FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(X) QUARTERLY REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF
1934
FOR THE QUARTERLY PERIOD ENDED: MARCH 28, 1998
COMMISSION FILE NUMBER: 1-5555
WELLCO ENTERPRISES, INC.
(Exact name of registrant as specified in charter)
NORTH CAROLINA 56-0769274
(State of Incorporation) (I.R.S. Employer Identification No.)
150 Westwood Circle, P.O. Box 188, Waynesville, NC 28786
(Address of Principal Executive Office)
Registrant's telephone number, including area code 828-456-3545
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No .
1,163,246 shares of $1 par value common stock were outstanding on May 12, 1998.
-1-
<PAGE>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
WELLCO ENTERPRISES, INC.
CONSOLIDATED FINANCIAL STATEMENTS FILED WITH FORM 10-Q
FOR THE FISCAL QUARTER ENDED MARCH 28, 1998
The attached unaudited financial statements reflect all adjustments which are,
in the opinion of management, necessary to reflect a fair statement of the
financial position, results of operations, and cash flows for the interim
periods presented. All significant adjustments are of a normal recurring nature.
-2-
<PAGE>
WELLCO ENTERPRISES, INC.
CONSOLIDATED BALANCE SHEETS
MARCH 28, 1998 AND JUNE 28, 1997
(in thousands)
ASSETS
<TABLE>
<CAPTION>
(unaudited)
MARCH 28, JUNE 28,
1998 1997
--------- --------
<S> <C> <C>
CURRENT ASSETS:
Cash ........................................ $ 7 $ 181
Receivables (Note 6) ........................ 3,664 4,926
Inventories-
Finished goods ......................... 3,953 2,551
Work in process ........................ 2,249 2,647
Raw materials .......................... 3,431 2,479
-------- --------
Total .................................. 9,633 7,677
Deferred taxes and prepaid expenses ......... 290 347
-------- --------
Total ....................................... 13,594 13,131
-------- --------
MACHINERY LEASED TO LICENSEES
(less accumulated depreciation of
$1,498 and $1,483) .......................... 21 36
PROPERTY, PLANT AND EQUIPMENT:
Land ........................................ 107 107
Buildings ................................... 1,076 774
Machinery and equipment ..................... 3,588 2,797
Furniture and automobiles ................... 697 610
Leasehold improvements ...................... 63 63
-------- --------
Total cost .................................. 5,531 4,351
Less accumulated depreciation and
amortization ............................. (3,208) (3,038)
-------- --------
Net ......................................... 2,323 1,313
-------- --------
INTANGIBLE ASSETS:
Excess of cost over net assets of
subsidiary at acquisition ................ 228 228
Intangible pension asset .................... 511 511
-------- --------
Total ....................................... 739 739
DEFERRED TAXES ................................... 433 433
-------- --------
TOTAL ............................................ $ 17,110 $ 15,652
======== ========
</TABLE>
See Notes to Consolidated Financial Statements.
-3-
<PAGE>
WELLCO ENTERPRISES, INC.
CONSOLIDATED BALANCE SHEETS
MARCH 28, 1998 AND JUNE 28, 1997
(in thousands)
LIABILITIES AND STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
(unaudited)
MARCH 28, JUNE 28,
1998 1997
--------- --------
<S> <C> <C>
CURRENT LIABILITIES:
Short-term borrowing from bank (Note 2) ....... $ 2,500 $ 1,687
Accounts payable .............................. 2,608 2,064
Accrued compensation .......................... 962 1,062
Accrued pension ............................... 75 133
Accrued income taxes .......................... 115 357
Other liabilities ............................. 326 375
Current maturity of note payable .............. 146 107
-------- --------
Total ................................. 6,732 5,785
-------- --------
LONG-TERM LIABILITIES:
Pension obligation ............................ 1,759 1,759
Notes payable (Note 3) ........................ 867 1,030
CONTINGENCIES (Note 7 )
STOCKHOLDERS' EQUITY (Note 3):
Common stock, $1.00 par value ................. 1,163 1,151
Additional paid-in capital .................... 192 119
Retained earnings ............................. 7,019 6,430
Pension liability adjustment .................. (622) (622)
-------- --------
Total ................................. 7,752 7,078
-------- --------
TOTAL .............................................. $ 17,110 $ 15,652
======== ========
</TABLE>
See Notes to Consolidated Financial Statements.
-4-
<PAGE>
WELLCO ENTERPRISES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE FISCAL NINE MONTHS ENDED
MARCH 28, 1998 AND MARCH 29, 1997
(in thousands except per share and number of shares)
<TABLE>
<CAPTION>
(unaudited)
MARCH 28, MARCH 29,
1998 1997
--------- ---------
<S> <C> <C>
REVENUES (Note 5) ............................ $ 18,764 $ 12,229
----------- -----------
COSTS AND EXPENSES:
Cost of sales and services .............. 17,798 10,011
General and administrative expenses ..... 1,508 1,588
----------- -----------
Total ................................... 19,306 11,599
----------- -----------
CONTRACT CLAIM (Note 6) ...................... 980 --
----------- -----------
OPERATING INCOME ............................. 438 630
NET INTEREST EXPENSE (Note 3) ................ (133) (75)
----------- -----------
INCOME BEFORE INCOME TAXES ................... 305 555
PROVISION FOR INCOME TAXES ................... 89 140
----------- -----------
NET INCOME ................................... $ 216 $ 415
=========== ===========
BASIC EARNINGS PER SHARE
based on weighted average number of
shares outstanding) (Note 1) ............ $ 0.19 $ 0.37
=========== ===========
Shares used in computing basic
earnings per share ...................... 1,160,374 1,123,961
=========== ===========
DILUTED EARNINGS PER SHARE based on
weighted average number of shares
outstanding and dilutive stock
options) (Note 1) ...................... $ 0.18 $ 0.36
=========== ===========
Shares used in computing diluted
earnings per share ...................... 1,190,311 1,151,235
=========== ===========
</TABLE>
See Notes to Consolidated Financial Statements.
-5-
<PAGE>
WELLCO ENTERPRISES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE FISCAL THREE MONTHS ENDED
MARCH 28, 1998 AND MARCH 29, 1997
(in thousands except per share and number of shares)
<TABLE>
<CAPTION>
(unaudited)
MARCH 28, MARCH 29,
1998 1997
--------- ---------
<S> <C> <C>
REVENUES (Note 5) ............................ $ 5,162 $ 2,501
----------- -----------
COSTS AND EXPENSES:
Cost of sales and services .............. 5,046 2,008
General and administrative expenses ..... 458 538
----------- -----------
Total ................................... 5,504 2,546
----------- -----------
CONTRACT CLAIM (Note 6) ...................... 980 --
----------- -----------
OPERATING INCOME (LOSS) ...................... 638 (45)
NET INTEREST EXPENSE (Note 3) ............... (46) (56)
----------- -----------
INCOME (LOSS) BEFORE INCOME TAXES ............ 592 (101)
PROVISION (BENEFIT) FOR INCOME TAXES ......... 158 (10)
----------- -----------
NET INCOME (LOSS) ............................ $ 434 $ (91)
=========== ===========
BASIC EARNINGS PER SHARE
based on weighted average number of
shares outstanding) (Note 1) ............ $ 0.37 $ (0.08)
=========== ===========
Shares used in computing basic
earnings per share ...................... 1,163,193 1,125,591
=========== ===========
DILUTED EARNINGS PER SHARE based on
weighted average number of shares
outstanding and dilutive stock
options) (Note 1) ...................... $ 0.37 $ (0.08)
=========== ===========
Shares used in computing diluted
earnings per share ...................... 1,181,168 1,125,591
=========== ===========
</TABLE>
See Notes to Consolidated Financial Statements.
-6-
<PAGE>
WELLCO ENTERPRISES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE FISCAL NINE MONTHS ENDED
MARCH 28, 1998 AND MARCH 29, 1997
(in thousands)
<TABLE>
<CAPTION>
(unaudited)
MARCH 28, MARCH 29,
1998 1997
--------- ---------
<S> <C> <C>
CASH FLOWS FROM OPERATING
ACTIVITIES:
Net income ...................................... $ 216 $ 415
------- -------
Adjustments to reconcile net income
to net cash provided (used)
Depreciation and amortization .............. 303 234
(Increase) decrease in-
Accounts receivable ................... 1,262 2,527
Inventories ........................... (1,956) (5,390)
Other current assets .................. 57 28
Increase (decrease)in-
Accounts payable ...................... 544 125
Accrued liabilities ................... (100) (8)
Accrued income taxes .................. (242) (54)
Pension obligation .................... (58) (52)
Other ................................. (49) 39
------- -------
Total adjustments ............................... (239) (2,551)
------- -------
NET CASH PROVIDED BY (USED IN)
OPERATING ACTIVITIES ............................ (23) (2,136)
------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of plant and equipment ................ (1,298) (333)
------- -------
NET CASH PROVIDED BY (USED IN)
INVESTING ACTIVITIES ........................... (1,298) (333)
------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net borrowings under short-term agreements ...... 813 2,190
Proceeds from bank note payable ................. 400 --
Principal payments of bank note payable ......... (35) --
Cash dividends paid ............................. (116) (112)
Exercise of stock options ....................... 85 13
------- -------
NET CASH PROVIDED BY (USED IN)
FINANCING ACTIVITIES ............................ 1,147 2,091
------- -------
NET DECREASE IN CASH ................................. (174) (378)
CASH AT BEGINNING OF PERIOD .......................... 181 673
------- -------
CASH AT END OF PERIOD ................................ $ 7 $ 295
======= =======
-7-
<PAGE>
WELLCO ENTERPRISES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE FISCAL NINE MONTHS ENDED
MARCH 28, 1998 AND MARCH 29, 1997
(in thousands)
(unaudited)
MARCH 28, MARCH 29,
1998 1997
--------- ---------
<S> <C> <C>
SUPPLEMENTAL DISCLOSURE OF CASH
FLOW INFORMATION:
Cash paid for-
Interest ...................................... $ 97 $ 25
Income taxes .................................. 131 193
Noncash increase (decrease) in note payable ........ (489) 829
===== =====
</TABLE>
See Notes to Consolidated Financial Statements.
-8-
<PAGE>
WELLCO ENTERPRISES, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
FOR THE FISCAL NINE MONTHS ENDED
MARCH 28, 1998
(in thousands except number of shares)
(unaudited)
<TABLE>
<CAPTION>
Common Stock Additional
Par Paid-In Retained
Shares Value Capital Earnings
-------------------------------------------------
<S> <C> <C> <C> <C>
BALANCE AT JUNE 28, 1997 1,150,646 $ 1,151 $ 119 $ 6,430
Net income for the
fiscal nine months
ended March 28, 1998 216
Adjustment of note payable
issued for stock
repurchase (Note 3) 489
Exercise of stock options 12,600 12 73
Cash dividend declared
($.10 per share) (116)
-------------------------------------------------
BALANCE AT MARCH 28, 1998 1,163,246 $ 1,163 $ 192 $ 7,019
=================================================
Pension
Liability
Adjustment
----------
<S> <C>
BALANCE AT JUNE 28, 1997 $ (622)
Change for the fiscal nine
months ended
March 28, 1998 -
-----------
BALANCE AT MARCH 28, 1998 $ (622)
===========
</TABLE>
See Notes to Consolidated Financial Statements.
-9-
<PAGE>
WELLCO ENTERPRISES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE FISCAL NINE MONTHS ENDED MARCH 28, 1998
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Earnings Per Share Data
In February 1997 the Financial Accounting Standards Board issued
the Statement of Financial Accounting Standards (SFAS) No. 128,
"Earnings per Share" effective for financial statements issued
for periods ending after December 15, 1997. This Statement
requires companies to present basic earnings per share and
diluted 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. As required by SFAS No. 128, all
earnings per share data has been restated for all periods
presented.
The following is the reconciliation of the numerators and
denominators of the basic and diluted EPS computations:
For the Nine Months Ended 3-28-98
Income Shares Per-Share
(Numerator)(Denominator) Amount
Basic EPS
Income available to
shareholders $216,000 1,160,374 $0.19
Effect of Dilutive Securities
Stock-based compensation
arrangements 29,937
Diluted EPS
Income available to
shareholders $216,000 1,190,311 $0.18
For the Nine Months Ended 3-29-97
Income Shares Per-Share
(Numerator)(Denominator) Amount
Basic EPS
Income available to
shareholders $415,000 1,123,961 $0.37
Effect of Dilutive Securities
Stock-based compensation
arrangements 27,274
Diluted EPS
Income available to
shareholders $415,000 1,151,235 $0.36
-10-
<PAGE>
For the Three Months Ended 3-28-98
Income Shares Per-Share
(Numerator)(Denominator) Amount
Basic EPS
Income available to
shareholders $434,000 1,163,193 $0.37
Effect of Dilutive Securities
Stock-based compensation 17,975
arrangements
Diluted EPS
Income available to
shareholders $434,000 1,181,168 $0.37
For the Three Months Ended 3-29-97
Income Shares Per-Share
(Numerator)(Denominator) Amount
Basic EPS
Loss available to
shareholders $(91,000) 1,125,591 $(0.08)
Effect of Dilutive Securities
Stock-based compensation
arrangements
Note: Zero shares included due
to loss in the three months
ended March 29, 1997
Diluted EPS
Loss available to
shareholders $(91,000) 1,125,591 $(0.08)
2. LINES OF CREDIT:
During the second quarter of the 1998 fiscal year, the Company increased
its bank line of credit from $1,500,000 to $2,000,000. In addition, during
the third quarter, a bank granted a promissory note in the amount of
$500,000 due and payable in full on May 22, 1998. At March 28, 1998
borrowings on the bank line of credit and the promissory note were
$2,500,000.
In April 1998 the Company increased its bank line of credit to $4,000,000
and paid off the $500,000 promissory note due in May 1998. The increased
line, which expires December 31, 1998, can be renewed annually at the
bank's discretion. This line of credit is secured by a blanket lien on all
machinery and equipment (carrying value of $1,710,000) and all
non-governmental accounts receivable and inventory ($ 2,355,000).
The bank credit agreement contains, among other provisions, defined levels
of net worth and current ratio requirements and the Company was not in
compliance with the current ratio loan covenant at March 28, 1998. The
Company has received from the bank a waiver regarding this loan covenant
violation.
-11-
<PAGE>
3. NOTES PAYABLE:
Stock Repurchase Note Payable-
This note payable represents the present value of the future payments that
may be made, if enforceable, related to Wellco's repurchase of 510,424
shares of its common stock from its former majority shareholder on
December 29, 1995. Payments under the note will only be made for amounts
by which 60% of each fiscal year's net income exceeds certain defined
amounts, calculated on a cumulative basis, and applying to fiscal years
1997 through 2002. The amount of each estimated payment, discounted at a
rate of 8.5%, is shown in the following table:
<TABLE>
<CAPTION>
Paid in
Fiscal Year Amount
- ----------- ------
<S> <C>
2001 $ 63,136
2002 231,276
2003 354,719
--------
Total $ 649,131
=========
</TABLE>
During the third quarter of the 1998 fiscal year, the Company revised its
estimate of the amount that might be paid because of the decreased profits
for the fiscal year. This decreased the Note Payable as shown in the
Consolidated Balance Sheet and increased Retained Earnings by $489,000.
Bank Note Payable-
Also, in September 1997, the Company began construction of a warehouse
addition adjoining its existing facilities in Waynesville, North Carolina,
at an estimated cost of $400,000. The warehouse was almost complete at
March 28, 1998. A bank had provided a 3-year term loan which is payable in
monthly installments of $12,125 plus interest at the bank's prime rate and
$364,000 was outstanding at March 28, 1998. The installments of long-term
debt maturing in each of the four fiscal years are: 1998 - $26,000, 1999 -
$145,000, 2000 - $145,000 and 2001 - $48,000.
4. YEAR 2000 DATE CONVERSION:
The Company recognizes the need to ensure its operations will not be
adversely impacted by Year 2000 software failures. Software failures due
to processing errors potentially arising from calculations using the Year
2000 date are a known risk. The Company is addressing this risk to the
availability and integrity of financial systems and the reliability of
operational systems. The Company primarily uses packaged software running
on personal computers, and does not use mainframes. The Company has
received assurances from their suppliers of software that their
software will be compatible with the Year 2000 date and the costs
will not be material. The total cost of compliance and its effect on the
Company's future results of operations is not expected to be significant.
-12-
<PAGE>
5. GOVERNMENT BOOT CONTRACT REVENUES:
Revenues in the nine-month period ended March 28, 1998 include $53,000
representing the estimated amount of contract change orders that have not
as yet been negotiated with the government. Any differences between the
estimates and the actual amounts negotiated will be recorded in the period
in which negotiations are completed.
6. CONTRACT CLAIM:
In April 1998 Wellco executed an Agreement with the Defense Supply Center
Philadelphia (DSCP), an agency of the U.S. Department of Defense to whom
the Company sells combat boots. The agreement provides that DSCP will
reimburse the Company for certain costs incurred related to contract
performance during the fourth fiscal quarter of the 1997 fiscal year and
the first two fiscal quarters of the 1998 fiscal year. Wellco maintained
that it was due reimbursement for costs incurred in performing in
accordance with a prior DSCP interpretation of the contract. This
interpretation was later changed to the detriment of Wellco.
Wellco must substantiate that the costs were reasonable and were incurred
in order to maximize its performance under the prior interpretation. The
Agreement provides that Wellco will be reimbursed these costs immediately
after receipt and review by DSCP and any disagreement will be subject to
binding arbitration. In return the Company will forego its right to file
suit for damages for recoupment of costs incurred for reliance on its
interpretation of the contract. The cost reimbursement is limited to
$1,000,000. After reduction for certain costs related to reaching this
Agreement, $980,000 was recorded in the March 28, 1998 period. Any
difference between the amount recorded and the actual amount received for
this claim will be recorded in the period in which this claim is settled.
Wellco only recently completed documentation of its claim, and will file
it shortly.
7. CONTINGENCIES :
In April 1997, the Company was served with a subpoena issued by a grand
jury empaneled in the United States District Court for the Eastern
District of Pennsylvania which requires the production of certain
documents for the period January 1, 1990 until April 29, 1997. The
subpoena was subsequently modified to provide that the initial production
of documents would start with documents dated January 1, 1993. In October,
1997, Wellco completed this initial document production by submitting more
than 200,000 documents. In March, 1998 the Company's counsel was notified
that certain documents from January 1, 1990 until December 31, 1992 should
also be provided. In April 1998 more than 25,000 additional documents were
submitted. The Company has been informed through its legal counsel that
the grand jury is investigating possible violations of antitrust laws
primarily involving alleged collusive activities among manufacturers of
combat boots for the U. S. government. The Company believes that this
investigation includes all U. S. manufacturers of combat boots for the U.
S. government. The Company is cooperating in this investigation, does not
believe it has engaged in any illegal conduct and does not believe that
this matter will have a material adverse effect on the Company's financial
position or results of future operations. However, the Company cannot
predict what the final outcome of this matter will be.
In 1988, the Company and the other military combat boot manufacturers
responded to subpoenas which investigated possible violation of antitrust
laws involving bids submitted on military combat boot procurements for
January 1, 1979 through May 6, 1988. This investigation was closed in
February, 1992 and no legal action of any kind resulted from it.
In addition, in March 1998 the Company was served with a civil action
complaint from Shoe Sale, Incorporated relating to certain sub-contracting
work performed. The complaint alleges the Company
-13-
<PAGE>
shipped defective product to their contractor, Multinational, who in turn
contracted with the plaintiff. The Company's counsel has responded to this
civil action. Management believes this complaint is without merit and will
not materially affect the Company's consolidated financial position.
-14-
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
RESULTS OF OPERATIONS
Comparing The Nine Months Ended March 28, 1998 and March 29, 1997
- ------------------------------------------------------------------
For the nine months ended March 28, 1998, Wellco had an operating income of
$438,000 compared to an operating income of $630,000 in the prior year nine
month period ended March 29, 1997. The current period income includes a $980,000
non-recurring income item representing the accrual of a claim under an agreement
with the Defense Supply Center Philadelphia (DSCP), an agency of the U.S.
Department of Defense to whom the Company sells combat boots.
In April 1998 Wellco executed an Agreement with DSCP. The Agreement provides
that DSCP will reimburse the Company for certain costs incurred related to
contract performance during the fourth fiscal quarter of the 1997 fiscal year
and the first two fiscal quarters of the 1998 fiscal year. Wellco maintained
that it was due reimbursement for costs incurred in performing in accordance
with a prior DSCP interpretation of the contract.
This interpretation was later changed to the detriment of Wellco.
Wellco must substantiate that the costs were reasonable and were incurred in
order to maximize its performance under the prior interpretation. The Agreement
provides that Wellco will be reimbursed these costs immediately after receipt
and review by DSCP and any disagreement will be subject to binding arbitration.
In return the Company will forego its right to file suit for damages for
recoupment of costs incurred for reliance on its interpretation of the contract.
The cost reimbursement is limited to $1,000,000. After reduction for certain
costs related to reaching this Agreement, $980,000 was recorded in the March 28,
1998 period. Any difference between the amount recorded and the actual amount
received for this claim will be recorded in the period in which this claim is
settled. Wellco only recently completed documentation of its claim, and will
file it shortly.
Revenues increased $6,535,000 in the nine months ended March 28, 1998, primarily
because of shipments under two new boot contracts. On February 25, 1997 Wellco
was awarded a contract from DSCP to supply the Intermediate Cold/Wet boot (ICW).
On June 25, 1997, Wellco was awarded a contract to supply the new Infantry
Combat Boot/Marine Corps (ICB). Wellco had not previously made these boots, and
their sale is not reflected in the prior year nine month period. As is often the
case when entering the manufacture of new products, margins on both the ICB and
ICW boots are less than those on the Direct Molded Sole (DMS) boots historically
supplied by Wellco to DSCP. In addition, pairs of DMS boots sold to DSCP
decreased 24% for the reason discussed later. The current period was also
adversely affected by start-up costs incurred in the initial production of the
Infantry Combat Boot (ICB).
-15-
<PAGE>
The ICB contract required that Wellco, within 90 days after contract award,
manufacture and have in inventory a significant quantity of this boot. At the
end of this 90 period, the contract also required Wellco to have the capacity to
quickly deliver orders for this boot to all Marine recruit induction centers and
major Marine clothing stores. This 90 day period compares to a normal "make
ready" time in government boot contracts of 165 days or longer.
The ICB boot has several technologies and manufacturing methods which are
significantly different than those in the DMS boot. During this 90 day period,
Wellco rearranged its production lines, purchased and installed significant new
manufacturing equipment, hired and trained new employees, tested new materials,
and developed many new manufacturing procedures and methods. If time had
permitted, this should have been done with small trial production runs. With
only 90 days, Wellco had to simultaneously do all of this and reach full
production without the benefit and efficiencies of trial production runs.
ICB boot start-up costs, estimated to be approximately $800,000, were charged
against operating income in the nine months ended March 28, 1998. In addition to
labor inefficiencies in training new employees, significant overtime premiums
were paid. Bonuses were paid to direct labor personnel for meeting production
quotas. Instead of using ocean freight, expensive air freight costs were
incurred to send materials to the Company's plant in Puerto Rico and then to
send completed boot uppers to the North Carolina plant for bottoming and
finishing. Because the 90 day period did not give enough time to develop
manufacturing procedures and methods using small trial production runs,
significant material losses were incurred. Production quantities of materials
were purchased and processed. Some materials did not perform as expected
resulting in boots whose value is less than cost.
The start-up of ICB production proved to be more expensive than initially
anticipated. Management's judgement is that, if Wellco had included an adequate
amount of start-up costs in its bid prices, those prices would have been so much
higher than the prices of other bidders that Wellco would not have received the
contract award.
On April 15, 1997, Wellco and three other contractors were awarded DMS combat
boot contracts from DPSC for the one year period starting April 15, with options
for each of the ensuing four years. These are indefinite quantity contracts
under which each contractor is guaranteed receiving delivery orders for a
minimum number of pairs and DSCP can order up to a stated maximum number of
pairs. Wellco's award is for 25% of total combat boot purchases, with the other
three contractors receiving 35%, 20% and 20% of total purchases. DPSC had
estimated award to be in December, 1996, and Wellco substantially completed
shipments under its prior contract in that month. Instead of ceasing combat boot
manufacturing operations from January, 1997
-16-
<PAGE>
to contract award, Wellco continued to manufacture and inventory boots in
anticipation of a contract award.
This resulted in Wellco having a significant inventory of combat boots at the
date of contract award, and in Wellco being the only contractor which was in
position to start shipping immediately upon contract award. During the fourth
quarter of the 1997 fiscal year and continuing into part of the quarter ended
September 27, 1997, Wellco was allowed to accelerate its first year shipments.
Starting in late October, 1997, when Wellco was very close to having shipped its
guaranteed minimum pairs, DPSC significantly reduced Wellco's orders. This was
done to give the other three contractors delivery orders for their guaranteed
minimum pairs. Wellco understood that once the guaranteed minimum pairs had been
purchased from each contractor, addition pairs would be bought. This did not
occur. Therefore, DMS boot shipments to DSCP were significantly reduced in the
last two months of the fiscal quarter ended December 27, 1997 and in all of the
fiscal quarter ended March 28, 1998.
Forward Looking Information:
ICB boot production costs have been reduced significantly from those incurred in
earlier production. Wellco is continuing to improve its manufacturing methods
which should further lower this boot's cost.
On February 20, 1998 DSCP exercised it's first year option on the ICW boot.
However, the issuance of delivery orders has been delayed because of an excess
supply of this boot in government depots.
On April 10, 1998 DSCP exercised it's first option on the DMS boot for the one
year period April 15, 1998 to April 15, 1999, with Wellco's option being for 25%
of total DMS pairs purchased during this period. For several years, DSCP has
been reducing its inventory of DMS boots held at depots. In late February, 1998,
DSCP meet with all DMS boot contractors informing them that DSCP depot
inventories had not decreased as much as estimated. Out of this meeting came a
contract modification reducing the total guaranteed minimum pairs to be
purchased by DSCP during the first option. For Wellco, this is a reduction in
the minimum pairs from 155,000 to 125,000 pairs. The price per pair for the
first 155,000 pairs during the first option was increased to compensate for the
reduced pairs. DSCP has expressed their intent, without giving a binding
commitment, to purchase more than the minimum pairs if their total usage in the
first option year exceeds 900,000 pairs. Boot usage in the year ended April 15,
1998 was between 1,100,000 and 1,200,000. The maximum quantity that can be
purchased from Wellco in the first year option is 263,706. During the first year
of this contract, which ended April 15, 1998, Wellco shipped 175,000 pairs and
an additional one-time 59,000 pairs of the Desert boot used by the government as
war reserve stock. Shipments under the first option started April 20, 1998.
-17-
<PAGE>
The resumption of DMS boot shipments and additional reductions in ICB boot
production costs will have a favorable affect on the results of Wellco's
operations. While the significant ICB boot excess costs have had a major
negative affect on operating results, management's believes that this boot,
although requiring several changes, will be one of the combat boots of the
future.
See Note 4 to the Consolidated Financial Statements for information about the
Company's Year 2000 conversion. See Note 7 to the Consolidated Financial
Statements for information about a subpoena served on the Company in April, 1997
and other legal matters.
Except for historical information, this Form 10-Q includes forward looking
statements that involve risks and uncertainties, including, but not limited to,
the receipt of contracts and delivery orders from the U. S. government and the
performance thereunder, the ability to control costs under fixed price
contracts, the cancellation of contracts, and other risks detailed from time to
time in the Company's Securities and Exchange Commission filings, including Form
10-K for the year ended June 28, 1997. Actual results may differ materially from
management expectations.
Comparing The Three Months Ended March 28, 1998 and March 29, 1997
- --------------------------------------------------------------------
For the fiscal quarter ended March 28, 1998, Wellco had an operating profit of
$638,000 compared to an operating loss of $45,000 in the prior year fiscal
quarter ended March 29, 1997. The March 28, 1998 quarter includes the $980,000
claim accrual mentioned above.
Revenues in the current year quarter increased $2,661,000. As with the nine
month period, this increase was caused by sales in the current quarter of the
ICB and ICW boot which were not in the prior year quarter. Sales of DMS boots to
DSCP were negligible in the prior year because award of the current DMS contract
was delayed from December, 1996 until April 15, 1998. Sales to DSCP of DMS boots
increased by 18,000 pairs in the current quarter, primarily because of shipments
of the one-time Desert boot war reserve stock. However, for the reasons stated
earlier, total pairs of DMS boots shipped in the current quarter was
significantly less than the total shipped in typical prior quarters.
ICB boot start-up costs, estimated to be approximately $100,000, were charged
against operating income in the March, 1998 quarter. The Company continued to
incur excess costs, primarily related to labor inefficiencies. Labor operations
are presently undergoing a detailed function and cost study, which should result
in a cost reduction.
-18-
<PAGE>
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 the most recent fiscal nine months
and the last fiscal year the availability of cash from the Company's most liquid
assets and from its existing borrowing sources:
<TABLE>
<CAPTION>
(in thousands)
March 28, 1998 June 28, 1997
-------------- -------------
<S> <C> <C>
Cash ......................................... $ 7 $ 181
Unused Lines of Credit ....................... 0 2,813
------ ------
Total ........................................ $ 7 $2,994
====== ======
</TABLE>
The following table summarizes the major sources (uses) of cash for the nine
months ended March 28, 1998:
<TABLE>
<CAPTION>
(in thousands)
March 28, 1998
--------------
<S> <C>
Net Income Plus Depreciation .................................... $ 519
Net Change in Accounts Receivable, Inventories,
Accounts Payable, Accrued Liabilities, and Accrued
Income Taxes .................................................... (492)
Other ........................................................... (50)
Net Cash Used By Operations ..................................... (23)
Net Cash Provided by a Line of Credit ........................... 813
Cash Provided by Bank Note Payable .............................. 400
Cash Used for Payments of Bank Note Payable ..................... (35)
Cash Used to Purchase Plant and Equipment ....................... (1,298)
Cash Dividends Paid ............................................. (116)
Cash Provided By Exercise of Stock Options ...................... 85
Net Decrease in Cash ........................................... $ (174)
</TABLE>
-19-
<PAGE>
As stated in the Results of Operations section, Wellco accelerated shipments of
combat boots in the fourth quarter of the 1997 fiscal year, which resulted in a
significant increase in accounts receivable at June 28, 1997. A $1,262,000
reduction in accounts receivable, additional net bank borrowings of $1,178,000
and $519,000 of net income plus depreciation were the primary sources of cash
for a $1,956,000 increase in inventory and $1,298,000 additional investment in
plant and equipment.
Equipment purchases for production of the new ICB boot and the construction of a
new warehouse caused the amount of cash used for additional plant and equipment
for the nine months ended March 28, 1998 to be much greater than normal. The
increased investment in inventory was caused by the manufacture of two new
boots, ICB boot and ICW boot, and by a new government requirement contracting
procedure that effectively requires contractors to maintain substantial finished
boot inventory for quick shipment direct to customers. The new warehouse was
needed to meet the space needs caused by the new contracting procedure. The cost
of the new warehouse is approximately $400,000, which is being financed by a
three year bank loan.
In addition to a $1,500,000 unsecured line of credit which has been available
for many years, Wellco's bank provided a second $3,000,000 secured line of
credit which was used to finance the build up in combat boot inventories during
the period of delay in awarding the April 15, 1997 DMS boot contract and the
subsequent increase in accounts receivable as Wellco accelerated its shipments
after contract award. The bank's commitment to provide this second line expired
on September 24, 1997. At that time the bank increased the original $1,500,000
to $2,000,000.
During the quarter ended March 28, 1997 Wellco's bank provide an additional
$500,000 through a short term note. In April 1998 the bank increased the line of
credit to $4,000,000, with $500,000 being used to pay off the short term note.
The increased line, which expires December 31, 1998, can be renewed annually at
the bank's discretion.
As discussed in Results of Operations section, the resumption of DMS boot
shipments and additional reductions in ICB boot production costs will improve
cashflows from operations. The resumption of DMS boot shipments and reduced
production will decrease our investment in inventory. Also, investment in
property, plant and equipment should return to a more normal amount. The
combination of these actions taken should result in improved cash liquidity.
The Company has no other material commitments for capital equipment. The Company
does not know of any
-20-
<PAGE>
other demands, commitments, uncertainties, or trends that will result in or that
are reasonablely likely to result in its liquidity increasing or decreasing in
any material way.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
The Company does not have any derivative financial instruments, other financial
instruments, or derivative commodity instruments that requires disclosures.
-21-
<PAGE>
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.
See Note 5 to the Consolidated Financial Statements in Part I of
this Form 10-Q.
Item 2. Changes in Securities. N/A
Item 3. Defaults Upon Senior Securities. N/A
Item 4. Submission of Matters to a Vote of Security Holders. N/A
Item 5. Other Information. N/A
Item 6. Exhibits and Reports on Form 8-K.
a). Exhibits: None
b). Reports on Form 8-K: None
-22-
<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Wellco Enterprises, Inc., Registrant
\s\ \s\
David Lutz, President and Treasurer Tammy Francis, Controller
May 14, 1998
-23-
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM
THE FINANCIAL STATEMENTS FOR THE THIRD QUARTER 10-Q, PERIOD ENDED MARCH
28, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL
STATEMENTS.
</LEGEND>
<CIK> 0000105532
<NAME> WELLCO ENTERPRISES, INC.
<MULTIPLIER> 1,000
<CURRENCY> U.S. COLLARS
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> JUN-27-1998
<PERIOD-START> JUN-29-1997
<PERIOD-END> MAR-28-1998
<EXCHANGE-RATE> 1
<CASH> 7
<SECURITIES> 0
<RECEIVABLES> 3,722
<ALLOWANCES> 58
<INVENTORY> 9,633
<CURRENT-ASSETS> 13,594
<PP&E> 7,050
<DEPRECIATION> 4,706
<TOTAL-ASSETS> 17,110
<CURRENT-LIABILITIES> 6,732
<BONDS> 867
0
0
<COMMON> 1,163
<OTHER-SE> 6,589
<TOTAL-LIABILITY-AND-EQUITY> 18,764
<SALES> 19,744
<TOTAL-REVENUES> 20,724
<CGS> 19,306
<TOTAL-COSTS> 19,306
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 305
<INCOME-TAX> 89
<INCOME-CONTINUING> 216
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 216
<EPS-PRIMARY> 0.19
<EPS-DILUTED> 0.18
</TABLE>
