================================================================================ SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 Form 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended August 26, 2001 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED] For the transition period ended from _________ to _________ Commission File No. 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 or organization) Identification No.) 15250 Wayzata Boulevard Wayzata, Minnesota 55391 ---------------------------------------- ---------- (Address of principal executing offices) (Zip Code) Registrant's telephone number, including area code (952) 473-1271 -------------------------- 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) 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, and (2) has been subject to such filing requirements for the past 90 days. Yes X No -------------------- ---------------------- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (ss.229.405 of this chapter) is not contained herein, and will not 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-K or any amendment to this Form 10-K. [ ] The aggregate market value of the common shares held by non-affiliates of the Registrant on November 12, 2001 (based upon the closing sale price of those shares on the NASDAQ Small Cap System) was approximately $3,057,000. Number of shares outstanding of the Registrant's common stock, par value $.10 per share, as of November 12, 2001 is 2,465,229. DOCUMENTS INCORPORATED BY REFERENCE: Portions of the Proxy Statement for the annual meeting of shareholders to be held on January 10, 2002 are incorporated by reference into Part III. ---------- This form 10-K Report consists of 55 pages (including exhibits); the index to the exhibits is set forth on page 12. ================================================================================ WSI INDUSTRIES, INC. ANNUAL REPORT ON FORM 10-K YEAR ENDED AUGUST 26, 2001 INFORMATION REQUIRED IN REPORT PART I 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. The major portion of Company revenues are derived from machining work for agricultural related markets, the aerospace industry, construction and recreational vehicles markets. On February 15, 1999, the Company purchased Taurus Numeric Tool, Inc. ("Taurus") for approximately $7.2 million, with $5.5 million being paid in cash and bank debt and an additional $1.7 million being in the form of a Subordinated Promissory Note to the prior owner. Taurus is a precision contract machining company that sells primarily to the aerospace and avionics markets. On August 6, 1999, the Company purchased Bowman Tool & Machining, Inc. ("Bowman") for approximately $7.6 million, with $6.8 million being paid by additional debt and $844,000 being paid in the form of a Subordinated Promissory Note to the prior owner of Bowman. An additional amount of $1,090,600 was earned by the seller in connection with the purchase which was added to the Promissory Note. Bowman is a precision contract machining company serving the construction industry. The acquisitions were completed as a result of the Company's publicly stated objective of diversifying the markets that it serves. During fiscal 2000, the Company closed its Long Lake, Minnesota facility and consolidated all of its manufacturing operations into its facilities at Taurus and Bowman in Osseo, Minnesota and Rochester, Minnesota, respectively. The initiative placed the Company in closer proximity to its major customers as well as reduced its overhead structure and optimized its plant capacity. Contract manufacturing constitutes the Company's entire business. 2 (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 the Company's effort to diversify its customer and market base. Sales to the agricultural industry were 53%, 35% and 36% of total Company sales in fiscal years 1999, 2000 and 2001, respectively. Sales to the recreational vehicle market totaled 13%, 9% and 12% in 1999, 2000 and 2001 respectively. Sales to the aerospace/avionics/defense market totaled 14%, 12% and 19% in fiscal 1999, 2000 and 2001, respectively. Sales to the construction/power systems market totaled 20% and 19% in fiscal 2000 and 2001, respectivly. 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. * * * * * (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. (vi) The Company does not believe that its business demands unusual working capital requirements. 3 (vii) Sales in excess of 10 percent of fiscal 2001 consolidated sales were made to Deere & Co. and related entities in the amount of $11,493,000 or 55% of Company revenues. Sales were also made to Rockwell in the amount of $2,265,000 or 11% of Company revenues as well as Polaris in the amount of $2,510,000 or 12% of sales. (viii) Approximate dollar backlog at August 26, 2001, August 27, 2000, and August 29, 1999 was $13,108,000, $23,876,000 and $16,032,000 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 26, 2001 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 26, 2001, the Registrant had 80 employees, none of whom were subject to a union contract. (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 1999 were not significant. In 2000 and 2001, sales to companies in Mexico amounted to $2,061,000 and $2,623,000, respectively. See Note 8 to the Consolidated Financial Statements. Item 2. Properties: The Company's former executive offices and production facility were located in Long Lake, Minnesota (a western suburb of Minneapolis). The property was sold in June 2001 for approximately $2.4 million. The Company leases two production facilities that are located in Osseo, Minnesota and Rochester, Minnesota. The Rochester facility is approximately 38,000 square feet with the lease being for six-month periods with options to renew. The Osseo facility is approximately 28,000 square feet and is leased until February 2002 with options to renew. In connection with the Rochester operation, the Company also leases on a month-to-month basis approximately 4,000 square feet at a location that primarily stores excess tooling. 4 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: Registrant is not a party to any material legal proceedings, other than ordinary routine litigation incidental to its business. 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: Name Age Position ------------------ --- -------------------------------------------- George J. Martin 64 Chairman of the Board Michael J. Pudil 53 President, Chief Executive Officer, and Director Paul D. Sheely 42 Vice President, Treasurer, and Assistant Secretary Gerald E. Magnuson 71 Secretary Mr. Martin was engaged as Chairman of the Board on July 28, 1993 and previously served as the Company's Chief Executive Officer from December 1983 to January 1985 and on an interim basis from July 1993 to November 1993. 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 from 1962 to 2001. He is a retired partner of the law firm of Lindquist & Vennum P.L.L.P., Minneapolis, Minnesota. 5 PART II 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 Small Cap Market System under the symbol WSCI. (c) Common stock information: Stock Price ------------------------- High Low ------- ------- FISCAL 2001: First quarter $ 4.500 $ 2.250 Second quarter 3.313 1.813 Third quarter 3.313 1.560 Fourth quarter 2.370 1.600 FISCAL 2000: First quarter $ 4.875 $ 3.500 Second quarter 5.625 3.000 Third quarter 6.000 3.625 Fourth quarter 5.000 3.750 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 12, 2001 there were 552 shareholders of record of the Company's Common Stock. 6 Item 6. Selected Financial Data: FIVE-YEAR SUMMARY OF OPERATIONS (In thousands, except for per share information and financial ratios) 2001 2000 1999 1998 1997 ---- ---- ---- ---- ---- Net sales $ 20,877 32,157 $ 21,550 $ 23,948 $ 24,153 Cost of products sold 17,023 26,746 18,279 19,547 20,495 --------- -------- -------- -------- -------- Gross margin 3,854 5,411 3,271 4,401 3,658 Selling and administrative expense 2,995 3,217 2,444 2,453 2,329 Pension curtailment (gain) -- (353) -- -- -- Acquisition related noncompete and consulting expense 550 596 134 -- -- Goodwill amortization 337 296 83 -- -- Carrying cost of closed facility 347 214 -- -- -- Severance expense -- 249 -- -- -- Fair market value impairment of equipment 151 -- -- -- -- Interest and other income (157) (472) (158) (162) (583) Interest expense 821 998 481 190 286 --------- -------- -------- -------- -------- Earnings (loss) from continuing operations before taxes (1,190) 666 287 1,920 1,626 Income tax expense 3 27 26 46 42 --------- -------- -------- -------- -------- Net earnings (loss) $ (1,193) $ 639 $ 261 $ 1,874 $ 1,584 ========= ======== ======== ======== ======== Basic earnings (loss) per common share $ (.48) $ .26 $ .11 $ .77 $ .65 ========= ======== ======== ======== ======== Average number of common shares 2,465 2,462 2,452 2,434 2,425 Diluted earnings (loss) per common and dilutive potential common share $ (.48) $ .25 $ .10 $ .73 $ .64 ========= ======== ======== ======== ======== Average number of common and dilutive potential common shares 2,465 2,535 2,527 2,555 2,482 Additional information: Financial Data: Total plant and equipment additions $ 513 $ 916 $ 1,238 $ 2,102 $ 507 Long-term debt 4,111 9,601 10,666 1,802 2,671 Total assets 16,338 23,432 24,525 13,615 12,791 Cash flow from operations 2,634 1,961 2,641 3,047 2,610 Stockholders' equity 7,752 8,945 8,264 7,995 6,055 EBIDTA 2,017 4,046 2,299 3,225 3,278 Financial Ratios: Current ratio .78:1 1.35:1 1.27:1 1.94:1 1.90:1 Percentage of long term debt to equity 53% 107% 129% 23% 44% Book value per basic common share $ 3.14 $ 3.63 $ 3.37 $ 3.28 $ 2.50 7 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation LIQUIDITY AND CAPITAL RESOURCES: As discussed in Item 1., the Company purchased both Taurus Numeric Tool, Inc. and Bowman Tool & Machining, Inc. during fiscal 1999. The net result of these transactions was the addition of $4.4 million of term debt from the Company's bank, $2.5 million from a mortgage from the same bank, $1.3 million from the Company's Revolving Line of Credit, and $2.5 million from Subordinated Promissory Notes to the seller of Bowman and Taurus. During fiscal 2000, the Company paid down $1.6 million of the term debt and $167,000 of the mortgage. Also during 2000, the seller of Bowman earned the first of two possible contingencies. Therefore, an additional $750,000 was added to his Subordinated Promissory Note Payable. During fiscal 2001, the Company paid down an additional $1.6 million of the term debt. The Company also sold its Long Lake, Minnesota property for approximately $2.4 million, the proceeds from which paid off the balance on the mortgage of $2.3 million. Also during fiscal 2001, the seller of Bowman partially earned the last of two possible contingencies. The Company calculated the amount to be $340,600, which was added to his Subordinated Promissory Note Payable. The Company's negative working capital of $1,001,000 on August 26, 2001 reflected a decrease of $2.7 million from the prior year. The major item that caused the decrease in working capital was the reclassification of one-third of the Subordinated Promissory Notes Payable into current maturities as those amounts will be due in fiscal 2002. The current portion of Subordinated Notes amounted to approximately $1.2 million in fiscal 2001. The entire amount of the bank term debt was classified as current as that agreement expires in March 2002. Other decreases in working capital were caused by lower accounts receivable and inventories partially offset by lower accounts payable and accrued compensation. The fiscal 2001 ratio of current assets to current liabilities decreased to .78 to 1.0 from 1.35 to 1.0 for fiscal 2000. Cash provided by operating activities in fiscal 2001 was $2.6 million. Non-cash charges for depreciation and amortization as well as a decrease in working capital primarily accounted for the cash provided by operating activities. Cash provided by operations was $2.0 million in fiscal 2000 and $2.6 million in fiscal 1999. Additions to property, plant and equipment were $513,000 in fiscal 2001 compared to $916,000 in 2000 and $1,238,000 in 1999. These amounts included $323,000, $433,000 and $980,000 of machinery acquired through capital leases in 2001, 2000 and 1999, respectively. The major 2001 capital expenditures consisted of the acquisition of new production equipment. Proceeds from the sale of equipment amounted to $746,000 and $57,000 in fiscal 2000 and1999, respectively. The relatively large proceeds in 2000 resulted from the sale of excess equipment derived from the consolidation initiative. As mentioned previously, the Company sold its Long Lake, Minnesota property for $2.4 million in fiscal 2001. The Company's total debt was $7 million at August 26, 2001 and consisted of $1.1 million of bank term debt, seller subordinated notes of $3.6 million and capital lease obligations of $2.3 million. The total debt was $3.8 million lower that fiscal 2000. 8 At August 26, 2001 and August 27, 2000 the Company had available a line of credit of $3,000,000. At August 27, 2000, the outstanding balance on the line was $369,000 with no balance at August 26, 2001. At August 26, 2001, the maximum amount available to borrow on the line of credit was approximately $1.1 million. 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 2002. RESULTS OF OPERATIONS: Net sales of $20.9 million decreased $11.3 million or 35% from fiscal 2000 sales of $32.2 million and 673,000 or 3% from fiscal 1999 sales of $21.5 million. Sales decreased in 2001 as compared to 2000 for three primary reasons. The first was the overall downturn in the economy affected all markets served by the Company. Secondly, as mentioned in previous 10-Q's, a major customer made the decision to effectvely consign raw materials for its manufacturing programs to the Company instead of WSI purchasing the material and subsequently reselling the material after manufacture. This consignment thus resulted in lower sales to that customer. The last reason for the decreased in sales was the loss of a larger customer at the end of the second quarter. The sales decrease in 2001 versus 1999 would have been approximately equivalent to the 2001/2000 comparison had Bowman and Taurus been included in 1999 for the full fiscal year. However, Taurus was acquired in the middle of fiscal 1999 while Bowman was acquired at the end of fiscal 1999. In fiscal 2001, the Company reported a net loss of $1.2 million or $.48 per share compared to net earnings of $639,000 or $.25 per share in 2000 and $261,000 or .10 per share in 1999. The net earnings in fiscal 2000 included a gain from the termination of the Company's defined pension plan of $354,000, a gain on the sale of excess equipment of $395,000, and $248,000 in severance costs paid to employees affected by the Long Lake plant shutdown. The gross margin on parts sold in fiscal 2001 was 18.5% of sales compared to 16.8% of sales and 15.2% of sales in 2000 and 1999, respectively. Margin improved in 2001 versus 2000 and 1999 despite the lower level of sales. The primary reason for this was the increased efficiencies obtained at the new Taurus and Bowman manufacturing plants as compared to the Company's Long Lake, Minnesota facility which was open a partial year in 2000 and a full year in 1999. Fiscal 2001 gross margin was hampered as the year went on and the level of sales softened - gross margin in the first quarter was 21.9% versus 8.1% in the fourth quarter. Gross margin in 2000 was negatively affected by relocation and training costs associated with the consolidation initiative. Selling and administrative expense of $4.2 million in fiscal 2001 was a decrease of $95,000 and an increase of $1.6 million from fiscal years 2000 and 1999, respectively. The 2001 versus 1999 increase was related to the addition of Taurus and Bowman expenses for a full year. The 2001 slight decrease versus 2000 was a combination of lower incentive compensation and profit sharing partially offset by the carrying cost of the Long Lake building being included in selling and administrative expense for a longer period in 2001 versus 2000. Interest and other income of $33,000 was $43,000 lower in fiscal 2001 than 2000, and $125,000 lower than 1999 primarily due to less interest income due to lower average cash balances. 9 Interest and other expense of $820,000 in fiscal 2001 was $177,000 lower than 2000 and $339,000 higher than 1999. The lower interest in 2001 versus 2000 was due to the lower level of debt during the year as compared to the prior year. The interest expense was higher versus 1999 as the acquisition debt did not appear on the balance sheet until after the middle of 1999. Income tax expense is significantly less than the statutory amount due to the utilization of net operating loss carryforwards in each of fiscal 2000 and 1999. See Notes to Consolidated Financial Statements regarding recent accounting standards to be adopted. 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. 10 Item 8. Financial Statements and Supplementary Data: See Consolidated Financial Statements section of this Annual Report on Form 10-K beginning on page 15, attached hereto, which consolidated financial statements are incorporated herein by reference. Quarterly earnings summary (unaudited): Basic Diluted Net Gross Net Earnings Earnings Sales Margin Earnings Per Share Per Share ---------- ---------- --------- --------- --------- FISCAL 2001: First quarter $6,575,040 $1,441,427 $ 66,810 $ .03 $ .03 Second quarter 5,370,556 1,103,795 (275,692) (.11) (.11) Third quarter 5,140,495 1,000,425 (315,234) (.13) (.13) Fourth quarter 3,791,090 308,596 (669,074) (.27) (.27) FISCAL 2000: First quarter $7,294,952 $1,027,357 $ 50,674 $ .02 $ .02 Second quarter 7,710,690 1,098,074 (223,164) (.09) (.09) Third quarter 9,085,495 1,873,792 602,817 .24 .23 Fourth quarter 8,065,830 1,412,029 208,917 .08 .08 PART III Pursuant to General Instruction G(3), Registrant omits Part III, Items 10, 11, 12, and 13, except that portion of Item 10 relating to Executive Officers of the Registrant (which is included in Part I, Item 4A), as a definitive proxy statement will be filed with the Commission pursuant to Regulation 14(a) within 120 days after August 26, 2001 and such information required by such items is incorporated herein by reference from the proxy statement. 11 PART IV 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 17) hereinafter contained for all Consolidated Financial Statements. 2. Financial Statement Schedules: Schedule II - Valuation and Qualifying Accounts - page 30 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 of the Registrant's Form 10-Q for the quarter ended November 29, 1998. 3.2 Bylaws, as amended. 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. 12 Exhibit Page No. Description No. -------- --------------------------------------------- --------- 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 Stock Purchase Agreement dated August 6, 1999, between William D. Bowman and the Registrant incorporated by reference from Exhibit 2.1 of Form 8-K filed August 21, 1999. 10.7 Stock Purchase Agreement dated February 15, 1999 between Rodney Winter and the Registrant incorporated by reference from Exhibit 2.1 of Form 8-K filed February 28, 1999. 10.8 Employment (change in control) Agreement between Michael J. Pudil and Registrant dated January 11, 2001 incorporated by reference from Exhibit 10.1 of the Registrants Form 10-Q for the quarter ended May 27, 2001. 10.9 Employment (change in control) Agreement between Paul D. Sheely and Registrant dated January 11, 2001 incorporated by reference from Exhibit 10.2 of the Registrants Form 10-Q for the quarter ended May 27, 2001. 10.10 Purchase Agreement between DRB#8 and Registrant incorporated by reference from Exhibit 10.1 of the Registrants Form 8-K filed June 25, 2001. 10.11 Sixth Amendment to Amended and Restated Credit Agreement dated April 1, 2000. 23.1 Consent of Ernst & Young LLP. 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 19, 2001 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 19, 2001 ------------------------------------- Director Michael J. Pudil /s/ Paul Baszucki Director November 19, 2001 ------------------------------------- Paul Baszucki /s/ Melvin L. Katten Director November 19, 2001 ------------------------------------- Melvin L. Katten /s/ George J. Martin Director November 19, 2001 ------------------------------------- George J. Martin /s/ Eugene J. Mora Director November 19, 2001 ------------------------------------- Eugene J. Mora 14 INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULE Page ---- CONSOLIDATED FINANCIAL STATEMENTS Report of Independent Auditors 16 Consolidated Balance Sheets - August 26, 2001 and August 27, 2000 17 Consolidated Statements of Income - Years Ended August 26, 2001, August 27, 2000 and August 29, 1999 18 Consolidated Statements of Stockholders' Equity - Years Ended August 26, 2001, August 27, 2000 and August 29, 1999 19 Consolidated Statements of Cash Flows - Years Ended August 26, 2001, August 27, 2000 August 29, 1999 20 Notes to Consolidated Financial Statements 21 SCHEDULE Schedule II - Valuation and Qualifying Accounts 30 15 REPORT OF INDEPENDENT AUDITORS Board of Directors and Shareholders WSI Industries, Inc. We have audited the accompanying consolidated balance sheets of WSI Industries, Inc. and subsidiaries as of August 26, 2001 and August 27, 2000, and the related consolidated statements of income, changes in shareholders' equity and cash flows for the years ended August 26, 2001, August 27, 2000 and August 29, 1999. Our audits also included the financial statement schedule listed in the Index at Item 14 (a). These financial statements and schedule 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 auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. 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 WSI Industries, Inc. and subsidiaries as of August 26, 2001 and August 27, 2000, and the consolidated results of their operations and their cash flows for the years ended August 26, 2001, August 27, 2000 and August 29, 1999 in conformity with accounting principles generally accepted in the United States. 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 12, 2001 16 WSI INDUSTRIES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS AUGUST 26, 2001 AND AUGUST 27, 2000 -------------------------------------------------------------------------------- 2001 2000 ---- ---- ASSETS CURRENT ASSETS: Cash and cash equivalents $ 8,292 $ 6,300 Accounts receivable, less allowance for doubtful accounts of $27,500 at each year-end 1,778,969 3,713,198 Inventories 1,584,415 2,738,346 Prepaid and other current assets 101,879 148,206 ------------- ------------ Total current assets 3,473,555 6,606,050 PROPERTY, PLANT, AND EQUIPMENT, AT COST (NOTE 4): Land -- 66,906 Buildings and improvements -- 5,198,081 Machinery and equipment 16,779,167 16,347,768 ------------- ------------ 16,779,167 21,612,755 Less accumulated depreciation 10,087,807 10,957,059 ------------- ------------ Total property, plant, and equipment 6,691,360 10,655,696 INTANGIBLE ASSETS: Goodwill and related acquisition costs net of accumulated amortization of $711,605 and $374,244 at each year-end 6,173,158 6,169,919 ------------- ------------ $ 16,338,073 $ 23,431,665 ============= ============ LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Revolving credit facility (Note 3) $ -- $ 369,134 Trade accounts payable 687,426 2,041,089 Accrued compensation and employee withholdings 445,693 857,739 Accrued real estate taxes -- 151,230 Miscellaneous accrued expenses 425,330 229,719 Current portion of long-term debt (Note 3) 2,916,061 1,236,460 ------------- ------------ Total current liabilities 4,474,510 4,885,371 Long-term debt, less current portion (Note 3) 4,111,462 9,601,003 COMMITMENTS (Note 4) STOCKHOLDERS' EQUITY (Note 5): Common stock, par value $.10 a share; authorized 10,000,000 shares; issued and outstanding 2,465,229 shares 246,523 246,523 Capital in excess of par value 1,640,934 1,640,934 Retained earnings 5,864,644 7,057,834 ------------- ------------ Total stockholders' equity 7,752,101 8,945,291 ------------- ------------ $ 16,338,073 $ 23,431,665 ============= ============ See notes to consolidated financial statements. 17 WSI INDUSTRIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME YEARS ENDED AUGUST 26, 2001, AUGUST 27, 2000 AND AUGUST 29, 1999 -------------------------------------------------------------------------------- 2001 2000 1999 ---- ---- ---- Net sales (Note 8) $ 20,877,181 $ 32,156,967 $ 21,549,861 Cost of products sold 17,022,938 26,745,715 18,278,492 ------------ ------------ ------------- Gross margin 3,854,243 5,411,252 3,271,369 Selling and administrative expense 4,228,849 4,323,892 2,660,683 Pension curtailment (gain) -- (353,375) -- Gain on sale of equipment and building (123,279) (395,382) -- Severance costs -- 248,506 -- Fair market value impairment of equipment 150,859 -- -- Interest and other income (32,945) (76,223) (157,748) Interest expense 820,949 997,690 481,569 ------------ ------------ ------------- 5,044,433 4,745,108 2,984,504 ------------ ------------ ------------- Income (loss) before income taxes (1,190,190) 666,144 286,865 Income tax expense (Note 6) 3,000 26,900 25,800 ------------ ------------ ------------- Net income (loss) $ (1,193,190) $ 639,244 $ 261,065 ============ ============ ============= Basic earnings (loss) per share $ (.48) $ .26 $ .11 ============ ============ ============= Diluted earnings (loss) per share $ (.48) $ .25 $ .10 ============ ============ ============= Weighted average number of common shares outstanding 2,465,229 2,461,980 2,451,836 ============ ============ ============= Weighted average number dilutive common shares outstanding 2,465,229 2,535,197 2,527,299 ============ ============ ============= See notes to consolidated financial statements. 18 WSI INDUSTRIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY -------------------------------------------------------------------------------- CAPITAL TOTAL COMMON STOCK IN EXCESS RETAINED STOCKHOLDERS' SHARES AMOUNT OF PAR VALUE EARNINGS EQUITY --------- --------- ------------ ---------- ------------- BALANCE AT AUGUST 30, 1998 2,448,800 $244,880 $1,592,515 $6,157,525 $7,994,920 Net earnings 261,065 261,065 Exercise of stock options 4,625 463 7,787 8,250 ---------- -------- ---------- ---------- ---------- BALANCE AT AUGUST 29, 1999 2,453,425 245,343 1,600,302 6,418,590 8,264,235 Net earnings 639,244 639,244 Exercise of stock options 11,804 1,180 40,632 41,812 ---------- -------- ---------- ---------- ---------- BALANCE AT AUGUST 27, 2000 2,465,229 $246,523 $1,640,934 $7,057,834 $8,945,291 Net loss (1,193,190) (1,193,190) ---------- -------- ---------- ---------- ---------- BALANCE AT AUGUST 26, 2001 2,465,229 $246,523 $1,640,934 $5,864,644 $7,752,101 ========== ======== ========== ========== ========== See notes to consolidated financial statements. 19 WSI INDUSTRIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED AUGUST 26, 2001, AUGUST 27, 2000 AND AUGUST 29, 1999 -------------------------------------------------------------------------------- 2001 2000 1999 ---- ---- ---- CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss) $(1,193,190) $ 639,244 $ 261,065 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 2,386,716 2,382,267 1,530,523 Gain on sale of property, plant, and equipment and other assets (123,279) (393,843) (48,164) Increase (decrease) in pension liability -- (347,437) (32,636) Fair market value impairment of equipment 150,859 -- -- Changes in assets and liabilities: (Increase) decrease in: Accounts receivable 1,934,229 (750,930) 1,515,192 Inventories 1,153,931 753,554 (429,587) Prepaid and other current assets 46,327 (75,728) 159,260 (Decrease) increase in accounts payable and accrued expenses (1,721,328) (245,666) (314,294) ----------- ---------- ---------- Net cash provided by operating activities 2,634,265 1,961,461 2,641,359 CASH FLOWS FROM INVESTING ACTIVITIES: Additions to property, plant, and equipment (189,928) (483,801) (257,897) Proceeds from sale of equipment and other assets 2,400,000 746,165 57,036 Purchase of subsidiaries, net of cash assumed -- (27,000) (8,704,234) --------- ---------- ----------- Net cash provided by (used in) investing activities 2,210,072 235,364 (8,905,095) CASH FLOWS FROM FINANCING ACTIVITIES: Issuance of long-term debt 5,379,844 13,021,304 6,690,399 Payments of long-term debt (10,222,189) (15,385,229) (3,000,429) Issuance of common stock -- 41,812 8,250 ----------- ----------- ----------- Net cash provided by (used in) financing activities (4,842,345) (2,322,113) 3,698,220 ----------- ----------- ----------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 1,992 (125,288) (2,565,516) CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 6,300 131,588 2,697,104 ----------- ----------- ----------- CASH AND CASH EQUIVALENTS AT END OF YEAR $ 8,292 $ 6,300 $ 131,588 =========== =========== =========== SUPPLEMENTAL CASH FLOW INFORMATION: Cash paid during the year for: Interest $ 846,631 $ 1,004,800 $ 420,874 Income taxes 7,500 32,383 45,361 Noncash investing and financing activities: Acquisition of machinery through capital lease 322,671 432,625 980,250 Acquisition related debt 340,600 750,000 5,206,657 See notes to consolidated financial statements. 20 WSI INDUSTRIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED AUGUST 26, 2001, AUGUST 27, 2000 AND AUGUST 29, 1999 -------------------------------------------------------------------------------- 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Fiscal Year - WSI Industries, Inc. and Subsidiaries' (the Company) fiscal years represent a 52- to 53-week period ending the last Sunday in August. Fiscal 2001, 2000 and 1999 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. 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 $263,372 and $131,789 at August 26, 2001 and August 27, 2000, respectively. 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 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. During 2001, the Company determined that some excess equipment that is currently on consignment to be sold was worth less than its net book value. The Company has written the book value of the related equipment to its estimated net realizable value. In 2001, the Company recognized $150,000 in expense related to this impairment. 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. 21 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 - 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. 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. Reclassification - Certain prior year items have been reclassified to conform to the current year presentation. Recently Issued Accounting Standards - In July 2001, the FASB issued Statement of Financial Accounting Standards No. 141, "Business Combinations" and No. 142, "Goodwill and Other Intangible Assets". These standards change the accounting for business combinations by, among other things, prohibiting the prospective use of pooling-of-interests accounting and requiring companies to stop amortizing goodwill and certain intangible assets with an indefinite useful life created by business combinations accounted for using the purchase method of accounting. Instead, goodwill and intangible assets deemed to have an indefinite useful life will be subject to an annual review for impairment. The Company will adopt the standards in the first quarter of fiscal 2002. The Company has determined the impact of Statement 142 will be a reduction of $344,000 per year in amortization expense. 2. ACQUISITIONS On February 15, 1999, the Company completed the acquisition of Taurus Numeric Tool, Inc. ("Taurus") by purchasing all the shares of common stock from its sole shareholder. The value of the transaction was approximately $7.2 million including acquisition costs, with $5.5 million being paid by cash and debt borrowings, and an additional $1.7 million being in the form of a Subordinated Promissory Note to the prior owner. The acquisition was accounted for by the purchase method. The Taurus consideration was allocated to assets and liabilities based on fair values as follows: Net assets acquired $ 4,535,000 Goodwill and other intangible assets 2,713,000 ----------- $ 7,248,000 =========== On August 6, 1999, the Company completed the acquisition of Bowman Tool & Machining, Inc. ("Bowman") by purchasing all the shares of common stock from its sole shareholder. The value of the transaction was approximately $7.6 million, with $6.8 million being paid by debt borrowings, and approximately $844,000 being paid in the form of a Subordinated Promissory Note to the prior owner. The acquisition was accounted for by the purchase method. 22 The Bowman consideration was allocated to assets and liabilities based on fair values as follows: Net assets acquired $ 4,560,000 Goodwill and other intangible assets 3,054,000 ----------- $ 7,614,000 =========== In fiscal 2001, 2000 and 1999, contingent payments were earned in the amount of $1,090,000 and were included in goodwill. Goodwill and other intangible assets are being amortized over their estimated useful lives of 20 years on a straight-line basis. Amortization for the years ended August 26, 2001, August 27, 2000 and August 29, 1999 was $337,361, $291,950 and $82,300, respectively. The following table shows the unaudited pro forma consolidated results of operations for fiscal 1999 as if both Taurus and Bowman had been acquired as of the beginning of that period: Unaudited Pro Forma Consolidated Results Year Ended ---------------------------------------- August 29, 1999 --------------- Sales $ 33,802,000 Net earnings $ 2,105,000 Net earnings per share $ .83 The unaudited pro forma results are not necessarily indicative of what actually would have occurred if the acquisitions had been in effect for the entire period presented. In addition, they are not intended to be a projection of future results and do not reflect any synergies that might have been achieved from combined operations. 3. DEBT Long-term debt consisted of the following: August 26, 2001 August 27, 2000 --------------- --------------- Bank term debt $ 1,142,856 $ 2,771,428 Mortgage note payable -- 2,333,332 Subordinated promissory notes 3,597,256 3,256,657 Capitalized lease obligations (Note 4) 2,287,411 2,476,046 ----------- ----------- 7,027,523 10,837,463 Less current portion 2,916,061 1,236,460 ----------- ----------- Long-term debt $ 4,111,462 $ 9,601,003 =========== =========== During fiscal 1999, 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 requires principal payments of $52,381 per month on the Term Note with the agreement expiring on March 31, 2002. Interest on the term debt is calculated at the bank's base rate (6.50% at August 26, 2001 and 9.50% at August 27, 2000) plus .75% and is also paid monthly. During fiscal 1999, the Company obtained a mortgage with the same bank with which it currently has its term debt and line of credit facility. The agreement required monthly principal payments of $13,889. Interest on the mortgage was calculated at the bank's base rate plus 1.0% and was paid monthly. The entire balance was paid off June 12, 2001 after the sale of the building securing the mortgage. 23 Interest on the line of credit is at the bank's base rate plus 0.5 percentage points (6.5% at August 26, 2001). The line expires March 31, 2002. The agreement provides for secured borrowing of up to $3,000,000; however, the Company is charged an annual unused credit line fee of 0.5%. At August 26, 2001 there was no balance outstanding. Restrictive provisions of the agreement require, among other provisions, that the Company (1) maintain a net worth of not less than $7,000,000, (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 26, 2001 and August 27, 2000, 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. In connection with the acquisitions of Bowman Tool & Machining, Inc. and Taurus Numeric Tool, Inc., the Company entered into Subordinated Promissory Notes with the sellers of the respective companies. The agreements call for quarterly interest payments at 7.75%. The note in connection with the Bowman transaction is due in three equal annual installments commencing August 6, 2002. The note in connection with the Taurus transaction is also due in three equal annual installments commencing February 15, 2002. The notes are subordinated to all bank debt, but are collateralized by equipment. Also in connection with the acquisitions, both sellers had contingent payments that they could earn if certain sales or profitability targets were met. In fiscal 2000 the seller of Bowman met his first contingent payment and $750,000 was added to his subordinated promissory note effective August 6, 2000. In fiscal 2001, the Company calculated that the seller of Bowman earned an additional $340,600 which was added to his subordinated promissory note effective January 21, 2001. Maturities of long-term debt, excluding capital lease obligations, for the fiscal years subsequent to August 26, 2001 are as follows: 2002 $2,341,942 2003 1,199,086 2004 1,199,084 ---------- $4,740,112 ========== 4. COMMITMENTS Leases - Included in the consolidated balance sheet at August 26, 2001 are cost and accumulated depreciation on equipment subject to capitalized leases of $6,174,337 and $3,916,359, respectively. At August 27, 2000, the amounts were $5,851,666 and $3,143,779, respectively. 24 The present value of the net minimum payments on capital leases as of August 26, 2001 is as follows: Capital Leases ---------- Fiscal years ending August: 2002 $ 742,227 2003 614,580 2004 572,121 2005 470,201 2006 178,707 Thereafter 165,333 ---------- Total minimum lease payments 2,743,169 Less amount representing interest 455,758 ---------- Present value of net minimum lease payments 2,287,411 Current portion 574,119 ---------- Capital lease obligation, less current portion $1,713,292 ========== The Company leases its Taurus facility under an operating lease that expires in February, 2002 with a monthly base rent of $8,900. Operating expenses and real estate taxes are paid by the Company. The Company also leases its Bowman facility under a lease that expires in February, 2002 for $10,000 per month and is also responsible for operating expenses and real estate taxes. The Company also rents a storage warehouse on a month-to-month basis for $2,750 per month. The Company leases its corporate office on a month-to-month basis with 60 days notice required, for a monthly base rent of $3,685. The Company also has various equipment leases that expire in 2002. Future minimum lease payments for operating leases are: Fiscal years ending August: 2002 $ 101,100 ---------- Total minimum lease payments $ 101,100 ========== Rent expense of approximately $437,000, $386,000, and $67,000 have been charged to operations for the years ended August 26, 2001, August 27, 2000 and August 29, 1999, 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. At August 26, 2001, 111,666 shares remained reserved and available for grant under the plan. 25 Option transactions during the three years ended August 26, 2001 are summarized as follows: 1987 Stock 1994 Stock Option Plan Option Plan -------------------- ----------------- Average Average Shares Price Shares Price ------ -------- ------ ------- Outstanding at August 30, 1998 128,000 $ 2.32 134,000 $ 4.58 Granted -- 125,000 4.99 Lapsed -- -- Exercised (5,000) 2.06 -- ------- -------- Outstanding at August 29, 1999 123,000 2.33 259,000 4.78 Granted -- 55,000 4.13 Lapsed (5,000) 3.63 (9,000) 4.56 Exercised -- (13,500) 3.62 ------- -------- Outstanding at August 27, 2000 118,000 2.26 291,500 4.71 Granted 59,000 2.97 Lapsed (9,000) 2.60 (34,000) 4.23 ------- -------- Outstanding at August 26, 2001 109,000 $ 2.20 316,500 $ 4.44 ======= ======== 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 using the Black-Scholes option pricing model with the following assumptions for grants issued during fiscal 2001, fiscal 2000 and fiscal 1999 as set forth in the table below. The estimated fair value of the options is amortized to expense over the options' vesting period. 2001 2000 1999 ---- ---- ---- Dividend yield None None None Expected volatility 55.7% 38.6% 47.7% Risk free interest rate 5.5% 6.0% 6.0% Expected term 10 years 10 years 10 years The Company's net income and income per share would be adjusted to the pro forma amounts as follows: Years ended ------------------------------------------------------- August 26, 2001 August 27, 2000 August 29, 1999 --------------- --------------- --------------- Net Income (loss): As reported $(1,193,190) $ 639,244 $ 261,065 Pro forma $(1,417,714) $ 383,094 $ 71,632 Income (loss) per basic common share: As reported $ (.48) $ .26 $ .11 Pro forma $ (.58) $ .16 $ .03 Income per diluted common share: As reported $ (.48) $ .25 $ .10 Pro forma $ (.58) $ .15 $ .03 26 As of August 26, 2001, there were 152,000 options outstanding with exercise prices between $2.00 and $2.94, 165,500 options outstanding with exercise prices between $3.00 and $4.75, and 108,000 options outstanding with exercise prices between $5.50 and $6.13. At August 26, 2001, outstanding options had a weighted-average remaining contractual life of 5 years. The numbers of options exercisable as of August 26, 2001, August 27, 2000 and August 29, 1999 were 348,500, 304,920, and 251,171 respectively, at weighted average share prices of $3.88, $3.81, and $3.50 per share, respectively. The weighted average fair value of options granted during the years ended August 26, 2001, August 27, 2000 and August 29, 1999 was $2.97, $2.39, and $4.99 per share, respectively. 6. INCOME TAXES Income tax expense (benefit) consisted of the following: Years Ended ----------------------------------------------- August 26, August 27, August 29, 2001 2000 1999 ---- ---- ---- Currently payable: Federal $ -- $ 20,000 $ 17,500 State 3,000 6,900 8,300 --------- ---------- ---------- 3,000 26,900 25,800 Deferred: Federal -- -- -- State -- -- -- --------- ---------- ---------- Total $ 3,000 $ 26,900 $ 25,800 ========= ========== ========== 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: Years Ended ---------------------------------------- August 27, August 29, August 30, 2001 2000 1999 ---- ---- ---- Ordinary federal income tax statutory rate (35.0)% 35.0 35.0% Limitation on (utilization of) tax assets 35.0 (32.0) (28.9) State income taxes, net of federal tax benefit .3 1.0 2.9 ------- ------- ------- Taxes provided .3% 4.0% 9.0 ======= ======= ======= 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: 27 Year ended Year ended August 26, 2001 August 27, 2000 --------------- --------------- DEFERRED TAX ASSETS Accrued liabilities $ 21,746 $ 31,098 Inventory valuation accruals 89,547 44,808 Net operating loss carryforwards 1,043,878 633,987 Tax credit carryforwards 530,265 530,265 Other 201,118 136,238 -------------- --------------- 1,886,554 1,376,396 DEFERRED TAX LIABILITIES Tax depreciation and amortization greater than book 586,294 460,279 -------------- --------------- Net deferred tax assets 1,300,260 916,117 Valuation allowance (1,300,260) (916,117) -------------- --------------- $ -- $ -- ============== =============== As of August 26, 2001, the Company had federal net operating loss carryforwards of approximately $2,963,000 of which $1,324,000 will expire in fiscal years 2008 and 2009, $415,000 in 2011 and $1,106,000 in 2016. Also as of August 26, 2001, 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. 7. EMPLOYEE BENEFITS The Company terminated its non-contributory pension plan effective February 1, 2000. Participants were given the choice of receiving their benefit by either taking a lump sum distribution, rolling their benefit over to another qualified plan or receiving a monthly annuity from an insurance company. At August 26, 2001 all assets of the Plan had been distributed. Net periodic pension cost consisted of the following: Years Ended ---------------------------- 2000 1999 ---- ---- Service cost - benefits earned during the year $ 128,699 $ 119,314 Interest cost on projected benefit obligation 566,664 509,347 Actual return on plan assets (712,904) (661,377) Net amortization and deferral 24,969 (1,339) ----------- ----------- Net periodic pension cost $ 7,428 $ (34,055) =========== =========== 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 and individual performance objectives. The Company and its two operating subsidiaries, Bowman Tool & Machining, Inc and Taurus Numeric Tool, Inc. merged their retirement savings 401(k) plans into one consolidated plan effective January 1, 2000. All employees are eligible to participate. Contributions charged to operations for fiscal 2001, 2000, and 1999, were approximately $151,383, $146,184 and $51,954, respectively. 28 8. INFORMATION CONCERNING SALES TO MAJOR CUSTOMERS The Company had sales to four customers which exceeded 10 percent of total sales during any one of fiscal years 2001, 2000 or 1999 as listed below: Fiscal Year Sales ---------------------------------------------------------- Customer 2001 2000 1999 -------- ---- ---- ---- #1 $11,493,000 $17,084,000 $11,748,000 #2 2,510,000 3,406,000 2,884,000 #3 2,265,000 2,970,000 2,682,000 #4 729,000 3,108,000 1,112,000 9. EARNINGS PER SHARE The following table sets forth the computation of basic and diluted earnings per share: 2001 2000 1999 ---- ---- ---- Net Income (Loss) $(1,193,190) $ 639,244 $ 261,065 =========== =========== =========== Denominator for earnings per share: Weighted average shares; denominator for basic earnings per share 2,465,229 2,461,980 2,451,836 Effect of dilutive securities; employee and nonemployee options -- 73,217 75,463 ----------- ----------- ----------- Dilutive common shares; denominator for diluted earnings per share 2,465,229 2,535,197 2,527,299 Basic (loss) income per share $ (.48) $ .26 $ .11 =========== =========== =========== Dilutive income (loss) per share $ (.48) $ .25 $ .10 =========== =========== =========== 29 WSI INDUSTRIES, INC. AND SUBSIDIARIES SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS -------------------------------------------------------------------------------- BALANCE AT NET ADDITIONS BALANCE AT BEGINNING CHARGED TO NET 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, 1999 $ 25,000 $ 2,500(2) $ 0 $ 27,500 ============ ============ ========= ============ Year ended August 27, 2000 $ 27,500 $ 0 $ 0 $ 27,500 ============ ============ ========= ============ Year ended August 26, 2001 $ 27,500 $ 0 $ 0 $ 27,500 ============ ============ ========= ============ ALLOWANCE FOR EXCESS OR OBSOLETE INVENTORY: Year ended August 29, 1999 $ 155,000 $ 0 $ 0 $ 155,000 ============ ============ ======== =========== Year ended August 27, 2000 $ 155,000 $ 74,717 $ 97,928(1) $ 131,789 ============ ============ ======== =========== Year ended August 26, 2001 $ 131,789 $ 131,583 $ 0(1) $ 263,372 ============ ============ ======== =========== ---------- (1) Write-offs of excess or obsolete inventory. (2) Additional amount assumed due to the acquisition of Taurus Numeric Tool, Inc. 30