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 July 3, 2004
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
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(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, 2004, 1,249,046 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, 2004) of Wellco
Enterprises, Inc. held by nonaffiliates was approximately $6,400,000.
Documents incorporated by reference:
Definitive Proxy Statement, to be dated October 15, 2004, in PART IV.
Form 8-K , dated March 4, 2004, in Item 4.
Definitive Proxy Statement, dated October 17, 2003, in PART IV.
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 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
($39,648,000 in 2004 and $18,209,000 in 2003) 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. The primary
boot products supplied DSCP are the general issue combat boot, the hot wet
(jungle) boot and the hot dry (desert) boot, and the Infantry Combat Boot (ICB).
The government awards fixed price boot contracts on the basis of bids from
several qualified U. S. manufacturers. The Company also sells similar
military-style boot products, as well as anti-personnel mine protective footwear
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 2004 fiscal year was $2,448,000 ($1.97 diluted income per
share) compared to net income of $823,000 ($0.68 diluted income per share) for
the 2003 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
$20,860,000. 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 for the
manufacture of Direct Molded Sole (DMS) boots. 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 232,000 more pairs of DMS boots than in the
prior year.
Also in March 2003, DSCP awarded the Company a contract to supply the black ICB
boot. This contract is for a one year period, with four one-year options which
are exercisable at the government's discretion. The Company shipped 75,000 pairs
of the new black ICB boot during fiscal year 2004.
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More information about these, and other events affecting Wellco's 2004 and 2003
operating results, are contained in the Management's Discussion and Analysis of
Results of Operations and Financial Condition section of the Company's 2004
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.
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
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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.
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
2004, 2003 and 2002 is $101,000, $110,000 and $180,000.
The Company's backlog of all sales, not including license fees and rentals, as
of August 31, 2004 was approximately $28,000,000 compared to $19,100,000 at
August 31, 2003. The Company estimates that substantially all of the current
year backlog will be shipped in the 2005 fiscal year. The current year's backlog
increased because the Company was awarded a new contract in May 2004 to supply
the U.S. Army with the ICB boot in the tan color.
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 693 persons during the 2004 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
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
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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 2004.
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WELLCO(R)
ENTERPRISES, INC.
ANNUAL REPORT
2004
WELLCO ENTERPRISES, INC.
CONSOLIDATED SELECTED FINANCIAL DATA
(In Thousands Except for Per Share Amounts)
Fiscal Year Ended
July 3, June 28, June 29, June 30, July 1,
2004 2003 2002 2001 2000
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Revenues $ 45,693 $ 24,833 $ 19,981 $ 19,417 $ 22,225
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Net Income 2,448 (A) 823 683 1,153 711
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Basic Earnings per Share 2.04 0.70 0.58 0.99 0.61
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Diluted Earnings per Share 1.97 0.68 0.56 0.97 0.61
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Cash Dividends Declared per
Share of Common Stock 0.45 0.40 0.40 0.40 0.25
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Total Assets at Year End 22,642 15,310 12,929 12,787 12,950
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Long-Term Liabilities at Year End $ 1,725 $ 1,972 $ 1,328 $ 1,532 $ 1,593
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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
Dixon Hughes PLLC
Asheville, N.C.
Annual Meeting
November 16, 2004
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 2004, your company had net income of $2,448,000, equivalent to
basic earnings per share of $2.04 (diluted $1.97), from revenues of $45,693,000.
This compares with net income of $823,000, equivalent to basic earnings per
share of $.70 (diluted $.68) in the 2003 fiscal year, from revenues of
$24,883,000. For both revenues and net income, this is a record for your
company. The Management's Discussion and Analysis section of this Annual Report
gives you more details about this change.
A "surge" in desert boots, caused by the involvement of U. S. Armed Forces
personnel in Iraq increased revenues by $13,800,000. Shipments under a contract
for the Army's new Infantry Combat Boot (ICB) increased revenues $6,000,000.
Our contracts with the Defense Supply Center Philadelphia (DSCP) contain surge
option clauses. When a significant need arises, DSCP invokes this option clause,
which requires us to accelerate production to the maximum extent possible. On
one of our contracts, surge was invoked in March, 2003 and was in effect for all
of the 2004 fiscal year.
For many years we were one of the suppliers of an all-leather combat boot, which
is the basic boot issued to all U. S. Army recruits. This boot represented about
half of our total boot sales to DSCP. About two years ago, the Army replaced
this boot with the ICB boot. We submitted a response to the Army's first
solicitation of the ICB boot, and in March, 2003 were one of the three companies
awarded a contract.
The combination of surge and incorporation of the ICB boot into production, both
of which occurred at the same time, was a massive task. It resulted in a record
year, but was not without its problems.
Margins suffered from excess costs. Mo-Ka Shoe Corporation, our wholly-owned
subsidiary in Aguadilla, Puerto Rico, where we manufacture the majority of our
boots, increased employment from approximately 200 to a high of approximately
800 people. In the past few years, several shoe manufacturing plants in Puerto
Rico have closed. To my surprise, we still found it difficult to hire a
sufficient number of skilled shoe makers, and we incurred significant excess
labor cost. However, we did not have a choice. Production had to be quickly
increased.
The increased level of operations required the utmost dedication and greatly
extended working hours on the part of management and supervisory staff, as well
as on the part of production workers. It was only through the committed efforts
of many people that we were able to manage the increase.
Our need for cash grew significantly. You will see from this Annual Report that
we had to add a lot of equipment and had to make a significant investment in
inventory and accounts receivable. We are fortunate in having Wachovia Bank that
truly understands our operations and needs. Wachovia responded quickly to our
request for additional borrowings which allowed us to continue the expansion in
operations without interruption.
Although manufacturing costs increased at approximately the rate of revenues,
our administrative staff went far beyond what could reasonably be expected, and,
because of their efforts, we were able to limit the increase in administrative
costs.
I understand that, when we complete shipping the last of our orders that are
under surge, which should be in the second quarter of fiscal year 2005, future
orders will not be under surge, which also means that the need for desert boots
will be less. It is very difficult to project what the demand will be. Our
contracts are "indefinite quantity" contracts, meaning that each contract has a
minimum and a maximum number of pairs that DSCP can order, and the spread
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between minimum and maximum is very large. I do feel that revenues in the 2005
fiscal year will be greater than those of the recent past, except for 2004.
I encourage you to read the "Forward Looking" section of Management's Discussion
and Analysis section of this Annual Report. It contains current information
about our contracts and other useful information.
I will emphasize that, in addition to being very demanding, government boot
contracting is very competitive. Footwear manufacturing remains a labor
intensive operation and very few companies can afford to manufacture in the U.
S. and remain competitive against foreign made footwear in the civilian.
Therefore, our government contracting is attractive for many of the remaining U.
S. boot manufacturers.
We are presently taking the necessary steps to lower our manufacturing costs. In
order to prepare for the future, your management is also concentrating on new
processes and technology. If wisely chosen and successfully implemented, this
will be one of the foundations of our future.
This past year I have learned that we have many great employees. It was only
through their skills, long hours and determination that we have had a successful
2004 fiscal year.
David Lutz
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Chief Executive Officer and President
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September 29, 2004
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL
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CONDITION
---------
RESULTS OF OPERATIONS
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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 July 3, 2004 to the Fiscal Year ended June 28,
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2003:
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OVERVIEW
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The most significant event affecting the Company's operations in the current
fiscal year is the increased demand for desert boots used by U. S. Armed Forces
personnel serving in Iraq. To meet the need, boot production has more than
doubled, new employees have been hired and trained, overtime has been incurred
and new equipment has been purchased. While this level of activity has increased
income, significant excess costs have been incurred which resulted in no
significant change in the percent of gross profit to revenues.
The second most significant event occurring in this fiscal year is the
integration into manufacturing of a new boot for the U. S. Army (the Infantry
Combat Boot, "ICB"). While sales of this boot increased revenues, excess costs
were incurred in training employees and establishing manufacturing procedures
and methods.
Comparative results for these two periods is as follows:
Fiscal Year Fiscal Year
Ended July 3, Ended June 28, % of
(Amounts in thousands) 2004 2003 Change Change
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Revenues $ 45,693 $ 24,833 $ 20,860 84%
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Cost of Sales 39,438 21,272 18,166 85%
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Unrecovered Contract
Preparation Costs - 70 (70)
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Gross Profit 6,255 3,491 2,764 79%
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Administrative Expenses 3,009 2,390 619 26%
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Grant Income 80 80 -
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Operating Income 3,326 1,181 2,145 181%
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Net Interest Expense 196 21 175
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Income Taxes 682 109 573
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Income Before Accounting
Change 2,448 1,051 1,397
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Accounting Change - (228) (228)
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Net Income $ 2,448 $ 823 $ 1,625
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The Company's primary customer is the Defense Supply Center Philadelphia (DSCP),
the Department of Defense agency with which the Company contracts for the
manufacture of boots used by U. S. Armed Forces personnel. Since late March
2003, DSCP has exercised its surge option clause under contracts to manufacture
the Direct Molded Sole (DMS) boot. Invoked in response to the need for desert
boots used by U. S. Armed Forces personnel in Iraq, the surge option required
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Wellco to significantly increase its rate of boot production.
In the 2004 fiscal year, the Company's increased shipments of DMS boots which
were under surge increased revenues approximately $13,800,000. In the 2004
fiscal year, the Company shipments of the new Army ICB boot increased revenues
approximately $6,000,000.
In order to meet the surge requirement, work shifts were added, new employees
were hired, overtime premiums were paid, and premium air freight costs were
incurred for shipping some raw materials and production machinery.
In March 2003, the Company was awarded a contract to supply the U. S. Army's new
ICB boot. About two years ago, the Army decided to replace its all-leather
combat boot, one of the three DMS boots manufactured by Wellco which represents
about half of Wellco's historical sales to DSCP, with the ICB boot. Wellco,
along with two other manufacturers, was awarded a contract to supply this boot.
During the 2004 fiscal year, the Company incurred significant costs (new
employee training costs, materials for production trials, boot testing, plant
infrastructure costs, etc.) to integrate the production of this new boot into
the Company's factories.
Although revenues increased significantly because of surge and the new ICB
contract, the excess costs associated with this activity resulted in Cost of
Sales increasing at approximately the same rate as the increase in revenues.
Revenues from technical assistance fees and equipment rentals from licensees,
which vary with licensee sales, were greater in the fiscal year because of
increased sales of certain licensees, primarily licensees that were also under
surge.
Increased salaries and bonus expense caused the majority of the increase in
administrative expenses. Two persons have been hired to replace two near-term
retirements. Several administrative clerks have been added to do the work caused
by the increased activity level. One in-house sales person has been added
because of increases in commercial sales of military boots. Employee bonuses
substantially vary directly with net income. Travel costs have also increased as
management personnel traveled more frequently to the Company's primary
manufacturing facility in Puerto Rico.
The increase in interest expense was caused by increased use of the Company's
bank line of credit, which was the primary source of cash needed for surge and
the new ICB contract. See the "Liquidity and Capital Resources" section below.
Grant income represents the straight line recognition of a grant issued by the
government of Puerto Rico related to the Company's 1999 consolidation of
manufacturing operations in Puerto Rico. This income was completely recognized
in the fourth quarter of fiscal year 2004.
Prior fiscal year net income was reduced by the write-off of $228,000 of
previously recorded goodwill that was determined to be impaired under Statement
of Financial Accounting Standards No. 142 which became effective in the fiscal
year 2003.
The income tax rate (the percent of Provision for Income Taxes to the Income
Before Income Taxes) for the 2004 fiscal year was 22% compared to 9% for the
prior fiscal year. The income tax rate increase is primarily due to an increase
in the proportion of total Income Before Income Taxes which is subject to full
federal tax. As shown in Footnote 11 to the Consolidated Financial Statements,
income earned by the Company's Puerto Rico subsidiary, which is exempt from
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Puerto Rico income tax, and which is partially exempt from U. S. income taxes,
was a smaller percent of total Income Before Income Taxes. The income tax rate
was reduced by 9% from the realization of previously recorded deferred tax
assets whose value had been reduced by a valuation allowance.
Comparing the Fiscal Year ended June 28, 2003 to the Fiscal Year ended June 29,
2002:
Comparative results for these two periods are as follows:
Fiscal Year Fiscal Year
Ended June 28, Ended June 29, % of
(Amounts in thousands) 2003 2002 Change Change
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Revenues $ 24,833 $ 19,981 $ 4,852 24%
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Cost of Sales 21,272 16,361 4,911 30%
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Unrecovered Contract
Preparation Costs 70 335 (265) (79)%
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Gross Profit 3,491 3,285 206 6%
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Administrative Expenses 2,390 2,551 (161) (6)%
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Grant Income 80 80 -
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Operating Income 1,181 814 367 45%
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Interest Expense 30 32 (2)
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Interest Income 9 260 251
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Income Taxes 109 359 (250)
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Income Before Accounting
Change 1,051 683 368
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Accounting Change (228) - (228)
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Net Income $ 823 $ 683 $ 140
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The Company received the first surge order for DMS boots in March 2003 and
responded immediately by increasing its rate of production. This increased
revenues in the 2003 fiscal year by $2,700,000. In addition, shipments under a
small new DSCP contract to manufacture the Extreme Cold Weather boot increased
revenues by $1,500,000. The sale of boot manufacturing equipment to a state
prison increased revenues $353,000.
Cost of sales increased more than revenues for the following reasons:
Substantially all DMS boots sold to DSCP in the 2003 fiscal year 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 DMS boot
solicitation. Prices offered by Wellco on the outstanding solicitation,
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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 2003 fiscal 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 2003 fiscal year includes surge
costs, as explained above.
In addition, employee group health insurance, workers' compensation
insurance and general property insurance costs increased $259,000
during the 2003 fiscal year. Wellco's group health insurance is
self-funded, and the additional cost was primarily for two employees'
major medical procedures.
In the 2003 fiscal year, 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.
The 2003 fiscal year also 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
2003 fiscal 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.
Lower total administrative personnel salary cost and lower legal costs were the
primary reasons general and administrative expenses decreased $161,000 in the
2003 fiscal year.
Interest income in the 2002 fiscal 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 2003 fiscal year rate is lower, on the higher pretax income, because
during the prior period the Company recorded a valuation allowance of $300,000
-8-
to reflect the estimated amount of deferred tax assets that may not be realized.
Forward Looking Information:
- ---------------------------
Below is a summary of the Company's current boot contracts with DSCP.
On September 30, 2003, DSCP awarded Wellco a new contract for DMS
combat boots. Wellco's award was 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. 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 ICB boot. 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. The Company believes
DSCP will exercise the first year option but cannot estimate the
quantity of boots that will be ordered in this option year, which will
be for October 2004 through September 2005.
In March 2003, DSCP awarded the Company a contract to supply the black
ICB boot. This contract is for a one year period, with four one-year
options which are exercisable at the government's discretion. Just as
in the current DMS contract, the margins on the black ICB boot are less
than those historically earned under prior contracts. In July 2004,
DSCP exercised the first year option under this contract, which will be
for July 2004 through June 2005. The Company cannot estimate the
quantity of boots that will be ordered in this option year.
On March 10, 2004, DSCP awarded a new contract to Wellco to supply
110,010 pairs of the ICB boot in the desert tan color. The contract has
a delivery period of August 2004 through April 2005. Just as in the
above two contracts, the margins on this contract are less than those
historically earned under prior contracts.
In the first half of fiscal year 2005, Wellco will complete shipping all boots
which are under the surge orders. Wellco believes that future orders will not
include the surge requirement. When compared to fiscal year 2004, fiscal year
2005 revenues should be less. The Company cannot reasonably estimate how much
the decrease will be.
In September 2004, Hurricane Jeanne interrupted power at the Puerto Rico factory
for approximately one week. No damage was done to the factory building or its
contents. However, the interruption will result in reduced boot sales in the
quarter ended October 2, 2004.
DSCP has temporarily suspended shipments under the above-mentioned DMS contract
until it completes administrative adjustments to that contract. This will not
affect the total pairs Wellco will ship under this contract, but will affect the
timing of those shipments.
The Company believes that DSCP will soon exercise the first option term under
the DMS contract mentioned above. The maximum pairs that DSCP can order under
this option is less than that of the base contract year. Wellco also believes
that DSCP will not invoke its surge option clause under orders issued during
this first option year. The first option term will be for the period October
2004 thorough September 2005. Since March 2003, DSCP has exercised its surge
option, requiring Wellco to accelerate its production of desert boots.
-9-
The majority of the Company's boot manufacturing operations occur at the factory
of a wholly-owned subsidiary located in Puerto Rico. The Company is
participating in a Puerto Rican government program under which it is reimbursed
for part of the compensation paid to certain employees. On September 23, 2004,
that subsidiary received a reimbursement of $780,000 for compensation paid
employees in the 2004 fiscal year. The Company's policy is to record these
reimbursements in the fiscal period in which they are received, and this amount
will be recorded as a reduction in cost of sales in the fiscal quarter which
will end October 2, 2004.
On December 31, 2004, agreements under which the Company earns fees for
providing certain equipment and related services to other boot manufacturers
expire. The company intends to negotiate an extension of these agreements. The
effect on future operating results would be adverse if the negotiations do not
result in an extension of the agreements.
The business of providing boots to DSCP is very competitive, as U. S. boot
manufacturers attempt to replace volume lost to low-cost foreign-made boots by
manufacturing for the U. S. Defense Department.
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).
A 1% increase in the assumed discount rate used to compute the Company's pension
benefit obligation would decrease the obligation at June 30, 2004 by $514,000.
Conversely, a 1% decrease in the assumed discount rate would increase the
benefit obligation at June 30, 2004 by $601,000.
A 1% increase in the assumed discount rate used to compute the Company's retiree
health benefit obligation would decrease the benefit obligation at July 3, 2004
by $28,000. Conversely, a 1% decrease in the assumed discount rate would
increase the benefit obligation at July 3, 2004 by $33,000.
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)
2004 2003 2002
- --------------------------------------------------------------------
Cash and Cash Equivalents $ 58 $ 133 $ 270
- --------------------------------------------------------------------
Unused Bank Line of Credit 3,220 910 3,000
- --------------------------------------------------------------------
Total $ 3,278 $ 1,043 $ 3,270
- --------------------------------------------------------------------
-10-
The following table summarizes the other major sources and (uses) of cash and
cash equivalents for the last three years:
(in thousands)
2004 2003 2002
- --------------------------------------------------------------------------------
Income Before Depreciation and Other Non-cash
Adjustments $ 3,741 $ 2,080 $ 1,616
- --------------------------------------------------------------------------------
Net Change in Accounts Receivable, Inventory,
Accounts Payable and Accrued Compensation (5,597) (1,087) (629)
- --------------------------------------------------------------------------------
Net Change in Income Taxes, Pension Obligation,
and Other 472 (87) (99)
- --------------------------------------------------------------------------------
Net Cash Provided By (Used In) Operations (1,384) 906 888
- --------------------------------------------------------------------------------
Cash From Bank Line of Credit 6,930 995 370
- --------------------------------------------------------------------------------
Cash Used to Repay Bank Line of Credit (3,740) (405) (370)
- --------------------------------------------------------------------------------
Cash Used to Purchase Plant and Equipment (2,066) (1,183) (962)
- --------------------------------------------------------------------------------
Cash Provided by Exercise of Stock Options 730 24 163
- --------------------------------------------------------------------------------
Cash Dividends Paid (545) (474) (472)
- --------------------------------------------------------------------------------
Decrease in Cash and Cash Equivalents $ (75) $ (137) $ (383)
- --------------------------------------------------------------------------------
In 2004, cash used by operations was $1,384,000. Net income of $2,448,000 and
depreciation of $1,100,000 was far short of providing the cash needs for an
increase of $2,620,000 in accounts receivable and $4,062,000 in inventory. The
increase in accounts receivable and inventory was primarily caused by surge and
the new ICB contract.
In order to provide cash, the Company negotiated an increase effective December
29, 2003 in its bank line of credit from $4,500,000 to $5,000,000.
Inconsistencies in certain government tests of the ICB boot resulted in a delay
in collecting accounts receivable from these boots sales. In response to this,
the Company negotiated a further increase, effective February 20, 2004, in its
bank line of credit to $10,000,000. The testing situation was subsequently
resolved in the Company's favor and accounts receivable were collected. Under
this change, the line was reduced to $9,000,000 on May 1, 2004; to $8,000,000 on
June 1, 2004; to $7,000,000 on July 1, 2004; to $6,000,000 on August 1, 2004;
and, to $5,000,000 on September 1, 2004. The bank line of credit will remain at
$5,000,000 until December 31, 2004, when it expires and is subject to renewal.
In 2003, cash provided by operations was $906,000. Net income of $823,000 and
depreciation and amortization of $995,000 and a $1,832,000 increase in accounts
payable were the main sources. The main use of cash for operations was a
$2,076,000 increase in accounts receivable and a $761,000 increase in inventory.
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.
In 2002, cash provided by operations was $888,000. This primarily resulted from
net income plus depreciation and amortization, which totaled $1,539,000. A
$556,000 reduction in accounts receivable, primarily from completion of a
-11-
contract, and an increase in accounts payable and accrued liabilities of
$208,000, also provided operating cash.
The following table shows aggregated information about contractual obligations
as of July 3, 2004:
Payments Due by Period
Total Less Than 1 1-3 Years 4-5 Years After 5
Year Years
- --------------------------------------------------------------------------------
Long -Term
Debt $300,000 - - - $300,000
- --------------------------------------------------------------------------------
Building Lease 840,000 $156,000 $330,000 $354,000 -
- --------------------------------------------------------------------------------
Total $1,140,000 $156,000 $330,000 $354,000 $300,000
- --------------------------------------------------------------------------------
The Company's has a commitment to purchase certain equipment of $500,000 during
the first half of fiscal year 2005. Other than this, Wellco does not know of any
other demands, commitments, uncertainties, or trends that will result in or that
are reasonably likely to result in its liquidity increasing or decreasing in any
material way.
The bank line of credit of $5,000,000 will expire on December 31, 2004 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 or not renew the line of credit. Events
that would cause a substantial reduction in operations include, but are not
limited to, cancellation of existing government contracts or receiving
government contracts that do not provide enough revenues to provide adequate
liquidity.
At July 3, 2004, $3,780,000 of additional borrowing was available under the bank
line of credit and the Company was in compliance with the loan covenants on that
date. Because of the investment in accounts receivable and inventory for
manufacture of the new contract for the desert tan ICB boot, the Company expects
to use the bank line of credit, if necessary, to meet this need. If new orders
for the DMS boot do not contain the surge requirement, cash will be provided by
the decrease in accounts receivable and inventory created while under surge.
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 operations will
continue to be a significant source of cash in fiscal year 2005.
The Promissory Note, Loan Agreement and Security Agreement documenting the bank
line of credit provide that:
o All amounts borrowed shall become due and immediately payable
upon demand of the bank.
o The bank's obligation to make advances under the note shall
terminate: if the bank makes a demand for payment; if a
default under any loan document occurs; or, in any event, on
December 31, 2004, unless the Note is extended by the bank
under terms satisfactory to the bank.
-12-
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.
CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING INFORMATION
Statements throughout this report that are not historical facts are
forward-looking statements. These statements are based on current expectations
and beliefs, and involve numerous risks and uncertainties. Many factors could
affect the Company's actual results, causing results to differ materially from
those expressed in any such forward-looking information.
These factors include, but are not limited to, the receipt of contracts from the
U. S. government and the performance thereunder; the ability to control costs
under fixed price contracts; the cancellation of contracts; and other risks
detailed from time to time in the Company's Securities and Exchange Commission
filings, including Form 10-K for the year ended July 3, 2004. Those statements
include, but may not be limited to, all statements regarding intent, beliefs,
expectations, projections, forecasts, and plans of the Company and its
management. Actual results may differ materially from management expectations.
The Company assumes no obligation to update any forward-looking statements.
-13-
WELLCO ENTERPRISES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
FOR THE FISCAL YEARS ENDED
JULY 3, 2004, JUNE 28, 2003 AND JUNE 29, 2002
(in thousands except per share amounts)
JULY 3, JUNE 28, JUNE 29,
2004 2003 2002
------------------------------
REVENUES (Notes 5, 15 and 16) .............. $ 45,693 $ 24,833 $ 19,981
-------- -------- --------
COSTS AND EXPENSES
Cost of sales and services ................ 39,438 21,272 16,361
Unrecovered contract preparation costs
(Note 18) ............................... -- 70 335
General and administrative expenses ....... 3,009 2,390 2,551
-------- -------- --------
Total ................................. 42,447 23,732 19,247
-------- -------- --------
GRANT INCOME (Note 17) ...................... 80 80 80
-------- -------- --------
OPERATING INCOME ............................ 3,326 1,181 814
INTEREST EXPENSE ............................ 200 30 32
DIVIDEND AND INTEREST INCOME (Note 12) ...... 4 9 260
-------- -------- --------
INCOME BEFORE INCOME TAXES .................. 3,130 1,160 1,042
PROVISION FOR INCOME TAXES (Note 11) ........ 682 109 359
-------- -------- --------
INCOME BEFORE CUMULATIVE EFFECT
OF CHANGE IN ACCOUNTING PRINCIPLE ......... 2,448 1,051 683
CUMULATIVE EFFECT OF CHANGE IN
ACCOUNTING PRINCIPLE (Notes 2 and 21) ..... -- 228 --
-------- -------- --------
NET INCOME .................................. 2,448 823 683
OTHER COMPREHENSIVE INCOME (LOSS) (Note 9):
Decrease (increase) in additional minimum
pension liability ......................... 324 (924) (159)
-------- -------- --------
COMPREHENSIVE INCOME (LOSS) ................. $ 2,772 $ (101) $ 524
======== ======== ========
EARNINGS PER SHARE (Note 14):
Basic, before cumulative effect ....... $ 2.04 $ 0.89 $ 0.58
Cumulative effect ..................... -- (0.19) --
-------- -------- --------
Basic, after cumulative effect ........ $ 2.04 $ 0.70 $ 0.58
======== ======== ========
Diluted, before cumulative effect ..... $ 1.97 $ 0.87 $ 0.56
Cumulative effect ..................... -- (0.19) --
-------- -------- --------
Diluted, after cumulative effect ...... $ 1.97 $ 0.68 $ 0.56
======== ======== ========
See Notes to Consolidated Financial Statements.
-14-
WELLCO ENTERPRISES, INC.
CONSOLIDATED BALANCE SHEETS
JULY 3, 2004 AND JUNE 28, 2003
(in thousands)
ASSETS
JULY 3, JUNE 28,
2004 2003
--------------------
CURRENT ASSETS:
Cash and cash equivalents .................... $ 58 $ 133
Receivables, net (Notes 3 and 7) ............. 6,070 3,450
Inventories (Notes 4 and 7) .................. 11,063 7,001
Deferred taxes (Note 11) .................... 80 185
Prepaid expenses ............................. 244 290
------- --------
Total ........................................ 17,515 11,059
------- --------
MACHINERY LEASED TO LICENSEES, net
(Notes 2 and 5) .............................. 17 23
PROPERTY, PLANT AND EQUIPMENT, net
(Notes 6 and 7) .............................. 5,091 4,119
INTANGIBLE ASSETS:
Intangible pension asset (Note 9) ............ 19 29
DEFERRED TAXES (Note 11) ........................... -- 80
------- -------
TOTAL .............................................. $22,642 $15,310
======= =======
(continued on next page)
-15-
WELLCO ENTERPRISES, INC.
CONSOLIDATED BALANCE SHEETS
JULY 3, 2004 AND JUNE 28, 2003
(in thousands except share data)
LIABILITIES AND STOCKHOLDERS' EQUITY
JULY 3, JUNE 28,
2004 2003
--------------------
CURRENT LIABILITIES:
Short-term borrowing from bank (Note 7) .......... $ 3,780 $ 590
Accounts payable ................................. 3,659 3,138
Accrued compensation ............................. 1,374 810
Accrued liabilities (Notes 8, 9, 10, and 17) ..... 604 582
Accrued income taxes (Note 11) ................... 1,048 722
-------- --------
Total ........................................ 10,465 5,842
-------- --------
LONG-TERM LIABILITIES:
Pension obligation (Note 9) ...................... 1,337 1,672
Notes payable (Note 12) .......................... 222 213
Deferred taxes (Note 11) ........................ 88 --
Deferred revenues (Note 12) ...................... 78 87
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 - 1,245,046 ...................... 1,245 1,186
Additional paid-in capital ....................... 1,027 357
Retained earnings ................................ 9,499 7,596
Accumulated other comprehensive loss ............. (1,319) (1,643)
-------- --------
Total ........................................ 10,452 7,496
-------- --------
TOTAL .................................................. $ 22,642 $ 15,310
======== ========
See Notes to Consolidated Financial Statements.
-16-
WELLCO ENTERPRISES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE FISCAL YEARS ENDED
JULY 3, 2004, JUNE 28, 2003 AND JUNE 29, 2002
(in thousands)
JULY 3, JUNE 28, JUNE 29,
2004 2003 2002
-------------------------------
CASH FLOWS FROM OPERATING
ACTIVITIES:
Net income ......................... $ 2,448 $ 823 $ 683
------- ------- -------
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 .. 1,100 995 856
Deferred income taxes .......... 273 44 232
Non-cash reduction in accrued
interest ....................... -- -- (234)
Non-cash asset impairment ...... -- 70 159
Non-cash grant income recognized (80) (80) (80)
Non-cash interest expense ...... 9 8 7
Non-cash reduction in deferred
revenues ....................... (9) (8) (7)
(Increase) decrease in-
Receivables ................ (2,620) (2,076) 556
Inventories ................ (4,062) (761) (1,230)
Other current assets ....... 25 57 (78)
Increase (decrease) in-
Accounts payable ........... 521 1,832 129
Accrued compensation ....... 564 (82) (84)
Other accrued liabilities .. 102 95 79
Accrued income taxes ....... 326 (47) 37
Pension obligation ......... 19 (192) (137)
------- ------- -------
Total adjustments .................. (3,832) 83 205
------- ------- -------
NET CASH PROVIDED BY (USED IN)
OPERATING ACTIVITIES ............... (1,384) 906 888
------- ------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of equipment ............. (2,066) (1,183) (962)
------- ------- -------
NET CASH USED IN INVESTING ACTIVITIES .... (2,066) (1,183) (962)
------- ------- -------
(continued on next page)
-17-
WELLCO ENTERPRISES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE FISCAL YEARS ENDED
JULY 3, 2004, JUNE 28, 2003 AND JUNE 29, 2002
(in thousands)
JULY 3, JUNE 28, JUNE 29,
2004 2003 2002
-------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net advances of line of credit
borrowings ....................... 3,190 590 --
Cash dividends paid .............. (545) (474) (472)
Stock option exercise ............ 730 24 163
----- ----- -----
NET CASH PROVIDED BY (USED IN)
FINANCING ACTIVITIES ............. 3,375 140 (309)
----- ----- -----
NET DECREASE IN CASH AND
CASH EQUIVALENTS ................. (75) (137) (383)
CASH AND CASH EQUIVALENTS AT
BEGINNING OF YEAR ................ 133 270 653
----- ----- -----
CASH AND CASH EQUIVALENTS AT
END OF YEAR ...................... $ 58 $ 133 $ 270
===== ===== =====
SUPPLEMENTAL DISCLOSURE OF CASH
FLOW INFORMATION:
Cash paid (received) for-
Interest ..................... $ 191 $ 22 $ 32
Income taxes paid (refunded) . (22) 113 65
NONCASH INVESTING AND FINANCING
ACTIVITY:
Adjustment of stock repurchase note .... -- -- (347)
Increase in leasehold improvements $ (38) $-- $ 112
===== ===== =====
See Notes to Consolidated Financial Statements.
-18-
WELLCO ENTERPRISES, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE FISCAL YEARS ENDED
JULY 3, 2004, JUNE 28, 2003 AND JUNE 29, 2002
(in thousands except share data)
JULY 3, JUNE 28, JUNE 29,
2004 2003 2002
------------------------------
COMMON STOCK :
Balance at beginning of year ........ $ 1,186 $ 1,183 $ 1,164
Stock option exercise (Note 13) ..... 59 3 19
------- ------- -------
Balance at end of year ............. 1,245 1,186 1,183
------- ------- -------
ADDITIONAL PAID-IN CAPITAL:
Balance at beginning of year ........ 357 336 192
Stock option exercise (Note 13) ..... 566 21 144
Tax benefit from stock option plans
(Note 11) ........................... 104 -- --
------- ------- -------
Balance at end of year ............. 1,027 357 336
------- ------- -------
RETAINED EARNINGS:
Balance at beginning of year ........ 7,596 7,247 6,689
Adjustment of note payable from stock
repurchase (Note 12) ................ -- -- 347
Net income .......................... 2,448 823 683
Cash dividends (per share: 2004-$.45,
2003-$.40, 2002-$.40) ........... (545) (474) (472)
------- ------- -------
Balance at end of year .............. 9,499 7,596 7,247
------- ------- -------
ACCUMULATED OTHER COMPREHENSIVE LOSS
Additional minimum pension liability,
net of tax (Note 9):
Balance at beginning of year ........ (1,643) (719) (560)
Change for the year ................. 324 (924) (159)
------- ------- -------
Balance at end of year .............. (1,319) (1,643) (719)
------- ------- -------
TOTAL STOCKHOLDERS' EQUITY ................ $ 10,452 $ 7,496 $ 8,047
======= ======= =======
See Notes to Consolidated Financial Statements.
-19-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- ------------------------------------------
For the Fiscal Years Ended July 3, 2004, June 28, 2003, and June 29, 2002
- -------------------------------------------------------------------------
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 ($39,648,000 in 2004, $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.
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.
-20-
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 July 3, 2004 and June 28, 2003 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 $101,000 in 2004, $110,000 in 2003
and $180,000 in 2002.
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 at June 28, 2003, 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
-21-
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 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 2004-2007. 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
-22-
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 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 2004 fiscal year contains 53 weeks of
operating results while the 2003 and 2002 fiscal years contain
52 weeks each .
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. 148 (SFAS 148), "Accounting for Stock- Based
Compensation- Transition and Disclosure." 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 December 2003, the FASB issued SFAS No. 132(R), a revision
to SFAS No. 132, "Employers' Disclosure about Pensions and
Other Postretirement Benefits". SFAS No. 132(R) does not
change the measurement or recognition related to pension and
other postretirement plans required by SFAS No. 87,
"Employers' Accounting for Pensions", SFAS No. 88, "Employers'
Accounting for Settlements and Curtailments of Defined Benefit
Pension Plans and for Termination Benefits", and SFAS No. 106,
"Employers' Accounting for Postretirement Benefits Other Than
Pensions" and retains the disclosure requirements contained in
SFAS No. 132. SFAS No. 132(R) requires additional disclosures
about the assets, obligations, cash flows and net periodic
benefit cost of defined benefit pension plans and other
defined benefit postretirement plans. SFAS No. 132(R) is
effective for financial statements with fiscal years ending
after December 15, 2003. The Company included the required
annual disclosures in its consolidated financial statements as
of and for the year ended July 3, 2004 and has included the
required disclosures in Note 9 to its consolidated financial
-23-
statements. The adoption of SFAS No. 132(R) did not impact the
Company's consolidated balance sheet or results of operations.
3. RECEIVABLES:
The majority of receivables at July 3, 2004 and June 28, 2003 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 2004, 2003 and 2002 are not significant.
4. INVENTORIES:
The components of inventories are:
(in thousands)
2004 2003
- ----------------------------------------------------------------------
Finished Goods $ 2,228 $ 1,247
- ----------------------------------------------------------------------
Work in Process 2,771 1,753
- ----------------------------------------------------------------------
Raw Materials and Supplies 6,064 4,001
- ----------------------------------------------------------------------
Total $ 11,063 $ 7,001
- ----------------------------------------------------------------------
5. MACHINERY LEASED TO LICENSEES:
Accumulated depreciation netted against the cost of leased assets in
the Consolidated Balance Sheets at July 3, 2004 and June 28, 2003 is
$1,543,000 and $1,537,000, respectively. Rental revenues for the fiscal
years 2004, 2003, and 2002 were $279,000, $178,000 and $148,000,
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)
2004 2003 Estimated Useful Life
- --------------------------------------------------------------------------------
Land $ 107 $ 107 N/A
- --------------------------------------------------------------------------------
Buildings 1,439 1,439 40-45 Years
- --------------------------------------------------------------------------------
Machinery & Equipment 9,553 7,559 2-20 Years
- --------------------------------------------------------------------------------
Furniture & Fixtures 985 951 2-10 years
- --------------------------------------------------------------------------------
Leasehold Improvements 809 771 *
- --------------------------------------------------------------------------------
-24-
2004 2003 Estimated Useful Life
- --------------------------------------------------------------------------------
Total Cost $ 12,893 $ 10,827
- --------------------------------------------------------------------------------
Total Accumulated
Depreciation and
Amortization $ 7,802 $ 6,708
- --------------------------------------------------------------------------------
*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:
Due to the Company's increased accounts receivable from shipping DMS
boots under surge, and to increased inventories, caused by both surge
and the initial production of the ICB boot, the Company increased its
line of credit during the 2004 fiscal year to $10,000,000. The current
line of credit agreement contains terms that require the available
borrowings to be revised to $7,000,000 as of July 1, 2004 and
subsequently to $5,000,000 by September 1, 2004. The line, which
expires December 31, 2004, can be renewed annually at the bank's
discretion. This line of credit is secured by a blanket lien on all
machinery and equipment and all accounts receivables and inventory. At
July 3, 2004, borrowings on this line of credit were $ 3,780,000 with $
3,220,000 available in additional borrowings.
Interest is at the London Interbank Offered Rate (LIBOR) plus 2.25
points or 3.61% at July 3, 2004. 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
July 3, 2004. 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 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)
2004 2003
- ---------------------------------------------------------------
Retiree Health Benefits (Note 10) $ 295 $ 231
- ---------------------------------------------------------------
Interest Expense (Note 12) 2 2
- ---------------------------------------------------------------
Accrued Lease Payments (Note 20) 93 135
- ---------------------------------------------------------------
Deferred Grant Revenues (Note 17) - 80
- ---------------------------------------------------------------
Other 214 134
- ---------------------------------------------------------------
Total $ 604 $ 582
- ---------------------------------------------------------------
-25-
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)
2004 2003 2002
- ---------------------------------------------------------------------
Benefits Earned for Service in the
Current Year $ 129 $ 132 $ 119
- ---------------------------------------------------------------------
Interest on the Projected Benefit
Obligation 355 365 372
- ---------------------------------------------------------------------
Expected Return on Plan Assets (297) (286) (303)
- ---------------------------------------------------------------------
Amortization of: Unrecognized Net
Pension Obligation at July 1, 1987;
Cost of Benefit Changes Since That
Date; and Gains and Losses 116 80 119
- ---------------------------------------------------------------------
Against Actuarial Assumptions
Pension Expense $ 303 $ 291 $ 307
- ---------------------------------------------------------------------
Below are various analyses and other information relating to the
Company's pension liability, assets and expense as of July 2004 and
June 2003, (all amounts are in thousands except for those indicated as
percent):
Change in Benefit Obligation: 2004 2003
- ---------------------------------------------------------------------------
Benefit Obligation at Beginning of Year $ 6,158 $ 5,658
- ---------------------------------------------------------------------------
Current Year Service Cost 129 132
- ---------------------------------------------------------------------------
Interest Cost on Projected Liability 355 365
- ---------------------------------------------------------------------------
Benefit Payments (533) (580)
- ---------------------------------------------------------------------------
Actuarial (Gain)Loss (292) 583
- ---------------------------------------------------------------------------
Benefit Obligation at End of Year $ 5,817 $ 6,158
- ---------------------------------------------------------------------------
Change in Plan Assets: 2004 2003
- ---------------------------------------------------------------------------
Fair Value of Plan Assets at Beginning of Year $ 4,374 $ 4,247
- ---------------------------------------------------------------------------
Company Contributions 283 482
- ---------------------------------------------------------------------------
-26-
Change in Plan Assets: 2004 2003
- ---------------------------------------------------------------------------
Actual Return on Plan Assets 580 225
- ---------------------------------------------------------------------------
Benefit Payments (533) (580)
- ---------------------------------------------------------------------------
Fair Value of Plan Assets at End of Year $ 4,704 $ 4,374
- ---------------------------------------------------------------------------
Reconciliation of Funded Status: 2004 2003
- ---------------------------------------------------------------------------
Funded Status $ (1,113) $ (1,785)
- ---------------------------------------------------------------------------
Unrecognized Actuarial Loss 1,319 2,001
- ---------------------------------------------------------------------------
Unrecognized Prior Service Cost 19 29
- ---------------------------------------------------------------------------
Net Amount Recognized $ 225 $ 245
- ---------------------------------------------------------------------------
Amounts Recognized in the Consolidated Balance
Sheets: 2004 2003
- ---------------------------------------------------------------------------
Intangible Pension Asset $ 19 $ 29
- ---------------------------------------------------------------------------
Accumulated Other Comprehensive Loss 1,319 1,643
- ---------------------------------------------------------------------------
Accrued Pension Liability:
- ---------------------------------------------------------------------------
Prepaid Benefit Cost 478 463
- ---------------------------------------------------------------------------
Accrued Benefit Cost (254) (218)
- ---------------------------------------------------------------------------
Additional Minimum Pension Liability (1,337) (1,672)
- ---------------------------------------------------------------------------
Net Amount Recognized in Financial Statements $ 225 $ 245
- ---------------------------------------------------------------------------
Accumulated Benefit Obligation in Excess of Plan
Assets: 2004 2003
- ---------------------------------------------------------------------------
Projected Benefit Obligation $ 5,817 $ 6,158
- ---------------------------------------------------------------------------
Accumulated Benefit Obligation 5,460 5,802
- ---------------------------------------------------------------------------
Fair Value of Plan Assets $ 4,704 $ 4,374
- ---------------------------------------------------------------------------
-27-
2004 2003
- ---------------------------------------------------------------------------
Increase (Decrease) in Minimum Liability Included in
Other Comprehensive Income $ (691) $ 563
- ---------------------------------------------------------------------------
Weighted-average assumptions used to determine
benefit obligations: 2004 2003
- ---------------------------------------------------------------------------
Assumed Discount Rate 6.25% 6.00%
- ---------------------------------------------------------------------------
Expected Long-Term Rate of Return on Plan Assets 6.75% 6.75%
- ---------------------------------------------------------------------------
Rate of Compensation Increase, For the Pay Related
Benefit Plan 5.5% 5.5%
- ---------------------------------------------------------------------------
Weighted-average assumptions used to determine net
periodic benefit cost: 2004 2003
- ---------------------------------------------------------------------------
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
Benefit Plan 5.50% 5.50%
- ---------------------------------------------------------------------------
PLAN ASSETS:
Pension plan's weighted-average asset allocations by
asset category: 2004 2003
- ---------------------------------------------------------------------------
Equity Securities 46% 40%
- ---------------------------------------------------------------------------
Debt Securities 5% 10%
- ---------------------------------------------------------------------------
Real Estate 0% 0%
- ---------------------------------------------------------------------------
Other 49% 50%
- ---------------------------------------------------------------------------
Total 100% 100%
- ---------------------------------------------------------------------------
CASH FLOWS:
Contributions
Contributions to the pension plan for fiscal year 2005 are expected to
be $362,000.
-28-
(in thousands)
Estimated Future Benefit Payments Amount
- -------------------------------------------------------------------------
2005 $ 481
- -------------------------------------------------------------------------
2006 471
- -------------------------------------------------------------------------
2007 462
- -------------------------------------------------------------------------
2008 457
- -------------------------------------------------------------------------
2009 455
- -------------------------------------------------------------------------
2010-2014 $ 2,288
- -------------------------------------------------------------------------
At July 2004, one of the pension plans has a benefit obligation
($2,520,000) that is greater than its plan assets ($2,109,000)
resulting in the additional liability of $890,000 and at June 2003, the
plan had a benefit obligation ($2,714,000) that was greater than its
plan assets ($1,963,000) resulting in the additional liability of
$1,215,000. At July 2004, the other pension plan has a benefit
obligation ($3,297,000) that is greater than its plan assets
($2,595,000) resulting in the additional liability of $448,000 and at
June 2003, this plan had a benefit obligation ($3,087,000) that is
greater than its plan assets ($2,412,000) resulting in the additional
liability of $457,000.
A 1% increase in the assumed discount rate would decrease the benefit
obligation at July 2004 by $514,000. Conversely, a 1% decrease in the
assumed discount rate would increase the benefit obligation at July
2004 by $601,000.
The Consolidated Statements 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 is recorded for the
deferred tax asset ($448,000) that arises from the cumulative Other
Comprehensive Income (Loss).
In addition, the Company provides retirement benefits to certain
employees through deferred compensation contracts and the unfunded
liability associated with these contracts was $92,000 at July 3, 2004
and $76,000 at June 28, 2003.
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.
-29-
The cost of retiree health benefits included in the accompanying
Statements of Operations and Comprehensive Income was:
(in thousands)
2004 2003 2002
- -------------------------------------------------------------------------------
Benefits Earned for Current Service $ 36 $ 28 $ 20
- -------------------------------------------------------------------------------
Interest Cost on Accumulated Liability 24 22 27
- -------------------------------------------------------------------------------
Amortization of the July 4, 1993 Liability 4 4 4
- -------------------------------------------------------------------------------
Total Cost $ 64 $ 54 $ 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 July 3, 2004 and June 28, 2003 is as follows:
(in thousands)
2004 2003
- -------------------------------------------------------------------------------
Total Obligation at Beginning of Year $ 414 $ 330
- -------------------------------------------------------------------------------
Liability for Current Service 36 28
- -------------------------------------------------------------------------------
Interest on Liability 24 22
- -------------------------------------------------------------------------------
Benefit Payments - -
- -------------------------------------------------------------------------------
Actuarial (Gain) Loss (82) 34
- -------------------------------------------------------------------------------
Total Obligation at End of Year 392 414
- -------------------------------------------------------------------------------
Less Unamortized Liability at July 4, 1993 (42) (46)
- -------------------------------------------------------------------------------
Unrecognized Loss (55) (137)
- -------------------------------------------------------------------------------
Liability Recognized in the Consolidated Balance Sheets $ 295 $ 231
- -------------------------------------------------------------------------------
The assumed health care cost trend rate used to project expected future
cost was 15% in 2004 and 2003, gradually decreasing to 6% by 2009 and
remaining at 6% thereafter. The assumed discount rate used to determine
the accumulated liability was 6.25% for 2004 and 6.00% for 2003.
A 1% increase in the assumed health care cost trend rate would increase
the benefit obligation at July 3, 2004 by $11,000. Conversely, a 1%
decrease in the assumed health care cost trend rate would decrease the
benefit obligation at July 3, 2004 by $11,000.
A 1% increase in the assumed discount rate would decrease the benefit
obligation at July 3, 2004 by $28,000. Conversely, a 1% decrease in the
assumed discount rate would increase the benefit obligation at July 3,
2004 by $33,000.
-30-
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)
2004 2003 2002
- -------------------------------------------------------------------------------
Federal Provision:
- -------------------------------------------------------------------------------
Currently Payable $ 389 $ 50 $ 92
- -------------------------------------------------------------------------------
Deferred 273 44 232
- -------------------------------------------------------------------------------
Total Federal 662 94 324
- -------------------------------------------------------------------------------
State Provision Currently Payable 20 15 35
- -------------------------------------------------------------------------------
Total Provision $ 682 $ 109 $ 359
- -------------------------------------------------------------------------------
A reconciliation of the effective income tax rate for the 2004, 2003
and 2002 fiscal years is as follows:
2004 2003 2002
- -------------------------------------------------------------------------------
Statutory Federal Income Tax Rate 34% 34% 34%
- -------------------------------------------------------------------------------
Current Period Income of Puerto Rico
Subsidiary Substantially Exempt From Puerto
Rican and Federal Income Taxes (5)% (28)% (25)%
- -------------------------------------------------------------------------------
Deferred Tax Valuation Allowance (Reversal of
Previously Recorded Valuation Allowance) (9)% - 29%
- -------------------------------------------------------------------------------
State Taxes, Net of Federal Tax Benefit 1% 1% 3%
- -------------------------------------------------------------------------------
Other 1% 2% (7)%
- -------------------------------------------------------------------------------
Effective Income Tax Rate 22% 9% 34