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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-KSB
[X] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 For the fiscal year ended August 27, 2006 or
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 For the transition period ended from _________ to
_________
Commission File No. 000-00619
WSI INDUSTRIES, INC.
(Exact name of Registrant as specified in its charter)
MINNESOTA 41-0691607
(State or other jurisdiction of incorporation (I.R.S. Employer
or organization) Identification No.)
213 CHELSEA RD
MONTICELLO, MINNESOTA 55362
(Address of principal executing offices) (Zip Code)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (763) 295-9202
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: None
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: __________
COMMON STOCK (PAR VALUE $.10 PER SHARE)
(Title of Class)
Check whether the issuer is not required to file reports pursuant to Section 13
or Section 15(d) of the Exchange Act [ ]
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or such shorter prior
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
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Check if there is no disclosure of delinquent filers pursuant to Item 405 of
Regulation S-B contained in this form, and no disclosure will be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB. [ ]
Indicate by check whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).
Yes No X
----- -----
Issuer's revenues for its most recent fiscal year: $16,091,635 for the fiscal
year ended August 27, 2006.
The aggregate market value of the common shares held by non-affiliates of the
Company on November 7, 2006 was approximately $8,712,000, based upon the closing
sale price on that date of $3.25 as reported by The NASDAQ Capital Market.
Number of shares outstanding of the Company's common stock, par value $0.10 per
share, as of November 20, 2006 is 2,680,630.
DOCUMENTS INCORPORATED BY REFERENCE:
Portions of the Proxy Statement for the Company's Annual Meeting of Shareholders
to be held on January 4, 2007, which will be filed within 120 days after the end
of the fiscal year covered by this report, are incorporated by reference into
Part III of this Form 10-KSB.
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PART I
ITEM 1. DESCRIPTION OF BUSINESS.
WSI Industries, Inc. (the "Company") makes its periodic and current reports
available free of charge as soon as reasonably practicable after such material
is electronically filed with, or furnished to, the Securities and Exchange
Commission. These reports can be obtained by contacting the Company through its
website at www.wsiindustries.com.
OVERVIEW
The Company was incorporated in Minnesota in 1950 for the purpose of performing
precision contract machining for the aerospace, communication, and industrial
markets. The major portions of Company revenues are derived from machining work
for the aerospace/avionics/defense industries, recreational vehicles (ATV and
motorcycle) markets and bioscience industry.
Contract manufacturing constitutes the Company's entire business.
PRODUCTS AND SERVICES
The Company manufactures metal components in medium to high volumes requiring
tolerances as close as one ten-thousandth (.0001) of an inch. These components
are manufactured in accordance with customer specifications using materials
generally purchased by the Company, but occasionally supplied by the customer.
SALES AND MARKETING
The major markets served by the Company have been relatively stable in the past
several years with sales growth coming primarily from the recreational vehicle
market, and more recently in fiscal 2006, the bioscience industry. Sales to the
recreational vehicle market totaled 81%, 84% and 79% of total sales in fiscal
2006, 2005 and 2004, respectively. Sales to the aerospace/avionics/defense
markets totaled 12%, 11% and 14% of total sales in fiscal 2006, 2005 and 2004,
respectively. Sales to the bioscience industry amounted to 4% of total sales in
fiscal 2006, while sales to the biosciences industry accounted for less than 1%
of total sales in fiscal years 2005 and 2004.
The Company has a reputation as a dependable supplier capable of meeting
stringent specifications to produce quality components at high production rates.
The Company has demonstrated an ability to develop sophisticated manufacturing
processes and controls essential to produce precision and reliability in its
products.
SEASONALITY
Seasonal patterns in the Company's business are reflections of the Company's
customers' seasonal patterns since the Company's business is that of a provider
of manufacturing services.
2
CUSTOMERS
Sales in excess of 10 percent of fiscal 2006 consolidated sales were made to
Polaris Industries, Inc. and related entities in the amount of $13,103,000 or
81% of Company revenues for fiscal year 2006.
BACKLOG
Approximate dollar backlog at August 27, 2006, August 28, 2005 and August 29,
2004 was $3,908,000, $3,883,000 and $3,091,000, respectively. Backlog is not
deemed to be any more significant for the Company than for other companies
engaged in similar businesses. The Company believes that the level of backlog is
not necessarily indicative of future yearly sale increases or decreases.
COMPETITION
Although there are a large number of companies engaged in machining, the Company
believes the number of entities with the technical capability and capacity for
producing products of the class and in the volumes manufactured by the Company
is relatively small. Competition is primarily based on product quality, service,
timely delivery, and price.
RESEARCH AND DEVELOPMENT; INTELLECTUAL PROPERTY
No material amount has been spent on company-sponsored research and development
activities. Patents and trademarks are not deemed significant to the Company.
EMPLOYEES
At August 27, 2006, the Company had 62 employees, none of whom were subject to a
union contract. We consider our relationship with our employees to be good.
FOREIGN AND DOMESTIC OPERATIONS AND EXPORT SALES
The Company has no operations in any foreign country. In 2006, 2005 and 2004,
sales to a customer in Mexico amounted to $71,000, $130,000 and $360,000,
respectively.
ITEM 2. DESCRIPTION OF PROPERTY.
The Company purchased an existing 49,000 square foot facility located in
Monticello, Minnesota in May 2004 to house its production and its headquarters.
The purchase price was $1.9 million and was paid for by a combination of cash
and debt. The Company relocated its former production facility located in Osseo,
Minnesota to the Monticello facility. The Osseo building was leased until
February 2005 with monthly rent of approximately $9,600 plus operating expenses
and taxes. The Company was fully relocated by the end of its fiscal 2005 second
quarter.
The Company considers its manufacturing equipment, facilities, and other
physical properties to be suitable and adequate to meet the requirements of its
business.
ITEM 3. LEGAL PROCEEDINGS.
The Company is not a party to any material legal proceedings, other than
ordinary routine litigation incidental to its business.
3
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
The common stock of the Company is traded on The NASDAQ Capital Market of the
NASDAQ Stock Market, Inc. under the symbol "WSCI."
As of November 7, 2006 there were 473 shareholders of record of the Company's
common stock.
The following table sets forth, for the periods indicated, the high and low
closing sales price information for our common stock as reported by the Nasdaq
Capital Market.
Stock Price
-------------
High Low
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FISCAL 2006:
First quarter $4.43 $3.11
Second quarter 3.81 3.09
Third quarter 3.44 3.01
Fourth quarter 3.09 2.66
FISCAL 2005:
First quarter $2.49 $2.13
Second quarter 3.09 2.26
Third quarter 3.20 2.60
Fourth quarter 4.70 2.87
The Company announced a quarterly dividend program in June 2003 and has paid a
quarterly dividend of $0.0375 for each of the fourteen quarters thereafter, with
its most recent dividend paid on November 22, 2006.
4
The following table sets forth information regarding our equity compensation
plans in effect as of August 27, 2006. Each of our equity compensation plans is
an "employee benefit plan" as defined by Rule 405 of Regulation C of the
Securities Act of 1933.
Equity Compensation Plan Information
Number of shares of common
stock remaining available for
Number of shares of common Weighted-average future issuance under equity
stock to be issued upon exercise price of compensation plans (excluding
exercise of outstanding outstanding options, securities reflected in the
Plan category options, warrants and rights warrants and rights first column)
------------- ---------------------------- -------------------- -----------------------------
Equity compensation plans
approved by shareholders:
1994 Stock Plan 231,499 $3.13 --
2005 Stock Plan 83,000 $3.44 117,000
Equity compensation plans not
approved by shareholders -- -- --
Total 314,499 $3.21 117,000
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ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES:
Management's Discussion and Analysis of Financial Condition and Results of
Operations discuss our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States. The preparation of these financial statements requires management
to make estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses and related disclosure of contingent assets
and liabilities.
We believe that the estimates, assumptions and judgments involved in the
accounting policies described below have the greatest potential impact on our
financial statements, so we consider these to be our critical accounting
policies. Because of the uncertainty inherent in these matters, actual results
could differ from the estimates we used in applying the critical accounting
policies. Within the context of these critical accounting policies, we are not
currently aware of any reasonably likely event that would result in materially
different amounts being reported.
Allowance for Excess and Obsolete Inventory:
Inventories, which are composed of raw materials, work in process and finished
goods, are valued at the lower of cost or market by comparing the cost of each
item in inventory to its most recent sales price or sales order price. Any
excess of cost over the net realizable value of inventory components is included
in the allowance for obsolete inventory.
In addition, the Company determines the reserve for excess and obsolete
inventory by analyzing the sales history of its inventory, sales orders on hand
and indications from the Company's customers as to the future of various parts
or programs. If, in the Company's determination, the inventory value has become
impaired, the Company establishes an obsolescence reserve at the amount the
Company estimates as the ultimate net realizable value for that inventory. The
obsolescence reserve remains on the Company's books until the inventory is
disposed of or sold. Actual customer requirements in any future periods are
inherently uncertain and thus may differ from our estimates. If actual or
expected customer requirements were significantly lower than the established
reserves, the Company would record an increase to the obsolescence allowance in
the period in which the Company made such a determination. The Company performs
its lower of cost or market testing as well as its excess or obsolete inventory
analyses, quarterly.
The Company's allowance for obsolete inventory consists of the following at
August 27, 2006 and August 28, 2005:
August 27, 2006 August 28, 2005
--------------- ---------------
Obsolete finished goods $ 87,917 $ 85,853
Obsolete work-in-process 6,900 6,900
Cost exceeding market value 73,965 81,203
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$168,782 $173,956
The Company disposed of a substantial portion of its obsolete inventory during
fiscal 2005. Since the inventory disposed of had been previously reserved for
and thus had minimal net book value, there was no material effect on the gross
margin in the financial statements when the Company disposed of this inventory.
The total quantity disposed amounted to 15% of the gross inventory value. The
Company has no specific timeline to dispose of its remaining obsolete inventory
and intends to sell this obsolete inventory from time to time, as market
conditions allow.
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Goodwill Impairment:
The Company evaluates the valuation of its goodwill according to the provisions
of SFAS 142 to determine if the current value of goodwill has been impaired. The
Company believes that its stock price is not necessarily an indicator of the
Company's value given its limited trading volume and its wide price
fluctuations. The Company follows the guidance provided by SFAS 142 and utilizes
a present value technique to measure fair value by estimating future cash flows.
The major assumptions in this analysis include: (a) sales estimates for the
Company in part provided with guidance from the Company's customers; and (b)
material and labor costs of the Company's major programs. The Company constructs
a discounted cash flow analysis based on these assumptions to estimate the fair
value of the Company (which is the only reporting unit). The result of the
analysis performed in the fiscal 2006 fourth quarter did not show an impairment
of goodwill. If the Company has changes in events or circumstances, including
reductions in anticipated cash flows generated by our operations, goodwill could
become impaired which would result in a charge to earnings.
Deferred Taxes:
The Company accounts for income taxes using the liability method. Deferred
income taxes are provided for temporary difference between the financial
reporting and tax bases of assets and liabilities. A valuation allowance would
be set up should the realization of any deferred taxes become less likely than
not to occur. The valuation allowance is analyzed periodically by the Company
and may result in income tax expense different than statutory rates. The Company
has not established a valuation allowance as it believes it is more likely than
not that it will fully realize the benefit of its tax assets. Currently, the
Company's deferred tax assets have two major components which relate to the
Company's NOL and the Company's AMT tax credit carryforwards. The Company's AMT
tax credit carryforward does not expire. The Company's NOL carryforward has
$112,000 expiring in fiscal year 2009, $415,000 in fiscal 2011 and $3.1 million
expiring in fiscal 2021 and after. The Company believes that its current rate of
growth will be sufficient to fully utilize its NOL carryforwards before they
expire. However, a significant loss of a customer or a change in the Company's
business could affect the realization of the deferred tax assets. If a major
program were discontinued, the Company would immediately assess the impact of
the loss of the program on the realization of the deferred tax assets.
Revenue Recognition:
The Company considers its revenue recognition policy to fall under the guidance
of FASB's conceptual framework for revenue recognition. The Company recognizes
revenue only after: (a) The Company has received a purchase order identifying
price and delivery terms or services to be rendered; (b) shipment has occurred,
or in the case of services, after the service has been completed; (c) the
Company's price is fixed as evidenced by the purchase order; and (d)
collectibility is reasonably assured. The Company continually monitors its
accounts receivable for any delinquent or slow paying accounts. The Company
believes that based upon its past history with minimal bad debt write-offs, that
all accounts are collectible upon shipment or delivery of services. Credit
losses from customers have been minimal and within management's expectations.
Based on management's evaluation of uncollected accounts receivable, bad debts
are provided for on the allowance method. Accounts are considered delinquent if
they are 120 days past due. If an uncollectible account should arise during the
year, it would be written-off at the point it was determined to be
uncollectible. The Company mitigates its credit risk by performing periodic
credit checks and actively pursuing past due accounts. The Company refers to
"net sales" in its consolidated statements of operations as the Company's sales
are sometimes reduced by product returned by its customers.
LIQUIDITY AND CAPITAL RESOURCES:
The Company's net working capital at the end of fiscal 2006 was $2,891,000 as
compared to $2,245,000 at the end of fiscal 2005. The increase was derived
primarily from comparable increases in the three major components of current
assets - cash, accounts receivable and inventory. The ratio of current assets to
current liabilities increased to 2.31 to 1.0 from 2.24 to 1.0 in the prior year.
7
Additions to property, plant and equipment were $469,000 in fiscal 2006 compared
to $551,000 in 2005 and $2,745,000 in 2004. These amounts included $382,000,
$457,000 and $593,000 of machinery acquired through capital leases in fiscal
2006, 2005 and 2004, respectively. Major additions in 2006 were two vertical and
one horizontal machining center. The major addition in fiscal 2005 was a
horizontal machining center. The major addition in fiscal 2004 was the purchase
of the Company's new manufacturing facility located in Monticello, Minnesota.
The purchase price was $1.9 million and was paid for by a combination of
$190,000 in cash and $1,710,000 in mortgages.
On January 1, 2006 the Company renewed its revolving line credit agreement with
its bank. Under the agreement, the Company can borrow up to $1 million depending
on the level of accounts receivable and raw material. The agreement expires on
January 1, 2007. No balances were owed at August 27, 2006 and August 28, 2005.
The Company is currently pursuing a renewal of the line beyond January 1, 2007.
Proceeds from the sale of equipment amounted to $29,000 in fiscal 2006.
The Company's total debt was $3,086,000 at August 27, 2006 that consisted of
mortgages on its building of $1,624,000 and capital lease obligations secured by
production equipment of $1,462,000. Current maturities of long-term debt consist
of $335,000 due on capital leases and $41,000 on its mortgages. It is
management's belief that internally generated funds as well as its revolving
line of credit will be sufficient to enable the Company to meet its financial
requirements during fiscal 2007.
RESULTS OF OPERATIONS:
Net sales in fiscal 2006 were $16.1 million as compared to $15.7 million in the
prior year, or an increase of $437,000 or 2.8%. The increase in fiscal 2006 came
primarily from increased sales in its biosciences market, which did not
contribute to sales in 2005. Net sales in fiscal 2005 were $15.7 million, an
increase of $4.1 million or 36% from fiscal 2004. The primary reason for the
sales increase in 2005 as compared to 2004 was a new program in the Company's
recreational vehicle market. The Company also experienced a general sales
increase from its other programs in its recreational vehicle market.
The following is a reconciliation of sales by major market:
Fiscal 2006 Fiscal 2005 Fiscal 2004
----------- ----------- -----------
Recreational vehicle $13,103,000 $13,193,000 $ 9,107,000
Aerospace and defense 1,972,000 1,734,000 1,546,000
Biosciences 593,000 131,000 95,000
Other 424,000 596,000 777,000
----------- ----------- -----------
$16,092,000 $15,654,000 $11,525,000
=========== =========== ===========
Sales in the recreational vehicle market were slightly lower in fiscal 2006 as
compared to 2005 with lower sales in the Company's all terrain vehicle (ATV)
market offset by increases in its motorcycle market. The recreational vehicle
market sales increased in fiscal 2005 from fiscal 2004 due to a new component in
its motorcycle market that contributed $3.1 million in additional sales. The
market's sales also increased due to a general overall increase in the number of
units shipped.
The Company believes that the increase in sales in its aerospace and defense
market in both fiscal 2006 and 2005 are a result of a general increase in the
level of business as opposed to a significant change in customer or product.
8
In June 2005, the Company announced a partnering arrangement with an existing
customer in the biosciences industry. The increase in sales in fiscal 2006 vs.
2005 and 2004 is a direct result of this arrangement. The overall implementation
of the arrangement has been somewhat slower than the Company's original
expectations; however the Company still anticipates a higher level of business
with this customer in fiscal 2007.
The Company's other market is primarily derived from sales in the small engine
and computer components fields. The decrease in sales from fiscal 2004 through
fiscal 2006 came primarily from the computer components industry due to product
life cycle issues.
The Company reported net income in fiscal 2006 of $573,000 or $.21 per share vs.
the fiscal 2005 amount of $335,000 or $.13 per share. In fiscal 2005, the
Company's income was negatively affected by relocation and second building
expense incurred with the move to its new Monticello, Minnesota facility. The
Company estimated that it incurred $328,000 in costs associated with this
relocation in the first six months of fiscal 2005.
The Company reported net income of $49,000 or $.02 per share in fiscal 2004. The
Company also incurred relocation and second building costs during the last four
months of fiscal 2004 of $239,000.
Gross margins in fiscal 2006 were 17.2%, an increase of .6% over fiscal 2005's
margin of 16.6% and an increase of 3.6% over fiscal 2004's margin of 13.6%. The
slight increase in 2006 margins is attributable primarily to higher volumes of
business, offset by startup costs in the Company's biosciences' programs. The
increase in 2005's margins is also largely attributable to efficiencies gained
due to higher volume partially offset by start-up expenses of the Company's new
program in the recreational vehicle market incurred in fiscal 2004.
No significant sales of obsolete items occurred in fiscal 2004 to 2006 and,
correspondingly, no significant gross margin was recognized.
Selling and administrative expense of $1.7 million in fiscal 2006 was a decrease
of $180,000 from fiscal 2005 and an increase of $335,000 from fiscal 2004. The
decrease in fiscal 2006 vs. 2005 was due to relocation costs incurred in fiscal
2005 partially offset by higher compensation costs. The increase in expense in
fiscal 2005 vs. 2004 was due primarily to higher compensation costs and by
higher relocation costs.
Interest expense of $172,000 in fiscal 2006 was comparable to the fiscal 2005
amount of $173,000 and $80,000 higher than the 2004 amount of $92,000. The
higher expense in fiscal 2006 and 2005 is due primarily to the purchase of the
Monticello, Minnesota facility and related mortgages.
The Company recorded income tax expense at an effective tax rate of 38%, for
fiscal 2006 and 36% for fiscal years 2005 and 2004. The Company maintained its
valuation allowance at zero during 2006.
CAUTION REGARDING FORWARD-LOOKING STATEMENTS
Statements included in this Management's Discussion and Analysis of Financial
Condition and Results of Operations, in the letter to shareholders, elsewhere in
the Annual Report, in the Company's Form 10-KSB and in future filings by the
Company with the Securities and Exchange Commission, in the Company's press
releases and in oral statements made with the approval of an authorized
executive officer which are not historical or current facts are "forward-looking
statements." These statements are made pursuant to the safe harbor provisions of
the Private Securities Litigation Reform Act of 1995. The Company wishes to
caution readers not to place undue reliance on any such forward-looking
statements, which speak only as of the date made and are not predictions of
actual future results. Forward-looking statements are subject to certain risks
and uncertainties that could cause actual results to differ materially from
historical earnings and those presently anticipated or projected. The following
risks and uncertainties, as well as others not now anticipated, in some cases
have affected, and in the future could affect, the Company's
9
actual results and could cause the Company's actual financial performance to
differ materially from that expressed in any forward-looking statement: (i) the
Company's ability to obtain additional manufacturing programs and retain current
programs; (ii) the loss of significant business from any one of its current
customers could have a material adverse effect on the Company; (iii) the Company
was dependent upon one customer for 81% of its revenues in fiscal year 2006 and
expects that a significant portion of its future revenue will be derived from
this customer; (iv) a significant downturn in the industries in which the
Company participates could have an adverse effect on the demand for Company
services; (v) our sales are concentrated in a limited number of highly
competitive industries, each with a limited number of customers; (vi) the prices
of our products are subject to a downward pressure from customers and market
pressure from competitors; (vii) the Company's ability to curtail its costs and
expenses for new manufacturing programs, commensurate with expected revenues;
(viii) the Company's ability to comply with covenants of its credit facility;
(ix) fluctuations in operating results due to, among other things, changes in
customer demand for our product in our manufacturing costs and efficiencies of
our operations; and (x) a trend among our customers toward outsourcing
manufacturing to foreign operations.
ITEM 7. FINANCIAL STATEMENTS.
See Consolidated Financial Statements section of this Annual Report on Form
10-KSB beginning on page 16, attached hereto, which consolidated financial
statements are incorporated herein by reference.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
ITEM 8A. CONTROLS AND PROCEDURES.
DISCLOSURE CONTROLS AND PROCEDURES
The Company's Chief Executive Officer, Michael J. Pudil, and Chief Financial
Officer, Paul D. Sheely, have evaluated the Company's disclosure controls and
procedures as of the end of the period covered by this report. Based upon that
review, they have concluded that these controls and procedures are effective.
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
There have been no changes in internal control financial reporting that occurred
during the fiscal period covered by this report that have materially affected,
or are reasonably likely to materially affect, the Company's internal control
over financial reporting.
ITEM 8B. OTHER INFORMATION.
None.
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PART III
Pursuant to General Instruction G (3), the Company omits Part III, Items 9, 10,
11, 12, and 14, as a definitive proxy statement will be filed with the
Commission pursuant to Regulation 14(a) within 120 days after August 27, 2006
and such information required by such items is incorporated herein by reference
from the proxy statement.
ITEM 13. EXHIBITS.
(a) Documents filed as part of this report.
1. Consolidated Financial Statements: Reference is made to the Index to
Consolidated Financial Statements (page 15) hereinafter contained for
all Consolidated Financial Statements.
2. Financial Statement Schedules:
Schedule II - Valuation and Qualifying Accounts - page 32
Schedules not listed above have been omitted, because they are either
not applicable or not material, or the required information is
included in the financial statements or related notes.
3. Exhibits.
Exhibit
No. Description
------- -----------
3.1 Articles of Incorporation as amended, incorporated by
reference from Exhibit 3 of the Registrant's Form 10-Q for
the quarter ended November 29, 1998.
3.2 Restated and Amended Bylaws, as amended through January 6,
2005, incorporated by reference from Exhibit 3.2 of the
Registrant's Form 10-K for the year ended August 28, 2005.
10.1 1987 Stock Option Plan, incorporated by reference from
Exhibit 10.4 of the Registrant's Form 10-K for the fiscal
year ended August 30, 1987.
10.2 Amendment dated August 31, 1989 to the 1987 Stock Option
Plan, incorporated by reference from Exhibit 10.5 of the
Registrant's Form 10-K for the fiscal year ended August 27,
1989.
10.3 Washington Scientific Industries, Inc. 1994 Stock Plan,
incorporated by reference from Exhibit 4.1 of the
Registrant's Form S-8 as registered on May 14, 1999.
10.4 Employment Agreement between Michael J. Pudil and Registrant
dated November 4, 1993, is incorporated by reference from
Exhibit 10.4 of Registrant's Form 10K for the fiscal year
ended August 28, 1994.
11
10.5 Amendment dated January 9, 1997 to the employment agreement
between the Registrant and Michael J. Pudil incorporated by
reference from Exhibit 10 of the Registrant's Form 10-Q for
the quarter ended February 23, 1997.
10.6 Employment (change in control) Agreement between Michael J.
Pudil and Registrant dated January 11, 2001 incorporated by
reference from Exhibit 10.1 of the Registrant's Form 10-Q
for the quarter ended May 27, 2001.
10.7 Employment (change in control) Agreement between Paul D.
Sheely and Registrant dated January 11, 2001 incorporated by
reference from Exhibit 10.2 of the Registrant's Form 10-Q
for the quarter ended May 27, 2001.
10.8 Amendment No. 1 to Employment (change in control) Agreement
between Michael J. Pudil and Registrant dated November 1,
2002. Incorporated by reference from Exhibit 10.10 of the
Registrant's Form 10-K for the year ended August 25, 2002.
10.9 Amendment No. 1 to Employment (change in control) Agreement
between Paul D. Sheely and Registrant dated November 1,
2002. Incorporated by reference from Exhibit 10.11 of the
Registrant's Form 10-K for the year ended August 25, 2002.
10.10 Board of Directors Retirement Program dated June 25, 1982.
Incorporated by reference from Exhibit 10.12 of the
Registrant's Form 10-K for the year ended August 25, 2002.
10.11 Promissory Note dated as of May 3, 2004 by WSI Industries,
Inc. as debtor and Excel Bank Minnesota as holder in the
original principal amount of $1,360,000. Incorporated by
reference from Exhibit 10.2 of the Registrant's Form 8-K
dated May 3, 2004.
10.12 Loan Agreement dated as of May 3, 2004 between WSI
Industries, Inc. and Excel Bank Minnesota. Incorporated by
reference from Exhibit 10.3 of the Registrant's Form 8-K
dated May 3, 2004.
10.13 Promissory Note dated as of May 3, 2004 by WSI Industries,
Inc. as debtor and Monticello Economic Development Authority
as holder in the original principal amount of $350,000.
Incorporated by reference from Exhibit 10.4 of the
Registrant's Form 8-K dated May 3, 2004.
10.14 Loan Agreement dated as of May 3, 2004 between WSI
Industries, Inc. and the Monticello Economic Development
Authority. Incorporated by reference from Exhibit 10.5 of
the Registrant's Form 8-K dated May 3, 2004.
12
10.15 Mortgage and Security Agreement and Fixture Financing
Statement dated as of May 3, 2004 between WSI Industries,
Inc. and Excel Bank Minnesota. Incorporated by reference
from Exhibit 10.6 of the Registrant's Form 8-K dated May 3,
2004.
10.16 Mortgage dated as of May 3, 2004 between WSI Industries,
Inc. and the Monticello Economic Development Authority.
Incorporated by reference from Exhibit 10.7 of the
Registrant's Form 8-K dated May 3, 2004.
10.17 Second Amendment and Modification of Revolving Line of
Credit Loan Agreement and Reaffirmation of Guaranties dated
as of May 3, 2004 by and among WSI Industries, Inc., Taurus
Numeric Tool, Inc. and WSI Rochester, Inc. and Excel Bank
Minnesota. Incorporated by reference from Exhibit 10.7 of
the Registrant's Form 8-K dated May 3, 2004.
10.18 Third Amendment and Modification of Revolving Line of Credit
Loan Agreement and Reaffirmation of Guaranties dated as of
January 1, 2005 by and among WSI Industries, Inc., Taurus
Numeric Tool, Inc. and WSI Rochester, Inc. and Excel Bank
Minnesota. Incorporated by reference from Exhibit 10.1 of
the Registrant's Form 10-Q for the quarter ended November
28, 2004.
10.19 Fourth Amendment and Modification of Revolving Line of
Credit Loan Agreement and Reaffirmation of Guaranties dated
as of January 1, 2006 by and among WSI Industries, Inc.,
Taurus Numeric Tool, Inc. and WSI Rochester, Inc. and Excel
Bank Minnesota. Incorporated by reference from Exhibit 10.1
of the Registrant's Form 10-QSB for the quarter ended
November 27, 2005.
10.20 WSI Industries, Inc. 2005 Stock Plan, incorporated by
reference from Exhibit 4.1 of the Registrant's Registration
Statement on Form S-8 (SEC File No. 333-133012).
14.1 Code of Ethics & Business Conduct adopted by the Company on
October 29, 2003. Incorporated by reference to Exhibit 14.1
of the Registrant's Annual Report on Form 10-K for the year
ended August 31, 2003.
23.1 Consent of Schechter Dokken Kanter Andrews & Selcer Ltd.
31.1 Certification of Chief Executive Officer pursuant to Rules
13a-14 and 15d-14 of the Exchange Act.
31.2 Certification of Chief Financial Officer pursuant to Rules
13a-14 and 15d-14 of the Exchange Act.
32.1 Certificate pursuant to 18 U.S.C. Section 1350.
13
SIGNATURES
Pursuant to the requirements of Section 13 of the Securities Exchange Act of
1934, the Registrant has duly caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized.
WSI INDUSTRIES, INC.
BY: /s/ Michael J. Pudil
------------------------------------
Michael J. Pudil, President and
Chief Executive Officer
BY: /s/ Paul D. Sheely
------------------------------------
Paul D. Sheely
Vice President and Treasurer
DATE: November 20, 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:
SIGNATURE TITLE DATE
--------- ----- ----
/s/ Michael J. Pudil President, Chief Executive Officer, November 20, 2006
---------------------- Director
Michael J. Pudil
/s/ Paul Baszucki Director November 20, 2006
----------------------
Paul Baszucki
/s/ Melvin L. Katten Director November 20, 2006
----------------------
Melvin L. Katten
/s/ George J. Martin Director November 20, 2006
----------------------
George J. Martin
/s/ Eugene J. Mora Director November 20, 2006
----------------------
Eugene J. Mora
14
INDEX TO
CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULE
PAGE
----
CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Registered Public Accounting Firm 16
Consolidated Balance Sheets - August 27, 2006 and August 28, 2005 17
Consolidated Statements of Income - Years Ended August 27, 2006,
August 28, 2005 and August 29, 2004 18
Consolidated Statements of Stockholders' Equity - Years Ended
August 27, 2006, August 28, 2005 and August 29, 2004 19
Consolidated Statements of Cash Flows - Years Ended August 27, 2006,
August 28, 2005 and August 29, 2004 20
Notes to Consolidated Financial Statements 21
SCHEDULE
Schedule II - Valuation and Qualifying Accounts 32
15
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Shareholders
WSI Industries, Inc.
Monticello, Minnesota
We have audited the consolidated balance sheets of WSI Industries, Inc. and
Subsidiaries as of August 27, 2006 and August 28, 2005 and the related
consolidated statements of income, stockholders' equity and cash flows for each
of the years in the three-year period ended August 27, 2006. Our audits also
included the financial statement schedule listed in the Index at Item 13 (a).
These financial statements and schedule are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements and 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 financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of WSI
Industries, Inc. and Subsidiaries as of August 27, 2006 and August 28, 2005, and
the results of its operations and its cash flows for each of the years in the
three-year period ended August 27, 2006, in conformity with accounting
principles generally accepted in the United States of America. Also in our
opinion, the related financial statement schedule for the three years ended
August 27, 2006, when considered in relation to the basic financial statements
taken as a whole, presents fairly, in all material respects, the information set
forth therein.
/s/ Schechter Dokken Kanter Andrews & Selcer Ltd
Minneapolis, Minnesota
October 23, 2006
16
WSI INDUSTRIES, INC.
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AUGUST 27, 2006 AND AUGUST 28, 2005
2006 2005
----------- -----------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 1,282,717 $ 937,575
Accounts receivable, less allowance for doubtful
accounts of $10,074 2,347,494 1,907,870
Net Inventories (Note 2) 1,223,842 1,017,966
Prepaid and other current assets 115,239 73,252
Deferred tax assets (Note 6) 133,448 121,581
----------- -----------
Total current assets 5,102,740 4,058,244
PROPERTY, PLANT, AND EQUIPMENT, AT COST (NOTES 3 AND 4):
Land 819,000 819,000
Building and improvements 1,209,096 1,195,329
Machinery and equipment 6,989,094 6,723,976
Less accumulated depreciation (5,414,607) (5,028,867)
----------- -----------
Total property, plant, and equipment 3,602,583 3,709,438
DEFERRED TAX ASSETS (NOTE 6) 1,320,940 1,675,506
INTANGIBLE ASSETS (NOTE 10):
Deferred financing costs, net of accumulated
amortization of $15,429 and $8,817, respectively 17,633 24,246
Goodwill and related acquisition costs 2,368,452 2,368,452
----------- -----------
$12,412,348 $11,835,886
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Trade accounts payable $ 1,129,190 $ 881,197
Accrued compensation and employee withholdings 531,537 479,296
Miscellaneous accrued expenses 174,462 142,074
Current portion of long-term debt (Note 3) 376,116 311,030
----------- -----------
Total current liabilities 2,211,305 1,813,597
LONG-TERM DEBT, LESS CURRENT PORTION (NOTE 3) 2,709,768 2,728,456
COMMITMENTS (Note 4)
STOCKHOLDERS' EQUITY (Note 5):
Common stock, par value $.10 a share; authorized
10,000,000 shares; issued and outstanding
2,680,630 shares and 2,672,630, respectively 268,063 267,263
Capital in excess of par value 2,129,167 2,104,289
Retained earnings 5,094,045 4,922,281
----------- -----------
Total stockholders' equity 7,491,275 7,293,833
----------- -----------
$12,412,348 $11,835,886
=========== ===========
See notes to consolidated financial statements.
17
WSI INDUSTRIES, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED AUGUST 27, 2006, AUGUST 28, 2005 AND AUGUST 29, 2004
2006 2005 2004
----------- ----------- -----------
Net sales (Note 8) $16,091,635 $15,654,232 $11,524,835
Cost of products sold 13,326,957 13,053,549 9,963,157
----------- ----------- -----------
Gross margin 2,764,678 2,600,683 1,561,678
Selling and administrative expense 1,741,439 1,921,309 1,406,471
Gain on sale of equipment (29,000) -- --
Interest and other income (44,855) (16,418) (13,689)
Interest expense 172,357 172,626 92,339
----------- ----------- -----------
1,839,941 2,077,517 1,485,121
----------- ----------- -----------
Income before income taxes 924,737 523,166 76,557
Income tax expense (Note 6) 351,400 188,340 27,561
----------- ----------- -----------
Net income $ 573,337 $ 334,826 $ 48,996
=========== =========== ===========
Basic earnings per share $ .21 $ .13 $ .02
=========== =========== ===========
Diluted earnings per share $ .21 $ .13 $ .02
=========== =========== ===========
Cash dividend per share $ .15 $ .15 $ .15
=========== =========== ===========
Weighted average number of common
shares outstanding 2,677,795 2,577,533 2,554,489
=========== =========== ===========
Weighted average number of dilutive
common shares outstanding 2,719,020 2,642,020 2,625,238
=========== =========== ===========
See notes to consolidated financial statements.
18
WSI INDUSTRIES, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
COMMON STOCK CAPITAL IN TOTAL
-------------------- EXCESS OF RETAINED STOCKHOLDERS'
SHARES AMOUNT PAR VALUE EARNINGS EQUITY
--------- -------- ---------- ---------- -------------
BALANCE AT AUGUST 31, 2003 2,551,129 $255,113 $1,826,901 $5,309,581 $7,391,595
Net earnings -- -- -- 48,996 48,996
Exercise of stock options 6,500 650 10,540 -- 11,190
Dividends paid -- -- -- (383,161) (383,161)
--------- -------- ---------- ---------- ----------
BALANCE AT AUGUST 29, 2004 2,557,629 $255,763 $1,837,441 $4,975,416 $7,068,620
Net earnings -- -- -- 334,826 334,826
Exercise of stock options 115,001 11,500 266,848 -- 278,348
Dividends paid -- -- -- (387,961) (387,961)
--------- -------- ---------- ---------- ----------
BALANCE AT AUGUST 28, 2005 2,672,630 $267,263 $2,104,289 $4,922,281 $7,293,833
Net earnings -- -- -- 573,337 573,337
Exercise of stock options 8,000 800 24,878 -- 25,678
Dividends paid -- -- -- (401,573) (401,573)
--------- -------- ---------- ---------- ----------
BALANCE AT AUGUST 27, 2006 2,680,630 $268,063 $2,129,167 $5,094,045 $7,491,275
========= ======== ========== ========== ==========
See notes to consolidated financial statements.
19
WSI INDUSTRIES, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED AUGUST 27, 2006, AUGUST 28, 2005 AND AUGUST 29, 2004
2006 2005 2004
---------- ---------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 573,337 $ 334,826 $ 48,996
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation 576,062 678,956 624,419
Amortization 6,613 6,613 2,204
(Gain) loss on sale of property, plant, and equipment
and other assets (29,000) 1,125 --
Deferred taxes 344,877 188,340 96,501
Changes in assets and liabilities:
(Increase) decrease in:
Accounts receivable (439,624) (150,588) (226,471)
Inventories (205,876) (94,743) (316,961)
Prepaid and other current assets (41,987) 20,142 (17,647)
Increase in accounts payable and accrued expenses 332,622 297,883 266,261
---------- ---------- -----------
Net cash provided by operating activities 1,117,024 1,282,554 477,302
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property, plant, and equipment (87,259) (94,039) (2,151,376)
Proceeds from sale of equipment and other assets 29,000 -- --
---------- ---------- -----------
Net cash used in investing activities (58,259) (94,039) (2,151,376)
CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance of long-term debt -- -- 1,710,000
Payment of long-term debt (335,550) (336,822) (227,344)
Issuance of common stock 23,500 179,077 11,190
Dividends paid (401,573) (387,961) (383,161)
Deferred financing costs -- -- (33,063)
---------- ---------- -----------
Net cash provided by (used in) financing activities (713,623) (545,706) 1,077,622
---------- ---------- -----------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 345,142 642,809 (596,452)
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 937,575 294,766 891,218
---------- ---------- -----------
CASH AND CASH EQUIVALENTS AT END OF YEAR $1,282,717 $ 937,575 $ 294,766
========== ========== ===========
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid during the year for:
Interest $ 172,668 $ 172,940 $ 86,484
Income taxes 3,423 3,100 --
Noncash investing and financing activities:
Acquisition of machinery through capital lease 381,948 456,570 593,355
Deferred tax benefit from exercise of stock options 2,178 99,271 --
See notes to consolidated financial statements.
20
WSI INDUSTRIES, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED AUGUST 27, 2006, AUGUST 28, 2005 AND AUGUST 29, 2004
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Business Description - WSI Industries, Inc. and Subsidiaries' (the Company)
is involved in the precision contract metal machining business primarily
serving the recreational vehicle, aerospace/avionics and bioscience
industries.
Fiscal Year - WSI Industries, Inc.'s fiscal years represent a 52- to
53-week period ending the last Sunday in August. Fiscal 2004, 2005 and 2006
each consisted of 52 weeks.
Basis of Presentation - The consolidated financial statements include the
accounts of WSI Industries, Inc. and its subsidiaries. All material
intercompany balances and transactions have been eliminated.
Cash and Cash Equivalents - Cash and cash equivalents include cash on hand,
bank account balances and money market investments including debt
obligations issued by the U. S. Government or its agencies and corporate
obligations. At times bank balances exceed federally insured limits. Cash
equivalents are carried at cost plus accrued interest which approximates
fair value.
Inventories - Inventory costs determined using the average cost method
consist of material, direct labor, and manufacturing overhead. They are
valued at the lower of cost or market by comparing the cost of each item in
inventory to its most recent sales price or sales order price. Any excess
of cost over the net realizable value of inventory components is included
in the allowance for obsolete inventory.
In addition, the Company determines the reserve for excess and obsolete
inventory by analyzing the sales history of its inventory, sales orders on
hand and indications from the Company's customers as to the future of
various parts or programs. If, in the Company's determination, the
inventory value has become impaired, the Company establishes an
obsolescence reserve at the amount the Company estimates as the ultimate
net realizable value for that inventory. The obsolescence reserve remains
on the Company's books until the inventory is disposed of or sold. Actual
customer requirements in any future periods are inherently uncertain and
thus may differ from our estimates. If actual or expected customer
requirements were significantly lower than the established reserves, the
Company would record an increase to the obsolescence allowance in the
period in which the Company made such a determination. The Company performs
its lower of cost or market testing, as well as its excess or obsolete
inventory analyses, quarterly.
Depreciation - The cost of substantially all machinery and equipment, and
buildings and improvements are being depreciated using the straight-line
method. The estimated useful lives of the assets are as follows:
Machinery and equipment 3 to 10 years
Building and improvements 15 to 40 years
The Company evaluates long-term assets on a periodic basis in compliance
with Statement of Financial Accounting Standards (SFAS) No. 121, Accounting
for the Impairment of Long-lived Assets when indicators of impairment are
present and the undiscounted cash flows estimated to be generated by those
assets are less than the assets carrying amount.
21
Income Taxes - The Company accounts for income taxes using the liability
method. Deferred income taxes are provided for temporary differences
between the financial reporting and tax bases of assets and liabilities.
Revenue Recognition - Revenues from sales of product are recorded generally
upon shipment. The Company considers its revenue recognition policy to fall
under the guidance of FASB's conceptual framework for revenue recognition.
The Company recognizes revenue only after: (a) The Company has received a
purchase order identifying price and delivery terms or services to be
rendered; (b) shipment has occurred, or in the case of services, after the
service has been completed; (c) the Company's price is fixed as evidenced
by the purchase order; and (d) collectibility is reasonably assured. The
Company generally does not require collateral on its trade receivables. The
Company refers to its revenues as "net sales" in its Consolidated
Statements of Operations as the Company's sales are reduced for any product
returned by customers.
In fiscal years 2004 and 2005, the Company had an agreement with a customer
to provide product on a consignment basis. In this case, revenues are
recognized when the customer notifies the Company that it has consumed the
product. This agreement ended during fiscal 2006.
Credit losses relating to customers have been minimal and within
management's expectations. Based on management's evaluation of uncollected
accounts receivable throughout the year, bad debts are provided for on the
allowance method. Accounts are considered delinquent if they are 120 days
past due. The Company mitigates its credit risk by performing credit checks
and actively pursuing past due accounts.
Use of Estimates - The preparation of financial statements in conformity
with U. S. generally accepted accounting principles requires management to
make estimates and assumptions that affect the amounts reported in the
financial statements and accompanying notes. Actual results could differ
from those estimates. Significant estimates made in those financial
statements consist of estimates related to the impairment of goodwill, the
evaluation of excess or obsolete inventory and the valuation allowance
connected to the deferred tax assets.
Earnings per Share - Basic earnings per share is computed using the
weighted average number of common shares outstanding. Diluted earnings per
share is computed using the combination of dilutive common share
equivalents and the weighted average number of common shares outstanding.
Reclassification - Certain prior year Statement of Operation items have
been reclassified to conform to the current year presentation.
Stock Options - The Company has adopted the disclosure-only provisions of
Statement of Financial Accounting Standards (SFAS) No. 123, Accounting for
Stock-Based Compensation, but applies Accounting Principles Board Opinion
No. 25 (APB 25) and related interpretation in accounting for its plans.
Under APB 25, when the exercise price of employee stock options equals the
market price of the underlying stock on the date of grant, no compensation
expense is recognized. In fiscal 2006, 208,000 shares of stock options were
excluded from the diluted earnings per share computation due to their
anti-dilutive effect. In fiscal 2005 and 2004, the number of shares
excluded was 105,000 and 245,000, respectively.
22
Recent Accounting Pronouncements
In December 2004, the FASB issued SFAS No. 123 (R) (revised 2004),
Share-Based Payment, which is a revision of SFAS No. 123, Accounting for
Stock-Based Compensation. SFAS No 123 (R) supersedes APB Opinion No. 25,
Accounting for Stock Issued to Employees, and Amends SFAS No 95, Statement
of Cash Flows. Generally, the approach in SFAS No. 123 (R) is similar to
the approach described in SFAS No. 123. However, SFAS No. 123 (R) requires
all shared-based payments to employees, including grants of employee stock
options, to be recognized in the income statement based on their fair
values. Pro forma disclosure is not an alternative. SFAS No. 123 (R) must
be adopted no later than the first interim period for fiscal years
beginning after December 15, 2005 for small business filers. We expect to
adopt SFAS No. 123 (R) on August 28, 2006, the first day of our fiscal
2007.
SFAS No. 123 (R) permits public companies to adopt its requirements using
one of two methods: a "modified prospective" approach or a "modified
retrospective" approach. Under the modified prospective approach,
compensation cost is recognized beginning with the effective date based on
the requirements of SFAS 123 (R) for all share-based payments granted after
the effective date and the requirements of SFAS No. 123 (R) for all awards
granted to employees prior to the effective date of SFAS No. 123 (R) that
remain unvested on the effective date. The modified retrospective approach
includes the requirements of the modified prospective approach but also
permits entities to restate based on the amounts previously recognized
under SFAS No. 123 for purposes of pro forma disclosures either for all
prior periods presented or prior interim periods of the year of adoption.
We will adopt the modified prospective approach.
As permitted by SFAS No. 123, we currently account for the share-based
payments to employees using APB Opinion No. 25's intrinsic value method
and, as such, generally recognize no compensation cost for employee stock
options. We expect the adoption of SFAS No. 123 (R) to have an unfavorable
effect on our results of operations. If we had adopted SFAS No. 123 (R) in
prior periods, the impact of that standard would have approximated the
impact of SFAS No. 123 as described in Note 5 to our financial statements.
SFAS No. 123 (R) also requires the benefit of tax deductions in excess of
recognized compensation cost to be reported as a financing cash flow,
rather than an operating cash flow under current accounting literature.
Since we do not have the benefit of tax deductions in excess of recognized
compensation cost, because of our net operating loss position, the change
will have no immediate impact on our consolidated financial statements.
In November 2004, the FASB issued Statement of Financial Accounting
Standards No. 151 Inventory Costs - an amendment of ARB No. 43, Chapter 4
("SFAS No. 151") effective for fiscal years beginning after June 15, 2005,
SFAS No. 151 became effective for us on August 29, 2005, the first day of
our fiscal 2006. This Statement amends the guidance in ARB No. 43, Chapter
4, Inventory Pricing, to clarify the accounting for abnormal amounts of
idle facility expense, freight, handling costs, and wasted material
(spoilage). This Statement requires that those items be recognized as
current-period charges. In addition, this Statement requires that
allocation of fixed production overheads to the costs of conversion be
based on the normal capacity of the production facilities. We believe that
the adoption of SFAS No. 151 did not have a material effect on our
financial position or results of operations.
In May 2005, the FASB issued Statement of Financial Accounting Standards
No. 154 Accounting Changes and Error Correction ("SFAS No. 154") effective
for fiscal years beginning after December 15, 2005. SFAS No. 154 replaces
APB Opinion No. 20 and SFAS No. 3 and changes the requirements for the
accounting and reporting of a change in accounting principle. APB 20
previously required that
23
most voluntary changes in accounting principle be recognized by including
in net income of the period of the change the cumulative effect of changing
to the new principle. SFAS No. 154 requires retrospective application to
prior periods' financial statements of changes in accounting principle,
unless it is impracticable to determine either the period-specific effects
or the cumulative effect of the change. We do not expect the adoption of
SFAS No. 154 to have a significant effect on our financial position or
results of operations.
In June 2006, the FASB issued FASB Interpretation (FIN) No 48, Accounting
for Uncertainty in Income Taxes an Interpretation of FASB Statement No.
109. FIN 48 prescribes a comprehensive model for how a company should
recognize, measure, present, and disclose in its financial statements
uncertain tax positions that the company has taken or expects to take on a
tax return. FIN 48 states that a tax benefit from an uncertain position may
be recognized if it is "more likely than not" that the position is
sustainable, based on its technical merits. The tax benefit of a qualifying
position is the largest amount of tax benefit that is greater than 50
percent likely of being realized upon ultimate settlement with a taxing
authority having full knowledge of all relevant information. The Company
currently recognizes a tax position if it is probable of being sustained.
FIN 48 is effective for fiscal years beginning after December 15, 2006. The
Company will be required to adopt this interpretation in the first quarter
of fiscal year 2008. Management is currently evaluating the requirements of
FIN No. 48.
2. INVENTORIES
Inventories consist primarily of raw material, work-in-process (WIP) and
finished goods. The following table breaks out the values in each category
net of the inventory valuation allowances of $168,782 and $173,956 at
August 27, 2006 and August 28, 2005, respectively:
August 27, 2006 August 28, 2005
--------------- ---------------
Raw material $ 569,799 $ 335,798
WIP 380,521 338,219
Finished goods 273,522 343,949
---------- ----------
$1,223,842 $1,017,966
========== ==========
3. DEBT
Long-term debt consists of the following:
August 27, 2006 August 28, 2005
--------------- ---------------
Mortgages $1,623,677 $1,662,992
Capitalized lease obligations (Note 4) 1,462,207 1,376,494
---------- ----------
3,085,884 3,039,486
Less current portion 376,116 311,030
---------- ----------
Long-term debt $2,709,768 $2,728,456
========== ==========
The Company purchased land and a building located in Monticello, Minnesota
in May 2004. In connection with the purchase, the Company entered into two
mortgages. The first mortgage was with its bank for $1,360,000 that matures
on May 1, 2014. The mortgage has an initial interest rate of 5.37% with a
provision that the rate will adjust on May 3, 2009 to a rate 2.5% above the
monthly yield on United States Treasury five-year securities. The mortgage
requires monthly principal and interest payments of $8,307 based on a
25-year amortization schedule. The mortgage is secured by all assets of the
Company.
24
The Company also entered into a mortgage with the City of Monticello
Economic Development Authority (MEDA). The MEDA mortgage is subordinated to
the bank mortgage, carries an interest rate of 2% and matures May 1, 2009.
The mortgage also requires monthly principal and interest payments of
$1,483 based on a 25-year amortization schedule.
Maturities of long-term debt are as follows:
Fiscal years ending August:
2007 $ 376,116
2008 372,177
2009 562,153
2010 258,700
2011 246,981
Thereafter 1,269,757
Line of Credit:
The Company renewed its revolving credit agreement with its bank on January
1, 2006. Under the agreement, the Company can borrow up to $1 million, with
the loan being collateralized by all assets of the Company. The agreement
expires January 1, 2007 and has restrictive provisions requiring minimum
net worth, current and debt service coverage ratios as well as a maximum
ratio of debt to tangible net worth. At August 27, 2006, the Company was in
compliance with these provisions. Interest on any amounts borrowed under
the agreement would be at the bank's base rate (8.25% at August 27, 2006).
There were no amounts outstanding related to its revolving credit agreement
at August 27, 2006 and August 28, 2005, respectively.
4. COMMITMENTS
Leases - Included in the consolidated balance sheet at August 27, 2006 are
cost and accumulated depreciation on equipment subject to capitalized
leases of $3,267,100 and $1,873,698 respectively. At August 28, 2005, the
amounts were $2,875,836 and $1,556,802, respectively. The leases carry
interest rates from 6.1% to 8.4% and mature from 2008 - 2013.
25
The present value of the net minimum payments on capital leases as of
August 27, 2006 is as follows:
Fiscal years ending August:
2007 $ 429,070
2008 398,941
2009 276,631
2010 258,195
2011 228,626
Thereafter 144,858
----------
Total minimum lease payments 1,736,321
Less amount representing interest 274,114
----------
Present value of net minimum lease payments 1,462,207
Current portion 335,005
----------
Capital lease obligation, less current portion $1,127,202
==========
The Company leased a facility in Osseo, Minnesota under an operating lease
that expired in February 2005 for a monthly base rent of $9,640. Operating
expenses and real estate taxes were paid by the Company.
The Company also leased a storage facility under an operating lease that
expired in November 2004 for a monthly rent of $2,013.
Rent expense of approximately $1,000, $58,000 and $143,000 have been
charged to operations for the years ended August 27, 2006, August 28, 2005
and August 29, 2004, respectively.
5. STOCK OPTIONS
Stock Options - In fiscal 1988, the 1987 stock option plan was approved and
175,000 shares of common stock were reserved for granting of options to
officers, key employees, and directors. No shares remain available for
grant from this plan since the term of grant is limited to ten years from
the date of the plan.
In fiscal 1995, the 1994 stock option plan was approved and 250,000 shares
of common stock were reserved for granting of options to officers, key
employees, and directors. During fiscal 1999, the plan was amended to
reserve an additional 200,000 shares. The Plan expired on September 29,
2004 and therefore no shares remain to be granted.
In fiscal 2006, the Company's shareholders approved the 2005 stock option
plan and 200,000 shares of common stock were reserved for granting of
options to officers, key employees and directors. The Plan has a term of 10
years and will expire in 2015.
Stock options that are granted vest over a period of six months to three
years for all stock option plans.
26
Option transactions during the three years ended August 27, 2006 are
summarized as follows:
1987 Stock 1994 Stock 2005 Stock
Option Plan Option Plan Option Plan
---------------- ------------------ ------------------
Average Average Average
Shares Price Shares Price Shares Price
------ ------- -------- ------- -------- -------
Outstanding at August 31, 2003 9,000 $3.04 328,000 $ 2.78
Granted -- 65,000 2.75
Lapsed -- (14,000) 4.17
Exercise (4,000) 2.00 (2,500) 1.28
------ ----- -------- -------
Outstanding at August 29, 2004 5,000 3.88 376,500 2.68
Lapsed -- (10,000) 3.94
Exercised -- (115,001) 1.28
------ -------- -------
Outstanding at August 28, 2005 5,000 3.88 251,499 3.14
Granted -- -- 83,000 $3.44
Lapsed (5,000) 3.88 (12,000) 3.76 --
Exercised -- (8,000) 2.94 --
------ ----- -------- ------- ------ -----
Outstanding at August 27, 2006 -- $ -- 231,499 $ 3.13 83,000 $3.44
====== ===== ======== ======= ====== =====
The following pro forma information has been determined as if the Company
had accounted for its stock options under the fair value method of SFAS
123. The fair value for these options was estimated at the date of grant in
fiscal 2006 and 2004 using the Black-Scholes option pricing model with the
following assumptions as set forth in the table below. The estimated fair
value of the options is amortized to expense over the options' vesting
period.
Date of Grant in fiscal - 2006 2004
------------------------- ---------- ----------
Dividend yield 5.0% 5.5%
Expected volatility 70.12% 76.29%
Risk free interest rate 4.75%-4.77% 3.4%-4.2%
Expected term 5-10 years 5-10 years
There were no options granted in fiscal 2005.
27
The Company's net income and income per share would be adjusted to the pro
forma amounts as follows:
Years ended
---------------------------------------------------
August 27, 2006 August 28, 2005 August 29, 2004
--------------- --------------- ---------------
Net Income (loss):
As reported $573,337 $334,826 $ 48,996
Less: Total Stock based compensation
expense determined under fair value
based method for all awards (51,864) (23,466) (76,098)
-------- -------- --------
Pro forma $521,473 $311,360 $(27,102)
Income (loss) per basic common share:
As reported $ .21 $ .13 $ .02
Pro forma $ .19 $ .12 $ (.01)
Income per diluted common share:
As reported $ .21 $ .13 $ .02
Pro forma $ .19 $ .12 $ (.01)
As of August 27, 2006, there were 46,833 options outstanding with exercise
prices between $1.22 and $1.44, 84,666 options outstanding with exercise
prices between $2.00 and $2.94, 118,000 shares with exercise prices between
$3.00 and $3.88 and 65,000 options outstanding with exercise prices between
$4.13 and $5.50. At August 27, 2006, outstanding options had a
weighted-average remaining contractual life of 5 years.
The number of options exercisable as of August 27, 2006, August 28, 2005
and August 29, 2004 were 256,501, 232,416 and 319,500, respectively, at
weighted average share prices of $3.16, $3.22, and $2.79 per share,
respectively.
6. INCOME TAXES
Income tax expense (benefit) consisted of the following:
Years Ended
------------------------------------
August 27, August 28, August 29,
2006 2005 2004
---------- ---------- ----------
Current:
Federal $ -- $ -- $(68,940)
State 6,523 -- --
-------- -------- --------
6,523 -- (68,940)
Deferred:
Federal 332,905 177,877 94,501
State 11,972 10,463 2,000
-------- -------- --------
344,877 188,340 96,501
-------- -------- --------
Total $351,400 $188,340 $ 27,561
======== ======== ========
A reconciliation of the federal income tax provision at the statutory rate
with actual taxes provided on earnings from continuing operations is as
follows:
28
Years Ended
------------------------------------
August 27, August 28, August 29,
2006 2005 2004
---------- ---------- ----------
Ordinary federal income tax statutory rate 34.0% 34.0% 34.0%
State income taxes net of federal tax effect 2.0 2.0 2.6
Other 2.0 -- (.6)
---- ---- ----
Taxes provided 38.0% 36.0% 36.0%
==== ==== ====
Deferred income taxes are provided for the temporary differences between
the financial reporting and tax bases of the Company's assets and
liabilities. Temporary differences, net operating loss carryforwards, and
valuation allowances comprising the net deferred taxes on the balance sheet
are as follows:
August 27, 2006 August 28, 2005
--------------- ---------------
DEFERRED TAX ASSETS
Accrued liabilities $ 50,006 $ 43,136
Inventory valuation accruals 60,762 64,117
Net operating loss carryforwards 1,266,061 1,542,366
Tax credit carryforwards 459,324 459,324
Other 160,507 183,953
---------- ----------
1,996,660 2,292,896
DEFERRED TAX LIABILITIES
Tax depreciation and amortization greater than book (542,272) (495,809)
---------- ----------
Net Deferred Tax Asset $1,454,388 $1,797,087
========== ==========
The Company determined that it was more likely than not that it will be
able to generate taxable income in the future to offset these deductions
and carryforwards.
As of August 27, 2006, the Company had federal net operating loss
carryforwards of approximately $3.6 million expiring in 2009-2025. Also as
of August 27, 2006, the Company had $454,000 in federal alternative minimum
tax (AMT) credit carryforward that has no expiration. The AMT credits are
available to offset future tax liabilities only to the extent that the
Company has regular tax liabilities in excess of AMT tax liabilities.
7. EMPLOYEE BENEFITS
The Company maintains a 401(k) profit sharing and retirement savings plan
that all employees are eligible to participate in. Contributions charged to
operations for profit sharing and 401(k) matching contributions for fiscal
2006, 2005, and 2004, were $175,595, $155,529 and $88,788, respectively.
29
8. INFORMATION CONCERNING SALES TO MAJOR CUSTOMERS
The Company had sales to one customer that exceeded 10 percent of total
sales during fiscal years 2006, 2005 and 2004 as listed below:
2006 2005 2004
----------- ----------- ----------
$13,103,000 $13,193,000 $9,107,000
The Company had accounts receivable from its largest customer of $1,734,000
and $1,421,000 at August 27, 2006 and August 28, 2005, respectively.
9. EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted
earnings per share:
2006 2005 2004
---------- ---------- ----------
Net Income $ 573,337 $ 334,826 $ 48,996
========== ========== ==========
Denominator for earnings per share:
Weighted average shares;
denominator for basic earnings
per share 2,677,795 2,577,533 2,554,489
Effect of dilutive securities;
employee and non-employee options 41,225 64,487 70,749
---------- ---------- ----------
Dilutive common shares;
denominator for diluted earnings
per share 2,719,020 2,642,020 2,625,238
========== ========== ==========
Basic income per share $ .21 $ .13 $ .02
========== ========== ==========
Dilutive income per share $ .21 $ .13 $ .02
========== ========== ==========
30
10. GOODWILL AND INTANGIBLE ASSETS
Goodwill and other intangible assets consist of costs resulting from
business acquisitions which total $2,368,452 (net of accumulated
amortization of $344,812 recorded prior to the adoption of SFAS No. 142
Goodwill and Other Intangible Assets). The Company assesses the valuation
or potential impairment of its goodwill by utilizing a present value
technique to measure fair value by estimating future cash flows. The
Company constructs a discounted cash flow analysis based on various sales
and cost assumptions to estimate the fair value of the Company (which is
the only reporting unit). The result of the analysis performed in the
fiscal 2006 fourth quarter did not show an impairment of goodwill. The
Company will analyze goodwill more frequently should changes in events or
circumstances, including reductions in anticipated cash flows generated by
our operations, occur.
The Company recorded $33,063 of deferred financing costs incurred in
connection with the mortgages described in Note 3. The costs are being
amortized over five years on a straight-line basis with the Company
incurring approximately $6,600 of amortization expense for each of the
years August 27, 2006 and August 28, 2005, respectively.
31
WSI INDUSTRIES, INC. AND SUBSIDIARIES
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
BALANCE AT ADDITIONS BALANCE AT
BEGINNING CHARGED TO END OF
DESCRIPTION OF PERIOD COST AND EXPENSES DEDUCTIONS PERIOD
----------------------------- ---------- ----------------- ---------- ----------
Reserves deducted from assets
to which it applies:
ALLOWANCE FOR DOUBTFUL
ACCOUNTS:
Year ended August 29, 2004 $ 10,735 $ 0 $ 661 $ 10,074
======== ======= ======== ========
Year ended August 28, 2005 $ 10,074 $ 0 $ 0 $ 10,074
======== ======= ======== ========
Year ended August 27, 2006 $ 10,074 $ 0 $ 0 $ 10,074
======== ======= ======== ========
ALLOWANCE FOR EXCESS OR
OBSOLETE INVENTORY:
Year ended August 29, 2004 $422,930 $ 0 $ 13,681 $409,249
======== ======= ======== ========
Year ended August 28, 2005 $409,249 $31,890 $267,183 $173,956
======== ======= ======== ========
Year ended August 27, 2006 $173,956 $13,455 $ 18,629 $168,782
======== ======= ======== ========
The deduction in fiscal 2005 resulted from the disposal of obsolete inventory.
The deductions in 2004 and 2006 were primarily from sales of obsolete inventory.
32