials and Supplies 4,001 2,463
- ------------------------------------------------------
Total $ 7,001 $ 6,240
- ------------------------------------------------------
-22-
5. MACHINERY LEASED TO LICENSEES:
Accumulated depreciation netted against the cost of leased assets in the
Consolidated Balance Sheets at June 28, 2003 and June 29, 2002 is
$1,537,000 and $1,532,000, respectively. Rental revenues for the fiscal
years 2003, 2002, and 2001 were $178,000, $148,000 and $105,000,
respectively, and vary with lessees' production or shipments.
6. PROPERTY, PLANT AND EQUIPMENT:
The components of property, plant and equipment are summarized as follows:
(in thousands)
2003 2002 Estimated Useful Life
- --------------------------------------------------------------------------------
Land $ 107 $ 107 N/A
- --------------------------------------------------------------------------------
Buildings 1,439 1,176 40-45 Years
- --------------------------------------------------------------------------------
Machinery & Equipment 7,559 6,727 2-20 Years
- --------------------------------------------------------------------------------
Furniture & Fixtures 951 967 2-10 years
- --------------------------------------------------------------------------------
Leasehold Improvements 771 735 *
- --------------------------------------------------------------------------------
Total Cost $ 10,827 $ 9,712
- --------------------------------------------------------------------------------
Total Accumulated
Depreciation and Amortization $ 6,708 $ 5,786
- --------------------------------------------------------------------------------
*Leasehold improvements are amortized using the straight-line method
over the shorter of the estimated useful lives of the improvements or
the period of the respective leases.
7. LINES OF CREDIT:
The Company maintains a $1,500,000 bank line of credit. The line, which
expires December 31, 2003, can be renewed annually at the bank's
discretion. This line of credit is secured by a blanket lien on all
machinery and equipment (carrying value of $2,712,000 at June 28, 2003) and
all non-governmental receivables and inventory ($1,310,000 at June 28,
2003). At June 28, 2003, borrowings on this line of credit were $ 590,000
with $ 910,000 available in additional borrowings.
Interest is at the London Interbank Offered Rate (LIBOR) plus 2.25 points
or 3.37% at June 28, 2003. The bank credit agreement contains, among other
provisions, defined levels of net worth and current ratio requirements. The
Company was in compliance with the loan covenants at June 28, 2003. The
covenants are subject to review at the end of each fiscal quarter.
Historically, the bank has always renewed the line of credit. Under
conditions of substantial reduction in operations, with little basis for
projecting a reversal of such reduction, it is possible that the bank
-23-
would cancel the line of credit or not renew it when it expires. Events
that would cause a substantial reduction in operations include:
cancellation of existing government contracts that are being solicited; not
receiving future government contracts; and, receiving government contracts
that do not provide enough revenues to provide adequate liquidity.
8. ACCRUED LIABILITIES:
The components of accrued liabilities are:
(in thousands)
2003 2002
- ---------------------------------------------------------------
Retiree Health Benefits (Note 10) $ 231 $ 176
- ---------------------------------------------------------------
Interest Expense (Note 12) 2 2
- ---------------------------------------------------------------
Accrued Lease Payments (Note 20) 135 128
- ---------------------------------------------------------------
Deferred Grant Revenues (Note 17) 80 160
- ---------------------------------------------------------------
Other 134 121
- ---------------------------------------------------------------
Total $ 582 $ 587
- ---------------------------------------------------------------
9. PENSION PLANS:
The Company has two non-contributory, defined benefit pension plans. The
components of pension expense, included in Cost of Sales and Services in
the Consolidated Statements of Operations and Comprehensive Income are as
follows:
(in thousands)
2003 2002 2001
- -------------------------------------------------------------------------
Benefits Earned for Service in the
Current Year $ 132 $ 119 $ 95
- -------------------------------------------------------------------------
Interest on the Projected Benefit
Obligation 365 372 376
- -------------------------------------------------------------------------
Expected Return on Plan Assets (286) (303) (315)
- -------------------------------------------------------------------------
Amortization of: Unrecognized Net
Pension Obligation at July 1, 1987;
Cost of Benefit Changes Since That
Date; and Gains and Losses 80 119 102
- -------------------------------------------------------------------------
Against Actuarial Assumptions
Pension Expense $ 291 $ 307 $ 258
- -------------------------------------------------------------------------
-24-
Below are various analyses and other information relating to the Company's
pension liability, assets and expense as of June 2003 and June 2002, (all
amounts are in thousands except for those indicated as percent):
Change in Benefit Obligation: 2003 2002
- ------------------------------------------------------------------------
Benefit Obligation at Beginning of Year $ 5,658 $ 5,516
- ------------------------------------------------------------------------
Current Year Service Cost 132 119
- ------------------------------------------------------------------------
Interest Cost on Projected Liability 365 372
- ------------------------------------------------------------------------
Benefit Payments (580) (489)
- ------------------------------------------------------------------------
Actuarial Loss 583 140
- ------------------------------------------------------------------------
Benefit Obligation at End of Year $ 6,158 $ 5,658
- ------------------------------------------------------------------------
Change in Plan Assets: 2003 2002
- ------------------------------------------------------------------------
Fair Value of Plan Assets at Beginning of Year $ 4,247 $ 4,314
- ------------------------------------------------------------------------
Company Contributions 482 443
- ------------------------------------------------------------------------
Actual Return on Plan Assets 225 (21)
- ------------------------------------------------------------------------
Benefit Payments (580) (489)
- ------------------------------------------------------------------------
Fair Value of Plan Assets at End of Year $ 4,374 $ 4,247
- ------------------------------------------------------------------------
Reconciliation of Funded Status: 2003 2002
- ------------------------------------------------------------------------
Funded Status $ (1,785) $ (1,412)
- ------------------------------------------------------------------------
Unrecognized Actuarial Loss 2,001 1,426
- ------------------------------------------------------------------------
Unrecognized Prior Service Cost 29 39
- ------------------------------------------------------------------------
Net Amount Recognized $ 245 $ 53
- ------------------------------------------------------------------------
Amounts Recognized in the Consolidated Balance
Sheets: 2003 2002
- ------------------------------------------------------------------------
Intangible Pension Asset $ 29 $ 21
- ------------------------------------------------------------------------
Deferred Tax Asset - 288
- ------------------------------------------------------------------------
Accumulated Other Comprehensive Loss 1,643 719
- ------------------------------------------------------------------------
-25-
Amounts Recognized in the Consolidated Balance
Sheets: 2003 2002
- ------------------------------------------------------------------------
Accrued Pension Liability:
- ------------------------------------------------------------------------
Prepaid Benefit Cost 463 331
- ------------------------------------------------------------------------
Accrued Benefit Cost (218) (278)
- ------------------------------------------------------------------------
Additional Minimum Pension Liability (1,672) (1,028)
- ------------------------------------------------------------------------
Net Amount Recognized in Financial Statements $ 245 $ 53
- ------------------------------------------------------------------------
CERTAIN ACTUARIAL ASSUMPTIONS: 2003 2002
- ------------------------------------------------------------------------
Assumed Discount Rate 6.00% 6.75%
- -----------------------------------------------------------------------
Expected Long-Term Rate of Return on Plan Assets 6.75% 6.75%
- -----------------------------------------------------------------------
Rate of Compensation Increase, For the Pay Related 5.5% 5.5%
Benefit Plan
- -----------------------------------------------------------------------
At June 2003, one of the pension plans has a benefit obligation ($2,714,000)
that is greater than its plan assets ($1,963,000) resulting in the additional
liability of $1,215,000 and at June 2002, the plan had a benefit obligation
($2,619,000) that was greater than its plan assets ($1,923,000) resulting in the
additional liability of $1,028,000. At June 2003, the other pension plan has a
benefit obligation ($3,087,000) that is greater than its plan assets
($2,412,000) resulting in the additional liability of $457,000 and at June 2002,
this plan did not have an additional liability.
A 1% increase in the assumed discount rate would decrease the benefit obligation
at June 2003 by $552,000. Conversely, a 1% decrease in the assumed discount rate
would increase the benefit obligation at June 2003 by $662,000.
The Consolidated Statement of Operations and Comprehensive Income shows the
amount included in Other Comprehensive Income (Loss) that resulted from
recording the additional minimum pension liability which represents the portion
of the pension liability that has not yet been charged against operations. A
valuation allowance was recorded for the deferred tax asset ($558,000) that
arose from the Other Comprehensive Loss for fiscal year 2003. A valuation
allowance was recorded for the deferred tax asset ($54,000) that arose from the
Other Comprehensive Loss for fiscal year 2002. The Other Comprehensive Loss for
fiscal year 2001 was reduced by an increase in deferred tax assets of $67,000.
In addition, the Company provides retirement benefits to certain employees
through deferred compensation contracts and the unfunded liability associated
with these contracts was $76,000 at June 28, 2003 and $83,000 at June 29, 2002.
-26-
10. RETIREE HEALTH BENEFITS:
The Company accounts for the costs and liability of health care benefits
for retired employees using Statement of Financial Accounting Standards No.
106 (FAS 106), "Employers Accounting for Postretirement Benefits Other Than
Pensions". The liability at the date of adoption of FAS 106 (July 4, 1993)
is being recognized over employee future service lives.
Employees of the North Carolina plant who meet certain criteria and retire
early (age 62-64) or become disabled, receive for themselves, but not for
their dependents, the same health insurance benefits received by active
employees. All benefits terminate when the employee becomes eligible to
receive Medicare (usually age 65 or 30 months after disability date). This
benefit is provided at no cost to the employee and the Company does not
fund the cost of this benefit prior to costs actually being incurred.
The cost of retiree health benefits included in the 2003, 2002 and 2001
Statements of Operations and Comprehensive Income was:
(in thousands)
2003 2002 2001
- ------------------------------------------------------------------------------
Benefits Earned for Current Service $ 28 $ 20 $ 19
- ------------------------------------------------------------------------------
Interest Cost on Accumulated Liability 22 27 28
- ------------------------------------------------------------------------------
Amortization of the July 4, 1993 Liability 4 4 4
- ------------------------------------------------------------------------------
Total Cost $ 54 $ 51 $ 51
- ------------------------------------------------------------------------------
An analysis of the total liability for the last two fiscal years, including
a reconciliation of the liability in the Consolidated Balance Sheets (see
Note 8) at June 28, 2003 and June 29, 2002 is as follows:
(in thousands)
2003 2002
- -------------------------------------------------------------------------------
Total Obligation at Beginning of Year $ 330 $ 377
- -------------------------------------------------------------------------------
Liability for Current Service 28 20
- -------------------------------------------------------------------------------
Interest on Liability 22 27
- -------------------------------------------------------------------------------
Benefit Payments 0 (15)
- -------------------------------------------------------------------------------
Actuarial (Gain) Loss 34 (79)
- -------------------------------------------------------------------------------
Total Obligation at End of Year 414 330
- -------------------------------------------------------------------------------
Less Unamortized Liability at July 4, 1993 (46) (50)
- -------------------------------------------------------------------------------
Unrecognized Gain (Loss) (137) (104)
- -------------------------------------------------------------------------------
Liability Recognized in the Consolidated Balance Sheets $ 231 $ 176
- -------------------------------------------------------------------------------
-27-
The assumed health care cost trend rate used to project expected future
cost was 15% in 2003 and 2002, gradually decreasing to 6% by 2009 and
remaining at 6% thereafter. The assumed discount rate used to determine the
accumulated liability was 6.00% for 2003 and 6.75% for 2002.
A 1% increase in the assumed health care cost trend rate would increase
the benefit obligation at June 28, 2003 by $16,000. Conversely, a 1%
decrease in the assumed health care cost trend rate would decrease the
benefit obligation at June 28, 2003 by $15,000.
A 1% increase in the assumed discount rate would decrease the benefit
obligation at June 28, 2003 by $34,000. Conversely, a 1% decrease in the
assumed discount rate would increase the benefit obligation at June 28,
2003 by $40,000.
11. INCOME TAXES:
The Company accounts for the provision and liability for income taxes using
Statement of Financial Accounting Standards No. 109, "Accounting for Income
Taxes." The provision for income taxes consists of the following:
(in thousands)
2003 2002 2001
- ------------------------------------------------------------------------------
Federal Provision:
- ------------------------------------------------------------------------------
Currently Payable $ 50 $ 92 $ 36
- ------------------------------------------------------------------------------
Deferred 44 232 171
- ------------------------------------------------------------------------------
Total Federal 94 324 207
- ------------------------------------------------------------------------------
State Provision Currently Payable 15 35 130
- ------------------------------------------------------------------------------
Total Provision $ 109 $ 359 $ 337
- ------------------------------------------------------------------------------
A reconciliation of the effective income tax rate for the 2003, 2002 and 2001
fiscal years is as follows:
2003 2002 2001
- ------------------------------------------------------------------------------
Statutory Federal Income Tax Rate 34% 34% 34%
- ------------------------------------------------------------------------------
Current Period Income of Puerto Rico
Subsidiary Substantially Exempt From Puerto (28)% (25)% (42)%
Rican and Federal Income Taxes
- ------------------------------------------------------------------------------
Deferred Tax Valuation Allowance - 29% 20%
- ------------------------------------------------------------------------------
State Taxes, Net of Federal Tax Benefit 1% 3% 9%
- ------------------------------------------------------------------------------
Other 2% (7)% 2%
- ------------------------------------------------------------------------------
Effective Income Tax Rate 9% 34% 23%
- ------------------------------------------------------------------------------
-28-
Income earned in Puerto Rico by the Company's Puerto Rican wholly-owned
subsidiary was 90% exempt from Puerto Rican income tax through 2000.
Effective July 1, 2000, the Company received a new multi-year tax exemption
grant that provided for a flat income tax rate of 2% and eliminated the
withholding tax (5%) on dividends paid. Income earned in Puerto Rico by
this subsidiary has not been subject to United States federal income tax.
The Small Business Job Protection Act (Act) terminated the federal tax
credit on this income subject to a phase out for existing companies, for
tax years beginning after December 31, 1996. Under the phase out, the
Company received a full credit through fiscal year 2002. For fiscal years
2003 through 2006, the credit will be limited, and will be completely
eliminated starting with the 2007 fiscal year.
The accumulated undistributed earnings ($3,431,000) through July 1, 2000 of
this subsidiary are subject to the 5% Puerto Rican withholding tax when
remitted to the parent Company as dividends. Accrued tax liabilities have
been provided for the withholding tax reasonably expected to be paid in the
future.
Significant components of the Company's deferred tax assets and liabilities
as of the end of fiscal 2003 and 2002 are as follows:
(in thousands)
Deferred Tax Assets: 2003 2002
- -------------------------------------------------------------------------------
Tax Effect of Pension Liability Charged Against Equity $ 558 $ 342
- -------------------------------------------------------------------------------
Employee Compensation Charged Against Financial
Statement Income, Not Yet Deducted From Taxable 237 162
Income
- -------------------------------------------------------------------------------
Additional Costs Inventoried for Tax Purposes 81 69
- -------------------------------------------------------------------------------
Federal NOL Carryforward 625 682
- -------------------------------------------------------------------------------
State NOL Carryforward 334 337
- -------------------------------------------------------------------------------
Alternative Minimum Tax Credit 70 70
- -------------------------------------------------------------------------------
Equipment Impairment Loss Not Yet Deductible 78 -
- -------------------------------------------------------------------------------
Other 186 77
- -------------------------------------------------------------------------------
Deferred Tax Assets Before Valuation Allowance 2,169 1,739
- -------------------------------------------------------------------------------
Valuation Allowance (1,767) (1,031)
- -------------------------------------------------------------------------------
Total Deferred Tax Assets 402 708
- -------------------------------------------------------------------------------
Deferred Tax Liabilities:
- -------------------------------------------------------------------------------
Depreciation and Prepaid Pension Costs Deducted From
Taxable Income Not Yet Charged Against Financial 137 111
Statement Income
- -------------------------------------------------------------------------------
Net Deferred Tax Assets $ 265 $ 597
- -------------------------------------------------------------------------------
-29-
Deferred tax assets have been reduced by a valuation allowance because it
is more likely than not that certain of these assets will not be used to
reduce future tax payments.
The Company has operating loss carryforwards of $1,861,000, which begin to
expire in 2019, available to reduce future federal taxable income. In
addition, $4,824,000 of operating loss carryforwards, which begin to expire
in 2013, are available to reduce certain future state taxable income.
12. NOTES PAYABLE:
On December 29, 1995 Wellco repurchased from Coronet Insurance Company and
some of its affiliates (Coronet and Affiliates) 1,531,272 shares of Wellco
common stock, which represented 57.69% of total shares outstanding at that
time. This repurchase provided for certain additional payments, without
interest, to be made if cumulative net income for the six fiscal years 1997
through 2002 exceeded a defined amount.
Generally accepted accounting principles required that an obligation be
reflected in the Consolidated Balance Sheets for the estimated additional
payments that would be made. Actual cumulative net income through fiscal
year 2002 is less than the defined amount that cumulative net income has to
exceed. Consequently, the $347,000 Note Payable, recorded at June 30, 2001
for the estimated additional contingent liability, was reversed and
Stockholders' Equity was increased by this amount during the second quarter
of fiscal year 2002. The Company also revised its estimate of the amount
that might be paid during fiscal year 2001. For fiscal year 2001, the
revised estimate decreased the Note Payable and increased Retained Earnings
by $355,000 (as required by generally accepted accounting principles for
stock repurchases).
Since its stock repurchase, Wellco, had accrued imputed interest expense on
the estimated additional contingent payment. At December 29, 2001, the
previously accrued $234,000 interest liability was reversed in connection
with the elimination of the Note Payable and accordingly, the 2002 fiscal
year Consolidated Statement of Operations and Comprehensive Income includes
interest income for this amount. Interest expense on the Stock Repurchase
Agreement for the fiscal years 2002 and 2001 was $0 and $75,000
respectively.
As part of an agreement with a customer for which the Company provi