ITEM 1. BUSINESS:
(a) GENERAL DEVELOPMENT OF BUSINESS:
The Company was incorporated in Minnesota in 1950 for the purpose of performing precision contract machining for the aerospace, communication, and industrial markets. Several years later, the Company focused on providing precision machining services for the computer peripheral market. That segment of business has since declined as a major portion of Company revenues as machining work for agricultural related markets and other markets have been and are expected to be of greater importance to the Company in the future.
As of the close of business on June 30, 1993, the Company sold the business and substantially all of the assets of Advanced Custom Molders, Inc. (ACM) to Moll PlastiCrafters, L.P. ACM was sold primarily because it did not meet profit expectations and because WSI's contract machining business required the attention of all the Company's resources.
On June 27, 1994, the Company announced the consolidation of its manufacturing operations in its Long Lake, Minnesota plant and the closing of its Owatonna, Minnesota plant. The consolidation allowed the Company to reduce expenses and capital employed in the business while optimizing plant capacity and human resources.
On October 5, 1994, the Company announced that it had entered into an agreement for the sale of its Owatonna property to OTC, a division of SPX Corporation. On January 4, 1995, the Company sold its Owatonna, Minnesota real estate to OTC, a division of SPX Corporation, for a total cash consideration of $1,534,000.
Contract manufacturing now constitutes the Company's business.
(b) FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS:
As noted above, the Company's business is now conducted in a single industry segment--contract manufacturing.
(c) NARRATIVE DESCRIPTION OF THE BUSINESS:
(1)(i) The principal products and services of the Company are set forth below.
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. The major markets served by the Company have changed in the past several years because of declining requirements in several mature computer programs and the Company's effort to diversify its customer and market base. Company sales to the computer industry amounted to 14%, 5% and 7% of total sales in fiscal 1996, 1997 and 1998, respectively. Sales to the agricultural industry were 61%, 73% and 76% of total Company sales in fiscal years 1996, 1997 and 1998, respectively. The Company expects that in fiscal 1999 a major portion of its sales will be to the agricultural industry and it will continue diversification efforts to broaden its customer and industry base.
The Company has a reputation as a dependable supplier, one 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.
* * * * *
(ii) The Company's machining business is continually developing or modifying processes, but no new single process in development is expected to require the investment of a material amount of the assets of the Company.
(iii) Purchased materials for the Company are generally available in adequate supply.
(iv) Patents and trademarks are not deemed significant to the Company.
(v) Seasonal patterns in the Company's business are reflections of its customers seasonal patterns since the Company's business is that of a provider of manufacturing services. The Company's customer mix has changed and currently its two major customers each have a one week shutdown near the end of the calendar year and a two week shutdown in the summer. This will affect the Company's production pattern until it gains other business to fill that void.
(vi) The Company does not believe that its business demands unusual working capital requirements.
(vii) Sales in excess of 10 percent of fiscal 1998 consolidated revenues were made to John Deere in the amount of $18,128,000 or 76% of Company revenues.
(viii) Approximate dollar backlog at August 30, 1998, August 31, 1997 and August 25, 1996 was $8,831,000, $6,395,000 and $5,694,000, respectively. Backlog is not deemed to be any more significant for the Company than for other companies engaged in similar businesses. The above backlog amounts are believed to be firm, and no appreciable amount of the backlog as of August 30, 1998 is scheduled for delivery later than during the current fiscal year.
(ix) No material portion of the contract business is subject to renegotiation of profits or termination of contracts or subcontracts at the election of the government.
(x) 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.
(xi) No material amount has been spent on company-sponsored research and development activities.
(xii) No material capital expenditures for environmental control were made or are anticipated in the foreseeable future.
(xiii) At August 30, 1998, the Registrant had 106 employees.
(d) FINANCIAL INFORMATION ABOUT FOREIGN AND DOMESTIC OPERATIONS AND EXPORT SALES:
The Company has no operations in any foreign country. The Company's export sales in fiscal 1998, 1997, and 1996 were not significant. See Note 7 to the Consolidated Financial Statements.
ITEM 2.
ITEM 2. PROPERTIES:
The Company's executive offices and a production facility are located in Long Lake, Minnesota (a western suburb of Minneapolis). The one-story, concrete block building is owned by the Company, contains approximately 182,500 square feet of floor space, and is located on approximately 25 acres of property owned by the Company.
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.
ITEM 3. LEGAL PROCEEDINGS:
Registrant is not a party to any material legal proceedings, other than ordinary routine litigation incidental to its business.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS:
None.
ITEM 4A. EXECUTIVE OFFICERS OF REGISTRANT:
The following table sets forth certain other information regarding Registrant's executive officers:
Mr. Martin was engaged as Chairman of the Board and interim Chief Executive Officer following the resignation of the former Chief Executive Officer on July 28, 1993 until Michael J. Pudil was hired as the Company's President and Chief Executive Officer effective November 4, 1993. Mr. Martin is a director of the Company and previously served as the Company's Chief Executive Officer from December 1983 to January 1985. Mr. Martin was the President, Chief Executive Officer and Chairman of PowCon, Incorporated, a manufacturer of electronic welding systems, from 1987 to October 1995. Mr. Martin now serves as an independent consultant.
Mr. Pudil was elected President, Chief Executive Officer, and a Director of the Company on November 4, 1993. During the prior nine years, Mr. Pudil served as General Manager and Vice President and General Manager of the Production Division for Remmele Engineering, Inc. Remmele Engineering is a contract manufacturer primarily involved in machining metal.
Mr. Sheely joined the Company in September 1998 as Vice President of Finance. From 1996 to 1998 he served as Chief Financial Officer of Graseby Medical, Inc., a medical device manufacturer of volumetric infusion pumps.
Mr. Magnuson has served as Secretary of the Company since 1961 and as a Director since 1962. He is a retired partner of the law firm of Lindquist & Vennum P.L.L.P., Minneapolis, Minnesota.
PART II
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS:
(a) The common stock of the Company is traded on the and NASDAQ National Market System under the symbol WSCI. (c)
COMMON STOCK INFORMATION:
The Company's credit agreement restricts payment of dividends. The Company has not paid any cash dividends since fiscal 1992 and does not anticipate payment of cash dividends in the foreseeable future.
(b) As of November 9, 1998 there were 633 shareholders of record of the Company's Common Stock.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA:
FIVE-YEAR SUMMARY OF OPERATIONS (In thousands, except for per share information and financial ratios)
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION
LIQUIDITY AND CAPITAL RESOURCES:
The Company's working capital of $3,239,000 on August 30, 1998 reflected a slight decrease of $2,000 from the prior year. Larger fluctuations in working capital included an increase in accounts payable and decrease in inventory offset by decreases in current maturities of long-term debt and miscellaneous accrued expenses and an increase in accounts receivable. The fiscal 1998 ratio of current assets to current liabilities increased to 1.94 to 1.0 from 1.90 to 1.0 for fiscal 1997.
Cash provided by operating activities in fiscal 1998 increased to $3,047,000. Net earnings and non-cash charges for depreciation primarily accounted for cash provided by operating activities. Cash provided by operations was $2,610,000 in fiscal 1997 and $1,720,000 in fiscal 1996.
Additions to property, plant and equipment from cash were $2,102,000 in fiscal 1998 compared to $507,000 in 1997 and $1,694,000 in 1996 including $1,309,000 and $885,000 of machinery acquired through capital leases in 1998 and 1996, respectively. The major 1998 capital expenditures consisted of the acquisition of new machinery.
Proceeds from the sale of equipment amounted to $537,000 in fiscal 1997 and $644,000 in fiscal 1996 and primarily resulted from disposition of excess equipment related to completed and discontinued manufacturing programs.
The Company's total debt was $1,161,000 lower at August 30, 1998 than the previous year-end. Term debt owed the bank was paid off in fiscal 1998 while capital lease debt increased $683,000 to $2,511,000 at August 30, 1998.
At August 30, 1998 and August 31, 1997 the Company had available a line of credit of $1,000,000.
It is managements' belief that internally generated funds combined with the line of credit will be sufficient to enable the Company to meet its financial requirements during fiscal 1999.
RESULTS OF OPERATIONS:
Net sales of $23,948,000 decreased $205,000 or .8% from fiscal 1997 sales of $24,153,000 but increased $3,774,000 or 19% from fiscal 1996 sales of $20,174,000. Sales from 1997 to 1998 remained flat as certain manufacturing programs were completed early in fiscal 1998 and thus did not have a full years impact on sales. The primary increase in sales from fiscal 1996 resulted from increased sales in the agribusiness market.
In fiscal 1998, the Company reported net earnings of $1,874,000 or $.73 per share compared to net earnings of $1,584,000 of $.64 per share in 1997 and a net loss of $(367,000) or $(.15) per share in 1996. The net earnings in 1997 included a gain of $410,000 or $.17 per share from the disposition of excess equipment related to completed or discontinued manufacturing programs. The net loss in 1996 included a similar gain of $455,000 or $.18 per share.
The gross margin on parts sold in fiscal 1998 was 18.4% of sales compared to 15.1% of sales and 8.0% of sales in 1997 and 1996, respectively. The increase in gross margin in 1998 can be primarily attributed to cost
reductions related to lower headcount, reduced depreciation expense, and increased manufacturing efficiencies.
Selling and administrative expense of $2,453,000 in fiscal 1998 was an increase of $123,000 and $307,000 from fiscal years 1997 and 1996, respectively. The increase from fiscal 1996 to 1998 was related to performance based compensation, depreciation and maintenance of new computer equipment and increased costs of selling efforts including attendance at trade shows. The increase from fiscal 1997 to 1998 is primarily related to an increased level of purchased services resulting from acquisition related activities.
Interest and other income of $162,000 was $421,000 lower in fiscal 1998 than 1997, and $496,000 lower than 1996 primarily due to the gain on the disposition of excess equipment that occurred in each of those prior years.
Interest and other expense of $190,000 in fiscal 1998 was $96,000 lower than 1997 and $302,000 lower than 1996 because of lower debt levels and lower interest rates.
Income tax expense is significantly less than the statutory amount due to the utilization of net operating loss carryforwards in each of fiscal 1998 and 1997. A valuation allowance was recorded against the benefit of the loss incurred in fiscal 1996 due to the uncertainty of realization.
See Notes to Consolidated Financial Statements regarding recent accounting standards to be adopted.
YEAR 2000 COMPLIANCE:
The Year 2000 issue is the result of computer systems that use two digits rather than four to define the applicable year, which may prevent such systems from accurately processing dates ending in the year 2000 and beyond. This could result in computer system failures or disruption of operations, including, but not limited to, an inability to process transactions, to send and receive electronic data, or to engage in routine business and production activities.
The Company has completed its initial assessment of all currently used computer and network systems as well as its precision machining production equipment and has developed a plan to correct those areas that will be affected by the year 2000 issue. The Company's plan includes replacement or upgrades of certain computer hardware and software. The Company will utilize outside vendors to assist in the upgrade of certain computer systems. For its precision machining equipment, the Company has received written assurance from the equipment manufacturers as to year 2000 compliance of their machines. The Company is also developing a limited testing plan that will test the equipment's ability to maintain operations in the year 2000. The Company estimates that it is 75% complete with respect to its major computer systems and 85% complete with respect to its precision machining equipment in its compliance programs. The Company's goal is to be substantially year 2000 compliant by the end of fiscal 1999.
In addition to reviewing its internal systems, the Company has begun formal communications with its significant vendors concerning Year 2000 compliance. There can be no assurance that the systems of other companies that interact with the Company will be sufficiently Year 2000 compliant so as to avoid an adverse impact on the Company's operations, financial condition and results of operations. The Company does not believe that its products involve any material Year 2000 risks.
The Company presently anticipates that the costs associated with addressing the year 2000 issues compliance will not have a material adverse impact on the Company's financial condition, results of operations or liquidity. Present estimated costs for the Company's compliance programs are less than $25,000.
The Company anticipates that it will complete its Year 2000 assessment and compliance programs by the end of fiscal 1999. However, there can be no assurance the Company will be successful in implementing its programs according to the anticipated schedule. In addition, the Company may be adversely affected by the inability of other companies whose systems interact with the Company to become Year 2000 compliant and by potential interruptions of utility, communication or transportation systems as a result of Year 2000 issues.
Although it expects its internal computer and manufacturing systems to be Year 2000 compliant as described above, the Company intends to prepare a contingency plan that will specify what it plans to do if it or important external companies are not Year 2000 compliant in a timely manner. The Company expects to prepare its contingency plan during calendar year 1999.
CAUTIONARY STATEMENT:
Statements included in this Management's Discussion and Analysis of Financial Condition and Results of Operations, in the letter to shareholders, elsewhere in the Annual Report, in the Company's Form 10-K and in future filings by the Company with the Securities and Exchange Commission, in the Company's press releases and in oral statements made with the approval of an authorized executive officer which are not historical or current facts are "forward-looking statements." These statements are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 and 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 Company wishes to caution readers not to place undue reliance on any such forward-looking statements, which speak only as of the date made. The following important factors, among others, in some cases have affected and in the future could affect the Company's 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) a significant downturn in the industries in which the Company participates, principally the agricultural industry, could have an adverse effect on the demand for Company services. The foregoing list should not be construed as exhaustive and the Company disclaims any obligation subsequently to revise any forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA:
See Consolidated Financial Statements section of this Annual Report on Form 10-K beginning on page 16, attached hereto, which consolidated financial statements are incorporated herein by reference.
QUARTERLY EARNINGS SUMMARY (UNAUDITED):
(a) Includes gain from sale of equipment in the amount of $410,000.
PART III
Pursuant to General Instruction G(3), Registrant omits Part III, Items 10, 11, 12, and 13, except that portion of Item 10
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K:
(a) Documents filed as part of this report:
1. Consolidated Financial Statements: Reference is made to the Index to Consolidated Financial Statements (page 16) hereinafter contained for all Consolidated Financial Statements.
2. Financial Statement Schedules: Schedule II - Valuation and Qualifying Accounts - 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 Page No. Description No. ------- ------------------------------------- ---- 3.1 Articles of Incorporation as amended, incorporated by reference from Exhibit 3.1 of the Registrant's Form 10-K for the year ended August 28, 1994.
3.2 Bylaws, as amended, incorporated by reference from Exhibit 3.2 of the Registrant's Form 10-K for the fiscal year ended August 30, 1987.
10.1 1981 Employee Incentive Stock Option Plan, incorporated by reference from Exhibit 10.3 of Registrant's Form 10-K for the fiscal year ended August 30, 1987.
10.2 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.
10.3 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.
10.4 Washington Scientific Industries, Inc. 1994 Stock Plan, incorporated by reference from Exhibit 10.2 of the Registrant's Form 10-Q for the quarter ended February 26, 1995.
Exhibit Page No. Description No. ------- ------------------------------------- ----- 10.5 Employment Agreement between Michael J. Pudil and Registrant dated November 4, 1993, is corporated by reference from Exhibit 10.4 of Registrant's Form 10K for the fiscal year ended August 28, 1994.
10.6 Amendment dated January 9, 1997 to the employment agreement between the Registrant and Michael J. Pudil incorporated by reference from Exhibit 10 of Registrant's Form 10-Q for the quarter ended February 23, 1997.
10.7 Employment (Change of Control) Agreement between Michael J. Pudil and Registrant dated October 18,
10.8 Amended and Restated Credit and Security Agreement between the Company and FBS Business Finance Corporation dated March 31, 1995, incorporated by reference from Exhibit 10.4 of the Registrant's Form 10-Q for the quarter ended February 26, 1995.
10.9 First Amendment to Amended and Restated Credit and Security Agreement dated April 20, 1995, incorporated by reference from Exhibit 10.1 of the Registrant's Form 10-Q for the quarter ended May 28, 1995.
16 Letter regarding change in certifying accountant incorporated by reference to Exhibit 1 of the Company's Form 8-K dated January 15, 1996.
23.1 Consent of Ernst & Young LLP. 32
27 Financial Data Schedule. 33
(b) Reports on Form 8-K.
None
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.
WASHINGTON SCIENTIFIC 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, 1998
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, 1998 - ----------------------- Director Michael J. Pudil
/s/ Paul Baszucki Director November 20, 1998 - ----------------------- Paul Baszucki
/s/ Melvin L. Katten Director November 20, 1998 - ----------------------- Melvin L. Katten
/s/ Gerald E. Magnuson Director November 20, 1998 - ----------------------- Gerald E. Magnuson
/s/ George J. Martin Director November 20, 1998 - ----------------------- George J. Martin
/s/ Eugene J. Mora Director November 20, 1998 - ----------------------- Eugene J. Mora
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULE
Page
CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Auditors 17 Consolidated Balance Sheets - August 30, 1998 and August 31, 1997 18 Consolidated Statements of Operations - Years Ended August 30, 1998, August 31, 1997 and August 25, 1996 19 Consolidated Statements of Stockholders' Equity - Years Ended August 30, 1998, August 31, 1997, August 25, 1996 20 Consolidated Statements of Cash Flows - Years Ended August 30, 1998, August 31, 1997, August 25, 1996 21 Notes to Consolidated Financial Statements 22
SCHEDULE
Schedule II - Valuation and Qualifying Accounts 31
REPORT OF INDEPENDENT AUDITORS
Board of Directors and Shareholders Washington Scientific Industries, Inc.
We have audited the accompanying consolidated balance sheets of Washington Scientific Industries, Inc. and subsidiaries as of August 30, 1998 and August 31, 1997, and the related consolidated statements of operations, changes in shareholders' equity and cash flows for the years ended August 30, 1998, August 31, 1997 and August 26, 1996. Our audits also included the financial statement schedule listed in the Index at Item 14(a). These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. 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 financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Washington Scientific Industries, Inc. and subsidiaries as of August 30, 1998 and August 31, 1997, and the consolidated results of their operations and their cash flows for the years ended August 30, 1998, August 31, 1997 and August 25, 1996, in conformity with generally accepted accounting principles. Also in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
ERNST & YOUNG LLP
Minneapolis, Minnesota October 2, 1998
WASHINGTON SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS AUGUST 30, 1998 AND AUGUST 31, 1997 - --------------------------------------------------------------------------------
See notes to consolidated financial statements.
WASHINGTON SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS YEARS ENDED AUGUST 30, 1998, AUGUST 31, 1997, AND AUGUST 25, 1996 - -------------------------------------------------------------------------------
See notes to consolidated financial statements.
WASHINGTON SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
See notes to consolidated financial statements.
WASHINGTON SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED AUGUST 30, 1998, AUGUST 31, 1997, AND AUGUST 25, 1996 - --------------------------------------------------------------------------------
See notes to consolidated financial statements.
WASHINGTON SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED AUGUST 30, 1998, AUGUST 31, 1997, AND AUGUST 25, 1996
- ------------------------------------------------------------------------------- 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
FISCAL YEAR - Washington Scientific Industries, Inc. and subsidiaries' (the Company) fiscal years represent a 52- to 53-week period ending the last Sunday in August. Fiscal 1998 and 1996 each consisted of 52 weeks. Fiscal 1997 consisted of 53 weeks.
BASIS OF PRESENTATION - The consolidated financial statements include the accounts of Washington Scientific 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. Cash equivalents are carried at cost plus accrued interest which approximates fair value.
INVENTORIES - Inventories are stated at the lower of cost (first-in, first-out method) or market. Inventory costs consist of material, direct labor, and manufacturing overhead. The Company's inventories are stated net of valuation allowances of approximately $155,000 and $155,000 at August 30, 1998 and August 31, 1997, respectively. Inventories consist primarily of work-in-process.
DEPRECIATION - The cost of buildings and substantially all equipment is being depreciated using the straight-line method. The estimated useful lives of the assets are as follows:
Buildings and improvements 15 to 32 years Machinery and equipment 3 to 10 years Transportation equipment 3 to 5 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. The adoption of this Statement in fiscal 1997 did not have a material impact on the Company's financial position, results of operations or liquidity.
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 upon shipment. The Company performs periodic credit evaluations of its customers' financial condition. Credit losses relating to customers have been minimal and within management's expectations.
USE OF ESTIMATES - The preparation of financial statements in conformity with generally accepted accounting principals 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.
EARNINGS PER SHARE - In February 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 128, Earnings per Share, requiring dual presentation of basic earnings per share and diluted earnings per share. Basic earnings per share is calculated by dividing net income by the weighted average shares outstanding. Diluted earnings per share is calculated by dividing net income by the weighted average diluted shares outstanding, which includes the dilutive effect of options outstanding. SFAS No. 128 was adopted by the Company on August 30, 1998. All earnings per share amounts for all periods have been presented, and where appropriate, restated to conform to SFAS No. 128 requirements.
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.
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS - In June 1997, the FASB issued Statement 130, "Reporting Comprehensive Income." Statement 130 is effective for financial statements for fiscal years beginning after December 15, 1997. This standard defines comprehensive income as the changes in equity of an entity except those resulting from shareholder transactions. All components of comprehensive income are required to be reported in a new financial statement. The adoption of Statement 130 is not expected to have a material effect on the Company's financial statements.
In June 1997, the FASB also issued Statement 131, "Disclosures about Segments of an Enterprise and Related Information." Statement 131 is effective for financial statements for periods beginning after December 31, 1997. Statement 131 establishes standards for disclosures about operating segments, products and services, geographic areas and major customers. The adoption of Statement 131 is not expected to have a material effect on the Company's financial statements.
In February 1998, the FASB issued Statement 132, "Employers Disclosures about Pensions and Other Postretirement Benefits". Statement No. 132 modifies the disclosure requirements for pensions and other postretirement benefits, but does not change the measurement or recognition of those plans. Statement 132 is effective for financial statements for periods beginning after December 15, 1997. The adoption of Statement 132 is not expected to have a material effect on the Company's financial statements.
RECLASSIFICATION - Certain prior year items have been reclassified to conform to the current year presentation.
2. DEBT
Long-term debt consisted of the following:
During fiscal 1997, the Company renegotiated its term debt and its line of credit with the same bank with which the Company previously had its debt and line of credit. The agreement required principal payments of $37,500 per month with the loan balance due at March 31, 2000. At August 30, 1998, the balance of term debt was $0. Interest on the term debt is calculated at the bank's base rate (8.5% at August 30, 1998 and August 31, 1997) plus 1.75%.
Interest on the line of credit is at the bank's base rate plus 0.5 percentage points for August 30, 1998 and August 31, 1997 and expires March 31, 2000. The agreement provides for secured borrowing of up to $1,000,000; however, the Company is charged an annual unused credit line fee of 0.5%. At August 30, 1998, and August 31, 1997 there was no balance outstanding on the line of credit.
Restrictive provisions of the agreement require, among other provisions, that the Company (1) maintain a net worth of not less than $3,000,000, (2) maintain a ratio of liabilities to net worth not greater than 4.0 to 1.0, (3) limit capital expenditures to $3,000,000 in each fiscal year with no more than $1,000,000 coming from its line of credit and (4) maintain a defined cash flow coverage ratio of no less than 1.1 to 1.0. Cash dividends are fully restricted. At August 30, 1998, the Company was in compliance with the various covenants of the credit agreement.
The notes, line of credit and capital leases are collateralized by the receivables, inventories, and property, plant, and equipment of the Company.
3. COMMITMENTS
LEASES - Included in the consolidated balance sheet at August 30, 1998 are cost and accumulated depreciation on equipment subject to capitalized leases of $4,526,435 and $1,826,568, respectively. At August 30 1997, the amounts were $3,175,430 and $1,259,878, respectively.
The present value of the net minimum payments on capital leases as of August 30, 1998 is as follows:
4. 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. At August 30, 1998, 107,666 shares remained reserved and available for grant under the plan.
No shares remain reserved, available for grant or outstanding under the 1981 employee incentive stock option plan at August 30, 1998.
Option transactions during the three years ended August 30, 1998 are summarized as follows:
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 using the Black-Scholes option pricing model with the following assumptions for grants issued during fiscal 1998, fiscal 1997 and fiscal 1996 as set forth in the table below. The estimated fair value of the options is amortized to expense over the options' vesting period.
The Company's net income and income per share would be adjusted to the pro forma amounts as follows:
The pro forma impact is not indicative of future periods, as a result of the phase-in provision of SFAS 123.
As of August 30, 1998, there were 113,000 options outstanding with exercise prices between $2.00 and $2.13, 99,000 options outstanding with exercise prices between $3.50 and $4.75, and 50,000 options outstanding with an exercise price of $5.63. At August 30, 1998, outstanding options had a weighted-average remaining contractual life of 6.3 years.
The number of options exercisable as of August 30, 1998, August 31, 1997 and August 25, 1996 were 199,504, 168,000, and 149,336 respectively, at weighted average share prices of $3.04, $2.60, and $2.28 per share, respectively.
The weighted average fair value of options granted during the years ended August 30, 1998, August 31, 1997, and August 25, 1996 was $2.82, $2.83, and $2.29 per share, respectively.
5. INCOME TAXES
Income tax expense (benefit) consisted of the following:
A reconciliation of the federal income tax provision at the statutory rate with actual taxes provided on (loss) earnings from continuing operations is as follows:
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:
As of August 30, 1998, the Company had federal, Minnesota, and California state income tax net operating loss carryforwards of approximately $2,059,000, $60,000, and $644,000, respectively, of which most will expire in fiscal years 2008 and 2009. Also as of August 30, 1998, the Company had $478,000 in federal alternative minimum tax (AMT) credit carryforward and approximately $46,000 in other credit carryforward. 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.
6. EMPLOYEE BENEFITS
The Company combined its two non-contributory pension plans into one plan effective February 1, 1995, for employees who are at least 21 years of age and have completed at least one year of service. Benefits for the union employees are based on years of service and a pre-established rate in the year of
retirement. Benefits for non-union employees are based on years of service and a percentage of annual compensation in the five years preceding retirement. Plan assets consist primarily of shares of a balanced fund offered by a major regional bank.
Net periodic pension cost consisted of the following:
The funded status of the plans and the amount recognized on the balance sheet are as follows:
The Company's policy is to currently fund an amount to include full current costs and amortization of the unfunded actuarial accrued liability over the expected future service of active participants; however, contributions are not in excess of the maximum allowable tax deduction for the Company. Pension liability amounts expected to be funded under this policy within one year are included in miscellaneous accrued expenses with amounts expected to be funded in periods beyond one year included as long-term liabilities.
The Company has a management incentive compensation plan for certain key employees designated annually by a committee of the Board of Directors. The amount of incentive compensation for eligible participants is contingent on attaining minimum pre-tax earnings.
All employees are eligible to participate in the Company's retirement savings 401(k) plan. The Company matches contributions up to 25% of the first 6% of employee contributions to the plan. Further discretionary contributions are authorized by the Board of Directors. Contributions charged to operations for fiscal 1998, 1997 and 1996, were approximately $51,710, $47,836, and $66,648, respectively.
7. INFORMATION CONCERNING SALES TO MAJOR CUSTOMERS
The Company had sales to five customers which exceeded 10 percent of total sales during any one of fiscal years 1998, 1997 or 1996 as listed below:
8. EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted earnings per share:
WASHINGTON SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS - -------------------------------------------------------------------------------
(1) Receivables determined to be uncollectible are charged against reserves, net of collections on accounts previously written off.
(2) Write-offs of excess or obsolete inventory.
(3) Level of reserve reduced due to management assessment of exposure to potential write-offs.