Item 1. Business. - ----------------
Substantially all of the Company's operating activity is from the sale of military and other rugged footwear, the sale of specialized machinery and materials for the manufacture of this type of footwear and the rendering of technical assistance and other services to licensees for the manufacture of this type of footwear.
Footnote 15 to the Consolidated Financial Statements contains information about revenues by similar sources and by geographic areas. The majority of revenues ($38,528,000 in 2006 and $44,249,000 in 2005) were from sales to the U. S. government, primarily the Defense Supply Center Philadelphia (DSCP), under contracts for the supply of boots used by the U. S. Armed Forces. The loss of this customer would have a material adverse effect on the Company.
For more than the last five years, the Company has manufactured and sold military combat boots under firm fixed price contracts with DSCP. The primary boot products supplied DSCP are the hot weather boot and the temperate weather boot. The government awards fixed price boot contracts on the basis of bids from several qualified U. S. manufacturers. The Company also sells similar military-style boot products, as well as anti-personnel mine protective footwear products, to other customers, including customers located in other countries.
The Company provides, primarily under long-term licensing agreements, technology, assistance and related services for manufacturing military and commercial footwear to customers in the United States and abroad. Under these agreements licensees receive technology, services and assistance, and the Company earns fees based primarily on the licensees' sales volume. In addition to providing technical assistance, the Company also, from time to time, supplies certain foreign military footwear manufacturers with some of their machinery and material needs. The Company builds specialized footwear manufacturing equipment for use in its own and its customers' manufacturing operations. This equipment is usually sold, but in some cases it is leased.
Net income for the 2006 fiscal year was $746,000 ($0.58 diluted income per share) compared to net income of $1,907,000 ($1.47 diluted income per share) for the 2005 fiscal year.
Compared to the prior year, total revenues in the current year decreased by $6,445,000. The primary reason for the decrease was a 15% reduction of total pairs of boots shipped to the U.S. government. Gross profit for the current period was 8.2% of revenues as compared to gross profit of10.4% for the prior period. This decrease in gross profit as a percentage of revenues is primarily due to a higher per unit manufacturing costs associated with lower production levels and the decrease of $787,000 in reimbursement of revenues from the Puerto Rican government grant.
More information about these, and other events affecting Wellco's 2006 and 2005 operating results, are contained in the Management's Discussion and Analysis of Results of Operations and Financial Condition section of the Company's 2006 Annual Report to Shareholders which is incorporated in Part II of this Form 10-K.
Bidding on U. S. government boot solicitations is open to any qualified U. S. manufacturer. In addition to meeting very stringent manufacturing and quality standards, contractors are required to comply with demanding delivery schedules and quality standards.
The Company competes on U. S. government contracts with several other companies, none of which dominates the industry. Bidding on contracts is very competitive. U. S. footwear manufacturers have been adversely affected by sales of footwear made in low labor cost countries. This has significantly affected the competition for contracts to supply boots to U. S. Armed Forces, which by law must be made in the United States. Most boot contracts are for multi-year periods. Therefore, a bidder not receiving an award from a significant solicitation could be adversely affected for several years. Most of our current boot contracts contain additional option periods to purchase boots and the options are exercisable at the government's discretion.
Many factors affect the government's demand for boots, therefore the quantity purchased can vary from year to year. Contractors cannot influence the government's boot needs. Price, quality, quick delivery and manufacturing efficiency are the areas emphasized by the Company that strengthen its competitive position. While the government's demand for boots varies from month to month, the Company's business cannot be deemed seasonal.
The U. S. government usually evaluates bids received on solicitations for boots using their "best value" system, under which bidders offering the best value to the government are awarded the contract, or in the case of multiple contract awards, a greater portion of total boots contracted. Best value usually involves an evaluation of performance considerations, such as quality and delivery, with the prices bid being equally important. As bidders become more equal in the best value evaluation, price becomes more important.
Government contracts are subject to partial or complete termination under the following circumstances: (1) Convenience of the Government. The government's contracting officer has the authority to partially or completely terminate a contract for the convenience of the government only when it is in the government's interest to terminate. The contracting officer is responsible for negotiating a settlement with the contractor.
(2) Default of the Contractor. The government's contracting officer has the authority to partially or completely terminate a contract because of the contractor's actual or anticipated failure to perform his contractual obligations.
Under certain circumstances occasioned by the egregious conduct of a contractor, contracts may be terminated and a contractor may be prohibited for a certain period of time from receiving government contracts. The Company has never had a contract either partially or completely terminated.
Because domestic commercial footwear manufacturers are adversely affected by imports from low labor cost countries, the Company targets its marketing of technology and assistance primarily to military footwear manufacturers. The Company competes against several other footwear construction methods commonly used for heavy-duty commercial footwear. These methods include the Goodyear Welt construction, as well as boots bottomed by injection molding. These methods are used in work shoes, safety shoes, and hiking boots manufactured both in the U. S. and abroad for the commercial market. Quality, service and reasonable manufacturing costs are the most important features used to market the Company's technology, assistance and services.
The Company has a strong research and development program. While not all research and development results in successful new products or significant revenues, the continuing development of new products and processes has been and
will continue to be a significant factor in our growth and development.
Of the total amount spent on research and development, a significant portion is for personnel costs of mold engineers, rubber technicians, chemists, pattern engineers and management, all of whom have many responsibilities in addition to research and development. The Company estimates that the total cost of research and development, the majority of which is company sponsored, for fiscal years 2006, 2005 and 2004 is $83,000, $78,000 and $101,000.
The Company's backlog of all sales, not including license fees and rentals, as of September 22, 2006 was approximately $6,700,000 compared to $17,300,000 at August 31, 2005. The Company estimates that substantially all of the current year backlog will be shipped in the 2007 fiscal year. The current year's backlog decreased because the Department of Defense has stated that they are in an over-inventoried position on some products related to boots. Thus, DOD orders have decreased.
Most of the raw materials used by the Company can be obtained from at least two sources and are readily available. Because all materials in combat boots must meet rigid government specifications and because quality is the first priority, the Company purchases most of its raw materials from vendors who provide the best materials at a reasonable cost. The loss of some vendors would cause some difficulty for the entire industry, but the Company believes a suitable replacement could be found in a reasonably short period of time. Major raw materials include leathers, fabrics and rubber, and, by government regulation all are from manufacturers in the United States.
Compliance with various existing governmental provisions relating to protection of the environment has not had a material effect on the Company's capital expenditures, earnings or competitive position.
The Company employed an average of 719 persons during the 2006 fiscal year.
Item 1A.
Item 1A. Risk Factors. - ---------------------
The Company's business, operations, and financial condition are subject to various risks. Some of these risks are described below. This section does not describe all risks that may be applicable to the Company, the Company's industry, or the Company's business, and it is intended only as a summary of certain material risk factors.
Substantially all of the Company's operating activity is from the sale of military and other rugged footwear, the sale of specialized machinery and materials for the manufacture of this type of footwear and the rendering of technical assistance and other services to licensees for the manufacture of this type of footwear. The majority of revenues is from sales to the U. S. government, primarily the Defense Supply Center Philadelphia (DSCP), under contracts for the supply of boots used by the U. S. Armed Forces. The loss of this customer would have a material adverse effect on the Company.
Bidding on U. S. government boot solicitations is open to any qualified U. S. manufacturer. Bidding on contracts is highly competitive. U. S. footwear manufacturers have been adversely affected by sales of footwear made in low labor cost countries. This has significantly affected the competition for contracts to supply boots to U. S. Armed Forces, which by law must be made in the U. S.
Most boot contracts are for multi-year periods. Therefore, a bidder not receiving an award from a significant solicitation could be adversely affected up to five years. In addition, current boot contracts contain options for additional pairs that are exercisable at the sole discretion of the government. The Company's business may be adversely affected by periodic difficulties in obtaining raw materials and other items needed for the production of its
products, the effects of quality deviations in raw materials and fluctuations in prices of such materials.
We rely on our manufacturing facility in Aguadilla, Puerto Rico and our warehousing center in Waynesville, North Carolina. Any natural disaster or other serious disruption at either of these facilities due to fire, hurricane, flood, terrorist attack or any other cause could impair our ability to meet deliveries and adequately supply our customers with products and adversely affect our operating results.
Some of our operations use substances regulated under various federal, state, local and international environmental and pollution laws, including those relating to the storage, use, discharge, disposal and labeling of, and human exposure to, hazardous and toxic materials. We could incur costs, fines and civil or criminal sanctions, third party property damage or personal injury claims, if we were to violate or become liable under any environmental laws. There can be no assurance that violations of environmental laws or regulations have not occurred in the past and will not occur in the future as a result of our inability to obtain permits, human error, equipment failure or other causes, and any such violations could harm our business and financial condition.
Since the Company's first source of liquidity is cash from operations, a decrease in sales of the Company's products would reduce this source of liquidity and result in increased use of the bank line of credit. The bank line of credit of $7,500,000 will expire on December 31, 2006 and will then be subject to renewal at the discretion of the bank. Historically, the bank has always renewed the line of credit. Under conditions of substantial reduction in operations, with little basis for projecting a reversal of such reduction, it is possible that the bank would cancel or not renew the line of credit. Events that would cause a substantial reduction in operations include, but are not limited to, cancellation of existing government contracts or receiving government contracts that do not provide enough revenues to provide adequate liquidity.
The Estate of James T. Emerson owns 57% of our stock. The Estate of James T. Emerson can direct our affairs and significantly influence the election or removal of our directors and the outcome of all matters submitted to a vote of our stockholders. The interest of our principal stockholder may conflict with interests of other stockholders. This concentration of ownership may harm the market price of our common stock.
Our success depends in part on our ability to retain key executives and to attract and retain additional qualified management personnel who have experience both in defense contracting and small public companies. Competition for such personnel is strong in the footwear industry and we may not be successful in attracting or retaining the personnel we require. We expect to effectively compete in this area by offering competitive financial packages that include incentive-based compensation.
Item 1B.
Item 1B. Unresolved Staff Comments. (None) - ------- -------------------------
Item 2.
Item 2. Properties. - ------ ----------
The Company has manufacturing, warehousing and office facilities in Waynesville, North Carolina and Aguadilla, Puerto Rico. The building and land in North Carolina are owned by the Company. The Puerto Rico building and land are leased.
Management believes all its plants, warehouses and offices are in good condition and are reasonably suited for the purposes for which they are presently used.
Item 3.
Item 3. Legal Proceedings. - ------ -----------------
There are no material pending legal proceedings, other than ordinary routine litigation incidental to the Company's business, to which the Company or any of
its subsidiaries are a party or of which any of their property is subject.
Management does not know of any director, officer, affiliate of the Company, nor any stockholder of record or beneficial owner of more than 5% of the Company's common stock, or any associate thereof who is a party to a legal proceeding that is adverse to the Company or any of its subsidiaries.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders. - ------ ---------------------------------------------------
There were not any submissions of matters to a vote of security holders during the fourth quarter of fiscal year 2006.
WELLCO(R) ENTERPRISES, INC. ANNUAL REPORT
WELLCO ENTERPRISES, INC. CONSOLIDATED SELECTED FINANCIAL DATA (In Thousands Except for Per Share Amounts)
Fiscal Year Ended
July 1, July 2, July 3, June 28, June 29, 2006 2005 2004 2003 2002 - --------------------------------------------------------------------------------
Revenues $ 44,022 $ 50,467 $ 45,693 $ 24,833 $ 19,981 - --------------------------------------------------------------------------------
Net Income 746 1,907 2,448 823 683 - --------------------------------------------------------------------------------
Basic Earnings per Share 0.59 1.51 2.04 0.70 0.58 - --------------------------------------------------------------------------------
Diluted Earnings per Share 0.58 1.47 1.97 0.68 0.56 - --------------------------------------------------------------------------------
Cash Dividends Declared per Share of Common Stock 0.60 0.60 0.45 0.40 0.40 - --------------------------------------------------------------------------------
Total Assets at Year End 18,150 20,804 22,919 15,310 12,929 - --------------------------------------------------------------------------------
Long-Term Liabilities at Year End $ 2,054 $ 2,462 $ 2,112 $ 1,972 $ 1,328 - --------------------------------------------------------------------------------
See the Management's Discussion and Analysis of Results and Operations and Financial Condition section.
Independent Auditors Dixon Hughes PLLC Asheville, N.C.
Annual Meeting November 14, 2006 Corporate Offices Waynesville, N.C.
10-K Availability The Company's Form 10-K (annual report filed with the Securities and Exchange Commission) is available without charge to those who wish to receive a copy. Write to: Corporate Secretary, Wellco Enterprises, Inc., Box 188, Waynesville, N.C. 28786
To: Our Valued Shareholders:
For fiscal year 2006, your Company had net income of $746,000 equivalent to basic earnings per share of $0.59 (diluted $0.58) from revenues of $44,022,000. This compares with net income of $1,907,000 in the 2005 fiscal year, from revenues of $50,467,000. Management Discussion and Analysis section of the 2006 Annual Report will provide additional comparative information pertaining to the reasons for the changes occurring between fiscal years 2006 and 2005 results .. Although revenues were lower in fiscal 2006 when compared to fiscal 2005, revenues for fiscal 2006 were strong when compared to fiscal years 2002, 2003, 2004. As discussed in 2005 Annual Report, manufacturing inefficiency issues from 2005 also continued through the first three quarters of fiscal year 2006. Late in the third quarter of fiscal year 2006, I was named by your Board of Directors as President and Chief Executive Officer. Since that time, we have worked tirelessly to build a management team that I believe is highly skilled and ready to face the challenges that lie ahead.
The Company's boot manufacturing is performed by a wholly-owned subsidiary located in Aguadilla, Puerto Rico. The challenges this operation has been faced with that were alluded to in the prior year's 2005 Annual Report continued throughout the fiscal 2006 year. Although progress aimed at improving operations in Puerto Rico has been slow to materialize, your new management team made significant inroads toward operational improvements within the fourth quarter of fiscal year 2006. During the fourth quarter the new management team worked diligently on reducing costs related to overhead expense, improved many processes related to manufacturing methods, significantly reduced labor content on many select operations, intertwined automation with multiple operations, along with improvement in material consumption levels at operations in Puerto Rico. The success of all of the above resulted in gross margin improvement to 16% in the fourth quarter of 2006, up from the prior three quarters' average gross margin of 6%. Your management remains very focused on continued process improvements aimed at further improving our gross margin throughout fiscal year 2007 and beyond.
On July 7, 2006, your Company was awarded a new option for Temperate Weather boots known as Option III. The minimum pairs awarded were 10,000 pairs with a maximum pair opportunity of 227,000 pairs. The Company received delivery orders against this option for 15,000 pairs during the first quarter of fiscal year 2007. Your Company is near the completion of the third and final year of the Hot Weather boot contract. During September 2006, we were notified of two orders totaling 60,000 pairs of the Hot Weather boot that will be shipped during the second and third quarters of fiscal year 2007.
Recently, your Company has submitted a bid for a new Hot Weather boot solicitation with anticipated award in late calendar year 2006 or early 2007. The minimum pairs for this contract are 83,045 pairs with a maximum pair opportunity of 444,968 pairs per base year and four option years. Government bidding is very competitive and your Company cannot predict its being awarded or not being awarded a contract from any solicitation. As mentioned above, we have recently implemented many new cost reductions to enable us to remain competitive in the bidding process.
Your Company also submitted a bid for a new solicitation for a boot known as the Intermediate Cold Weather Boot. This particular boot will have a minimum 60,000 pairs with a maximum of 90,000 pairs per base year and four option years available. Your Company has also submitted a bid for a boot known as the Flight Deck Safety Boot. This product is a new item for Wellco in the bid process. The contract calls for minimum 37,782 pairs with maximum potential of 88,842 pairs in the base year with four option years.
Our DOD contracts are multi-year indefinite order quantity contracts. Each contract provides for a minimum number of pairs to be procured by the DOD, along with a maximum number of pairs that may be purchased by the DOD through issuance of delivery orders against that particular contract. While the multi-year feature of any contract provides for a certain number of years of delivery solely at the government's discretion, the indefinite quantity feature is often a variable that makes it extremely difficult to project actual levels of sustainable boot sales and deliveries for any given year.
For several years, the Company has also sold its various products through the commercial channel of distribution. The Company offers military specification products, as well as an assortment of products designed at servicing the military and law enforcement tactical end users that offer lighter weight and added levels of comfort. The Company has historically sold its products into the commercial channel via e-commerce and telemarketing methodologies. Although this effort has been marginally successful, the Company is looking to bring on line a sales representative force to better promote the Company product by taking the Company's products and technology direct to the retail distributors. This will create a greater brand awareness to current and potential accounts at a higher level of involvement than previously communicated. The sales representatives will all be paid on a commission basis. The Company is interviewing representatives based on their experience in the target marketplace. The Company expects to be selling via the new methodology by the start of the third quarter of fiscal 2007.
Going into fiscal year 2007, we have a lower than normal level of backlog for DOD orders. The DOD has stated that it is their feeling they are in an over-inventoried position on some products related to boots. With a new Hot Weather contract due to be awarded by late 2006 or early 2007, we are feeling optimistic about returning to higher levels of production within that period of time.
In conclusion, fiscal year 2006 was a year of ongoing challenges. Our associates have responded to many of those challenges in a highly constructive manner. The associates of your Company are focused to handle the challenges in the future and are very dedicated and committed to making Wellco a more efficient company in the months ahead. Your Company as a whole is focused on long-term value creation by expanding our products and broadening our customer base while reducing manufacturing costs. We are dedicated to building value for our shareholders.
- ----------------------------------- Lee Ferguson Chief Executive Officer and President
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL - -------------------------------------------------------------------------------- CONDITION - ---------
RESULTS OF OPERATIONS
Critical Accounting Policies: - ----------------------------
The Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States of America which require the Company to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the Consolidated Financial Statements, and revenues and expenses during the periods reported. Actual results could differ from those estimates. The Company believes the following are the critical accounting policies which could have the most significant effect on the Company's reported results and require the most difficult, subjective or complex judgements by management.
(A) Impairment of Long-Lived Assets: The Company reviews its long-lived assets for impairment whenever events or circumstances indicate that the carrying amount of an asset may not be recoverable. If the sum of the expected cash flows, undiscounted and without interest, is less than the carrying amount of the asset, an impairment loss is recognized as the amount by which the carrying amount of the asset exceeds its fair value. The Company makes estimates of its future cash flows related to assets subject to impairment review. One of the most critical estimates is future demand, primarily through U. S. Department of Defense contracts, for the Company's products. Changes to this and other estimates could result in an impairment charge in future periods.
(B) Inventory Valuation: Raw materials and supplies are valued at the lower of first-in, first-out cost or market. Finished goods and work in process are valued at the lower of actual cost, determined on a specific identification basis, or market. The Company estimates which materials may be obsolete and which products in work in process or finished goods may be sold at less than cost, and adjusts their inventory value accordingly. Future periods could include either income or expense items if estimates change and for differences between the estimated and actual amount realized from the sale of inventory.
(C) Recognition of Contract Adjustments: From time to time, contract price adjustments will occur which require the Company to compute and present to the Defense Department for audit its calculation of such adjustments. If the adjustment is one of a recurring nature, the Company will record its calculation in the period the change occurred. For other adjustments, the adjustment is not recorded until the period in which the Company and the government agree on the amount of adjustment.
(D) Income Taxes: The Company records a liability for potential tax assessments based on its estimate of the potential exposure. Due to the subjectivity and complex nature of the underlying issues, actual payments or assessments may differ from estimates. Income tax expense in future periods could be adjusted for the difference between actual payments and the Company's recorded liability based on its assessments and estimates.
The Company has recorded a valuation allowance for part of its deferred tax assets. The valuation allowance is based on an evaluation of the uncertainty of future taxable income from certain jurisdictions. An adjustment could be required if circumstances and events cause the Company to change these estimates.
Comparing the Fiscal Year ended July 1, 2006 to the Fiscal Year ended July 2, - ----------------------------------------------------------------------------- 2005: - ----
OVERVIEW -------- The most significant events occurring during fiscal year ended July 1, 2006 (current period) compared to the fiscal year ended July 2, 2005 (prior period) are:
1. 15% decrease in total pairs of boots sold under contracts with the U.S. Department of Defense (DOD).
2. In the current period, the Company received $787,000 less than the prior period as reimbursement from the Government of Puerto Rico for part of the compensation paid to certain employees. These payments are recorded as revenues in the period received.
Comparative results for these two periods is as follows:
- -------------------------------------------------------------------------------- Fiscal Year Fiscal Year Ended July Ended July Change % of Change (Amounts in thousands) 1, 2006 2, 2005 - -------------------------------------------------------------------------------- Revenues $44,022 $50,467 $(6,445) (13)% - -------------------------------------------------------------------------------- Cost of Sales and Services 40,400 45,232 (4,832) (11)% - -------------------------------------------------------------------------------- Gross Profit 3,622 5,235 (1,613) (31)% - -------------------------------------------------------------------------------- General and Administrative Expenses 2,716 2,717 (1) - - -------------------------------------------------------------------------------- Grant Income 174 135 39 29% - -------------------------------------------------------------------------------- Operating Income 1,080 2,653 (1,573) (59)% - -------------------------------------------------------------------------------- Net Interest Expense 264 253 11 4% - -------------------------------------------------------------------------------- Income Taxes 70 493 (423) (86)% - -------------------------------------------------------------------------------- Net Income $746 $1,907 $(1,161) (61)% - --------------------------------------------------------------------------------
For the current period, the Company had a net income of $746,000 from revenues of $44,022,000 compared to a net income of $1,907,000 from revenues of $50,467,000.
The Company's primary customer is the Defense Supply Center Philadelphia (DSCP), the Department of Defense agency with which the Company contracts for the manufacture of boots used by U. S. Armed Forces personnel. Revenues decreased by $6,445,000. The primary reason for the decrease was a 15% reduction of total pairs of boots shipped to the U.S. government. During the prior year, the Company was awarded and completed an exigency contract for 110,000 pairs of the Temperate Weather Army Combat Boot (TW). Comparing fiscal years 2006 and 2005, pairs shipped of the TW boot decreased 55,000 pairs because fiscal year 2005 included the exigency contract. Also, pairs sold of the Hot Weather boot (HW) deceased 88,000 pairs during fiscal year 2006 when compared to the prior period due to DSCP reducing inventories of certain boots. However, DSCP increased their purchases of the Extreme Cold Weather boot by 56,000 pairs.
The majority of the Company's boot manufacturing operations occur at the factory of a wholly-owned subsidiary located in Puerto Rico. The Company's Puerto Rico subsidiary participates in a Puerto Rico government program under which certain portions of wages paid to new employees in training are reimbursed to that subsidiary. In the current period, the Company received from the Government of Puerto Rico $598,000 under this program. This is $787,000 less than the $1,385,000 received during the prior year. The Company's policy is to recognize the reimbursements as revenue in the period that it is received, and not when the related compensation is paid.
Gross profit for the current period was $3,622,000 or 8.2% of revenues as compared to gross profit of $5,235,000 or 10.4% for the prior period. This decrease in gross profit as a percentage of revenues is primarily due to a higher per unit manufacturing costs associated with lower production levels and the decrease of $787,000 in reimbursement of wages from the Puerto Rican government mentioned above.
In early August 2005, the only U.S. supplier of a DOD required component had a significant quality problem. The Company's rate of boot production was reduced due to the limited supply of this component. After the supplier resolved his quality problem the rate of production continued to be impaired as it took that supplier several weeks to reestablish full production. The supplier agreed to reimburse the Company certain excess manufacturing costs and the current period costs have been reduced by the amount invoiced for these excess costs. However, some of the excess costs could not be recouped from the supplier and this decreased the gross profit percentage for the current period.
From time to time, the Company receives grants from the government of Puerto Rico, primarily related to the expansion of manufacturing operations. Grant income represents the straight-line recognition of grants over the grant period, with grant income first recognized in the period in which it is received. Fiscal years 2006 and 2005 reflect recognition of income from a new grant covering the fiscal years 2004 through 2008. The fiscal year 2004 amount represents the last recognition of a grant issued in 1999. See Footnote 17 to Consolidated Financial Statements.
Increased interest rates on the bank line of credit caused the increase in interest expense.
The income tax rate (the percent of Provision for Income Taxes to the Income Before Income Taxes) for the 2006 fiscal year was 9% compared to 21% for the prior fiscal year. Income earned by the Company's Puerto Rico subsidiary, which is exempt from Puerto Rico income tax is currently partially exempt from U. S. income taxes. Fiscal year 2006 is the last year in which this subsidiary has an exemption from U. S. income taxes. In addition, for the current period, the Company has reversed part of a previously recorded valuation allowance on deferred tax assets that are now likely to be realized. See Footnote 11 to the Consolidated Financial statements.
Comparing the Fiscal Year ended July 2, 2005 to the Fiscal Year ended July 3, - ----------------------------------------------------------------------------- 2004: - ----
Comparative results for these two periods are as follows:
- --------------------------------------------------------------------------------
Fiscal Year Fiscal Year Ended July Ended July Change % of Change (Amounts in thousands) 2, 2005 3, 2004 - -------------------------------------------------------------------------------- Revenues $ 50,467 $ 45,693 $ 4,774 10% - -------------------------------------------------------------------------------- Cost of Sales and Services 45,232 39,438 5,794 15% - --------------------------------------------------------------------------------
Gross Profit 5,235 6,255 (1,020) (16)% - -------------------------------------------------------------------------------- General and Administrative Expenses 2,717 3,009 (292) (10)% - -------------------------------------------------------------------------------- Grant Income 135 80 55 69% - -------------------------------------------------------------------------------- Operating Income 2,653 3,326 (673) (20)% - -------------------------------------------------------------------------------- Net Interest Expense 253 196 57 29% - -------------------------------------------------------------------------------- Income Taxes 493 682 (189) (28)% - -------------------------------------------------------------------------------- Net Income $ 1,907 $ 2,448 $ (541) (22)% - --------------------------------------------------------------------------------
In late March 2003, DSCP exercised its surge option clause under contracts to manufacture the Hot Weather (HW) boot. Surge orders ended in early fiscal year 2005, and the pairs of HW boots shipped in 2005 was 256,000 compared to 514,000 pairs in fiscal year 2004.
In March 2003, the Company was awarded a multi-year, indefinite quantity contract to supply the U. S. Army's Combat Boot-Temperate Weather (TW). During fiscal year 2005, the Company made significant shipments under DSCP orders for this boot. In addition, the Company was awarded and completed an exigency contract for this boot. Comparing fiscal year 2005 and 2004, pairs shipped of the TW boot increased to 324,000 from 75,000.
Although revenues increased, gross profit decreased. Margins earned on the TW boot are lower than those earned on the HW boot. In addition, some boot sales in fiscal year 2004 were under a now-expired contract that had a higher margin than the current HW boot contract.
Revenues from technical assistance fees and equipment rentals from licensees, which vary with licensee sales, decreased approximately 31% in the 2005 fiscal year. Some of these licensees have boot contracts with DSCP and their sales decreased with the end of surge. This revenue decrease also contributed to the lower gross profit.
The Company's Puerto Rico subsidiary participates in a Puerto Rico government program under which certain portions of wages paid to new employees in training are reimbursed to that subsidiary. This reimbursement is recorded as revenues in the period cash is received. Under this program, $1,385,000 was received and recorded in fiscal year 2005. The amount received and recorded in fiscal year 2004 was $321,000.
Decreased salary, bonus and travel costs were the major expense categories that reduced General and Administrative Expenses. In fiscal year 2005, two highly compensated salaried persons retired. Salary expense in fiscal year 2004 includes both the salaries of these persons and their replacements. Officer bonuses vary with net profit. In fiscal year 2005, fewer trips were made to the Company's boot manufacturing factory in Puerto Rico.
Increased interest rates on the bank line of credit caused the increase in interest expense.
From time to time, the Company receives grants from the government of Puerto Rico, primarily related to the expansion of manufacturing operations. Grant income represents the straight-line recognition of grants over the grant period. The fiscal year 2004 amount represents the last recognition of a grant issued in 1999, and fiscal year 2005 reflects recognition of income from a new grant covering the fiscal years 2004 through 2008. See Footnote 17 to Consolidated Financial Statements.
The income tax rate (the percent of Provision for Income Taxes to the Income Before Income Taxes) for the 2005 fiscal year was 21% compared to 22% for the prior fiscal year. Income earned by the Company's Puerto Rico subsidiary, which is exempt from Puerto Rico income tax is currently partially exempt from U. S. income taxes. Fiscal year 2006 is the last year in which this subsidiary will have an exemption from U. S. income taxes. See Footnote 11 to the Consolidated Financial statements.
Forward Looking Information: - ---------------------------
In early February 2006, Department of Defense extended the delivery dates for two boot orders under its contracts. The original delivery dates for boot shipments in April through June 2006 were extended to May through August 2006. The Company was informed the Army's current usage of boots was lower than the rate projected when the orders were issued. This was only an extension of the shipping date and no orders were cancelled. Subsequently, the DOD provided the Company with additional specific information about the significant reduction in year-to-year comparative boot usage.
During the three months of June, July and August 2006, DOD has issued much smaller orders for HW and TW boots. The Company has substantially completed production on these orders during the first quarter of fiscal year 2007, which will end September 30, 2006. Due to limited DOD orders, Wellco will ship approximately 50,000 pairs of boots to Defense Department for the first quarter of 2007compared to 92,000 pairs shipped the first quarter 2006.
During the month of September 2006, DOD issued orders for 60,000 pairs of HW boots and 5,000 pairs of TW boots. Approximately 50,000 pairs of these orders will be shipped during the second fiscal quarter of 2007 compared to 119,000 pairs shipped during the second quarter of 2006. The reduction in boot production will have a negative effect on margins for the first and second quarters of 2007.
Below is a summary of the Company's current boot contracts with the Defense Department. The Company's Defense Department boot contracts are indefinite quantity contracts. This means that each contract specifies a minimum number of pairs that must be ordered from a contractor and a maximum number of pairs that may be ordered.
On September 23, 2005, the Defense Department exercised the second and final option year under the Company's Hot Weather boot contract. The second option year is for the period October 2005 through September 2006. For the second option year, the minimum pairs are 41,000 and the maximum is 256,000. Pairs ordered to date under the second option year are 169,000.
On August 2, 2006, the Company submitted a proposal for the new Hot Weather boot solicitation. The solicitation is for an indefinite quantity contract with a base year and four one-year option periods. DSCP has 180 days to award the contract and intends to make five awards, of which three will be restricted to contractors who meet the criteria for being a small business, and two contracts will be awarded without the small business restriction. The Company is not a small business. Bidding on government solicitations is very competitive, and the Company cannot confidently predict its success in receiving a contract award from any solicitation. If the Company does not receive a contract from this solicitation, future operating results and liquidity will be adversely affected.
On July 7, 2006, the Defense Department exercised the third option year under the Company's Temperate Weather boot contract. For the third option year, the minimum pairs are 10,000 and the maximum are 227,000. Pairs ordered to date under the third option year are 15,000.This contract has one more option year outstanding. The exercise of any contract option is the unilateral decision of the Defense Department.
On April 13, 2006, the Company received a Department of Defense contract to supply the U.S. Army with Extreme Cold Weather boots. This contract is for a one year period, with four one year options which are exercisable at the government's discretion. The base year is for a minimum of 5,000 pairs and a maximum of 29,000 pairs.
The Company also submitted a bid for a new solicitation for a boot known as the Intermediate Cold Weather Boot. This particular boot will have a minimum 60,000 pairs with a maximum of 90,000 pairs per base year and four option years available. The Company has also submitted a bid for a boot known as the Flight Deck Safety Boot. This product is a new item for Wellco in the bid process. The contract calls for minimum 37,782 pairs with maximum potential of 88,842 pairs in the base year with four option years.
The majority of the Company's boots manufacturing operations occur at the factory of a wholly owned subsidiary located in Puerto Rico. The Company is participating in a Puerto Rican government program under which it is reimbursed for part of the compensation paid to certain employees in training. As of July 1, 2006, $808,000 has been filed for, but has not been received or recorded as revenues, reimbursement under this program. The government of Puerto Rico recently suspended new contracts for this program. The Company understands that this suspension will not affect its collection of the $808,000. In the past three fiscal years, the Company has received and recorded as revenues a total of $2,300,000 under this program.
In December 2005, the Company was one of two contract awardees for the development of the US Army Modular Boot System. This award was the result of the Company's response to the Modular Boot System solicitation that required submission of data and product demonstration models illustrating the Company's concept of the modular boot system.
This contract provides the development of a Modular Boot System for the U. S. military. Presently, the Department of Defense buys four different boot styles to meet the varied climatic conditions encountered by military personnel. The contract's goal is to develop a functional boot system to provide comfort in a temperature range of -60(0)F to 120(0)F. If successful, the new Modular Boot System would replace many, if not all, of the current boot styles.
The Department of Defense placed its first order under this contract for 580 pairs of the Modular Boot System and the boots were shipped in March 2006. Recent feedback from the Natick Contracting Division of the U.S. Army was very positive on the testing of the first order of boots. Recently, DOD exercised the second option to supply the development of the Modular Boot System. At the same time, they issued an order for 450 pairs of the MBS for expanded testing. If the Wellco Modular Boot System is successful through all phases of development and testing, the contract provides for Wellco to manufacture 160,000 pairs of this boot for issuance to military personnel. As with any contract, there is no assurance that Wellco will be successful in development of the Army's Modular Boot System.
Income earned by the Company's Puerto Rico subsidiary has for many years been fully exempt from U. S. income taxes and is currently partially exempt. Fiscal year 2006 is the last year in which this subsidiary has any exemption from U. S. income taxes. See Footnote 11 to the Consolidated Financial Statements.
The requirements of Section 404 of the Sarbanes-Oxley Act of 2002 will first apply to the Company's 2008 fiscal year. Section 404 requires the Company to document, test, and issue an opinion as to the adequacy of their internal controls over financial reporting. In addition, Section 404 requires the Company's Independent Accountants to review the Company's internal control documentation and testing results, and to issue its opinion as to the correctness of the Company's opinion as to the adequacy of their internal controls over financial reporting. The Company has received quotations from outside firms specializing in the review, documentation and testing of internal controls. Based on these quotations and on reported information about the costs other companies are incurring, the Company estimates that the cost of the internal control review and audit will be between $200,000 and $500,000. The Company cannot reasonably predict whether material weaknesses will be found in its internal controls over financial reporting.
The business of providing boots to the U. S. Defense Department is very competitive. With more than 98% of U. S. footwear sales being of foreign manufacture, the Company believes that many U. S. boot manufacturers are attempting to utilize excess U. S. manufacturing capacity by supplying boots to the U. S. military under contracts with the Defense Department.
A 1% increase in the assumed discount rate used to compute the Company's pension benefit obligation would decrease the obligation at June 30, 2006 by approximately $517,000. Conversely, a 1% decrease in the assumed discount rate would increase the benefit obligation at June 30, 2006 by approximately $621,000.
A 1% increase in the assumed discount rate used to compute the Company's retiree health benefit obligation would decrease the benefit obligation at July 1, 2006 by approximately $22,000. Conversely, a 1% decrease in the assumed discount rate would increase the benefit obligation at July 1, 2006 by approximately $26,000.
LIQUIDITY AND CAPITAL RESOURCES
Wellco uses cash from operations and a bank line of credit to supply most of its liquidity needs. The following table summarizes at the end of each fiscal year shown the Company's cash and funds available from the bank line of credit:
( in thousands) ----------------------------------------------------------------- 2006 2005 2004 ----------------------------------------------------------------- Cash and Cash Equivalents $44 $34 $58 ----------------------------------------------------------------- Unused Bank Line of Credit 6,875 5,780 3,220 ----------------------------------------------------------------- Total $6,919 $5,814 $3,278 -----------------------------------------------------------------
The following table summarizes the cash flow activities for the last three years:
(in thousands) ------------------------------------------------------------------- Cash provided by (used in): 2006 2005 2004 ------------------------------------------------------------------- Operating activities $2,365 $3,976 $(1,384) ------------------------------------------------------------------- Investing activities (498) (1,497) (2,066) ------------------------------------------------------------------- Financing activities (1,857) (2,503) 3,375 ------------------------------------------------------------------- Net increase (decrease) in cash and cash equivalents $10 $(24) $(75) -------------------------------------------------------------------
Operating Activities: In the 2006 fiscal year, cash provided by operations was $2,365,000. Net income of $746,000, depreciation of $1,337,000 and a $2,246,000 decrease in inventories were the main operating sources of cash. The main uses of operating cash were a decrease of $1,196,000 in accounts payable, a decrease of $242,000 in accrued income taxes, a decrease of $257,000 in accrued compensation and an increase of $354,000 in accounts receivable.
Investing Activities: For the 2006 fiscal year, purchases of machinery and other equipment was $498,000.
Financing Activities: For the 2006 fiscal year, the Company's net cash used in financing activity totaled $1,857,000. The use of financing activities were $762,000 to pay quarterly dividend payments to stockholders and $1,095,000 was used to repay the line of credit borrowings.
In 2005, cash provided by operations was $3,976,000. Net income of $1,907,000, depreciation of $1,277,000 and $2,865,000 decrease in accounts receivable were the main operating sources of cash. The main uses of operating cash were a decrease of $747,000 in accounts payable, a decrease of $676,000 in accrued income taxes, a decrease of $266,000 in accrued compensation and an increase of $594,000 in inventory. $58,000 of cash from the beginning of the fiscal year along with $317,000 from stock option exercises and cash provided by operations, provided the cash for purchases of equipment of $1,497,000, the payment of cash dividends of $760,000 and $2,060,000 was used to repay the line of credit borrowings.
In 2004, cash used by operations was $1,384,000. Net income of $2,448,000 and depreciation of $1,100,000 was far short of providing the cash needs for an increase of $2,620,000 in accounts receivable and $4,062,000 in inventory. The increase in accounts receivable and inventory was primarily caused by surge and the new ICB contract. $133,000 of cash from the beginning of the fiscal year, along with $3,190,000 of borrowings from the line of credit and $730,000 from stock option exercises, provided the cash for purchases of equipment of $2,066,000 and the payment of cash dividends of $545,000.
The following table shows aggregated information about contractual obligations as of July 1, 2006:
Payments Due by Period -------------------------------------------------------------------------- Total Less Than 1 After Year 1-3 Years 4-5 Years 5 Years --------------------------------------------------------------------------
Long -Term Debt $300,000 - - $300,000 - -------------------------------------------------------------------------- Building Lease 841,000 $271,000 $570,000 - - -------------------------------------------------------------------------- Total $1,141,000 $271,000 $570,000 $300,000 - --------------------------------------------------------------------------
During fiscal year 2006, the Company had the following material cash payments for interest of $258,000, pension plans contributions of $371,000 and income taxes paid of $186,000. For fiscal year 2007, the Company expects future cash requirements for these disclosed items to approximate the historical amounts paid during the previous year.
The Company has a commitment to purchase certain equipment of $350,000 during the first half of fiscal year 2007. Other than this, Wellco does not know of any other demands, commitments, uncertainties, or trends that will result in or that are reasonably likely to result in its liquidity increasing or decreasing in any material way.
The bank line of credit of $7,500,000 will expire on December 31, 2006 and will then be subject to renewal at the discretion of the bank. Historically, the bank has always renewed the line of credit. Under conditions of substantial reduction in operations, with little basis for projecting a reversal of such reduction, it is possible that the bank would cancel or not renew the line of credit. Events that would cause a substantial reduction in operations include, but are not limited to, cancellation of existing government contracts or receiving government contracts that do not provide enough revenues to provide adequate liquidity.
At July 1, 2006, $6,875,000 of additional borrowings was available under the bank line of credit and the Company was in compliance with the loan covenants on that date.
Since the Company's first source of liquidity is cash from operations, a decrease in sales of the Company's products would reduce this source of liquidity and result in increased use of the bank line of credit. Based on information available to date, the Company believes that operations will continue to be a significant source of cash in fiscal year 2007.
The Promissory Note, Loan Agreement and Security Agreement documenting the bank line of credit provide that:
o All amounts borrowed shall become due and immediately payable upon demand of the bank. o The bank's obligation to make advances under the note shall terminate: if the bank makes a demand for payment; if a default under any loan document occurs; or, in any event, on December 31, 2006, unless the Note is extended by the bank under terms satisfactory to the bank.
o All amounts borrowed shall become immediately payable if Wellco commences or has commenced against it a bankruptcy or insolvency proceeding, or in the event of default.
Events of default include:
o Having a current ratio less than that prescribed by the bank. o Having tangible net worth less than that prescribed by the bank. o Any failure to meet requirements under the Note, Loan Agreement or Security Agreement.
CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING INFORMATION
Statements throughout this report that are not historical facts are forward-looking statements. These statements are based on current expectations and beliefs, and involve numerous risks and uncertainties. Many factors could affect the Company's actual results, causing results to differ materially from those expressed in any such forward-looking information.
These factors include, but are not limited to, the receipt of contracts from the U. S. government and the performance thereunder; the ability to control costs under fixed price contracts; the cancellation of contracts; and other risks detailed from time to time in the Company's Securities and Exchange Commission filings, including Form 10-K for the year ended July 1, 2006. Those statements include, but may not be limited to, all statements regarding intent, beliefs, expectations, projections, forecasts, and plans of the Company and its management. Actual results may differ materially from management expectations. The Company assumes no obligation to update any forward-looking statements.
WELLCO ENTERPRISES, INC. CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME FOR THE FISCAL YEARS ENDED JULY 1, 2006, JULY 2, 2005 AND July 3, 2004 (in thousands except per share amounts)
JULY 1, JULY 2, JULY 3, 2006 2005 2004 --------------------------------- REVENUES (Notes 5 and 15) ................ $ 44,022 $ 50,467 $ 45,693 -------- ------- --------
COSTS AND EXPENSES Cost of sales and services ........... 40,400 45,232 39,438 General and administrative expenses ............................. 2,716 2,717 3,009 -------- ------- ------- Total ................................ 43,116 47,949 42,447 -------- ------- --------
GRANT INCOME (Note 17) .................... 174 135 80 -------- ------- --------
OPERATING INCOME .......................... 1,080 2,653 3,326
NET INTEREST EXPENSE ...................... 264 253 196 -------- ------- --------
INCOME BEFORE INCOME TAXES ................ 816 2,400 3,130
PROVISION FOR INCOME TAXES (Note 11) ................................. 70 493 682 -------- ------- --------
NET INCOME ................................ 746 1,907 2,448
OTHER COMPREHENSIVE INCOME (LOSS) (Note 9): Decrease (increase) in additional minimum pension liability ............ 469 (157) 324 -------- -------- --------
COMPREHENSIVE INCOME ...................... $ 1,215 $ 1,750 $ 2,772 ======= ======== ========
EARNINGS PER SHARE (Note 14): Basic earnings per share ............. $ 0.59 $ 1.51 $ 2.04
Diluted earnings per share ........... $ 0.58 $ 1.47 $ 1.97 ======== ======== ========
DIVIDENDS DECLARED PER SHARE .............. $ 0.60 $ 0.60 $ 0.45 ======== ======== ========
See Notes to Consolidated Financial Statements.
WELLCO ENTERPRISES, INC. CONSOLIDATED BALANCE SHEETS JULY 1, 2006 AND JULY 2, 2005 (in thousands)
ASSETS
JULY 1, JULY 2, 2006 2005 --------------------- CURRENT ASSETS: Cash and cash equivalents .................... $ 44 $ 34 Receivables, net (Notes 3 and 7) ............. 3,559 3,205 Inventories (Notes 4 and 7) .................. 9,411 11,657 Deferred taxes (Note 11) .................... 184 266 Prepaid expenses ............................. 455 304 ------- ------- Total ........................................ 13,653 15,466 ------- -------
MACHINERY LEASED TO LICENSEES, net (Note 5) ..................................... 5 11
PROPERTY, PLANT AND EQUIPMENT, net (Notes 6 and 7) .............................. 4,486 5,317
INTANGIBLE ASSETS: Intangible pension asset (Note 9) ............ 6 10 ------- -------
TOTAL .............................................. $18,150 $20,804 ======= =======
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WELLCO ENTERPRISES, INC. CONSOLIDATED BALANCE SHEETS JULY 1, 2006 AND JULY 2, 2005 (in thousands except share data)
LIABILITIES AND STOCKHOLDERS' EQUITY
JULY 1, JULY 2, 2006 2005 ----------------------
CURRENT LIABILITIES: Short-term borrowing from bank (Note 7) ...... $ 625 $ 1,720 Accounts payable ............................. 1,716 2,912 Accrued compensation ......................... 769 1,016 Accrued liabilities (Note 8) ................. 366 285 Accrued income taxes (Note 11) ............... 407 649 -------- -------- Total .................................... 3,883 6,582 -------- --------
LONG-TERM LIABILITIES: Pension obligation (Note 9) .................. 1,013 1,485 Notes payable (Note 12) ...................... 241 231 Other accrued liabilites (Notes 9 and 10) ............................. 363 425 Deferred grant income (Note 17) .............. 206 124 Deferred taxes (Note 11) .................... 172 128 Deferred revenues (Note 12) .................. 59 69
COMMITMENTS (Note 19)
STOCKHOLDERS' EQUITY (Notes 9 and 13): Common stock, $1.00 par value; shares authorized - 2,000,000; shares issued and outstanding - 1,270,746 .............. 1,271 1,271 Additional paid-in capital ................... 1,319 1,319 Retained earnings ............................ 10,630 10,646 Accumulated other comprehensive loss ........................... (1,007) (1,476) -------- -------- Total .................................... 12,213 11,760 -------- --------
TOTAL .............................................. $ 18,150 $ 20,804 ======== ========
See Notes to Consolidated Financial Statements.
WELLCO ENTERPRISES, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE FISCAL YEARS ENDED JULY 1, 2006, JULY 2, 2005 AND July 3, 2004 (in thousands)
JULY 1, JULY 2, JULY 3, 2006 2005 2004 ------------------------------ CASH FLOWS FROM OPERATING ACTIVITIES: Net income .............................. $ 746 $ 1,907 $ 2,448 ------- ------- ------- Adjustments to reconcile net income to net cash provided by (used in)operating activities: Depreciation and amortization ....... 1,335 1,277 1,100 Deferred income taxes ............... 126 131 (4)
Grant monies received (Non-cash grant income) ....................... 17 189 (80) Non-cash interest expense ........... 10 9 9 Non-cash reduction in deferred revenues ................... (10) (9) (9) (Increase) decrease in- Receivables ..................... (354) 2,865 (2,620) Inventories ..................... 2,246 (594) (4,062) Prepaid expenses ................ (151) (60) 25 Increase (decrease) in- Accounts payable ................ (1,196) (747) 521 Accrued compensation ............ (257) (266) 564 Other accrued liabilities ....... 95 (50) 102 Accrued income taxes ............ (242) (676) 603 Pension obligation .............. -- -- 19 ------- ------- ------- Total adjustments ....................... 1,619 2,069 (3,832) ------- ------- ------- NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES .................... 2,365 3,976 (1,384) ------- ------- -------
CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of equipment .................. (498) (1,497) (2,066) ------- ------- -------
NET CASH USED IN INVESTING ACTIVITIES ......... (498) (1,497) (2,066) ------- ------- -------
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WELLCO ENTERPRISES, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE FISCAL YEARS ENDED JULY 1, 2006, JULY 2, 2005 AND July 3, 2004 (in thousands) JULY 1, JULY 2, JULY 3, 2006 2005 2004 ------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES: Net advances (repayments) of line of credit borrowings .................... (1,095) (2,060) 3,190 Cash dividends paid ..................... (762) (760) (545) Stock option exercise and tax benefit ... -- 317 730 ------- ------- ------- NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES .................... (1,857) (2,503) 3,375 ------- ------- -------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS ........................ 10 (24) (75)
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR ....................... 34 58 133 ------- ------- -------
CASH AND CASH EQUIVALENTS AT END OF YEAR ............................. $ 44 $ 34 $ 58 ======= ======= =======
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash paid (received) for- Interest ............................ $ 258 $ 247 $ 191 Income taxes paid (refunded) ........ 186 966 (22)
NONCASH INVESTING AND FINANCING FLOW IACTIVITY:N: Increase in leasehold improvements .. $ -- $ -- $ 38 ======= ======= =======
See Notes to Consolidated Financial Statements.
WELLCO ENTERPRISES, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY FOR THE FISCAL YEARS ENDED JULY 1, 2006, JULY 2, 2005 AND July 3, 2004 (in thousands except share data)
JULY 1, JULY 2, JULY 3, 2006 2005 2004 ------------------------------- COMMON STOCK : Balance at beginning of year ......... $ 1,271 $ 1,245 $ 1,186 Stock option exercise (Note 13) ...... -- 26 59 -------- -------- -------- Balance at end of year .............. 1,271 1,271 1,245 -------- -------- --------
ADDITIONAL PAID-IN CAPITAL: Balance at beginning of year ......... 1,319 1,027 357 Stock option exercise (Note 13) ...... -- 233 566 Tax benefit from stock option plans .. -- 59 104 -------- -------- -------- Balance at end of year .............. 1,319 1,319 1,027 -------- -------- --------
RETAINED EARNINGS: Balance at beginning of year ......... 10,646 9,499 7,596 Net income ........................... 746 1,907 2,448 Cash dividends (per share: 2006 - $.60, 2005 - $.60, 2004 - $.45) ......................... (762) (760) (545) -------- -------- -------- Balance at end of year ............... 10,630 10,646 9,499 -------- -------- --------
ACCUMULATED OTHER COMPREHENSIVE LOSS Additional minimum pension liability, net of tax (Note 9): Balance at beginning of year ......... (1,476) (1,319) (1,643) Change for the year .................. 469 (157) 324 -------- -------- -------- Balance at end of year ............... (1,007) (1,476) (1,319) -------- -------- --------
TOTAL STOCKHOLDERS' EQUITY ................. $ 12,213 $ 11,760 $ 10,452 ======== ======== ========
See Notes to Consolidated Financial Statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS For the Fiscal Years Ended July 1, 2006, July 2, 2005, and July 3, 2003
1. BUSINESS OPERATIONS:
Substantially all of the Company's operating activity is from the sale of military and other rugged footwear, the sale of specialized machinery and materials for the manufacture of this type of footwear and the rendering of technical assistance and other services to licensees for the manufacture of this type of footwear. The majority of revenues ($38,528,000 in 2006, $44,249,000 in 2005, and $39,648,000 in 2004) were from sales to the U. S. government, primarily the Defense Supply Center Philadelphia (DSCP), under contracts for the supply of boots used by the U. S. Armed Forces. The loss of this customer would have a material adverse effect on the Company.
Bidding on U. S. government boot solicitations is open to any qualified U.S. manufacturer. Bidding on contracts is very competitive. U. S. footwear manufacturers have been adversely affected by sales of footwear made in low labor cost countries. This has significantly affected the competition for contracts to supply boots to U. S. Armed Forces, which by law must be made in the U. S.
Most boot contracts are for multi-year periods. Therefore, a bidder not receiving an award from a significant solicitation could be adversely affected for several years. In addition, current boot contracts contain options for additional pairs that are exercisable at the government's discretion. The Company cannot predict with certainty its success in receiving a contract from any solicitation.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Principles of Consolidation The accompanying financial statements include the consolidated accounts of the Company and its wholly-owned subsidiaries. Appropriate eliminations have been made of all material intercompany transactions and balances.
Cash and Cash Equivalents Cash in excess of daily requirements is invested in short-term interest earning instruments. The Company considers investments with original maturities of three months or less to be cash equivalents.
Receivables Accounts receivable from the sale of products or services are recorded at net realizable value and the Company grants credit to customers on an unsecured basis. The Company provides an allowance for doubtful collections that is based upon a review of outstanding receivables, historical collections information, and existing economic conditions. Normal trade receivables are due 30 days after the issuance of the invoice. Receivables past due more than 120 days are considered delinquent. Delinquent receivables are written off based on individual credit evaluations and specific circumstances of the customer.
Inventories Raw materials and supplies are valued at the lower of first-in, first-out cost or market. Finished goods and work in process are valued at the lower of actual cost, determined on a specific identification basis, or market.
Income Taxes The provision for income taxes is based on taxes currently payable adjusted for the net change in the deferred tax asset or liability during the current year. A deferred tax asset or liability arises from temporary differences between the carrying value of assets and liabilities for financial reporting and income tax purposes. A valuation allowance is recorded to reduce the carrying amounts of deferred tax assets unless it is more likely than not that such assets will be realized.
Fair Value of Financial Instruments The carrying values of cash, receivables and accounts payable at July 1, 2006 and July 2, 2005 approximate fair value. The carrying value of the notes payable (see Note 12 to the Consolidated Financial Statements) is equal to the present value of estimated future cash flows using a discount rate commensurate with the uncertainties involved and thus approximates fair value.
Depreciation and Amortization The Company uses the straight-line method to compute depreciation and amortization on machinery leased to licensees and property, plant and equipment used by the Company.
Machinery Leased to Licensees Certain shoe-making machinery is leased to licensees under cancelable operating leases. Such activity is accounted for by the operating method whereby leased assets are capitalized and depreciated over their estimated useful lives (5 to 10 years) and rentals, based primarily on the volume of shoes produced or shipped by the lessees, are recorded during the period earned.
Research and Development Costs All research and development costs are expensed as incurred unless subject to reimbursement. The amount charged against income was approximately $83,000 in 2006, $78,000 in 2005 and $101,000 in 2004.
Revenue Recognition Two of the Company's current boot contracts require a bill and hold procedure. Under bill and hold, the government issues a specific boot production order which, when completed and ready for shipment, is inspected and accepted by the Quality Assurance Representative (QAR), thereby transferring ownership to the government. Under the bill and hold procedure, after inspection and acceptance by the QAR, the boots become "government-owned property". Also, after QAR inspection and acceptance, Wellco invoices and receives payment from the government, and warehouses and distributes the related boots against government-issued requisition orders, which Wellco receives five days per week. Government-owned boots stored in Wellco's warehouse are complete, including packaging and labeling. The bill and hold procedure requires physical segregation and specific identification of government-owned boots and, because they are owned by the government, Wellco cannot use them to fill any other customers' orders. Wellco has certain custodial responsibilities for these boots, including loss or damage, which Wellco insures. The related insurance policies specifically provide that loss payment on finished stock and sold personal property completed and awaiting delivery is based on Wellco's selling price. The bill and hold procedure also provides that at the end of any one-year term when an option is not exercised, the government is to take final delivery of any and all of its remaining inventory within six months. In accordance with guidance issued under Securities and Exchange Commission Staff Accounting Bulletin No. 101, Revenue Recognition in Financial Statements, revenues from bill and hold transactions are recognized at the time of acceptance by the QAR.
Certain shoe-making machinery is leased to licensees under twenty-year cancelable operating leases. Lease payments are variable based on the quantity of boots manufactured and sold by the lessee to its customers and the contractual rental fee per pair of boots. There are no base rental amounts or contingent rentals contained in the agreements. Rental income is recognized by the Company when the lessee manufactures and sells boots to the customer and is based upon the quantity of boots manufactured or shipped by the lessee times the fixed rate per pair of boots contained in the lease agreements.
The Company earns service fees for providing customers with technical assistance in the manufacture of boots. The related agreements under which these services are provided are for a fixed term and expire in calendar year 2007. The Company records service fee revenues at a fixed rate per pair of boots times the quantity of boots manufactured and sold by the customer.
Revenues from the sale of machinery and materials are recorded at the time of shipment from our factory (FOB factory) or at the time of receipt by the customer (FOB destination). Other than a one-year warranty, the Company does not have any continuing responsibility related to machines sold. Warranty costs are diminimus.
Shipping and Handling Costs Shipping and handling costs are charged to Cost of Sales and Services in the period incurred. Any amounts paid by customers for shipping and handling are included in Revenues.
Cost of Sales and Services Cost of sales and services includes raw materials and freight-in on raw materials, direct and indirect manufacturing labor, employee fringe benefits on manufacturing labor, manufacturing supplies, purchasing and receiving costs, material inspection costs, warehousing costs, internal transfer costs, product distribution costs including shipping and handling, repairs and maintenance, supervisors salaries, depreciation on manufacturing equipment, and other manufacturing overhead costs.
General and Administrative Expenses General and Administrative Expenses include administrative personnel compensation costs, legal and audit costs, depreciation on administrative equipment, stock expense and director fees, travel costs, office supplies, and other such costs not directly related to the manufacture of the Company's products. Since the majority of its products are sold to the U. S. government, the Company does not incur significant selling costs, such as sales commissions and advertising.
Impairment of Long-Lived Assets The Company reviews its long-lived assets, including intangible assets, for impairment whenever events or circumstances indicate that the carrying amount of an asset may not be recoverable. If the sum of the expected cash flows, undiscounted and without interest, is less than the carrying amount of the asset, an impairment loss is recognized as the amount by which the carrying amount of the asset exceeds its fair value.
Self-Funded Group Health Insurance The cost of employee group health insurance is recorded in the period in which the health care costs are incurred including an estimate of the incurred but not reported claims. Third party administrator fees are recorded in the month to which they apply. The cost of stop loss insurance is recorded in the month to which
it applies. The liability for incurred but not reported insurance claims is accrued and included in the Accounts Payable caption in the Consolidated Balance Sheets.
Fiscal Year The Company's fiscal year ends on the Saturday closest to June 30. Consequently, the 2006 and 2005 fiscal years contained 52 weeks each of operating results while the 2004 fiscal year contained 53 weeks.
Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities, as well as the disclosure of contingent assets and liabilities, at the date of the financial statements. They also affect the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
3. RECEIVABLES:
The majority of receivables at July 1, 2006 and July 2, 2005 are from the U. S. Government. The Company's policy is to require either a confirmed irrevocable bank letter of credit or advance payment on significant orders from foreign customers. Allowances for doubtful accounts in 2006, 2005 and 2004 are not significant.
4. INVENTORIES:
The components of inventories are:
(in thousands)
2006 2005 -------------------------------------------------- Finished Goods $ 4,470 $ 4,853 -------------------------------------------------- Work in Process 1,509 2,880 -------------------------------------------------- Raw Materials and Supplies 3,432 3,924 -------------------------------------------------- Total $ 9,411 $ 11,657 --------------------------------------------------
5. MACHINERY LEASED TO LICENSEES:
Accumulated depreciation netted against the cost of leased assets in the Consolidated Balance Sheets at July 1, 2006 and July 2, 2005 is $1,555,000 and $1,549,000, respectively. Rental revenues for the fiscal years 2006, 2005, and 2004 were $259,000, $291,000 and $279,000, respectively, and vary with lessees' production or shipments.
6. PROPERTY, PLANT AND EQUIPMENT:
The components of property, plant and equipment are summarized as follows:
(in thousands)
2006 2005 Estimated Useful Life ------------------------------------------------------------------ Land $ 107 $ 107 N/A ------------------------------------------------------------------ Buildings 1,439 1,439 40-45 Years ------------------------------------------------------------------ Machinery & Equipment 11,239 10,846 2-20 Years ------------------------------------------------------------------ Furniture & Fixtures 1,121 1059 2-10 years ------------------------------------------------------------------ Leasehold Improvements 823 809 * ------------------------------------------------------------------ Total Cost $ 14,729 $ 14,260 ------------------------------------------------------------------ Total Accumulated Depreciation and Amortization $ 10,243 $ 8,943 ------------------------------------------------------------------ *Leasehold improvements are amortized using the straight-line method over the shorter of the estimated useful lives of the improvements or the period of the respective leases.
7. LINES OF CREDIT:
The Company maintains a $7,500,000 bank line of credit. The line, which expires on December 31, 2006, can be renewed annually at the bank's discretion. At July 1, 2006, borrowings on this line of credit were $625,000 with $6,875,000 available in additional borrowings.
Interest is at the London Interbank Offered Rate (LIBOR) plus 2.25 points or 7.52% at July 1, 2006. The bank credit agreement contains, among other provisions, defined levels of net worth and current ratio requirements. The Company was in compliance with the loan covenants at July 1, 2006. The covenants are subject to review at the end of each fiscal quarter. This line of credit is secured by a blanket lien on all machinery and equipment, receivables and inventory.
Historically, the bank has always renewed the line of credit. Under conditions of substantial reduction in operations, with little basis for projecting a reversal of such reduction, it is possible that the bank could cancel the line of credit or not renew it when it expires. Events that would cause a substantial reduction in operations include: cancellation of existing government contracts that are being solicited; not receiving future government contracts; and, receiving government contracts that do not provide enough revenues to provide adequate liquidity.
8. ACCRUED LIABILITIES:
The components of accrued liabilities are: (in thousands)
2006 2005 ---------------------------------------------------------- Interest Expense $ 2 $ 2 ---------------------------------------------------------- Accrued Lease Payments 56 56 ---------------------------------------------------------- Deferred Revenues (Note 18) 169 - ----------------------------------------------------------- Deferred Grant Revenues (Note 17) - 65 -----------------------------------------------------------
Accrued Payroll Taxes 99 122 ---------------------------------------------------------- Accrued Property Taxes 40 40 ---------------------------------------------------------- Total $ 366 $ 285 ----------------------------------------------------------
9. EMPLOYEE BENEFIT PLANS:
The Company has two non-contributory, defined benefit pension plans. The components of pension expense, included in Cost of Sales and Services in the Consolidated Statements of Operations and Comprehensive Income are as follows:
(in thousands) - ----------------------------------------------------------------------------- 2006 2005 2004 - ----------------------------------------------------------------------------- Benefits Earned for Service in the Current Year $ 186 $ 146 $ 129 - ----------------------------------------------------------------------------- Interest on the Projected Benefit Obligation 317 348 355 - ----------------------------------------------------------------------------- Expected Return on Plan Assets (325) (312) (297) - ----------------------------------------------------------------------------- Amortization of: Unrecognized Net Pension Obligation at July 1, 1987; Cost of Benefit Changes Since That Date; and Gains and Losses Against Actuarial Assumptions 94 61 116 - ----------------------------------------------------------------------------- Pension Expense $ 272 $ 243 $ 303 - -----------------------------------------------------------------------------
Below are various analyses and other information relating to the Company's pension liability, assets and expense as of July 2006 and July 2005, (all amounts are in thousands except for those indicated as percent): --------------------------------------------------------------------- Change in Benefit Obligation: 2006 2005 --------------------------------------------------------------------- Benefit Obligation at Beginning of Year $ 6,595 $ 5,817 --------------------------------------------------------------------- Current Year Service Cost 186 146 --------------------------------------------------------------------- Interest Cost on Projected Liability 317 348 --------------------------------------------------------------------- Benefit Payments (532) (529) --------------------------------------------------------------------- Actuarial (Gain)Loss (814) 813 --------------------------------------------------------------------- Benefit Obligation at End of Year $ 5,752 $ 6,595 ---------------------------------------------------------------------
Change in Plan Assets: 2006 2005 --------------------------------------------------------------------- Fair Value of Plan Assets at Beginning of Year $ 4,842 $ 4,704 --------------------------------------------------------------------- Company Contributions 371 284 --------------------------------------------------------------------- Actual Return on Plan Assets 421 383 --------------------------------------------------------------------- Benefit Payments (532) (529) --------------------------------------------------------------------- Fair Value of Plan Assets at End of Year $ 5,102 $ 4,842 ---------------------------------------------------------------------
Reconciliation of Funded Status: 2006 2005 --------------------------------------------------------------------- Funded Status $ (650) $ (1,752) --------------------------------------------------------------------- Unrecognized Actuarial Loss 1,007 2,008 --------------------------------------------------------------------- Unrecognized Prior Service Cost 6 10 --------------------------------------------------------------------- Net Amount Recognized $ 363 $ 266 ---------------------------------------------------------------------
Amounts Recognized in the Consolidated Balance Sheets: 2006 2005 --------------------------------------------------------------------- Intangible Pension Asset $ 6 $ 10 --------------------------------------------------------------------- Accumulated Other Comprehensive Loss 1,007 1,476 ---------------------------------------------------------------------
Accrued Pension Liability: --------------------------------------------------------------------- Prepaid Benefit Cost 617 521 --------------------------------------------------------------------- Accrued Benefit Cost (254) (256) --------------------------------------------------------------------- Additional Minimum Pension Liability (1,013) (1,485) --------------------------------------------------------------------- Net Amount Recognized in Financial Statements $ 363 $ 266 ---------------------------------------------------------------------
Accumulated Benefit Obligation in Excess of Plan Assets: 2006 2005 --------------------------------------------------------------------- Projected Benefit Obligation $ 5,752 $ 6,595 --------------------------------------------------------------------- Accumulated Benefit Obligation 5,343 6,062 --------------------------------------------------------------------- Fair Value of Plan Assets $ 5,102 $ 4,842 ---------------------------------------------------------------------
2006 2005 --------------------------------------------------------------------- Increase (Decrease) in Minimum Liability Included in Other Comprehensive Income $ (469) $ 157 ---------------------------------------------------------------------
Weighted-average assumptions used to determine benefit obligations: 2006 2005 --------------------------------------------------------------------- Assumed Discount Rate 6.00% 5.00% --------------------------------------------------------------------- Rate of Compensation Increase, For the Pay Related Benefit Plan 4.50% 5.50% ---------------------------------------------------------------------
Weighted-average assumptions used to determine net periodic benefit cost: 2006 2005 --------------------------------------------------------------------- Assumed Discount Rate 5.00% 6.25% --------------------------------------------------------------------- Expected Long-Term Rate of Return on Plan Assets 6.75% 6.75% --------------------------------------------------------------------- Rate of Compensation Increase, For the Pay Related Benefit Plan 4.50% 5.50% ---------------------------------------------------------------------
PLAN ASSETS:
Pension plan's weighted-average asset allocations by asset category: 2006 2005 --------------------------------------------------------------------- Equity Securities 45% 45% --------------------------------------------------------------------- Debt Securities 5% 5% --------------------------------------------------------------------- Real Estate 0% 0% --------------------------------------------------------------------- Other 50% 50% --------------------------------------------------------------------- Total 100% 100% ---------------------------------------------------------------------
This allocation and investment funds was selected as one that limits risk while providing higher returns on plan assets than guaranteed rate funds, while still providing adequate liquidity to meet payments to retirees.
In developing the assumed weighted-average long-term rate of return on plan assets, the Company used information from its third party pension plan assets manager, including their review of asset class return expectations and long-term inflation assumptions. Also considered in setting this rate is the historical return on plan assets.
CASH FLOWS:
Contributions
Contributions to the pension plan for fiscal year 2007 are expected to be $380,000.
Estimated Future Benefit Payments (In thousands) Amount ------------------------------------------------------------ 2007 $ 459 ------------------------------------------------------------ 2008 455 ------------------------------------------------------------ 2009 447 ------------------------------------------------------------ 2010 436 ------------------------------------------------------------ 2011 482 ------------------------------------------------------------ 2012-2016 2,159 ------------------------------------------------------------
At June 2006, one of the pension plans has a benefit obligation ($2,395,000) that is greater than its plan assets ($2,325,000) resulting in the additional liability of $70,683 and at June 2005, the plan had a benefit obligation ($2,696,000) that was greater than its plan assets ($2,180,000) resulting in the additional liability of $1,037,000. At June 2006, the other pension plan has a benefit obligation ($3,357,000) that is greater than its plan assets ($2,777,000) resulting in the additional liability of $580,324 and at June 2005, this plan had a benefit obligation ($3,367,000) that is greater than its plan assets ($2,663,000) resulting in the additional liability of $448,000.
A 1% increase in the assumed discount rate would decrease the benefit obligation at June 2006 by $517,000. Conversely, a 1% decrease in the assumed discount rate would increase the benefit obligation at June 2006 by $621,000.
The Consolidated Statements of Operations and Comprehensive Income shows the amount included in Other Comprehensive Income (Loss) that resulted from recording the additional minimum pension liability which represents the portion of the pension liability that has not yet been charged against operations. A valuation allowance is recorded for the deferred tax asset ($342,000) that arises from the cumulative Other Comprehensive Income (Loss). In addition, the Company provides retirement benefits to certain employees through deferred compensation contracts and the unfunded liability associated with these contracts was $61,000 at July 1, 2006 and $71,000 at July 2, 2005.
Benefit measurements for the pension plan is June 30.
10. RETIREE HEALTH BENEFITS:
The Company accounts for the costs and liability of health care benefits for retired employees using Statement of Financial Accounting Standards No. 106 (FAS 106), "Employers Accounting for Postretirement Benefits Other Than Pensions". The liability at the date of adoption of FAS 106 (July 4, 1993) is being recognized over employee future service lives.
Employees of the North Carolina plant who meet certain criteria and retire early (age 62-64) or become disabled, receive for themselves, but not for their dependents, the same health insurance benefits received by active employees. All benefits terminate when the employee becomes eligible to
receive Medicare (usually age 65 or 30 months after disability date). This benefit is provided at no cost to the employee and the Company does not fund the cost of this benefit prior to costs actually being incurred.
The cost of retiree health benefits included in the accompanying Statements of Operations and Comprehensive Income was: (in thousands) 2006 2005 2004 ---------------------------------------------------------------- Benefits Earned for Current Service $ 24 $ 35 $ 36 ---------------------------------------------------------------- Interest Cost on Accumulated Liability 17 19 24 ---------------------------------------------------------------- Amortization of the July 4, 1993 Liability 4 4 4 ---------------------------------------------------------------- Change in Actuarial Assumptions (97) - - ---------------------------------------------------------------- Total Cost $ (52) $ 58 $ 64 ----------------------------------------------------------------
An analysis of the total liability for the last two fiscal years, including a reconciliation of the liability in the Consolidated Balance Sheets at July 1, 2006 and July 2, 2005 is as follows:
(in thousands) 2006 2005 ------------------------------------------------------------ Total Obligation at Beginning of Year $ 383 $ 295 ------------------------------------------------------------ Liability for Current Service 24 35 ------------------------------------------------------------ Interest on Liability 17 19 ------------------------------------------------------------ Benefit Payments - - ------------------------------------------------------------ Actuarial (Gain) Loss (122) 34 ------------------------------------------------------------ Total Obligation at End of Year 302 383 ------------------------------------------------------------ Less Unamortized Liability at July 4, 1993 (33) (37) ------------------------------------------------------------ Unrecognized Loss 33 8 ------------------------------------------------------------ Liability Recognized in the Consolidated Balance Sheets $ 302 $ 354 ------------------------------------------------------------
The assumed health care cost trend rate used to project expected future cost was 8% in 2006 and remaining at 8% thereafter and 12% in 2005, gradually decreasing to 6% by 2010 and remaining at 6% thereafter. The assumed discount rate used to determine the accumulated liability was 6% for 2006 and 5% for 2005.
A 1% increase in the assumed health care cost trend rate would increase the benefit obligation at July 1, 2006 by $12,000. Conversely, a 1% decrease in the assumed health care cost trend rate would decrease the benefit obligation at July 1, 2006 by $11,000.
A 1% increase in the assumed discount rate would decrease the benefit obligation at July 1, 2006 by $22,000. Conversely, a 1% decrease in the
assumed discount rate would increase the benefit obligation at July 1, 2006 by $26,000.
Benefit measurements for the plan is June 30, 2006 and June 30, 2005.
11. INCOME TAXES:
The Company accounts for the provision and liability for income taxes using Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes." The provision for income taxes consists of the following:
(in thousands)
2006 2005 2004 ------------------------------------------------------------------- Federal Provision: ------------------------------------------------------------------- Currently Payable (Refundable) $ (61) $ 354 $ 666 ------------------------------------------------------------------- Deferred 126 131 (4) ------------------------------------------------------------------- Total Federal 65 485 662 ------------------------------------------------------------------- State Provision Currently Payable 5 8 20 ------------------------------------------------------------------- Total Provision $ 70 $ 493 $ 682 -------------------------------------------------------------------
A reconciliation of the effective income tax rate for the 2006, 2005 and 2004 fiscal years is as follows:
2006 2005 2004 ---------------------------------------------------------------------- Statutory Federal Income Tax Rate 34% 34% 34% ---------------------------------------------------------------------- Current Period Income of Puerto Rico Subsidiary Substantially Exempt From Puerto Rican and Federal Income Taxes (23)% (13)% (5)% ---------------------------------------------------------------------- Deferred Tax Valuation Allowance (Reversal of Previously Recorded Valuation Allowance) (3)% (2)% (9)% ---------------------------------------------------------------------- State Taxes, Net of Federal Tax Benefit 1% - 1% ---------------------------------------------------------------------- Other - 1% 1% ---------------------------------------------------------------------- Effective Income Tax Rate 9% 20% 22% ----------------------------------------------------------------------
Income earned in Puerto Rico by the Company's Puerto Rican wholly-owned subsidiary was 90% exempt from Puerto Rican income tax through 2000. Effective July 1, 2000, the Company received a new multi-year tax exemption grant that provided for a flat income tax rate of 2% and eliminated the withholding tax (5%) on dividends paid. Income earned in Puerto Rico by this subsidiary has not been subject to United States federal income tax. The Small Business Job Protection Act (Act) terminated the federal tax credit on this income subject to a phase out for existing companies, for
tax years beginning after December 31, 1996. Under the phase out, the Company received a full credit through fiscal year 2002. For fiscal years 2003 through 2006, the credit is limited, and will be completely eliminated starting with the 2007 fiscal year.
The accumulated undistributed earnings ($2,848,000) through July 1, 2000 of this subsidiary are subject to the 5% Puerto Rican withholding tax when remitted to the parent Company as dividends. Accrued tax liabilities have been provided for the withholding tax reasonably expected to be paid in the future.
Significant components of the Company's deferred tax assets and liabilities as of the end of fiscal 2006 and 2005 are as follows:
(in thousands)
Deferred Tax Assets: 2006 2005 ----------------------------------------------------------------------- Tax Effect of Pension Liability Charged Against Equity $ 342 $ 502 ----------------------------------------------------------------------- Employee Compensation Charged Against Financial Statement Income, Not Yet Deducted From Taxable Income 210 286 ----------------------------------------------------------------------- Additional Costs Inventoried for Tax Purposes 51 98 ----------------------------------------------------------------------- State NOL Carryforward 53 49 ----------------------------------------------------------------------- Alternative Minimum Tax Credit 102 102 ----------------------------------------------------------------------- Other 382 391 ----------------------------------------------------------------------- Deferred Tax Assets Before Valuation Allowance 1,140 1,428 ----------------------------------------------------------------------- Valuation Allowance (956) (1,162) ----------------------------------------------------------------------- Total Deferred Tax Assets 184 266 ----------------------------------------------------------------------- Deferred Tax Liabilities: ----------------------------------------------------------------------- Depreciation and Prepaid Pension Costs Deducted From Taxable Income Not Yet Charged Against Financial Statement Income 172 128 ----------------------------------------------------------------------- Net Deferred Tax Assets $ 12 $ 138 ----------------------------------------------------------------------- Deferred tax assets have been reduced by a valuation allowance because it is more likely than not that certain of these assets will not be used to reduce future tax payments.
The Company has state operating loss carryforwards of approximately $770,000, which begin to expire in 2015, available to reduce future state taxable income.
12. NOTES PAYABLE:
As part of an agreement with a customer for which the Company provides certain technology and equipment, in April, 2001 that customer loaned the Company $300,000. The loan agreement provides for quarterly interest payments at an annual rate of 3% with the $300,000 principal due in April 2011. Because this interest rate is less than the market rate, the Company recorded the note payable discounted at a market rate of 8% ($196,000), and is recording interest expense at this rate. The difference between interest
at the 8% and 3% rates ($104,000) was recorded as deferred service income, which is being recognized over the 10-year life of the loan agreement. The Company attributed the difference between the stated 3% rate and the market rate of 8% as part of its compensation for technology and equipment provided to the customer. The Consolidated Statements of Operations and Comprehensive Income for the fiscal years 2006, 2005 and 2004 include service fee income of $10,000, $9,000 and $9,000, respectively, and interest expense of $19,000, $18,000 and $17,000, respectively. The Consolidated Balance Sheets at July 1, 2006 and at July 2, 2005 includes $241,000 and $231,000, respectively, for this note, and $59,000 and $69,000, respectively, as deferred service income.
13. STOCK OPTIONS:
Effective July 3, 2005, the Company adopted Statement of Financial Accounting Standards No. 123R (revised 2004), "Share-Based Payment," ("SFAS No. 123R") which was issued by the FASB in December 2004. SFAS No. 123R revises SFAS No. 123 "Accounting for Stock Based Compensation," and supersedes APB No. 25, "Accounting for Stock Issued to Employees," (APB No. 25) and its related interpretations. SFAS No.123R requires recognition of the cost of employee services received in exchange for an award of equity instruments in the financial statements over the period the employee is required to perform the services in exchange for the award (presumptively the vesting period). SFAS No. 123R also requires measurement of the cost of employee services received in exchange for an award based on the grant-date fair value of the award. SFAS No. 123R also amends SFAS No. 95 "Statement of Cash Flows," to require that excess tax benefits be reported as financing cash inflows, rather than as a reduction of taxes paid, which is included within operating cash flows.
The Company adopted SFAS No. 123R using the modified prospective application as permitted under SFAS No. 123R. Accordingly, prior period amounts have not been restated. Under this application, the Company is required to record compensation expense for all awards granted after the date of adoption and for the unvested portion of previously granted awards that remain outstanding at the date of adoption. As of the date of adoption, the Company had no unvested previously granted awards and has not granted any awards after July 2, 2005. There have been no options exercised during the fiscal year ending July 1, 2006. Therefore, the new standard has had no impact on the consolidated statements of operations and cash flows, or earnings per share of the Company during the fiscal year ended July 1, 2006. There is no unrecognized compensation cost related to non-vested share-based compensation arrangements granted under all of the Company's stock benefit plans.
Prior to the adoption of SFAS No. 123R, the Company used the intrinsic value method as prescribed by APB No. 25 and thus recognized no compensation expense for options granted with exercise prices equal to the fair market value of the Company's common stock on the date of grant.
The Company anticipates providing for future exercises from authorized but unissued shares and not through purchases of its own stock.
On July 12, 2000, the Company and its Chairman of the Board executed an Agreement under which the Chairman was granted options to purchase up to 50,000 shares of the Company's common stock at an exercise price of $9.125 per share with such options vesting in 2005 or earlier if certain performance targets were met. During fiscal year 2005, 6,000 of the 50,000 shares were exercised and the remaining 44,000 shares expired on June 30, 2006.
The 1999 Stock Option Plan for Key Employees (1999 Employee Plan) and the 1999 Stock Option Plan for Non-Employee Directors (1999 Director Plan) provide for granting options to purchase 90,000 shares and 21,000 shares, respectively. As of July 1, 2006 options had been granted for 65,000 shares under the 1999 Employee Plan and 11,000 shares under the 1999 Director Plan. The plan terminated on June 30, 2004 and no options could be granted after June 30, 2004.
The1997 Stock Option Plan for Key Employees (1997 Employee Plan) and the 1997 Stock Option Plan for Non-Employee Directors (1997 Director Plan) provide for granting options to purchase 99,000 shares and 16,000 shares, respectively. As of July 1, 2006 options had been granted for 84,000 shares under the 1999 Employee Plan and 10,000 shares under the 1999 Director Plan. The plan terminated on June 30, 2002 and no options could be granted after June 30, 2002.
Under all of the above Plans, option price is the market price on the date granted, and options have a life of 10 years from the date granted. As of July 1, 2006, all granted options are exercisable. Transactions involving these Plans for the last fiscal year is summarized below: Weighted- Weighted- Average Average Remaining Aggregate No. of Exercise Contractual Intrinsic Option Shares: Shares Price Term Value --------------------------------------------------------------------------- Outstanding at July 2, 2005 111,500 $9.29 ---------------------------------------------------------------------------- Expired (59,000) $8.08 ---------------------------------------------------------------------------- Outstanding at July 1, 2006 52,500 $10.65 1.9 years $130,480 ----------------------------------------------------------------------------
Exercisable at July 1, 2006 52,500 $10.65 1.9 years $130,480 ----------------------------------------------------------------------------
The intrinsic value of options exercised during fiscal 2005 and 2004 was approximately $206,000 and $317,000, respectively. The approximate fair value of shares vested during the 2005 and 2004 fiscal years was $23,000 per fiscal year.
The following table summarizes information concerning options issued, options available for future issuance and approval of plans by security holders at July 1, 2006:
(A) (B) (C) ----------------------------------------------------------------------------
Number of Securities Number of Remaining Available Securities to for Future Issuance be issued Weighted- Under Equity Upon Average Compensation Plans Exercise of Exercise Price (Excluding Outstanding of Outstanding Securities Reflected Plan Category Options Options in Column (A)) ---------------------------------------------------------------------------- Equity Compensation Plans Approved by Security Holders 52,500 $10.65 - ---------------------------------------------------------------------------- Equity Compensation Plans Not Approved by Security Holders - - - ---------------------------------------------------------------------------- Total 52,500 $10.65 - ----------------------------------------------------------------------------
The following illustrates the effect on net income available to common stockholders if the Company had applied the fair value recognition provisions of SFAS No. 123 to the 2005 and 2004 fiscal years ( in thousands, except per share data):
2005 2004 --------------------------------------------------------------------- Net Income, As Reported (in thousands) $ 1,907 $ 2,448 --------------------------------------------------------------------- Net Income, Pro Forma (in thousands) $ 1,889 $ 2,430 --------------------------------------------------------------------- Basic Earnings Per Share, As Reported $ 1.51 $ 2.04 --------------------------------------------------------------------- Basic Earnings Per Share, Pro Forma $ 1.49 $ 2.02 --------------------------------------------------------------------- Diluted Earnings Per Share, As Reported $ 1.47 $ 1.97 --------------------------------------------------------------------- Diluted Earnings Per Share, Pro Forma $ 1.45 $ 1.95 ---------------------------------------------------------------------
14. EARNINGS PER SHARE:
The Company computes its basic and diluted earnings per share amounts in accordance with Statement of Financial Accounting Standards No. 128 (SFAS 128),"Earnings per Share." Basic earnings per share is computed by dividing net earnings by the weighted average number of common shares outstanding during the period. Diluted earnings per share is computed by dividing net earnings by the weighted average number of common shares outstanding during the period plus the dilutive potential common shares that would have been outstanding upon the assumed exercise of dilutive stock options.
The following is the reconciliation of the numerators and denominators of the basic and diluted earnings per share computations:
For the Fiscal Year Ended 7/1/06 Net Income Shares Per-Share (Numerator) (Denominator) Amount --------------------------------------------------------------------------- Basic EPS Available to Shareholders $746,000 1,270,746 $ 0.59 --------------------------------------------------------------------------- Effect of Dilutive Stock-based Compensation Arrangements 6,858 --------------------------------------------------------------------------- Diluted EPS Available to Shareholders $746,000 1,277,604 $ 0.58 ---------------------------------------------------------------------------
For the Fiscal Year Ended 7/02/05 Net Income Shares Per-Share (Numerator) (Denominator) Amount ---------------------------------------------------------------------------- Basic EPS Available to Shareholders $1,907,000 1,263,938 $ 1.51 ---------------------------------------------------------------------------- Effect of Dilutive Stock-based Compensation Arrangements 34,362 ---------------------------------------------------------------------------- Diluted EPS Available to Shareholders $1,907,000 1,298,300 $ 1.47 ----------------------------------------------------------------------------
For the Fiscal Year Ended 7/03/04 Net Income Shares Per-Share (Numerator) (Denominator) Amount ---------------------------------------------------------------------------- Basic EPS Available to Shareholders $2,448,000 1,200,937 $ 2.04 ---------------------------------------------------------------------------- Effect of Dilutive Stock-based Compensation Arrangements 43,017 ---------------------------------------------------------------------------- Diluted EPS Available to Shareholders $2,448,000 1,243,954 $ 1.97 ----------------------------------------------------------------------------
15. SEGMENT AND REVENUE INFORMATION:
The Company operates in one reportable segment. SFAS 131 requires disclosure of financial and descriptive information about reportable operating segments, revenues by products or services, and revenues and assets by geographic areas. Substantially all of the Company's operating activity is from the sale of military and other rugged footwear, the sale of specialized machinery and materials for the manufacture of this type of footwear and the rendering of technical assistance and other services to licensees for the manufacture of this type of footwear. The Company identifies segments based on the Company's organization under one management group. The Company's operations are managed as one unit and resources are allocated without regard to separate functions.
Information about the Company's revenues is as follows:
(in thousands) 2006 2005 2004 ---------------------------------------------------------------------------- Sales of Footwear and Related Items $ 43,088 $ 49,530 $ 44,327 ---------------------------------------------------------------------------- Revenues from Licensees 934 937 1,366 ---------------------------------------------------------------------------- Total Revenues by Major Product Group $ 44,022 $ 50,467 $ 45,693 ----------------------------------------------------------------------------
---------------------------------------------------------------------------- Revenues from U. S. Customers $ 42,850 $ 49,108 $ 45,344 ---------------------------------------------------------------------------- Revenues from International Customers 1,172 1,359 349 ---------------------------------------------------------------------------- Total Revenues by Geographic Region $ 44,022 $ 50,467 $ 45,693 ----------------------------------------------------------------------------
----------------------------------------------------------------------------
Location of Major International Customers: ---------------------------------------------------------------------------- Latin America $ 152 $ 116 $ 153 ---------------------------------------------------------------------------- Canada 6 - 14 ---------------------------------------------------------------------------- Asia/Pacific 160 40 171 ---------------------------------------------------------------------------- Mexico / Spain 833 137 2 ---------------------------------------------------------------------------- United Kingdom/Europe/South Africa 21 1,066 9 ----------------------------------------------------------------------------
----------------------------------------------------------------------------
Major Customer- U. S. Government $ 38,528 $ 44,249 $ 39,648 ----------------------------------------------------------------------------
The Company does not have long-lived assets or operations in foreign countries. The categorization of revenues as being from international customers was based upon the final destination of products sold or services rendered.
16. GOVERNMENT BOOT CONTRACT REVENUES:
From time to time, the Company records estimates of revenues or costs associated with certain contract actions before the amount of such actions are settled with the DSCP. Any differences between these estimates and the actual amounts agreed to are included in the period of settlement.
17. GRANT MONEY RECEIVED:
During fiscal year 2005, the Company received $323,000 from the government of Puerto Rico and another $171,000 during fiscal year 2006 under a Special Incentives Contract related to creating new job opportunities in its boot manufacturing operations in Puerto Rico. The grant is for a five year period (fiscal years 2004 through 2008) and requires the Company to maintain a certain level of employment in Puerto Rico over the grant period. If this requirement is not met, the Company may be required to refund a pro-rata
portion of the total grant. The grant is for a maximum of $526,000 and monies are disbursed based upon certain expenditures made by the Company. The Company's policy is to recognize grant monies pro-rata over the five year grant period, with grant income first recognized in the period in which it is received. The Consolidated Statements of Operations and Comprehensive Income for the fiscal year 2006 recognized $174,000 as grant income including $80,000 that related to grant periods prior to fiscal year 2006. The Consolidated Statements of Operations and Comprehensive Income for the fiscal year 2005 recognized $135,000 as grant income including $70,000 that related to grant periods prior to fiscal year 2005.
Under a grant issued in 1999, the remaining $80,000 of deferred grant income was recognized in the Consolidated Statements of Operations and Comprehensive Income for the fiscal year 2004.
18. DEFERRED REVENUES:
In December 2005, the Company received a contract for approximately $930,000 to supply machinery and assistance for the upgrade of boot manufacturing machinery to a factory in a foreign country. The deliveries began during the third quarter of 2006 fiscal year and will continue until the end of calendar year 2007. The customer paid a $200,000 deposit in January 2006 and this amount was recorded as a deferred revenue. The Consolidated Balance Sheet at July 1, 2006 included the unearned revenue from this contract of $169,000 in accrued liabilities (See Note 8).
19. COMMITMENTS:
The Company has a non-cancelable operating lease with a Puerto Rican governmental agency for its manufacturing facility. The term of the lease is for ten years, beginning July 1, 1999 with monthly payments that commenced on January 1, 2000. Total lease payments for the period July 2, 2006 through June 30, 2009 are $841,000. Lease payments for each of the Company's three fiscal years ending after July 1, 2006 are: $271,000, $280,000 and $290,000. Lease expense for the Company's current Puerto Rican facility in the 2006 fiscal year was $261,000. The Company leased more square footage during fiscal year 2006. Lease expense for fiscal year 2005 was $216,000 and fiscal year 2004 was $142,500.
20. PUERTO RICAN GOVERNMENT REFUND:
The majority of the Company's boot manufacturing operations occur at the factory of a wholly-owned subsidiary located in Puerto Rico. The Company is participating in a Puerto Rican government program to assist manufacturers in the training of new or expanded work force under which the Company is reimbursed for part of the compensation paid to certain employees. The Consolidated Statements of Operations for fiscal years 2006, 2005 and 2004 include $598,000, $1,385,000 and $321,000 respectively, as revenues from this program.
The Company has filed a reimbursement claim for an additional $808,000 for compensation paid employees and expensed through July 1, 2006. The Company's policy is to recognize reimbursement as a revenue in the period that they are received.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To The Board of Directors and Stockholders of Wellco Enterprises, Inc. Waynesville, North Carolina
We have audited the accompanying consolidated balance sheets of Wellco Enterprises, Inc. and subsidiaries (the "Company") as of July 1, 2006 and July 2, 2005, and the related consolidated statements of operations and comprehensive income, stockholders' equity, and cash flows for each of the three years in the period ended July 1, 2006. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated 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 consolidated financial statements are free of material misstatement. We were not engaged to perform an audit of the Company's 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 also includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial 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 financial position of the Company as of July 1, 2006 and July 2, 2005 and the results of their operations and their cash flows for each of the three years in the period ended July 1, 2006 in conformity with accounting principles generally accepted in the United States of America.
DIXON HUGHES PLLC
Asheville, North Carolina September 28, 2006
WELLCO ENTERPRISES, INC. PRICE RANGE, DIVIDENDS AND MARKET OF COMMON STOCK
Fiscal Year 2006 Quarters
First Second Third Fourth - ------------------------------------------------------------------------- Market Price Per Share- - ------------------------------------------------------------------------- High $13.97 $12.56 $13.20 $13.45 - ------------------------------------------------------------------------- Low $10.15 $11.30 $11.95 $11.45 - ------------------------------------------------------------------------- Per Share Cash Dividend Declared $0.15 $0.15 $0.15 $0.15 - -------------------------------------------------------------------------
Fiscal Year 2005 Quarters
First Second Third Fourth - ------------------------------------------------------------------------- Market Price Per Share- - ------------------------------------------------------------------------- High $21.24 $21.00 $16.65 $13.81 - ------------------------------------------------------------------------- Low $16.60 $14.25 $13.71 $11.70 - ------------------------------------------------------------------------- Per Share Cash Dividend Declared $0.15 $0.15 $0.15 $0.15 - -------------------------------------------------------------------------
The Company's Common Stock is traded on the American Stock Exchange.
The number of holders of record of Wellco's Common Stock as of September 15, 2006 was 176.
Registrar and Transfer Agent Mellon Shareholders Services New York, N. Y.
WELLCO ENTERPRISES, INC. SELECTED QUARTERLY FINANCIAL DATA (Unaudited) (In Thousands Except for Per Share Amounts)
Fiscal Year 2006 Quarters
First Second Third Fourth - ------------------------------------------------------------------------- Revenues $ 8,318 $11,041 $13,395 $11,268 - ------------------------------------------------------------------------- Cost of Sales and Services 8,402 10,127 12,389 9,482 - ------------------------------------------------------------------------- Net Income (Loss) (646) 225 162 1,005 - ------------------------------------------------------------------------- Basic Earnings (Loss) Per Share (0.51) 0.18 0.13 0.79 - ------------------------------------------------------------------------- Fully Diluted Earnings (Loss) Per Share $(0.51) $ 0.17 $ 0.13 $ 0.79 - -------------------------------------------------------------------------
Fiscal Year 2005 Quarters
First Second Third Fourth - ------------------------------------------------------------------------- Revenues $10,621 $13,974 $14,646 $11,226 - ------------------------------------------------------------------------- Cost of Sales and Services 9,387 12,505 13,731 9,609 - ------------------------------------------------------------------------- Net Income 397 521 209 780 - ------------------------------------------------------------------------- Basic Earnings Per Share 0.32 0.41 0.16 0.62 - ------------------------------------------------------------------------- Fully Diluted Earnings Per Share $ 0.31 $ 0.40 $ 0.16 $ 0.60 - -------------------------------------------------------------------------
Officers and Directors LEE FERGUSON Chief Executive Officer and President
GEORGE HENSON Chairman, Board of Directors
ROLF KAUFMAN Vice Chairman of the Board
FRED K. WEBB, Jr. Vice President
Officers RICHARD WOOD Secretary, Attorney, Retired Member of the law firm of McGuire, Wood & Bissette, P. A.
TAMMY FRANCIS Treasurer, Assistant Secretary and Controller
Neil Streeter Vice President of Sales
Directors CLAUDE S. ABERNETHY, Jr. Senior Vice President of IJL Wachovia
KATHERINE J. EMERSON Information Systems Controller and CPA Master Gage and Tool Company
R. DAVID KEMPER President of KemperStrategy, Inc.
JOHN D. LOVELACE Vice President of Credit and Collections of United Leasing Corporation
SARAH E. LOVELACE Executrix of the estate of James T. Emerson
PART II ------- Items 5, 6, 7, and 8. - --------------------
The information called for by the following items is in the Company's 2006 Annual Report to Shareholders which is incorporated starting on the following page in this Form 10-K:
Annual Report Page No. Item 5.
Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters 39 Item 6.
Item 6. Consolidated Selected Financial Data 1 Item 7.
Item 7. Management's Discussion and Analysis of Results of Operations and Financial Condition 5-13 Item 8. Consolidated Financial Statements and Supplementary Data 14-37, 40
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk. - ------- ----------------------------------------------------------
We are exposed to interest rate changes primarily as a result of our line of credit which we use to maintain liquidity and to fund capital expenditures and expansion. Our market risk exposure with respect to this debt is to changes in LIBOR. Our line of credit provides for interest on outstanding borrowings at rates tied to LIBOR. A 1% increase in interest rates on our current average borrowings would have had approximately $ 31,500 impact on income before income taxes. We do not enter into derivative or interest rate transactions for speculative purposes.
In the normal course of business and consistent with established policies and procedures we use the necessary financial instruments to manage the fluctuations in interest rates. The Company does not have any foreign currency risk.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and - ----------------------------------------------------------------------- Financial Disclosure. (None) - --------------------
Item 9A.
Item 9A. Controls & Procedures - ------- ---------------------
(a) Evaluation of Disclosure Controls and Procedures
Disclosure controls and procedures are controls and other procedures that are designed to ensure that information required to be disclosed in the reports that are filed or submitted under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission's rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in the reports that are filed under the Exchange Act is accumulated and communicated to management, including the chief executive officer and chief financial officer, as appropriate to allow timely decisions regarding required disclosure. Under the supervision of and with the participation of management, including the chief executive officer and chief financial officer, the Company has evaluated the effectiveness of the design and operation of its disclosure controls and procedures as of July 1, 2006, and based on its evaluation, our chief executive officer and chief financial officer have concluded that these controls and procedures are effective.
(b) Changes in Internal Controls
There were no changes in the Company's internal control over financial reporting that occurred during the fourth quarter ended July 1, 2006 that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting.
PART III --------
Responsive information called for by the following Items 10, 11, 12. 13 and 14, except for certain information about executive officers provided and the Registrant's Code of Ethics presented below, will be filed not later than 120 days after the close of the fiscal year with the Securities and Exchange Commission in a Proxy Statement dated October 13, 2006, and is incorporated herein by reference. After each item and shown in parenthesis is the proxy heading for the section containing the responsive information.
Item 10.
Item 10. Directors and Executive Officers of the Registrant.(Board of Directors) - ------- ----------------------------------------------------
The Proxy Statement will contain information disclosing delinquent filings of two Form 3 filers. Lee Ferguson was elected President and Chief Executive Officer and appointed a Director effective March 20, 2006 and he failed to file a Form 3 on a timely basis. Neil Streeter was elected Vice President of Sales on April 18, 2006 and he failed to file a Form 3 on a timely basis.
Identification of Executive Officers and Certain Significant Employees: ----------------------------------------------------------------------
Name Age Office Lee Ferguson 55 President and Chief Executive Officer George Henson 63 Chairman, Board of Directors Rolf Kaufman 76 Vice Chairman, Board of Directors Neil Streeter 44 Vice President of Sales Fred K. Webb, Jr. 46 Vice President Richard A. Wood, Jr. 69 Secretary Tammy Francis, CPA 47 Controller, Treasurer and Assistant Secretary
Effective March 20, 2006, Lee Ferguson was appointed as President, Chief Executive Officer, and a Director of the Company. Mr. Ferguson is 55 years of age. Mr. Ferguson served as President of the Armor and Defense Group of Arotech Company, Inc., in Auburn, AL, from June, 2005 until December, 2005. He served as Chief Operating Officer of Specialty Defense Systems in Dunmore, PA from June, 2002 to June 2005. Mr. Ferguson served as President and Chief Operating Officer of BIKE Athletic Company, in Knoxville, TN, from August, 1994 to June, 2002.
Effective February 15, 2006, Mr. Henson was elected as Chairman of the Board of Directors. Also, Mr. Henson was elected as a director at the November 15, 2005
Annual Stockholders meeting. From 1999 until 2000, he was Operations Senior Vice President at Blue Ridge Paper Products, Inc. From 2000 until his retirement in 2002, he was President and Chief Executive Officer of Blue Ridge Paper Products, Inc. From 1969 through 1999, he was employed with Weyerhaeuser Company in various engineering and corporate management positions.
Mr. Streeter was elected to Vice President of Sales in April 2006. He has been an employee with the Company since August 2003. From 1999 until August 2003, he was a North American sales manager for Kockner Desma, in Achim, Germany.
Mr. Webb has been a director since 1996 and an employee with the Company since August 1998. In November 2005, Mr. Webb was elected to Vice President. In February 1999, Mr. Webb was elected Vice President of Marketing.
Ms. Francis has been Controller since October, 1996 and was elected Treasurer in 2003 and Assistant Secretary in 1998.
Executive officers are elected by the Board of Directors to serve a term of one year. There are no arrangements or understandings pursuant to which any of the officers are elected, and all are elected to serve for one year terms.
The Registrant has a Code of Conduct and Ethics that applies to, among others, its principal executive officer, principal financial officer and principal accounting officer or controller.
Item 11.
Item 11. Executive Compensation. (Executive Compensation) - ------- ----------------------
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management. - ------- -------------------------------------------------------------- Security Ownership)
Item 13.
Item 13. Certain Relationships and Related Transactions. - ------- ---------------------------------------------- (Board of Directors/Security Ownership)
Since the beginning of the 2006 fiscal year, no executive officer of the Registrant or member of his immediate family or record or beneficial owner of more than 5% of the Company's stock has had any transaction or series of similar transactions with the Registrant or any of its subsidiaries exceeding $60,000, and there are no currently proposed transactions exceeding $60,000.
Since the beginning of the 2006 fiscal year, no - (1) executive officer of the Registrant or member of his immediate family, (2) corporation or organization of which any such person is an executive officer, partner, owner or 10% or more beneficial owner, or (3) trust or other estate in which any such person has a substantial interest or as to which such person serves as trustee or in a similar capacity, was indebted to the Registrant or its subsidiaries in an amount exceeding $60,000.
Item 14.
Item 14. Principal Accountant Fees and Services. (Independent Auditors Fees - -------- -------------------------------------- and Services)
PART IV -------
Item 15.
Item 15. Exhibits and Financial Statement Schedules. - ------- -------------------------------------------
(a) The following documents are filed as a part of this report:
1. All Financial Statements - ---------------------------
Page Number - ------------------------------------------------------------------------------- The following consolidated financial statements of Wellco Enterprises, Inc. are in the Registrant's 2006 Annual Report to Shareholders which is integrated into Part II of this Form 10-K immediately after page 5 - -------------------------------------------------------------------------------- Consolidated Balance Sheets - at July 1, 2006 and July 2, 2005 15-16* - -------------------------------------------------------------------------------- Consolidated Statements of Operations and Comprehensive Income - for the years ended July 1, 2006, July 2, 2005 and July 3, 2004 14* - -------------------------------------------------------------------------------- Consolidated Statements of Cash Flows - for the years ended July 1, 2006, July 2, 2005 and July 3, 2004 17-18* - -------------------------------------------------------------------------------- Consolidated Statements of Stockholders' Equity - for the years ended July 1, 2006, July 2, 2005 and July 3, 2004 19* - -------------------------------------------------------------------------------- Report of Independent Registered Public Accounting Firm 38* - -------------------------------------------------------------------------------- Notes to Consolidated Financial Statements 20-37* - --------------------------------------------------------------------------------
* Page number in the 2006 Annual Report to Shareholders included in Part II of this Form 10-K.
2. Financial Statement Schedules
Page Number - -------------------------------------------------------------------------------- Schedule II Valuation and Qualifying Accounts 22 - -------------------------------------------------------------------------------- All other schedules are omitted because they are not applicable or not required.
3. Exhibits
Exhibit Page Number Description Number - -------------------------------------------------------------------------------- 3 Articles of Incorporation and By-Laws (f) - ------------------------------------------------------------------------------- 10 Material Contracts: - --------------------------------------------------------------------------------
Exhibit Page Number Description Number - -------------------------------------------------------------------------------- A. 1996 Stock Option Plan for Key Employees of Wellco Enterprises, Inc.* (a) - -------------------------------------------------------------------------------- B. 1997 Stock Option Plan for Key Employees of Wellco Enterprises, Inc.* (b) - -------------------------------------------------------------------------------- C. 1997 Stock Option Plan for Non-Employee Directors of Wellco Enterprises, Inc.* (c) - -------------------------------------------------------------------------------- D. 1999 Stock Option Plan for Key Employees of Wellco Enterprises, Inc.* (d) - -------------------------------------------------------------------------------- E. 1999 Stock Option Plan for Non-Employee Directors of Wellco Enterprises, Inc.* (e) - -------------------------------------------------------------------------------- F. Exhibit was filed in Part IV of Form 10-K for the fiscal year ended July 3, 2004 and is incorporated herein by reference. (f) - -------------------------------------------------------------------------------- G. Resignation Agreement and Release of Claims* (h) - -------------------------------------------------------------------------------- H. Employment Agreement* (I) - -------------------------------------------------------------------------------- 14 Code of Conduct and Ethics (g) - -------------------------------------------------------------------------------- 21 Subsidiaries of Registrant 14 - -------------------------------------------------------------------------------- 23 Consent of Expert 15 - -------------------------------------------------------------------------------- 31 Certifications of the Chief Executive Officer and Chief Financial Officer under Section 302 of the Sarbanes-Oxley Act of 2002, filed herewith. 16 - 19 - -------------------------------------------------------------------------------- 32 Certifications of the Chief Executive Officer and Chief Financial Officer under Section 906 of the Sarbanes-Oxley Act of 2002, filed herewith. 20 -21 - --------------------------------------------------------------------------------
* Management Compensation Arrangement/Plan.
Copies of the below listed exhibits may be obtained on written request to Corporate Secretary, Wellco Enterprises, Inc., Box 188, Waynesville, N. C. 28786.
(a) Exhibit was filed as Exhibit A to the Proxy Statement dated October 18, 1996, and is incorporated herein by reference. (b) Exhibit was filed as Exhibit A to the Proxy Statement dated October 17, 1997, and is incorporated herein by reference. (C) Exhibit was filed as Exhibit B to the Proxy Statement dated October 17, 1997, and is incorporated herein by reference. (d) Exhibit was filed as Exhibit A to the Proxy Statement dated October 13, 2000, and is incorporated herein by reference. (e) Exhibit was filed as Exhibit B to the Proxy Statement dated October 13, 2000, and is incorporated herein by reference.
(f) Exhibit was filed in Part IV of Form 10-K for the fiscal year ended July 3, 2004, and is incorporated herein by reference. (g) Exhibit was filed in Part IV of Form 10-K for the fiscal year ended July 3, 2004, and is incorporated herein by reference. (h) Exhibit was filed in Form 8-K dated April 25, 2006, and is incorporated herein by reference. (i) Exhibit was filed in Form 8-K dated March 17, 2006, and is incorporated herein by reference.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Wellco Enterprises, Inc. has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
WELLCO ENTERPRISES, INC.
/s/ Lee Ferguson By: Lee Ferguson, Chief Executive Officer, President (Chief Executive Officer)
/s/ Tammy Francis By: Tammy Francis, Controller and Treasurer (Chief Financial Officer)
Date: September 28, 2006
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:
/s/ George Henson /s/ Rolf Kaufman George Henson, Director Rolf Kaufman, Director
/s/ Lee Ferguson /s/ Claude Abernethy, Jr. Lee Ferguson, Director Claude Abernethy, Jr. Director
/s/ Fred K. Webb, Jr. Fred K. Webb, Jr., Director
Date: September 28, 2006
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To The Board of Directors and Stockholders of Wellco Enterprises, Inc. Waynesville, North Carolina
We have audited the accompanying consolidated balance sheets of Wellco Enterprises, Inc. and subsidiaries (the "Company") as of July 1, 2006 and July 2, 2005 and the related consolidated statements of operations and comprehensive income, stockholders' equity, and cash flows for each of the three years in the period ended July 1, 2006. Our audits also included the financial statement schedule listed in the Index at Item 15(a)(2).These consolidated financial statements and the financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and the schedule 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 consolidated financial statements and schedule are free of material misstatement. We were not engaged to perform an audit of the Company's 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 also includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial 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 financial position of the Company as of July 1, 2006 and July 2, 2005 and the results of their operations and their cash flows for each of the three years in the period ended July 1, 2006 in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole presents fairly, in all material respects, the information set forth therein.
DIXON HUGHES PLLC
Asheville, North Carolina September 28, 2006
Exhibit 21 WELLCO ENTERPRISES, INC. SUBSIDIARIES OF THE REGISTRANT
Percentage of Voting Jurisdiction of Securities Owned by Name of Company Incorporation Immediate Parent - -------------------------------------------------------------------------------- Wellco Enterprises, Inc. North Carolina Registrant - -------------------------------------------------------------------------------- Wholly-Owned Subsidiaries: - -------------------------------------------------------------------------------- Ro-Search, Incorporated North Carolina 100% - -------------------------------------------------------------------------------- Mo-Ka Shoe Corporation Delaware 100% - -------------------------------------------------------------------------------- All of the Registrant's wholly-owned subsidiaries are included in the consolidated financial statements.
Exhibit 23
WELLCO ENTERPRISES, INC. CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
We consent to the incorporation by reference in the Registration Statement No. 1-333-72824 of Wellco Enterprises, Inc. on Form S-8 of our report dated September 28, 2006 appearing in this Annual Report on Form 10-K of Wellco Enterprises, Inc. for the fiscal year ended July 1, 2006.
DIXON HUGHES PLLC
Asheville, North Carolina September 28, 2006
Exhibit 31 WELLCO ENTERPRISES, INC. FORM 10-K FOR THE FISCAL YEAR ENDED JULY 1, 2006 CERTIFICATION OF CHIEF EXECUTIVE OFFICER PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Lee Ferguson, certify that:
1. I have reviewed this annual report on Form 10-K of Wellco Enterprises, Inc.(the registrant);
2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
3 Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
(b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
(C) Disclosed in this report any change in the registrant's internal controls over financial reporting that occurred during the registrant's fourth fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and
5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions):
(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting.
Date: September 28, 2006
/s/ Lee Ferguson By: Lee Ferguson, Chief Executive Officer and President (Chief Executive Officer)
Exhibit 31
WELLCO ENTERPRISES, INC. FORM 10-K FOR THE FISCAL YEAR ENDED JULY 1, 2006 CERTIFICATION OF CHIEF FINANCIAL OFFICER PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Tammy Francis, certify that:
1. I have reviewed this annual report on Form 10-K of Wellco Enterprises, Inc.(the registrant);
2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
3 Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
(b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
(c) Disclosed in this report any change in the registrant's internal controls over financial reporting that occurred during the registrant's fourth fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and
5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions):
(a) All significant deficiencies and material weaknesses in the design or operation of internal
control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting.
Date: September 28, 2006
/s/ Tammy Francis By: Tammy Francis, Controller and Treasurer (Chief Financial Officer)
Exhibit 32
WELLCO ENTERPRISES, INC. FORM 10-K FOR THE FISCAL YEAR ENDED JULY 1, 2006 CERTIFICATION OF CHIEF EXECUTIVE OFFICER PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEYACT OF 2002
I, Lee Ferguson, certify that:
1. I am the chief executive officer of Wellco Enterprises, Inc.
2. Attached to this certification is Form 10-K for the fiscal year ended July 1, 2006, a periodic report (the "periodic report") filed by the issuer with the Securities Exchange Commission pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (the "Exchange Act:), which contains financial statements.
3 I hereby certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that o the periodic report containing the financial statements fully complies with the requirements of Section 13(a) or 15(d) of the Exchange Act, and o the information in the periodic report fairly presents, in all material respects, the financial condition and results of operations of the issuer for the periods presented.
Date: September 28, 2006
/s/ Lee Ferguson By: Lee Ferguson, Chief Executive Officer and President (Chief Executive Officer)
A signed original of this written statement required by Section 906 has been provided to the Company and will be retained by Wellco Enterprises Inc. and furnished to the Securities and Exchange Commission or its staff upon request.
This certification will not be deemed "filed" for purposes of Section 18 of the Securities Exchange Act of 1934, or otherwise subject to the liability of that section. This certification will not be deemed to be incorporated by reference into any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934 even if the document with which it is submitted to the Securities and Exchange Commission is so incorporated by reference.
Exhibit 32
WELLCO ENTERPRISES, INC. FORM 10-K FOR THE FISCAL YEAR ENDED JULY 1, 2006 CERTIFICATION OF CHIEF FINANCIAL OFFICER PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
I, Tammy Francis, certify that:
1. I am the chief financial officer of Wellco Enterprises, Inc.
2. Attached to this certification is Form 10-K for the fiscal year ended July 1, 2006, a periodic report (the "periodic report") filed by the issuer with the Securities Exchange Commission pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (the "Exchange Act:), which contains financial statements.
3 I hereby certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that
o the periodic report containing the financial statements fully complies with the requirements of Section 13(a) or 15(d) of the Exchange Act, and o the information in the periodic report fairly presents, in all material respects, the financial condition and results of operations of the issuer for the periods presented.
Date: September 28, 2006
/s/ Tammy Francis By: Tammy Francis, Controller and Treasurer (Chief Financial Officer)
A signed original of this written statement required by Section 906 has been provided to the Company and will be retained by Wellco Enterprises Inc. and furnished to the Securities and Exchange Commission or its staff upon request.
This certification will not be deemed "filed" for purposes of Section 18 of the Securities Exchange Act of 1934, or otherwise subject to the liability of that section. This certification will not be deemed to be incorporated by reference into any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934 even if the document with which it is submitted to the Securities and Exchange Commission is so incorporated by reference.
SCHEDULE II
WELLCO ENTERPRISES, INC. AND WHOLLY-OWNED SUBSIDIARIES VALUATION ACCOUNTS FOR THE FISCAL YEARS ENDED July 1, 2006, JULY 2, 2005 AND JULY 3, 2004
Balance at Additions Beginning of Charged to Balance at End Description Year Income (A) Deductions(B) of Year Allowance for Doubtful Accounts- - -------------------------------------------------------------------------------- 2006 $37 10 - $47 - -------------------------------------------------------------------------------- 2005 $37 - - $37 - -------------------------------------------------------------------------------- 2004 $28 10 1 $37 - --------------------------------------------------------------------------------
(A) Additions for allowance for doubtful accounts. (B) Write-off of uncollectible accounts.