Attached files

file filename
EX-31.1 - EXHIBIT 31.1 - WSI INDUSTRIES, INC.c24861exv31w1.htm
EX-32.1 - EXHIBIT 32.1 - WSI INDUSTRIES, INC.c24861exv32w1.htm
EX-21.1 - EXHIBIT 21.1 - WSI INDUSTRIES, INC.c24861exv21w1.htm
EX-31.2 - EXHIBIT 31.2 - WSI INDUSTRIES, INC.c24861exv31w2.htm
EX-23.1 - EXHIBIT 23.1 - WSI INDUSTRIES, INC.c24861exv23w1.htm
EX-10.28 - EXHIBIT 10.28 - WSI INDUSTRIES, INC.c24861exv10w28.htm
EX-10.29 - EXHIBIT 10.29 - WSI INDUSTRIES, INC.c24861exv10w29.htm
EX-10.24 - EXHIBIT 10.24 - WSI INDUSTRIES, INC.c24861exv10w24.htm
EX-10.27 - EXHIBIT 10.27 - WSI INDUSTRIES, INC.c24861exv10w27.htm
EX-10.26 - EXHIBIT 10.26 - WSI INDUSTRIES, INC.c24861exv10w26.htm
EX-10.25 - EXHIBIT 10.25 - WSI INDUSTRIES, INC.c24861exv10w25.htm
Table of Contents

 
 
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
     
þ   ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended August 28, 2011
     
o   TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                      to                     
Commission File No. 000-00619
WSI Industries, Inc.
(Exact name of registrant specified in its charter)
     
Minnesota   41-0691607
(State or other jurisdiction of incorporation or organization)   (I.R.S. Employer Identification No.)
213 Chelsea Road, Monticello, Minnesota 55362
(Address of principal executive offices)(Zip code)
Issuer’s telephone number, including area code: (763) 295-9202

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $0.10 par value
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No þ
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Exchange Act. Yes o No þ
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 þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such filed). Yes o No o
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. þ
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “accelerated filer,” “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one)
             
Large accelerated filer o   Accelerated filer o   Non-accelerated filer o   Smaller reporting company þ
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ
The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant on February 25, 2011 (the business day immediately prior to the end of the registrant’s second fiscal quarter) was $13,816,000 based upon the closing sale price on that date of $4.82 as reported by The NASDAQ Capital Market.
The number of shares of the registrant’s common stock, $0.10 par value, outstanding as of November 11, 2011 was 2,895,664.
DOCUMENTS INCORPORATED BY REFERENCE:
Portions of the Proxy Statement for the Company’s Annual Meeting of Shareholders to be held on January 4, 2012, which will be filed within 120 days after the end of the fiscal year covered by this report, are incorporated by reference into Part III of this Form 10-K.
 
 

 

 


TABLE OF CONTENTS

PART I
Item 1. Description of Business
Item 1A. Risk Factors
Item 1B. Unresolved Staff Comments
Item 2. Properties
Item 3. Legal Proceedings
Item 4. [Removed and Reserved.]
PART II
Item 5. Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Item 6. Selected Financial Data
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Item 8. Financial Statements and Supplementary Data
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Item 9A. Controls and Procedures
Item 9B. Other Information
PART III
Item 15. Exhibits
SIGNATURES
Exhibit 10.24
Exhibit 10.25
Exhibit 10.26
Exhibit 10.27
Exhibit 10.28
Exhibit 10.29
Exhibit 21.1
Exhibit 23.1
Exhibit 31.1
Exhibit 31.2
Exhibit 32.1


Table of Contents

PART I
Item 1.   Description of Business.
WSI Industries, Inc. (the “Company”) makes its periodic and current reports available free of charge as soon as reasonably practicable after such material is electronically filed with, or furnished to, the Securities and Exchange Commission. These reports can be obtained by contacting the Company through its website at www.wsiindustries.com.
Overview
The Company was incorporated in Minnesota in 1950 for the purpose of performing precision contract machining for the aerospace, communication, and industrial markets. The major portions of Company revenues are derived from machining work for the aerospace/avionics/defense industries, recreational vehicles (ATV and motorcycle) markets, energy industry and bioscience industry.
Contract manufacturing constitutes the Company’s entire business.
Products and Services
The Company manufactures metal components in medium to high volumes requiring tolerances as close as one ten-thousandth (.0001) of an inch. These components are manufactured in accordance with customer specifications using materials both purchased by the Company as well as being supplied by our customer.
Sales and Marketing
In fiscal 2009, all areas of the Company’s business were affected by the national recession and we experienced decreases in sales of 27% versus fiscal 2008. Fiscal 2010 sales were flat as compared to fiscal 2009 as a decrease in the energy business was equally offset by increases in sales in all of the other industries served by the Company. In fiscal 2011, the Company experienced an increase in sales of 33% over the prior year. The sales increase came in large part from increases in the Company’s recreational vehicle market which increased 39% over the prior year. In fiscal 2011, the Company also realized a 27% increase in its sales to the energy industry. Sales to the recreational vehicle market totaled approximately 68%, 65% and 54% of total sales in fiscal 2011, 2010 and 2009, respectively. Sales to the energy industry totaled approximately 23%, 24% and 36% of sales in fiscal 2011, 2010 and 2009, respectively. Sales to the aerospace/avionics/defense markets totaled approximately 8%, 9% and 8% of total sales in fiscal 2011, 2010 and 2009, respectively. Sales to the bioscience industry amounted to approximately 1% of total sales in fiscal 2011 and 2% of total sales in fiscal 2010 and 2009.
The Company has a reputation as a dependable supplier capable of meeting stringent specifications to produce quality components at high production rates. The Company has demonstrated an ability to develop sophisticated manufacturing processes and controls essential to produce precision and reliability in its products.
Customers
Sales were made to Polaris Industries, Inc. and related entities in the amount of $16,804,000, or 67% of total Company revenues, in fiscal 2011. The Company also made sales of $4,525,000 or 18% of total Company revenues in fiscal 2011 to National Oilwell Varco.

 

2


Table of Contents

Competition
Although there are a large number of companies engaged in machining, the Company believes the number of entities with the technical capability and capacity for producing products of the class and in the volumes manufactured by the Company is relatively small. Competition is primarily based on product quality, service, timely delivery, and price.
Research and Development; Intellectual Property
No material amount has been spent on company-sponsored research and development activities. Patents and trademarks are not deemed significant to the Company.
Employees
At August 28, 2011, the Company had 76 full-time employees, none of whom were subject to a union contract. We consider our relationship with our employees to be good.
Foreign and Domestic Operations and Export Sales
The Company has no operations or any significant sales in any foreign country.
Item 1A.   Risk Factors.
In evaluating us as a company, careful consideration should be given to the following risk factors, in addition to the other information included in this Annual Report on Form 10-K. Each of these risk factors could adversely affect our business, operating results and/or financial condition, as well as adversely affect the value of an investment in our common stock. In addition to the following disclosures, please refer to the other information contained in this report, including our consolidated financial statements and the related notes.
The economic conditions in the United States and around the world could adversely affect our financial results. Demand for our services depends upon worldwide economic conditions, including but not limited to overall economic growth rates, consumer spending, financing availability, employment rates, interest rates, inflation, consumer confidence, and the profits, capital spending, and liquidity of large OEMs that we serve. The economic recession in the markets we serve has caused and could continue to cause our OEM customers to reduce ordering levels, resulting in reschedules, program delays or cancelled orders of our services having an adverse effect on our business and our financial results.
We operate in the highly competitive and fragmented contract machining industry. We compete against many contract machining companies. We also compete with OEM in-house operations that are continually evaluating manufacturing products internally against the advantages of outsourcing. We may also be at a competitive disadvantage with respect to price when compared to manufacturers with excess capacity, lower cost structures and availability of lower cost labor. The availability of excess manufacturing capacity of our competitors also creates competitive pressure on price and winning new business. To respond to competitive pressures, we may be required to reduce our prices to customers or increase discounts to customers, which would result in lower gross profit margins and decreased revenue. These factors also impact the Company’s ability to obtain additional manufacturing programs and retain our current programs.
Controlling manufacturing costs is a significant factor in operating results. The Company’s ability to manage its costs on existing manufacturing programs and its ability to curtail costs and expenses on potential new manufacturing programs could have a significant impact on the Company’s operating results.

 

3


Table of Contents

A large percentage of our sales have been made to a small number of customers in a small number of highly competitive industries, and the loss of a major customer would adversely affect us. In fiscal years 2011, 2010 and 2009, one customer in the recreational vehicle market accounted for 67%, 63% and 51% of our revenue, respectively. In addition, in fiscal years 2011, 2010 and 2009, one customer in the energy industry accounted for 18%, 24% and 30% of our revenue, respectively. If there is a loss of one or more of these major customers or a significant decline in sales to either of these major customers it could have an adverse effect on our results from operations.
Operating results may vary significantly from period to period. We can experience significant fluctuations in our revenue and operating results. One of the principal factors that contribute to these fluctuations is the significant changes in our customer’s delivery requirements. Results of operations in any period, therefore, should not be considered indicative of the results to be expected for any future period. Significant fluctuations in our revenue and operating results could also impact the Company’s ability to comply with its debt covenants of its credit facilities.
Internal control over financial reporting may not prevent or detect misstatements because of its inherent limitations. We require effective internal control over financial reporting in order to provide reasonable assurance with respect to our financial reports and to effectively prevent fraud. Internal control over financial reporting may not prevent or detect misstatements because of its inherent limitations, including the circumvention or overriding of controls, or fraud. Additionally, as of August 28, 2011, our management has concluded that our internal control over financial reporting was not effective due to a material weakness in the areas of segregation of duties and adequacy of personnel resulting from a staff reduction in the quarter ended May 31, 2009. Because of this material weakness in internal control over financial reporting, we may be more susceptible to misstatements in our financial statements or incidences of fraud. However, even effective internal controls can provide only reasonable and not absolute assurances with respect to the preparation and fair presentation of financial statements. The market price of our common stock has fluctuated significantly in the past and may continue in the future. The market price of our common stock has been volatile in the past and several factors could cause the price to fluctuate substantially in the future. These factors include quarterly fluctuations in our financial results, customer contract awards, and general economic and political conditions in our various markets. In addition, the stock prices of small public contract manufacturing companies have experienced significant price and volume fluctuations that often have been unrelated to the operating performance of such companies. This market volatility may adversely affect the market price of our common stock.
Complying with securities laws and regulations is costly for us. Changing laws, regulations and standards relating to corporate governance and public disclosure, including regulations promulgated by the SEC and Nasdaq, are creating particular challenges for smaller publicly-held companies like us. We are committed to maintaining high standards of corporate governance and public disclosure. As a result, our efforts to comply with evolving laws, regulations and standards have resulted in, and are likely to continue to result in, increased general and administrative expenses and a diversion of management time and attention from revenue-generating activities to compliance activities. In particular, our efforts to comply with Section 404 of the Sarbanes-Oxley Act of 2002 and the related regulations regarding our assessment of our internal control over financial reporting have required, and will continue to require, the expenditure of significant financial and managerial resources. In addition to Sarbanes-Oxley, we will also be required to expend financial and managerial resources to comply with the SEC requirement that mandates that our quarterly and yearly filings with them be in an XBRL readable format.
Item 1B.   Unresolved Staff Comments.
Not applicable.

 

4


Table of Contents

Item 2.   Properties.
The Company purchased an existing 49,000 square foot facility located in Monticello, Minnesota in May 2004 to house its production and its headquarters. The purchase price was $1.9 million and was paid for by a combination of cash and debt. The Company entered into two notes evidencing the debt used to purchase its Monticello facility that were secured by mortgages. The first note and mortgage was to Excel Bank Minnesota (now M&I Marshall and IIsley Bank) for $1,360,000 that matures on May 1, 2014. Effective May 3, 2009 the interest rate adjusted to a rate 2.5% above the monthly yield on United States Treasury five-year securities. The interest rate at August 28, 2011 is 4.38% with monthly payments of $7,637 based on a 25-year amortization schedule. The note is secured by a mortgage and security interest in all assets of the Company.
The Company also entered into a note and mortgage with the City of Monticello, Minnesota Economic Development Authority (MEDA). The MEDA mortgage was subordinated to the mortgage of Excel Bank Minnesota. The note to MEDA carried an interest rate of 2% and required monthly principal and interest payments of $1,483 based on a 25-year amortization schedule. Effective May 1, 2009, the Company amended the note to extend the maturity date to May 1, 2011, at which time the entire balance was paid in full.
In fiscal 2008, the Company commenced an addition to its facility to add manufacturing space. Upon completion in early fiscal 2009, the addition added 12,500 square feet of manufacturing space. In August 2008, the Company obtained a loan from M&I Marshall and IIsley Bank to finance this addition. The loan was secured by certain assets of the Company and guarantees by the Company’s subsidiaries. The Company was able to draw upon the loan on a non-revolving basis through May 31, 2009 in an aggregate amount not to exceed $1,200,000. The loan required monthly payments of interest only at the bank’s prime rate plus 0.50%. The loan became due and was paid in full on June 30, 2010.
The Company considers its manufacturing equipment, facilities, and other physical properties to be suitable and adequate to meet the requirements of its business.
Item 3.   Legal Proceedings.
The Company is not a party to any material legal proceedings; we may be subject from time to time ordinary routine litigation incidental to its business.
Item 4.   [Removed and Reserved.]

 

5


Table of Contents

PART II
Item 5.   Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
The common stock of the Company is traded on The NASDAQ Capital Market of the NASDAQ Stock Market, Inc. under the symbol “WSCI.”
As of November 7, 2011 there were 360 shareholders of record of the Company’s common stock.
The following table sets forth, for the periods indicated, the high and low closing sales price information for our common stock as reported by the Nasdaq Capital Market.
                 
    Stock Price  
    High     Low  
 
 
FISCAL 2011:
               
First quarter
  $ 7.41     $ 3.43  
Second quarter
    6.57       4.50  
Third quarter
    5.23       4.42  
Fourth quarter
    7.42       4.82  
 
               
FISCAL 2010:
               
First quarter
  $ 3.22     $ 2.12  
Second quarter
    2.20       1.74  
Third quarter
    2.52       1.80  
Fourth quarter
    4.41       1.98  
In fiscal year 2010, the Company did not pay a quarterly dividend during the fiscal year. In fiscal 2011, the Company paid a quarterly cash dividend of $.04 per share in each quarter. The Company expects to continue its quarterly dividend program, subject to its financial performance.

 

6


Table of Contents

The following table sets forth information regarding our equity compensation plans in effect as of August 28, 2011. Each of our equity compensation plans is an “employee benefit plan” as defined by Rule 405 of Regulation C of the Securities Act of 1933.
Equity Compensation Plan Information
                         
                    Number of shares of  
    Number of shares of             common stock remaining  
    common stock to be     Weighted-average     available for future issuance  
    issued upon exercise of     exercise price of     under equity compensation  
    outstanding options,     outstanding options,     plans (excluding securities  
Plan category   warrants and rights     warrants and rights     reflected in the first column)  
Equity compensation plans approved by shareholders:
                       
 
                       
2005 Stock Plan
    248,166     $ 4.16       226,220  
 
                 
 
                       
Total
    248,166     $ 4.16       226,220  
 
                 
There are no outstanding equity compensation plans not approved by shareholders.
The Company made no repurchases of its common stock in fiscal year 2011.

 

7


Table of Contents

Item 6.   Selected Financial Data
Not applicable.
Item 7.   Management’s Discussion and Analysis of Financial Condition and Results of Operations
Critical Accounting Policies and Estimates:
Management’s Discussion and Analysis of Financial Condition and Results of Operations discuss our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities.
We base our estimates on historical experience and on various other assumptions that we believe are reasonable under the circumstances, the result of which forms the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Results may differ from these estimates due to actual outcomes being different from those on which we based our assumptions. The estimates and judgments utilized are reviewed by management on an ongoing basis and by the audit committee of our board of directors at the end of each quarter prior to the public release of our financial results. We made no significant changes to our critical accounting policies during fiscal 2011.
Application of Critical Accounting Policies:
Excess and Obsolete Inventory:
Inventories, which are composed of raw materials, work in process and finished goods, are valued at the lower of cost or market by comparing the cost of each item in inventory to its most recent sales price or sales order price. Inventory cost is adjusted down for any excess cost over net realizable value of inventory components.
In addition, the Company determines whether its inventory is obsolete by analyzing the sales history of its inventory, sales orders on hand and indications from the Company’s customers as to the future of various parts or programs. If, in the Company’s determination, the inventory value has become impaired, the Company adjusts the inventory value to the amount the Company estimates as the ultimate net realizable value for that inventory. Actual customer requirements in any future periods are inherently uncertain and thus may differ from our estimates. The Company performs its lower of cost or market testing, as well as its excess or obsolete inventory analyses, quarterly.
The Company has no specific timeline to dispose of its remaining obsolete inventory and intends to sell this obsolete inventory from time to time, as market conditions allow.
Goodwill Impairment:
The Company evaluates the valuation of its goodwill according to the provisions of Accounting Standards Codification (“ASC”) 350 to determine if the current value of goodwill has been impaired. The Company believes that its stock price is not necessarily an indicator of the Company’s value given its limited trading volume and its wide price fluctuations. The Company has also adopted Accounting Standard Update (ASU) No. 2011-08, Intangibles—Goodwill and Other (Topic 350). With ASU No. 2011-08, an entity is given the option to make a qualitative evaluation of goodwill impairment to determine whether it should calculate the fair value of its reporting unit. In the fiscal 2011 fourth quarter, the Company made its qualitative evaluation of its goodwill considering, among other things, the overall macroeconomic conditions, industry and market considerations, overall financial performance and other relevant company specific events. Based on this qualitative evaluation, the Company concluded that it was more likely than not that its goodwill was not impaired and that it wasn’t required to calculate the fair value of its reporting unit. If the Company has changes in events or circumstances, including reductions in anticipated cash flows generated by its operations, goodwill could become impaired which would result in a charge to earnings.

 

8


Table of Contents

Deferred Taxes:
The Company accounts for income taxes using the liability method. Deferred income taxes are provided for temporary differences between the financial reporting and tax bases of assets and liabilities. A deferred tax valuation allowance is set up should the realization of any deferred taxes become less likely than not to occur. The valuation allowance is analyzed periodically by the Company and may result in income tax expense being different than statutory rates. The Company has not established a valuation allowance as it believes it is more likely than not that it will fully realize the benefit of its tax assets. Currently, the Company’s deferred tax assets have two major components which relate to the Company’s net operating loss (NOL) and the Company’s alternative minimum tax (AMT) tax credit carryforwards. The Company’s AMT tax credit carryforward does not expire. The Company’s NOL carryforward is approximately $2.1 million expiring in 2021 - 2029. The Company believes that given the extended time period for the NOL carryforward to expire as well as a return to a more normal growth rate experienced prior to the economic recession of fiscal 2009, that the Company is more likely than not to fully utilize its NOL carryforward before it expires. However, a significant loss of a customer or a change in the Company’s business could affect the realization of the deferred tax assets. If a major program were discontinued, the Company would immediately assess the impact of the loss of the program on the realization of the deferred tax assets.
Revenue Recognition:
The Company considers its revenue recognition policy to fall under the guidance of FASB’s conceptual framework for revenue recognition. The Company recognizes revenue only after: (a) The Company has received a purchase order identifying price and delivery terms or services to be rendered; (b) shipment has occurred, or in the case of services, after the service has been completed; (c) the Company’s price is fixed as evidenced by the purchase order; and (d) collectability is reasonably assured. The Company continually monitors its accounts receivable for any delinquent or slow paying accounts. The Company believes that based upon its past history with minimal bad debt write-offs, that all accounts are collectible upon shipment or delivery of services. Credit losses from customers have been minimal and within management’s expectations. Based on management’s evaluation of uncollected accounts receivable, bad debts are provided for on the allowance method. Accounts are considered delinquent if they are 120 days past due. If an uncollectible account should arise during the year, it would be written-off at the point it was determined to be uncollectible. The Company mitigates its credit risk by performing periodic credit checks and actively pursuing past due accounts. The Company refers to “net sales” in its consolidated statements of operations as the Company’s sales are sometimes reduced by product returned by its customers.
Liquidity and Capital Resources:
The Company’s net working capital at the end of fiscal 2011 was $5,283,000 as compared to $4,438,000 at the end of fiscal 2010. The increase occurred primarily from increases in cash and accounts receivable and a decrease in current maturities of long-term debt. The ratio of current assets to current liabilities increased to 2.54 to 1.0 at August 28, 2011 from 2.30 to 1.0 at the end of the prior fiscal year. The Company generated $2,690,000, $1,634,000 and $1,767,000 in cash from operations in fiscal 2011, 2010 and 2009, respectively.
In fiscal 2011 and 2009, additions to property, plant and equipment either by cash or capitalized lease were $1,743,000 and $1,341,000, respectively. These amounts included $1,280,000 and $919,000 of machinery acquired through capital leases in fiscal 2011 and 2009, respectively. In fiscal 2010, the Company had minimal additions to property, plant and equipment, capitalizing $61,000 during the year.

 

9


Table of Contents

In its fiscal 2011 first quarter, the Company added two machining centers, one of which was purchased to supplement capacity in its energy business while the other machine was bought primarily for replacement purposes. In the Company’s second and fourth quarters, the Company added two more machining centers for new programs obtained in its energy business. In its fiscal 2009 first quarter, the Company added one machining center for its energy business. Also in fiscal 2009, the Company completed its building addition and capitalized $267,000 in cost in addition to amounts capitalized in fiscal 2008.
On February 1, 2011, the Company renewed its revolving line of credit agreement with its bank. Under the agreement, the Company can borrow up to $1 million. The agreement expires on February 1, 2012. No balances were owed at August 28, 2011 and August 29, 2010, and no advances were made on the credit line during either fiscal 2011 or 2010.
In August 2008, the Company entered into an agreement with its bank to finance a building addition to its existing manufacturing facility. The Company was able to draw upon the loan on a non-revolving basis through May 31, 2009 in an aggregate amount not to exceed $1.2 million. The loan required monthly payments of interest only at the bank’s prime rate plus 0.50%. The loan matured on, and was paid in full on June 30, 2010.
The Company’s total debt was $4,925,000 at August 28, 2011 which consisted of a mortgage on its building of $1,124,000 and capital lease obligations secured by production equipment of $3,801,000. Current maturities of long-term debt consist of $947,000 due on capital leases and $42,000 on its building related debt. During fiscal 2011, the Company made principal payments on its debt of $1.3 million. It is management’s belief that the combination of its current cash balance, its internally generated funds, as well as its revolving line of credit will be sufficient to enable the Company to meet its financial requirements during fiscal 2012.
Results of Operations:
Net sales in fiscal 2011 were $25.0 million as compared to fiscal 2010 and 2009 which were $18.8 million. The increases in the fiscal 2011 sales came primarily from a 39% increase in recreational vehicle sales and a 27% increase in energy sales. The comparable sales in fiscal 2010 to fiscal 2009 came as a result of a decrease in the energy business offset by increases in all other business categories.
The following is a reconciliation of sales by major market:
                         
    Fiscal 2011     Fiscal 2010     Fiscal 2009  
 
                       
Recreational vehicle
  $ 16,969,000     $ 12,209,000     $ 10,121,000  
Aerospace and defense
    1,886,000       1,633,000       1,507,000  
Energy
    5,693,000       4,485,000       6,693,000  
Biosciences
    337,000       379,000       351,000  
Other
    78,000       120,000       94,000  
 
                 
 
  $ 24,963,000     $ 18,826,000     $ 18,766,000  
 
                 
The increase in sales in the recreational vehicle market in fiscal 2011 resulted from the overall increase in demand from the Company’s largest customer for the parts the Company supplies. The increase in sales in fiscal 2010 as compared to fiscal 2009 in the recreational vehicle market came from two factors. The first was a general overall increase in the level of demand in both the ATV and motorcycle markets. The second contributing factor was the Company becoming the sole source supplier on a particular part in fiscal 2010 while the part was dual sourced in fiscal 2009.
The Company’s sales in its motorcycle market are predominantly with one customer. However, in fiscal 2011, 2010 and 2009 revenues were also somewhat positively impacted by an additional customer who contributed sales of $165,000, $287,000 and $429,000 in those three years, respectively.

 

10


Table of Contents

Sales from the Company’s aerospace and defense markets were up 15% in fiscal 2011 due primarily to increased product shipments to a new customer first announced in fiscal 2010. Fiscal 2010 sales in the aerospace and defense markets were up 8% with initial sales to that customer occurring in the Company’s fiscal fourth quarter.
Sales from the Company’s energy business were up 27% in fiscal 2011 as compared to fiscal 2010 with the increase due in large measure to sales to a new customer previously announced. The Company’s sales in its energy business decreased 33% in fiscal 2010 as compared to fiscal 2009. The Company believes that the reduction of the volume of orders from its customers in this segment in fiscal 2010 was due to a combination of factors including the recession, tight credit conditions, lower oil prices and a reduction in the demand of the particular type of oilfield equipment the Company manufactures. Sales also decreased as a result of the consignment of the raw material the Company machines in its end products as opposed to purchasing the raw material. The Company experienced in fiscal 2010 a higher percentage of consigned raw materials in its parts which then lead to a lower overall end sales price to its customers. This consignment of raw material effect has continued and has also affected sales in fiscal 2011.
Sales to the Company’s biosciences industry have fluctuated up and down in a $42,000 range in the last three fiscal years. The Company’s believes that these fluctuations are relatively minor and not indicative of any change in trend of sales in this market.
The Company’s sales from its “other” market are primarily derived from miscellaneous sales in the computer components fields and amount to less than 1% of the Company’s total sales.
The Company’s gross margin decreased in fiscal 2011 to 17.8% from 19.9% in fiscal 2010. The primary reason for the decrease were start-up expenses associated with new programs in the Company’s energy business that were incurred during the first two quarters of fiscal 2011. In addition, a higher material and outside services content as a percent of sales in fiscal 2011 was also a factor in the lower gross margins.
The Company’s gross margin increased to 19.9% in fiscal 2010 from 12.6% in fiscal 2009. The primary factor in the increase was that the fiscal 2009 margins were negatively affected by the recessionary conditions in that year. The increase in gross margin in fiscal 2010 is also partially attributable to a lower percentage of material and outside services content in product shipped during the year. Thus, the value added sales (net sales less material and outside services) were higher during fiscal 2010 than in fiscal 2009. So while the Company’s overall sales were virtually the same year-over-year, the Company’s value added sales were up 10% in fiscal 2010 versus fiscal 2009. This increase in the volume of value added sales, in combination with cost reduction efforts, were the primary drivers in the increase in the gross margin percentage in fiscal 2010.
No significant sales of obsolete items occurred in fiscal 2009 through 2011 and, correspondingly, no significant gross margin was recognized.
Selling and administrative expense in fiscal 2011 was approximately $2.8 million, an increase of $335,000 over the fiscal 2010 amount of approximately $2.4 million. The increase in fiscal 2011 was due primarily to increased payroll costs due to headcount additions as well as increased incentive compensation expense. Selling and administrative expense increased in fiscal 2010 versus 2009 by $199,000 to $2.4 million. The increase was due primarily to higher payroll costs. The Company adopted ASC 718 in fiscal 2007 and recorded a non-cash stock option compensation expense of $205,000, $211,000 and $196,000 in fiscal 2011, 2010 and fiscal 2009, respectively. In addition, the Company incurred professional service expense in each of those three fiscal years in connection with its analysis of internal controls over financial reporting as required by the Sarbanes-Oxley Act.

 

11


Table of Contents

Interest expense in fiscal 2011 amounted to $289,000 as compared to $359,000 in fiscal 2010. The lower expense is attributable to a lower average level of debt in fiscal 2011 as compared to fiscal 2010, with the lower level being primarily related to the $1.2 million loan for the Company’s building addition that was paid off in the fiscal 2010 fourth quarter. Interest expense in fiscal 2010 was $57,000 lower than in fiscal 2009 as the Company did not enter into any new lending or capital lease arrangements and paid down its debt by approximately $2.1 million during the 2010 fiscal year.
The Company recorded income taxes at an effective tax rate of 36% for fiscal 2011, 2010 and 2009, respectively. The Company maintained its valuation allowance at zero during 2011 and 2010.
Caution Regarding Forward-Looking Statements
Statements included in this Management’s Discussion and Analysis of Financial Condition and Results of Operations, in the letter to shareholders, elsewhere in the Annual Report, in the Company’s Form 10-K and in future filings by the Company with the Securities and Exchange Commission, in the Company’s press releases and in oral statements made with the approval of an authorized executive officer which are not historical or current facts are “forward-looking statements.” These statements are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. The Company wishes to caution readers not to place undue reliance on any such forward-looking statements, which speak only as of the date made and are not predictions of actual future results. Forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from historical earnings and those presently anticipated or projected. These risks and uncertainties are described above under Item 1A. Risk Factors.
Item 7A.   Quantitative and Qualitative Disclosures About Market Risk
Not applicable.
Item 8.   Financial Statements and Supplementary Data.
See Consolidated Financial Statements section of this Annual Report on Form 10-K beginning on page 20, attached hereto, which consolidated financial statements are incorporated herein by reference.
Item 9.   Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
None.

 

12


Table of Contents

Item 9A.   Controls and Procedures.
Disclosure Controls and Procedures
As of the end of the period covered by this report, the Company carried out an evaluation, under the supervision and with the participation of our chief executive officer and chief financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended. Based on that evaluation, Michael J. Pudil, the chief executive officer, and Paul D. Sheely, the chief financial officer, have concluded that as of August 28, 2011 our disclosure controls and procedures were not effective because of the material weakness in internal control over financial reporting described below. Notwithstanding the material weakness described below, we believe our consolidated financial statements presented in this Annual Report on Form 10-K fairly represent, in all material respects, our financial position, results of operations and cash flows for all periods presented herein.
Changes in Internal Controls over Financial Reporting
There have been no changes in internal control over financial reporting that occurred during the fourth quarter ended August 28, 2011 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
Management’s Report on Internal Control Over Financial Reporting
The management of the Company is responsible for the preparation of the financial statements and related financial information appearing in this Annual Report on Form 10-K. The financial statements and notes have been prepared in conformity with accounting principles generally accepted in the United States of America. The management of the Company also is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act. A company’s internal control over financial reporting is defined as a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Our internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the Company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the issuer are being made only in accordance with authorizations of management and directors of the Company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements.
Management, including the chief executive officer and chief financial officer, does not expect that the Company’s internal controls will prevent all error and all fraud. Because of its inherent limitations, a system of internal control over financial reporting can provide only reasonable, not absolute, assurance that the objectives of the control system are met and may not prevent or detect misstatements. Further, over time control may become inadequate because of changes in conditions or the degree of compliance with the policies or procedures may deteriorate.

 

13


Table of Contents

The Company’s management hired an outside consulting firm to assist it in the evaluation of the effectiveness of the Company’s internal control over financial reporting. The Company’s management assessed the effectiveness of the Company’s internal control over financial reporting as of August 28, 2011 based upon the framework in Internal Control —Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on the results of that evaluation, our management has concluded that, as of August 28, 2011, the Company’s internal control over financial reporting was not effective due to a material weakness in the areas of segregation of duties and adequacy of personnel resulting from a reduction in staff in its finance and accounting department during the quarter ended May 31, 2009.
This annual report does not include an attestation report of the Company’s independent registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s independent registered public accounting firm pursuant to rules of the Securities and Exchange Commission.
Item 9B.   Other Information.
None.

 

14


Table of Contents

PART III
Pursuant to General Instruction E (3), the Company omits Part III, Items 10, 11, 12, 13 and 14, as a definitive proxy statement will be filed with the Commission pursuant to Regulation 14(a) within 120 days after August 28, 2011 and such information required by such items is incorporated herein by reference from the proxy statement.
Item 15.   Exhibits.
(a) Documents filed as part of this report.
  1.   Consolidated Financial Statements: Reference is made to the Index to Consolidated Financial Statements (page 20) hereinafter contained for all Consolidated Financial Statements.
  2.   Exhibits.
 
      Exhibit
         
Exhibit    
No.   Description
  3.1    
Restated Articles of Incorporation of WSI Industries, Inc. Incorporated by reference from Exhibit 3 of the Registrant’s Form 10-Q for the quarter ended November 29, 1998.
       
 
  3.2    
Restated and Amended Bylaws, as amended through January 6, 2005. Incorporated by reference from Exhibit 3.2 of the Registrant’s Form 10-K for the year ended August 28, 2005.
       
 
  10.1    
WSI Industries, Inc. 1994 Stock Plan, as amended. Incorporated by reference from Exhibit 4.1 of the Registrant’s Registration Statement on Form S-8 (SEC File No. 333-78491).
       
 
  10.2    
WSI Industries, Inc. 2005 Stock Plan. Incorporated by reference from Exhibit 4.1 of the Registrant’s Registration Statement on Form S-8 (SEC File No. 333-155768).
       
 
  10.3    
Form of Restricted Stock Award Agreement under the Company’s 2005 Stock Plan. Incorporated by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K dated February 23, 2007.
       
 
  10.4    
Form of Non-Qualified Stock Option and Stock Appreciation Rights Agreement under the Company’s 2005 Stock Plan. Incorporated by reference to Exhibit 10.2 to the Registrant’s Current Report on Form 8-K dated February 23, 2007.
       
 
  10.5    
Form of Restricted Stock Bonus Award Agreement under the Company’s 2005 Stock Plan. Incorporated by reference to Exhibit 10.5 to the Registrant’s Annual Report on Form 10-K for the year ended August 30, 2009.

 

15


Table of Contents

         
Exhibit    
No.   Description
  10.6    
Board of Directors Retirement Program dated June 25, 1982. Incorporated by reference from Exhibit 10.12 of the Registrant’s Form 10-K for the year ended August 25, 2002.
       
 
  10.7    
Employment Agreement dated as of October 7, 2009 by and between WSI Industries, Inc. and Michael J. Pudil. Incorporated by reference to Exhibit 10.4 to the Registrant’s Form 8-K dated October 7, 2009.
       
 
  10.8    
Employment (change in control) Agreement between Paul D. Sheely and Registrant dated January 11, 2001 incorporated by reference from Exhibit 10.2 of the Registrant’s Form 10-Q for the quarter ended May 27, 2001.
       
 
  10.9    
Amendment No. 1 to Employment (change in control) Agreement between Paul D. Sheely and Registrant dated November 1, 2002. Incorporated by reference from Exhibit 10.11 of the Registrant’s Form 10-K for the year ended August 25, 2002.
       
 
  10.10    
Second Amendment to Employment Change in Control Agreement dated December 29, 2008 by and between WSI Industries, Inc. and Paul D. Sheely. Incorporated by reference to Exhibit 10.3 to the Registrant’s Form 8-K dated December 29, 2008.
       
 
  10.11    
Severance Letter Agreement dated October 7, 2009 by and between WSI Industries, Inc. and Paul D. Sheely. Incorporated by reference to Exhibit 10.5 to the Registrant’s Form 8-K dated October 7, 2009.
       
 
  10.12    
Employment Offer Letter dated October 5, 2009 by WSI Industries, Inc. to Benjamin Rashleger. Incorporated by reference to Exhibit 10.1 to the Registrant’s Form 8-K dated October 7, 2009.
       
 
  10.13    
Employment (Change In Control) Agreement dated October 12, 2009 by and between WSI Industries, Inc. and Benjamin Rashleger. Incorporated by reference to Exhibit 10.2 to the Registrant’s Form 8-K dated October 7, 2009.
       
 
  10.14    
Form of Restrictive Covenant Agreement by and between WSI Industries, Inc. and Michael J. Pudil, Paul D. Sheely and Benjamin Rashleger. Incorporated by reference to Exhibit 10.3 to the Registrant’s Form 8-K dated October 7, 2009.
       
 
  10.15    
Promissory Note dated as of May 3, 2004 by WSI Industries, Inc. as debtor and Excel Bank Minnesota as holder in the original principal amount of $1,360,000. Incorporated by reference from Exhibit 10.2 of the Registrant’s Form 8-K dated May 3, 2004.
       
 
  10.16    
Loan Agreement dated as of May 3, 2004 between WSI Industries, Inc. and Excel Bank Minnesota. Incorporated by reference from Exhibit 10.3 of the Registrant’s Form 8-K dated May 3, 2004.
       
 
  10.17    
Mortgage and Security Agreement and Fixture Financing Statement dated as of May 3, 2004 between WSI Industries, Inc. and Excel Bank Minnesota. Incorporated by reference from Exhibit 10.6 of the Registrant’s Form 8-K dated May 3, 2004.

 

16


Table of Contents

         
Exhibit    
No.   Description
  10.18    
Second Amendment and Modification of Revolving Line of Credit Loan Agreement and Reaffirmation of Guaranties dated as of May 3, 2004 by and among WSI Industries, Inc., Taurus Numeric Tool, Inc. and WSI Rochester, Inc. and Excel Bank Minnesota. Incorporated by reference from Exhibit 10.8 of the Registrant’s Form 8-K dated May 3, 2004.
       
 
  10.19    
Third Amendment and Modification of Revolving Line of Credit Loan Agreement and Reaffirmation of Guaranties dated as of January 1, 2005 by and among WSI Industries, Inc., Taurus Numeric Tool, Inc. and WSI Rochester, Inc. and Excel Bank Minnesota. Incorporated by reference from Exhibit 10.1 of the Registrant’s Form 10-Q for the quarter ended November 28, 2004.
       
 
  10.20    
Fourth Amendment and Modification of Revolving Line of Credit Loan Agreement and Reaffirmation of Guaranties dated as of January 1, 2006 by and among WSI Industries, Inc., Taurus Numeric Tool, Inc. and WSI Rochester, Inc. and Excel Bank Minnesota. Incorporated by reference from Exhibit 10.1 of the Registrant’s Form 10-QSB for the quarter ended November 27, 2005.
       
 
  10.21    
Fifth Amendment and Modification of Revolving Line of Credit Loan Agreement and Reaffirmation of Guaranties dated as of January 1, 2007 by and among WSI Industries, Inc., Taurus Numeric Tool, Inc. and WSI Rochester, Inc. and Excel Bank Minnesota. Incorporated by reference from Exhibit 10.1 of the Registrant’s Form 10-QSB for the quarter ended November 26, 2006.
       
 
  10.22    
Sixth Amendment and Modification of Revolving Line of Credit Loan Agreement and Reaffirmation of Guaranties dated as of January 31, 2008 by and among WSI Industries, Inc., Taurus Numeric Tool, Inc. and WSI Rochester, Inc. and M&I Marshall and IIsley Bank. Incorporated by reference from Exhibit 10.1 of the Registrant’s Form 10-QSB for the quarter ended February 24, 2008.
       
 
  10.23    
Loan agreement dated February 1, 2011 between WSI Industries, Inc., Taurus Numeric Tool, Inc., WSI Rochester, Inc., and M&I Marshall & Ilsley Bank. Incorporated by reference to Exhibit 10.1 of the Registrant’s Form 10-Q for the quarter ended February 27, 2011.
       
 
  10.24    
Amended and Restated Revolving Credit Promissory Note dated February 1, 2011 in the principal amount of $1,000,000 by WSI Industries, Inc. in favor of M&I Marshall & Ilsley Bank.
       
 
  10.25    
Amended and Restated Security Agreement dated February 1, 2011 by and between WSI Industries, Inc. and M&I Marshall & Ilsley Bank.
       
 
  10.26    
Amended and Restated Security Agreement dated February 1, 2011 by and between Taurus Numeric Tool, Inc. and M&I Marshall & Ilsley Bank.
       
 
  10.27    
Amended and Restated Security Agreement dated February 1, 2011 by and between WSI Rochester, Inc. and M&I Marshall & Ilsley Bank.

 

17


Table of Contents

         
Exhibit    
No.   Description
  10.28    
Guaranty dated February 1, 2011 by and WSI Rochester, Inc. and M&I Marshall & Ilsley Bank
       
 
  10.29    
Guaranty dated February 1, 2011 by and between Taurus Numeric Tool, Inc. and M&I Marshall & Ilsley Bank
       
 
  14.1    
Code of Ethics & Business Conduct adopted by WSI Industries, Inc. on October 29, 2003. Incorporated by reference to Exhibit 14.1 of the Registrant’s Annual Report on Form 10-K for the year ended August 31, 2003.
       
 
  21.1    
Subsidiaries of the Registrant.
       
 
  23.1    
Consent of Schechter Dokken Kanter Andrews & Selcer Ltd.
       
 
  31.1    
Certification of Chief Executive Officer pursuant to Rules 13a-14(a) and 15d-14(a) of the Exchange Act.
       
 
  31.2    
Certification of Chief Financial Officer pursuant to Rules 13a-14(a) and 15d-14(a) of the Exchange Act.
       
 
  32.1    
Certification pursuant to 18 U.S.C. §1350.

 

18


Table of Contents

SIGNATURES
Pursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
         
  WSI INDUSTRIES, INC.
 
 
  BY:   /s/ Michael J. Pudil    
      Michael J. Pudil   
      Chief Executive Officer
(principal executive officer) 
 
     
  BY:   /s/ Paul D. Sheely    
      Paul D. Sheely   
      Vice President and Treasurer
(principal financial and accounting officer) 
 
DATE: November 17, 2011
Each person whose signature appears below hereby constitutes and appoints Michael J. Pudil and Paul D. Sheely, and each of them, as his true and lawful attorney-in-fact and agent, with full power of substitution, to sign on his behalf, individually and in each capacity stated below, all amendments to this Form 10-K and to file the same, with all exhibits thereto and any other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully and to all intents and purposes as each might or could do in person, hereby ratifying and confirming each act that said attorneys-in-fact and agents may lawfully do or cause to be done by virtue thereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated:
         
Signature   Title   Date
 
       
/s/ Michael J. Pudil
 
Michael J. Pudil
  Chief Executive Officer and Director   November 17, 2011
 
       
/s/ Benjamin T. Rashleger
 
Benjamin T. Rashleger
  President, Chief Operating Officer and Director   November 17, 2011
 
       
/s/ Thomas C. Bender
 
Thomas C. Bender
  Director    November 17, 2011
 
       
/s/ Burton F. Myers II
 
Burton F. Myers II
  Director    November 17, 2011
 
       
/s/ James D. Hartman
 
James D. Hartman
  Director    November 17, 2011

 

19


Table of Contents

INDEX TO
CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULE

 

20


Table of Contents

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Shareholders
WSI Industries, Inc.
Monticello, Minnesota
We have audited the consolidated balance sheets of WSI Industries, Inc. and Subsidiaries as of August 28, 2011 and August 29, 2010 and the related consolidated statements of income, stockholders’ equity and cash flows for each of the years in the three-year period ended August 28, 2011. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of WSI Industries, Inc. and Subsidiaries as of August 28, 2011 and August 29, 2010, and the results of its operations and its cash flows for each of the years in the three-year period ended August 28, 2011, in conformity with accounting principles generally accepted in the United States of America.
     
/s/ Schechter Dokken Kanter
     Andrews & Selcer Ltd
   
Minneapolis, Minnesota
November 17, 2011

 

21


Table of Contents

WSI INDUSTRIES, INC.
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AUGUST 28, 2011 AND AUGUST 29, 2010
                 
    2011     2010  
 
 
ASSETS
               
 
 
Current assets:
               
Cash and cash equivalents
  $ 2,920,078     $ 2,347,113  
Accounts receivable, less allowance for doubtful accounts of $10,074
    3,292,227       3,087,087  
Inventories (Note 2)
    2,016,325       2,185,283  
Prepaid and other current assets
    227,239       60,686  
Deferred tax assets (Note 6)
    254,439       171,713  
 
           
Total current assets
    8,710,308       7,851,882  
 
               
Property, plant, and equipment, at cost:
               
Land
    819,000       819,000  
Building and improvements
    2,306,220       2,299,648  
Machinery and equipment
    12,507,519       10,998,303  
Less accumulated depreciation
    (8,554,678 )     (7,610,282 )
 
           
Total property, plant, and equipment
    7,078,061       6,506,669  
 
               
Deferred tax assets (Note 6)
          258,901  
 
               
Other assets (Note 10):
               
Goodwill and related acquisition costs
    2,368,452       2,368,452  
 
           
 
  $ 18,156,821     $ 16,985,904  
 
           
 
               
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
 
               
Current liabilities:
               
Trade accounts payable
  $ 1,302,958     $ 1,266,641  
Accrued compensation and employee withholdings
    1,018,665       615,048  
Other accrued expenses
    116,609       367,218  
Current portion of long-term debt (Note 3)
    989,191       1,165,192  
 
           
Total current liabilities
    3,427,423       3,414,099  
 
               
Long-term debt, less current portion (Note 3)
    3,935,712       3,736,505  
 
               
Deferred tax liabilities (Note 6)
    308,061        
 
               
Stockholders’ equity (Note 5):
               
Common stock, par value $.10 a share; authorized 10,000,000 shares; issued and outstanding 2,889,567 shares and 2,888,492 respectively
    288,957       288,850  
Capital in excess of par value
    3,149,674       2,922,048  
Deferred compensation
    (275,106 )     (250,412 )
Retained earnings
    7,322,100       6,874,814  
 
           
Total stockholders’ equity
    10,485,625       9,835,300  
 
           
 
  $ 18,156,821     $ 16,985,904  
 
           
See notes to consolidated financial statements.

 

22


Table of Contents

WSI INDUSTRIES, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED AUGUST 28, 2011, AUGUST 29, 2010 AND AUGUST 30, 2009
                         
    2011     2010     2009  
 
                       
Net sales (Note 8)
  $ 24,963,235     $ 18,826,498     $ 18,765,982  
 
                       
Cost of products sold
    20,527,925       15,079,679       16,394,530  
 
                 
Gross margin
    4,435,310       3,746,819       2,371,452  
 
                       
Selling and administrative expense
    2,759,493       2,424,651       2,225,914  
Interest and other income
    (18,640 )     (33,183 )     (22,385 )
Interest expense
    289,108       359,269       416,650  
 
                 
 
    3,029,961       2,750,737       2,620,179  
 
                 
 
                       
Income (loss) before income taxes
    1,405,349       996,082       (248,727 )
 
                       
Income taxes (benefits) (Note 6)
    505,926       358,589       (89,542 )
 
                 
 
                       
Net income (loss)
  $ 899,423     $ 637,493     $ (159,185 )
 
                 
 
                       
Basic earnings (loss) per share
  $ .32     $ .23     $ (.06 )
 
                 
 
                       
Diluted earnings (loss) per share
  $ .31     $ .23     $ (.06 )
 
                 
 
                       
Cash dividend per share
  $ .16     $     $ .0375  
 
                 
 
                       
Weighted average number of common shares outstanding, basic
    2,825,921       2,801.210       2,789,717  
 
                 
 
                       
Weighted average number of common shares outstanding, diluted
    2,877,064       2,801,210       2,789,717  
 
                 
See notes to consolidated financial statements.

 

23


Table of Contents

WSI INDUSTRIES, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
                                                 
    Common             Capital in                     Total  
    Stock             Excess of     Deferred     Retained     Stockholders’  
    Shares     Amount     Par Value     Compensation     Earnings     Equity  
 
                                               
Balance at August 31, 2008
    2,825,358     $ 282,536     $ 2,573,797     $ (245,984 )   $ 6,501,010     $ 9,111,359  
 
                                               
Net loss
                            (159,185 )     (159,185 )
Restricted stock grants
    63,382       6,338       226,591       (232,929 )            
Restricted stock issuance
                (48,176 )     48,176              
Stock option compensation
                196,284                   196,284  
Restricted stock grants not earned and payment of withholding taxes
    (9,872 )     (988 )     (77,428 )     68,876             (9,540 )
Dividends paid
                            (104,504 )     (104,504 )
 
                                   
 
                                               
Balance at August 30, 2009
    2,878,868     $ 287,886     $ 2,871,068     $ (361,861 )   $ 6,237,321     $ 9,034,414  
 
                                               
Net income
                            637,493       637,493  
Restricted stock grants
    58,405       5,841       133,215       (139,056 )            
Restricted stock issuance
                (94,919 )     94,919              
Stock option compensation
                210,712                   210,712  
Restricted stock grants not earned and payment of withholding taxes
    (48,781 )     (4,877 )     (198,028 )     155,586             (47,319 )
 
                                   
 
                                               
Balance at August 29, 2010
    2,888,492     $ 288,850     $ 2,922,048     $ (250,412 )   $ 6,874,814     $ 9,835,300  
 
                                               
Net income
                            899,423       899,423  
Restricted stock grants
    37,715       3,771       227,475       (231,246 )            
Restricted stock issuance
                (97,316 )     97,316              
Stock option compensation
                205,232                   205,232  
Restricted stock grants not earned and payment of withholding taxes
    (52,148 )     (5,215 )     (122,080 )     109,236             (18,059 )
Exercise of stock appreciation rights and payment of withholding taxes
    15,508       1,551       14,315                   15,866  
Dividends paid
                            (452,137 )     (452,137 )
 
                                   
 
                                               
Balance at August 28, 2011
    2,889,567     $ 288,957     $ 3,149,674     $ (275,106 )   $ 7,322,100     $ 10,485,625  
 
                                   
See notes to consolidated financial statements.

 

24


Table of Contents

WSI INDUSTRIES, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED AUGUST 28, 2011, AUGUST 29, 2010 AND AUGUST 30, 2009
                         
    2011     2010     2009  
CASH FLOWS FROM OPERATING ACTIVITIES:
                       
Net income (loss)
  $ 899,423     $ 637,493     $ (159,185 )
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
                       
Depreciation and amortization of property and equipment
    1,171,259       1,074,457       1,050,833  
Amortization of deferred financing cost
                4,409  
Net tax (benefits) expense related to share based compensation
    (21,901 )     30,496        
Deferred taxes
    506,138       339,979       (79,571 )
Stock option compensation
    205,232       210,712       196,284  
Changes in assets and liabilities:
                       
Decrease (increase) in:
                       
Accounts receivable
    (205,140 )     (351,501 )     1,017,768  
Inventories
    168,958       (38,752 )     389,475  
Prepaid and other current assets
    (166,553 )     (8,784 )     137,031  
Increase (decrease) in accounts payable and accrued expenses
    132,720       (259,953 )     (790,058 )
 
                 
Net cash provided by operating activities
    2,690,136       1,634,147       1,766,986  
 
                       
CASH FLOWS FROM INVESTING ACTIVITIES:
                       
Additions to property, plant, and equipment
    (462,588 )     (60,767 )     (421,634 )
 
                 
Net cash used in investing activities
    (462,588 )     (60,767 )     (421,634 )
 
                       
CASH FLOWS FROM FINANCING ACTIVITIES:
                       
Payment of long-term debt
    (1,256,857 )     (2,075,723 )     (829,497 )
Net tax benefits (expense) related to share based compensation
    21,901       (30,496 )      
Proceeds from issuance of long-term debt
                625,000  
Issuance of common stock
    32,510              
Dividends paid
    (452,137 )           (104,504 )
 
                 
Net cash used in financing activities
    (1,654,583 )     (2,106,219 )     (309,001 )
 
                 
 
                       
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
    572,965       (532,839 )     1,036,351  
 
                       
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR
    2,347,113       2,879,952       1,843,601  
 
                 
 
                       
CASH AND CASH EQUIVALENTS AT END OF YEAR
  $ 2,920,078     $ 2,347,113     $ 2,879,952  
 
                 
 
                       
SUPPLEMENTAL CASH FLOW INFORMATION:
                       
Cash paid during the year for:
                       
Interest
  $ 289,274     $ 363,278     $ 413,120  
Payroll withholding taxes in cashless stock option exercise
    56,604       16,823       9,540  
Income taxes
    35,641       15,536       13,762  
Noncash investing and financing activities:
                       
Acquisition of machinery through capital lease
    1,280,063             919,043  
See notes to consolidated financial statements.

 

25


Table of Contents

WSI INDUSTRIES, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED AUGUST 28, 2011, AUGUST 29, 2010 AND AUGUST 30, 2009
1.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Business Description — WSI Industries, Inc. and Subsidiaries (the Company) is involved in the precision contract metal machining business primarily serving the recreational vehicle, energy, aerospace/avionics and bioscience industries.
Fiscal Year — WSI Industries, Inc.’s fiscal years represent a 52- to 53-week period ending the last Sunday in August. Fiscal 2011, 2010 and 2009 each consisted of 52 weeks.
Basis of Presentation — The consolidated financial statements include the accounts of WSI Industries, Inc. and its subsidiaries. All material intercompany balances and transactions have been eliminated. Our consolidated financial statements for the year ended August 28, 2011 were evaluated for subsequent events through the date it was filed with the SEC on Form 10-K.
Cash and Cash Equivalents — Cash and cash equivalents include cash on hand, demand deposits with financial institutions and short-term, highly liquid investments with original maturities of three months or less. At times bank balances may exceed federally insured limits and the risk of losses related to such concentrations may have increased as a result of economic developments, particularly with the instability in the commercial and investment banking system. Cash equivalents are carried at cost plus accrued interest which approximates fair value.
Inventories — Inventory costs determined using the average cost method consist of material, direct labor, and manufacturing overhead. They are valued at the lower of cost or market by comparing the cost of each item in inventory to its most recent sales price or sales order price. Inventory cost is adjusted down for any excess of cost over the net realizable value of inventory components.
In addition, the Company determines whether its inventory is excess and obsolete by analyzing the sales history of its inventory, sales orders on hand and indications from the Company’s customers as to the future of various parts or programs. If, in the Company’s determination, the inventory value has become impaired, the Company adjusts the inventory value to the amount the Company estimates as the ultimate net realizable value for that inventory. The Company performs its lower of cost or market testing, as well as its excess or obsolete inventory analyses, quarterly.
Property, plant, equipment and depreciation and amortization — The cost of substantially all machinery and equipment, and buildings and improvements are being depreciated using the straight-line method. The estimated useful lives of the assets are as follows:
         
Machinery and equipment
    3 to 7 years  
Building and improvements
    15 to 40 years  

 

26


Table of Contents

Long-lived Assets — The Company evaluates long-term assets on a periodic basis in compliance with Accounting Standards Codification (“ASC”) 360, Accounting for the Impairment of Long-lived Assets when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the assets carrying amount. If the undiscounted cash flows are less than the carrying amount, the impairment recognized is measured by the amount the carrying value of the assets exceeds their fair value determined primarily through the present value of estimated future cash flows.
Goodwill — The Company assesses the valuation of its goodwill according to the provisions of ASC 350 to determine if the current value of goodwill has been impaired. The Company has also adopted Accounting Standard Update (ASU) No. 2011-08, Intangibles—Goodwill and Other (Topic 350). With ASU No. 2011-08, an entity is given the option to make a qualitative evaluation of goodwill impairment to determine whether it should calculate the fair value of its reporting unit. In the fiscal 2011 fourth quarter, the Company made its qualitative evaluation of its goodwill considering, among other things, the overall macroeconomic conditions, industry and market considerations, overall financial performance and other relevant company specific events. Based on this qualitative evaluation, the Company concluded that it was more likely than not that its goodwill was not impaired and that it wasn’t required to calculate the fair value of its reporting unit. If the Company has changes in events or circumstances, including reductions in anticipated cash flows generated by our operations, goodwill could become impaired which would result in a charge to earnings.
Income Taxes — The determination of the Company’s income tax-related account balances requires the exercised of significant judgment by management. Accordingly, the Company determines deferred tax assets and liabilities based upon the difference between financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year the differences are expected to affect taxable income. Management assesses the likelihood that deferred tax assets will be recovered from future taxable income and establishes a valuation allowance when management believes recovery is unlikely.
Revenue Recognition — Revenues from sales of product are recorded generally upon shipment. The Company considers its revenue recognition policy to fall under the guidance of FASB’s conceptual framework for revenue recognition. The Company recognizes revenue only after: (a) the Company has received a purchase order identifying price and delivery terms or services to be rendered; (b) shipment has occurred, or in the case of services, after the service has been completed; (c) the Company’s price is fixed as evidenced by the purchase order; and (d) collectability is reasonably assured. The Company refers to its revenues as “net sales” in its Consolidated Statements of Income as the Company’s sales are reduced for any product returned by customers.
The Company generally does not require collateral on its trade receivables. The maximum loss that the Company would incur if a customer failed to pay amounts owed would be limited to the recorded amount due after any allowances provided. Credit losses relating to customers have been minimal and within management’s expectations. Based on management’s evaluation of uncollected accounts receivable throughout the year, bad debts are provided for on the allowance method. Accounts are considered delinquent if they are 120 days past due. The Company mitigates its credit risk by performing credit checks and actively pursuing past due accounts.
Freight costs — The Company includes freight, shipping and handling costs, in the cost of goods sold.
Use of Estimates — The preparation of financial statements in conformity with U. S. generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. Significant estimates made in those financial statements consist of estimates related to the impairment of goodwill, the evaluation of excess or obsolete inventory and the valuation allowance connected to the deferred tax assets.

 

27


Table of Contents

Earnings per Share — Basic earnings per share is computed using the weighted average number of common shares outstanding. Diluted earnings per share is computed using the combination of dilutive common share equivalents and the weighted average number of common shares outstanding.
Stock-based compensation — The following information has been determined as if the Company had accounted for its stock options under the fair value method of ASC 718. The fair value for these options was estimated, for the purpose of determining compensation, at the date of grant using the Black-Scholes option pricing model with the following assumptions as set forth in the table below. The estimated fair value of the options is amortized to expense over the options’ vesting period.
             
Date of Grant in fiscal —   2011   2010   2009
Dividend yield
  2.3%-3.25%    
Expected volatility
  77.3%-78.5%   69.8%-70.2%   60.8%
Risk free interest rate
  1.2%-3.3%   2.6%-3.8%   1.6%-2.47%
Expected term
  5-10 years   5-10 years   5-10 years
ASC 718 also requires the benefit of tax deductions in excess of recognized compensation cost to be reported as a financing cash flow, rather than an operating cash flow under current accounting literature.
The Company granted shares of non-vested restricted stock to various employees during the years ended August 28, 2011, August 29, 2010 and August 30, 2009. The grants consisted of both outright stock grants as well as stock that could be earned in connection with the Company’s incentive compensation program should certain predetermined targets be met. Both kinds of non-vested restricted stock vest over three years with the grantees of the restricted stock entitled to receive dividends in additional shares of restricted stock that also vest yearly and to voting rights for the shares. The shares are accounted for under ASC 718 as expense over the period that they vest. The shares are also reflected in stockholder’s equity as deferred compensation which is calculated at the value of the shares at the date of the grant.
Reclassification — Certain prior year items have been reclassified to conform to the current year presentation.
Recent Accounting Pronouncements
In May 2011, the FASB issued ASU No. 2011-04, Fair Value Measurement to amend the accounting and disclosure requirements on fair value measurements. This ASU limits the highest-and-best-use measure to nonfinancial assets, permits certain financial assets and liabilities with offsetting positions in market or counterparty credit risks to be measured at a net basis, and provides guidance on the applicability of premiums and discounts. Additionally, this update expands the disclosure on Level 3 inputs by requiring quantitative disclosure of the unobservable inputs and assumptions, as well as description of the valuation processes and the sensitivity of the fair value to changes in unobservable inputs. ASU No. 2011-04 is to be applied prospectively and is effective during interim and annual periods beginning after December 15, 2011. The Company does not expect the adoption of this update will have a material effect on its consolidated financial statements.

 

28


Table of Contents

In June 2011, the FASB issued ASU No. 2011-05, Presentation of Comprehensive Income. This ASU presents an entity with the option to present the total of comprehensive income, the components of net income, and the component of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In both choices, an entity is required to present each component of other comprehensive income along with a total for other comprehensive income, and a total amount for comprehensive income. This update eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders’ equity/deficit. The amendments in this update do not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income. ASU No. 2011-05 should be applied retrospectively and is effective for fiscal years, and interim periods within those years, beginning after 15 December 2011. As ASU No. 2011-05 relates only to the presentation of Comprehensive Income, the Company does not expect the adoption of this update will have a material effect on its consolidated financial statements.
In September 2011, the FASB issued ASU No. 2011-08. Intangibles and Goodwill — Other (Topic 350). This ASU gives the entity the option to make a qualitative evaluation of goodwill impairment to determine whether it should calculate the fair value of its reporting unit. The amendments also improve previous guidance by expanding upon the examples of events and circumstances that an entity should consider between annual impairment tests in determining whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. Also, the amendments improve the examples of events and circumstances that an entity having a reporting unit with a zero or negative carrying amount should consider in determining whether to measure an impairment loss, if any, under the second step of the goodwill impairment test. The amendments are effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. Early adoption is permitted, including for annual and interim goodwill impairment tests performed as of a date before September 15, 2011, if an entity’s financial statements for the most recent annual or interim period have not yet been issued or, for nonpublic entities, have not yet been made available for issuance. The Company has adopted this update effective with these financial statements.
2.   INVENTORIES
Inventories consist primarily of raw material, work-in-process (WIP) and finished goods valued at the lower of cost or market value:
                 
    August 28, 2011     August 29, 2010  
 
 
Raw material
  $ 347,829     $ 584,719  
WIP
    976,879       939,085  
Finished goods
    691,617       661,479  
 
           
 
  $ 2,016,325     $ 2,185,283  
 
           
3.   DEBT
Long-term debt consists of the following:
                 
    August 28, 2011     August 29, 2010  
 
               
Building related mortgages & term debt
  $ 1,123,771     $ 1,442,676  
Capitalized lease obligations
    3,801,132       3,459,021  
 
           
 
    4,924,903       4,901,697  
Less current portion
    989,191       1,165,192  
 
           
Long-term debt
  $ 3,935,712     $ 3,736,505  
 
           

 

29


Table of Contents

The Company purchased its land and building in May 2004 and at that time entered into two mortgages. The first mortgage was with its bank for $1,360,000 that matures on May 1, 2014. The mortgage had an initial interest rate of 5.37% and required monthly principal and interest payments of $8,307 based on a 25-year amortization schedule. Effective May 3, 2009 the interest rate adjusted to a rate 2.5% above the monthly yield on United States Treasury five-year securities. The new interest rate is 4.38% with monthly payments of $7,637 also based on a 25-year amortization schedule. The mortgage is secured by all assets of the Company.
The Company also entered into a mortgage with the City of Monticello, Minnesota Economic Development Authority (MEDA). The MEDA mortgage was subordinated to the bank mortgage, carried an interest rate of 2% and required monthly principal and interest payments of $1,483 based on a 25-year amortization schedule. The entire balance was due May 1, 2011 and it was fully paid as of that date.
Maturities of long-term debt are as follows:
         
Fiscal years ending August:
       
2012
  $ 989,191  
2013
    974,537  
2014
    1,910,520  
2015
    530,723  
2016
    222,648  
Thereafter
    297,284  
Included in the consolidated balance sheet at August 28, 2011 are cost and accumulated depreciation on equipment subject to capitalized leases of $8,852,678 and $5,221,130, respectively. At August 29, 2010, the amounts were $7,537,576 and $4,258,583, respectively. The capital leases carry interest rates from 4.5% to 8.4% and mature from 2012 — 2018.
The present value of the net minimum payments on capital leases which is included in long-term debt as of August 28, 2011 is as follows:
         
Fiscal years ending August:
       
2012
  $ 1,151,040  
2013
    1,073,681  
2014
    958,590  
2015
    570,940  
2016
    242,196  
Thereafter
    308,660  
 
     
Total minimum lease payments
    4,305,107  
Less amount representing interest
    503,975  
 
     
Present value of net minimum lease payments
    3,801,132  
Current portion
    946,642  
 
     
Capital lease obligation, less current portion
  $ 2,854,490  
 
     
Line of Credit:
The Company renewed its revolving credit agreement with its bank on February 1, 2011. Under the agreement, the Company can borrow up to $1 million, with the loan being collateralized by all assets of the Company. The agreement expires February 1, 2012 and has restrictive provisions requiring minimum net worth, current and debt service coverage ratios as well as a maximum ratio of debt to tangible net worth. At August 28, 2011, the Company was in compliance with these provisions. Interest on any amounts borrowed under the agreement would be at a rate equal to the London Interbank Offered Rates (LIBOR) (.22% at August 28, 2011) plus 3.0%. However, the rate shall never be less than 3.75%. There were no amounts outstanding related to its revolving credit agreement at August 28, 2011 and August 29, 2010, respectively.

 

30


Table of Contents

4.   FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts of financial instruments, including cash and equivalents, receivables, accounts payable and accrued expenses, and current maturities on long-term debt obligations approximates fair values due to their short term nature. Interest on long-term debt is primarily at fixed rates which do not differ significantly from approximate market rates at August 28, 2011.
5.   STOCK-BASED COMPENSATION
Stock Options — The 1994 Stock Option Plan was approved and 450,000 shares of common stock were reserved for granting of options to officers, key employees, and directors. The Plan expired on September 29, 2004 and therefore no shares remain to be granted.
The 2005 Stock Option Plan was approved and 600,000 shares of common stock were reserved for granting of options to officers, key employees and directors. The Plan has a term of 10 years and will expire in 2015.
Stock options vest over a period of six months to three years for both stock option plans.
Option transactions during the three years ended August 28, 2011 are summarized as follows:
                                 
    1994 Stock     2005 Stock  
    Option Plan     Option Plan  
            Average             Average  
    Shares     Price     Shares     Price  
Outstanding at August 31, 2008
    2,000     $ 2.75       121,666     $ 4.35  
Granted
                53,000       3.46  
Forfeited
    (2,000 )     2.75              
Exercised
                       
 
                       
Outstanding at August 30, 2009
        $       174,666       4.08  
 
                           
Granted
                    45,000       2.32  
Forfeited
                           
Exercised
                           
 
                           
Outstanding at August 29, 2010
                    219,666       3.72  
Granted
                    61,000       5.39  
Forfeited
                    (7,000 )     4.18  
Exercised
                    (25,500 )     3.30  
 
                           
Outstanding at August 28, 2011
                    248,166     $ 4.16  
 
                           
Of the 25,500 stock options from the 2005 Plan that were exercised in fiscal 2011, 9,992 shares were returned to the Company to pay for the exercise price and for related payroll withholding taxes.
The weighted fair value of options granted during the years ended August 28, 2011, August 29, 2010, and August 30, 2009 was $3.10, $1.74 and $2.34, respectively. The total intrinsic value of options exercised for the years August 28, 2011, August 29, 2010 and August 30, 2009 was $50,900, $0 and $0, respectively. The intrinsic value for options outstanding at August 28, 2011 was $317,922.

 

31


Table of Contents

Cash received from option exercises for years ended August 28, 2011. August 29, 2010 and August 30, 2009 was $32,510, $0 and $0, respectively. The actual tax benefit realized for the tax deductions from option exercises totaled $21,901, $0 and $0 for fiscal years 2011, 2010 and 2009, respectively.
As of August 28, 2011, there was $135,287 of total unearned compensation cost related to option-based compensation arrangements to be recognized over an expected weighted average of 1 year.
As of August 28, 2011, there were 31,000 shares with an exercise price of $2.13, 103,166 shares with exercise prices between $3.00 and $3.47 and 114,000 options outstanding with exercise prices between $4.93 and $6.82. At August 28, 2011, outstanding options had a weighted-average remaining contractual life of 7 years.
The number of options exercisable as of August 28, 2011, August 29, 2010 and August 30, 2009 were 193,999, 169,999 and 115,666, respectively, at weighted average share prices of $4.02, $3.89, and $3.30 per share, respectively. At August 28, 2011, there were 54,167 options that had not vested.
The Company also grants non-vested restricted shares as part of the 2005 Stock Option Plan. These shares typically vest over a three year period and sometimes contain required minimum threshold levels before the shares are earned. Non-vested restricted share transactions during the three years ended August 28, 2011 are as follows:
                 
    Options     Average Price  
Outstanding at August 31, 2008
    42,375     $ 5.80  
Granted
    63,382       3.67  
Vested
    (13,444 )     5.53  
Forfeited
    (6,174 )     6.93  
 
           
Outstanding at August 30, 2009
    86,139       4.20  
Granted
    58,405       2.38  
Vested
    (20,129 )     4.72  
Forfeited
    (41,104 )     3.78  
 
           
Outstanding at August 29, 2010
    83,311       3.00  
Granted
    37,715       6.13  
Vested
    (22,478 )     2.46  
Forfeited
    (44,405 )     4.33  
 
           
Outstanding at August 28, 2011
    54,143     $ 5.08  
 
           
As of August 28, 2011, there was $95,877 in total unrecognized compensation cost related to non-vested restricted stock compensation arrangements granted under the Plan. That cost is expected to be recognized over a weighted average period of 1 year. The total intrinsic value of restricted stock options that vested during the year ended August 28, 2011 was $119,190.

 

32


Table of Contents

6.   INCOME TAXES
Income taxes consisted of the following:
                         
    Years Ended  
    August 28,     August 29,     August 30,  
    2011     2010     2009  
Current:
                       
Federal
  $     $ 15,289     $  
State
    19,457       15,676       (9,971 )
 
                 
 
    19,457       30,965       (9,971 )
 
                       
Deferred:
                       
Federal
    486,469       323,378       (72,577 )
State
          4,246       (6,994 )
 
                 
 
    486,469       327,624       (79,571 )
 
                 
Total
  $ 505,926     $ 358,589     $ (89,542 )
 
                 
A reconciliation of the federal income tax provision at the statutory rate with actual taxes provided on earnings from continuing operations is as follows:
                         
    Years Ended  
    August 28,     August 29,     August 30,  
    2011     2010     2009  
Ordinary federal income tax statutory rate
    34.0 %     34.0 %     (34.0 )%
State income taxes net of federal tax effect
    2.0       2.0       (2.0 )
 
                 
Effective rate
    36.0 %     36.0 %     (36.0 )%
 
                 
Deferred income taxes are provided for the temporary differences between the financial reporting and tax basis of the Company’s assets and liabilities. Temporary differences, net operating loss carryforwards, and valuation allowances comprising the net deferred taxes on the balance sheet are as follows:
                 
    August 28, 2011     August 29, 2010  
Deferred Tax Assets
               
Accrued liabilities
  $ 86,764     $ 78,998  
Inventory valuation adjustments
    54,026       26,262  
Net operating loss carryforwards
    767,705       827,896  
Tax credit carryforwards
    494,728       510,993  
Stock option expense
    174,551       151,244  
Other
    145,562       114,989  
 
           
 
    1,723,336       1,710,382  
 
               
Deferred Tax Liabilities
               
Tax depreciation and amortization greater than book
    (1,776,958 )     (1,279,768 )
 
           
Net deferred taxes
  $ (53,622 )   $ 430,614  
 
               
Included in the balance sheet as:
               
Deferred tax assets — current
    254,439       171,713  
Deferred tax assets — long-term
          258,901  
Deferred tax liabilities — long-term
    (308,061 )      
 
           
Net deferred taxes
  $ (53,622 )   $ 430,614  
 
           

 

33


Table of Contents

Based on the long-term nature of its net operating loss carryforwards and the Company’s recent operating history and growth in fiscal 2011, management believes that it is more likely than not that the Company will be able to generate taxable income in the future sufficient to utilize these deductions and carryforwards, and accordingly no tax asset valuation allowance is deemed necessary.
As of August 28, 2011, the Company had federal net operating loss carryforwards of approximately $2.1 million expiring in 2021-2029. Also as of August 28, 2011, the Company had $454,000 in federal alternative minimum tax (AMT) credit carryforward that has no expiration. The AMT credits are available to offset future tax liabilities only to the extent that the Company has regular tax liabilities in excess of AMT tax liabilities.
7.   EMPLOYEE BENEFITS
The Company maintains a 401(k) retirement savings plan that all employees are eligible to participate in as well as a profit sharing plan. Profit sharing contributions are discretionary and are based on Company results. Contributions charged to operations for the profit sharing plan and matching contributions for the 401(k) plan for fiscal 2011, 2010 and 2009, were $239,463, $184,037 and $137,762, respectively.
8.   INFORMATION CONCERNING SALES TO MAJOR CUSTOMERS
The Company had sales to two customers that exceeded 10 percent of total sales during fiscal years 2011, 2010 and 2009 as listed below:
                         
    2011     2010     2009  
Customer # 1
  $ 16,804,000     $ 11,922,000     $ 9,652,000  
Customer # 2
  $ 4,525,000     $ 4,480,000     $ 5,680,000  
The Company had accounts receivable from customer #1 of $1,938,000 and $2,171,000 at August 28, 2011 and August 29, 2010, respectively. The Company had accounts receivable from customer #2 of $607,000 and $633,000 at August 28, 2011 and August 29, 2010, respectively. Realization of these receivables, sale of inventory, and its future operations could be significantly affected by adverse changes in the financial condition or the Company’s relationship with these customers.

 

34


Table of Contents

9.   EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted earnings per share:
                         
    2011     2010     2009  
 
                       
Net Income (loss)
  $ 899,423     $ 637,493     $ (159,185 )
 
                 
Denominator for earnings per share:
                       
 
                       
Weighted average shares; denominator for basic earnings per share
    2,825,921       2,801,210       2,789,717  
 
                       
Effect of dilutive securities; employee and non-employee options
    51,143              
 
                 
 
                       
Dilutive common shares; denominator for diluted earnings per share
    2,877,064       2,801,210       2,789,717  
 
                 
 
                       
Basic earnings (loss) per share
  $ .32     $ .23     $ (.06 )
 
                 
 
                       
Dilutive earnings (loss) per share
  $ .31     $ .23     $ (.06 )
 
                 
10.   OTHER ASSETS
Goodwill consists of costs resulting from business acquisitions which total $2,368,452 (net of accumulated amortization of $344,812 recorded prior to the adoption of ASC 350 Goodwill and Other Intangible Assets).

 

35