UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D. C. 20549 FORM 10-Q (Mark One) X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE --- ACT OF 1934 For the quarterly period ended February 29, 2004 ------------------------------------------------- OR TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE --- ACT OF 1934 For the transition period from to -------------------- --------------------------- Commission File Number 0-619 --------------------------------------- WSI Industries, Inc. -------------------------------------------------------------------------------- (Exact name of registrant, as specified in its charter) Minnesota 41-0691607 -------------------------------------------------------------------------------- (State or other jurisdiction of (I. R. S. Employer incorporation of organization) Identification No.) Osseo, Minnesota 55369 -------------------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) (763) 428-4308 -------------------------------------------------------------------------------- (Registrant's telephone number, including area code) -------------------------------------------------------------------------------- (Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ------ Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes No X --------- ------- APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. 2,553,629 Common Shares were outstanding as of February 29, 2004. WSI INDUSTRIES, INC. AND SUBSIDIARIES INDEX Page No. ------- PART I FINANCIAL INFORMATION: Item 1. Financial Statements Condensed Consolidated Balance Sheets February 29, 2004 (Unaudited) and August 31, 2003 3 Condensed Consolidated Statements of Operations Thirteen and Twenty-Six weeks ended February 29, 2004 and February 23, 2003 (Unaudited) 4 Condensed Consolidated Statements of Cash Flows Twenty-Six weeks ended February 29, 2004 and February 23, 2003 (Unaudited) 5 Notes to Condensed Consolidated Financial Statements (Unaudited) 6, 7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 8, 9, 10 Item 4. Controls and Procedures 10 PART II. OTHER INFORMATION: Item 4. Submission of Matters to a Vote of the Security Holders 10 Item 6. Exhibits and Reports on Form 8-K 11 Signatures 11 2 Part I. Financial Information Item 1. Financial Statements WSI INDUSTRIES, INC AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS FEBRUARY 29, AUGUST 31, ASSETS 2004 2003 (unaudited) CURRENT ASSETS: Cash and cash equivalents $1,185,188 $ 891,218 Accounts receivable 1,272,207 1,530,811 Inventories 680,553 606,262 Prepaid and other current assets 55,037 75,747 Deferred tax assets 169,387 169,387 ---------- ---------- Total Current Assets 3,362,372 3,273,425 ---------- ---------- Property, Plant and Equipment - Net 1,464,044 1,718,599 ---------- ---------- Deferred tax assets 1,750,290 1,813,270 ---------- ---------- Intangible assets, net 2,368,452 2,368,452 ---------- ---------- $8,945,158 $9,173,746 ========== ========== LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Trade accounts payable $ 444,764 $ 403,277 Accrued compensation and employee withholdings 291,985 384,857 Miscellaneous accrued expenses 145,215 150,289 Current portion of long-term debt 203,551 195,720 ---------- ---------- Total Current Liabilities 1,085,515 1,134,143 ---------- ---------- Long term debt, net of current portion 544,236 648,008 ---------- ---------- STOCKHOLDERS' EQUITY: Common stock, par value $.10 a share; authorized 10,000,000 shares; issued and outstanding 2,553,629 shares and 2,551,129, respectively 255,363 255,113 Capital in excess of par value 1,829,841 1,826,901 Retained earnings 5,230,203 5,309,581 ---------- ---------- Total Stockholders' Equity 7,315,407 7,391,595 ---------- ---------- $8,945,158 $9,173,746 ========== ========== See notes to condensed consolidated financial statements 3 WSI INDUSTRIES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited) 13 weeks ended 26 weeks ended ---------------------------- ---------------------------- February 29, February 23, February 29, February 23, 2004 2003 2004 2003 ----------- ----------- ----------- ----------- Net sales $ 2,615,666 $ 2,359,109 $ 5,421,727 $ 4,793,402 Cost of products sold 2,207,463 1,947,275 4,602,867 3,920,105 ----------- ----------- ----------- ----------- Gross margin 408,203 411,834 818,860 873,297 Selling and administrative expense 340,788 310,382 658,677 689,251 Interest and other income (30,334) (43,375) (45,779) (62,349) Interest and other expense 15,043 38,701 31,026 79,683 ----------- ----------- ----------- ----------- Earnings from operations before income taxes 82,706 106,126 174,936 166,712 Income tax expense 27,116 38,200 62,977 60,135 ----------- ----------- ----------- ----------- Net earnings $ 55,590 $ 67,926 $ 111,959 $ 106,577 =========== =========== =========== =========== Basic earnings per share $ .02 $ .03 $ .04 $ .04 =========== =========== =========== =========== Diluted earnings per share $ .02 $ .03 $ .04 $ .04 =========== =========== =========== =========== Cash dividend per share $ .0375 $ -- $ .075 $ -- =========== =========== =========== =========== Weighted average number of common shares 2,552,008 2,465,229 2,551,569 2,465,229 =========== =========== =========== =========== Weighted average number of common and dilutive potential common shares 2,625,887 2,465,229 2,628,038 2,465,229 =========== =========== =========== =========== See notes to condensed consolidated financial statements. 4 WSI INDUSTRIES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) 26 weeks ended --------------------------- February 29, February 23, 2004 2003 ----------- ----------- CASH FLOWS FROM OPERATING ACTIVITIES: Net earnings $ 111,959 $ 106,577 Adjustments to reconcile net earnings to net cash provided by operating activities: Depreciation 294,827 316,642 Deferred taxes 62,977 60,135 Changes in assets and liabilities: (Increase) decrease in accounts receivable 258,604 (151,153) (Increase) decrease in inventories (74,291) 70,285 (Increase) decrease in prepaid expenses 20,710 (1,846) Increase (decrease) in accounts payable and accrued expenses (56,456) 133,767 ----------- ----------- Net cash provided by operations 618,330 534,407 ----------- ----------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of property, plant and equipment (40,272) (151,204) ----------- ----------- Net cash used in investing activities (40,272) (151,204) ----------- ----------- CASH FLOWS FROM FINANCING ACTIVITIES: Stock options exercised 3,190 -- Payments of long-term debt (95,941) (919,985) Dividends paid (191,337) -- ----------- ----------- Net cash used in financing activities (284,088) (919,985) ----------- ----------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 293,970 (536,782) CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 891,218 1,115,922 ----------- ----------- CASH AND CASH EQUIVALENTS AT END OF REPORTING PERIOD $ 1,185,188 $ 579,140 =========== =========== SUPPLEMENTAL CASH FLOW INFORMATION: Cash paid during the period for: Interest $ 31,026 $ 83,331 Income taxes $ -- $ -- See notes to condensed consolidated financial statements 5 WSI INDUSTRIES, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS: The condensed consolidated balance sheet as of February 29, 2004, the condensed consolidated statements of operations for the thirteen and twenty-six weeks ended February 29, 2004 and February 23, 2003 and the condensed consolidated statements of cash flows for the twenty-six weeks then ended, respectively, have been prepared by the Company without audit. In the opinion of management, all adjustments (which include normal recurring adjustments) necessary to present fairly the financial position, results of operations and cash flows for all periods presented have been made. The condensed consolidated balance sheet at August 31, 2003 is derived from the audited consolidated balance sheet as of that date. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted. Therefore, these condensed consolidated financial statements should be read in conjunction with the financial statements and notes thereto included in the Company's 2003 annual report to shareholders. The results of operations for interim periods are not necessarily indicative of the operating results for the full year. 2. Debt and Line of Credit: The Company has renewed its revolving credit agreement in the maximum amount of $1 million with its bank. Interest on the renewed agreement is at the bank's prime rate. The revolver was not accessed during the quarter ended February 29, 2004, and correspondingly, no amount was owed at February 29, 2004. The credit agreement is secured by all assets of the Company and expires December 31, 2004. The agreement also contains restrictive provisions requiring a minimum net worth and current ratio, and a maximum ratio of tangible net worth to debt. At February 29, 2004, the Company was in compliance with these provisions. 3. Goodwill And Intangible Assets: Under Statements of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets, goodwill and intangible assets are deemed to have indefinite lives and are not amortized, but are subjected to annual impairment tests in accordance with the statement. Other intangible assets will continue to be amortized over their useful lives. The Company adopted the new rules on accounting for goodwill and other intangible assets beginning in the first quarter of fiscal 2002. The Company performed its annual impairment test in the fourth quarter of fiscal 2003 and has determined no charge is warranted. Goodwill and other intangible assets resulting from acquisitions of business and the formation of the Company consist of the following: 6 February 29, February 23, 2004 2003 ---- ---- Goodwill $2,428,264 $2,428,264 Less accumulated amortization 308,595 308,595 ---------- ---------- $2,119,669 $2,119,669 ========== ========== Other identifiable intangibles: Organization Costs $ 285,000 $ 285,000 Less accumulated amortization 36,217 36,217 ---------- ---------- $ 248,783 $ 248,783 ========== ========== 4. EARNINGS PER SHARE: The following table sets forth the computation of basic and diluted earnings per share: Thirteen weeks ended Twenty- Six weeks ended --------------------------------- ----------------------------- February 29, February 23, February 29 February 23, 2004 2003 2004 2003 -------------- -------------- -------------- ---------- Numerator for basic and diluted earnings per share: Net earnings $ 55,590 $ 67,926 $ 111,959 $ 106,577 ============== ============== ============== ========== Denominator Denominator for basic earnings per share - weighted average shares 2,552,008 2,465,229 2,551,569 2,465,229 ============== ============== ============== ========== Effect of dilutive securities: Employee and non-employee options 73,879 -- 76,469 -- ============== ============== ============== ========== Dilutive common shares Denominator for diluted earnings Per share 2,625,887 2,465,229 2,628,038 2,465,229 ============== ============== ============== ========== Basic earnings per share $ .02 $ .03 $ .04 $ .04 ============== ============== ============== ========== Diluted earnings per share $ .02 $ .03 $ .04 $ .04 ============== ============== ============== ========== 7 Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION and RESULTS OF OPERATIONS Critical Accounting Policies and Estimates Management's Discussion and Analysis of Financial Condition and Results of Operations discusses our condensed 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. On a periodic basis, the Company analyzes the level of inventory on hand, its cost in relation to market value and estimated customer requirements to determine whether write-downs for excess or obsolete inventory are required. Actual customer requirements in any future periods are inherently uncertain and thus may differ from our estimates. If actual or expected requirements were significantly greater or lower than the established reserves, we would record a reduction or increase to the obsolescence allowance in the period in which we made such a determination. 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. To do this the Company determines the discounted present value of anticipated cash flows based on anticipated results of operations for the coming years. If we have 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. 8 Revenue Recognition: Revenues from sales of product are recorded upon shipment. Credit losses relating to customers have been minimal and within management's expectations. Based on management's evaluation of uncollected accounts receivable at the end of each 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. Results of Operations: Net sales were $2,616,000 for the quarter ending February 29, 2004, an increase of 11% or $257,000 from the same period of the prior year. Year to date sales in fiscal 2004 were $5,422,000 compared to $4,793,000 in the prior year. The increase in sales for the quarter, as well as the six months, came from an increase in sales to the Company's recreational vehicle market. Gross margin decreased to 16% for the quarter ending February 29, 2004 versus 17% in the year ago period. The slight decrease in gross margin is attributable to higher levels of production supply and repair expenses. Year to date gross margins were 15% and 18% for the six-month periods ending February 29, 2004 and February 23, 2003. Selling and administrative expense of $341,000 for the quarter ending February 29, 2004 was $30,000 higher than in the prior year period due to higher professional service costs. Year to date selling and administrative expense of $659,000 was $30,000 lower than the comparable prior year period. Selling and administrative expense for the six-month period ending February 23, 2003 was negatively affected by $60,000 of costs associated with a proxy contest that the Company was involved in. The proxy contest was resolved with all costs incurred by the end of the first quarter of fiscal 2003 Interest expense in the second quarter of fiscal 2004 was $15,000, which was $24,000 less than the second quarter of fiscal 2003 amount of $39,000. The decrease is attributable to reduced levels of debt for the Company - long-term debt at February 29, 2004 was $748,000 compared to $1,213,000 at February 23, 2003. Year to date interest expense is also down for the same reason. The Company recorded income tax expense at an effective tax rate of 33% and 36% for the quarter and six months ended February 29, 2004. For the quarter and six months ended February 23, 2003, the Company recorded income tax expense of 36%. Liquidity and Capital Resources On February 29, 2004, working capital was $2,277,000 compared to $2,139,000 at August 31, 2003. The ratio of current assets to current liabilities at February 29, 2004 was 3.10 to 1.0 compared to 2.89 to 1.0 at August 31, 2003. The Company's cash balance increased $294,000 during the first six months primarily from collections of accounts receivable. As discussed in the Notes to Consolidated Financial Statements, the Company renewed its $1,000,000 revolving credit facility with its bank. Interest on the new agreement is at the bank's prime rate. No amounts have been borrowed since the closing of the original agreement in December 2002. On each of November 13, 2003 and February 6, 2004, the Company paid quarterly dividends of $.0375 per share. The dividend payments for the 2004 fiscal year have totaled $191,000. 9 It is the Company's belief that its internally generated funds, as well as its line of credit, will be sufficient to enable the Company to meet its working capital requirements during fiscal 2004. Cautionary Statement: Statements included in this Management's Discussion and Analysis of Financial Condition and Results of Operations, 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 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 4. CONTROLS AND PROCEDURES (a) Evaluation of 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 this review, they have concluded that these controls and procedures are effective in ensuring that material information related to the Company is made known to them by others within the Company. (b) Changes in Internal Controls over Financial Reporting. There have been no significant 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. 10 PART II. OTHER INFORMATION: ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. A. The Annual Meeting of the Company Stockholders was held on January 8, 2004. B. Directors elected at that meeting were: Paul Baszucki For 2,437,986 Against 32,374 Melvin L. Katten For 2,435,486 Against 34,874 George J. Martin For 2,437,433 Against 32,927 Eugene J. Mora For 2,435,486 Against 34,874 Michael J. Pudil For 2,426,365 Against 43,995 Michael N. Taglich For 2,436,086 Against 34,274 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K: A. The following exhibits are included herein: Exhibit 31.1 Certification of Chief Executive Officer pursuant to Rules 13a-14(a) and 15d-14(a) of the Exchange Act. Exhibit 31.2 Certification of Chief Financial Officer pursuant to Rules 13a-14(a) and 15d-14(a) of the Exchange Act Exhibit 32 Certification pursuant to 18 U.S.C.Section 1350. B. Reports on Form 8-K: During the quarter, the Company furnished a Current Report on Form 8-K dated January 8, 2004, reporting under Item 12 its results of operations for the quarter ended November 30, 2003 and under Item 7, attaching a press release dated January 8, 2004 announcing the 2004 first quarter results of operations and a dividend. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. WSI INDUSTRIES, INC. Date: March 18, 2004 /s/ Michael J. Pudil -------------- ----------------------------------------------- Michael J. Pudil, President & CEO Date: March 18, 2004 /s/ Paul D. Sheely -------------- ------------------------------------------------ Paul D. Sheely, Vice President, Finance & CFO 11