winland2010q3form10q.htm
 



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
________________________
FORM 10-Q

þ  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarter Ended:
September 30, 2010

OR

o  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from _____________________ to ____________________._________________

Commission File No.:  1-15637

WINLAND ELECTRONICS, INC.
(Name of registrant in its charter)

Minnesota
41-0992135
(State or other jurisdiction of incorporation or organization)
(IRS Employer Identification Number)

1950 Excel Drive, Mankato, Minnesota 56001
(Address of principal executive offices)

(507) 625-7231
(Issuer’s telephone number)
________________________

Securities registered pursuant to Section 12(b) of the Exchange Act:

Title of Each Class
Name of Exchange
Common Stock, $.01 par value
American Stock Exchange
Preferred Stock Purchase Rights
American Stock Exchange

Securities registered pursuant to Section 12(g) of the Exchange Act:  None
________________________

Indicate by check mark  whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act 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 þ   No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a small reporting company.  See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o
Accelerated filer o
Non-accelerated filer o
Smaller Reporting Company þ

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o                      No þ
 
There were 3,699,230 shares of Common Stock, $.01 par value, outstanding as of November 11, 2010.
 
 
 
 

 
 
TABLE OF CONTENTS




 
Page 2

 

PART I – FINANCIAL INFORMATION

ITEM 1.                 FINANCIAL STATEMENTS

WINLAND ELECTRONICS, INC.
 
 
(In Thousands, Except Share Data)
 
             
ASSETS
 
September 30, 2010
   
December 31, 2009
 
   
(Unaudited)
       
Current Assets
           
 Cash
  $ 182     $ 55  
 Accounts receivable, less allowance for doubtful accounts of $43
               
 and $49, respectively
    2,532       2,823  
 Refundable income taxes
    291       1,023  
 Inventories, less allowance for obsolescence of $777 and
               
 $562, respectively
    3,319       3,039  
 Prepaid expenses and other assets
    250       256  
 Total current assets
    6,574       7,196  
                 
 Property and equipment at cost
    11,921       12,266  
 Less accumulated depreciation
    (8,212 )     (7,937 )
 Net property and equipment
    3,709       4,329  
 Total assets
  $ 10,283     $ 11,525  
                 
 LIABILITIES AND STOCKHOLDERS' EQUITY
               
                 
 Current Liabilities
               
 Revolving line of credit agreement
  $ 948     $ 367  
 Current maturities of long-term debt
    384       380  
 Accounts payable
    1,456       1,132  
 Accrued expenses:
               
 Compensation
    265       369  
 Other short-term tax liabilities
    68       -  
 Other
    120       49  
 Total current liabilities
    3,241       2,297  
                 
 Long-Term Liabilities
               
 Long-term debt, less current maturities
    413       699  
 Deferred revenue
    116       122  
 Other long-term tax liabilities
    -       258  
 Total long-term liabilities
    529       1,079  
                 
 Stockholders' Equity
               
Common stock, par value $0.01 per share; authorized 20,000,000
               
shares; issued and outstanding 3,699,230 shares as of September 30, 2010 and 3,686,435 as of December 31, 2009
    37       37  
 Additional paid-in capital
    5,047       5,016  
 Retained earnings
    1,429       3,096  
 Total stockholders' equity
    6,513       8,149  
 Total liabilities and stockholders' equity
  $ 10,283     $ 11,525  
                 
 See Notes to Condensed Financial Statements
               

Page 3

 
 

WINLAND ELECTRONICS, INC.
 
 
(In Thousands, Except Share and Per Share Amounts)
 
(Unaudited)
 
                         
   
For the Three Months Ended September 30,
   
For the Nine Months Ended September 30,
 
   
2010
   
2009
   
2010
   
2009
 
Net sales
  $ 4,378     $ 5,122     $ 14,053     $ 18,008  
Cost of sales
    3,999       4,831       13,061       16,153  
Gross profit
    379       291       992       1,855  
                                 
Operating expenses
                               
General and administrative
    368       468       1,339       1,636  
Sales and marketing
    295       347       1,039       1,122  
Research and development
    72       143       290       394  
Total operating expenses
    735       958       2,668       3,152  
                                 
Operating loss
    (356 )     (667 )     (1,676 )     (1,297 )
                                 
Other income (expense)
                               
Interest expense
    (52 )     (30 )     (100 )     (75 )
Other income (expense), net
    14       2       22       (12 )
Total other expense
    (38 )     (28 )     (78 )     (87 )
                                 
Loss before income taxes
    (394 )     (695 )     (1,754 )     (1,384 )
                                 
Income tax benefit (expense)
    89       -       87       (150 )
Net loss
  $ (305 )   $ (695 )   $ (1,667 )   $ (1,534 )
                                 
Loss per common share:
                               
Basic and diluted
  $ (0.08 )   $ (0.19 )   $ (0.45 )   $ (0.42 )
                                 
Weighted-average number of common shares outstanding:
                         
Basic and diluted
    3,699,230       3,679,719       3,690,911       3,672,710  
                                 
See Notes to Condensed Financial Statements
                         

Page 4

 


WINLAND ELECTRONICS, INC.
 
 
(In Thousands of Dollars)
 
(Unaudited)
 
   
For the NineMonths Ended September 30,
 
   
2010
   
2009
 
Cash Flows From Operating Activities
           
 Net loss
  $ (1,667 )   $ (1,534 )
 Adjustments to reconcile net loss to net cash used in
               
 operating activities:
               
 Depreciation and amortization
    589       615  
 Decrease in allowance for doubtful accounts
    (6 )     (89 )
 Loss on disposal of property and equipment
    56       20  
 Non-cash stock based compensation
    23       72  
 Decrease in deferred tax valuation allowance
    (86 )     -  
 Changes in assets and liabilities:
               
 Accounts receivable
    297       968  
 Refundable income taxes
    628       204  
 Inventories
    (280 )     520  
 Prepaid expenses
    6       (215 )
 Accounts payable
    324       (929 )
 Accrued expenses, including deferred revenue and
               
 other tax liabilities
    (39 )     159  
 Net cash used in operating activities
    (155 )     (209 )
                 
 Cash Flows From Investing Activities
               
 Purchases of property and equipment
    (31 )     (75 )
 Proceeds from sale of property and equipment
    7       8  
  Net cash used in investing activities
    (24 )     (67 )
                 
 Cash flows From Financing Activities
               
 Net borrowings on revolving line of credit
    581       506  
 Payments on long-term borrowings, including capital
               
 lease obligations
    (282 )     (302 )
 Proceeds from issuance of common stock
    7       6  
 Net cash provided by financing activities
    306       210  
                 
 Net increase (decrease) in cash
    127       (66 )
                 
 Cash
               
 Beginning of period
    55       356  
 Ending of period
  $ 182     $ 290  
                 
 Supplemental information
               
 Cash payments for:
               
 Interest
  $ 81     $ 77  
 Cash received for:
               
 Income taxes
  $ 628     $ 183  
           
Non-cash reclassification of other tax liability from long-term to short-term
  $ 258     $ -  
                 
 See Notes to Condensed Financial Statements
               
 
Page 5

 
Winland Electronics, Inc.
Notes to Condensed Financial Statements
 
Note 1.  Basis of Presentation

The accompanying unaudited condensed financial statements have been prepared by Winland Electronics, Inc. (the “Company” or “Winland”) in accordance with accounting principles generally accepted in the United States of America for the preparation of interim financial information and the instructions to Form 10-Q and Article 10 of Regulation S-X of the Securities and Exchange Commission (the “SEC”). Accordingly, they do not include all of the information and notes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. Financial results for the three and nine months ended September 30, 2010 are not necessarily indicative of the results that may be expected for the year ending December 31, 2010.   The footnotes are in thousands unless noted.

The condensed balance sheet at December 31, 2009 has been derived from the audited financial statements as of that date but does not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statement presentation.

This financial information should be read in conjunction with the financial statements and notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009.

Management is required to make certain estimates and assumptions which affect the amounts of assets, liabilities, revenue and expenses reported.  Actual results could differ materially from these estimates and assumptions.

The Company evaluates events through the date the financial statements are filed for events requiring adjustment to or disclosure in the financial statements.

The Company’s future liquidity needs will depend on many factors, including the timing and amount of its revenues and its investment decisions, which may affect the Company’s ability to generate additional cash.  If cash generated from operations and financing activities, through the use of the Company’s accounts receivable agreement through at least the next twelve months, is insufficient to satisfy working capital requirements during the next twelve months, the Company will seek additional funding through bank borrowings or other means. There can be no assurance that the Company will be able to secure such additional funding on acceptable terms or at all.

Reclassifications:  Certain condensed statement of operations and segment reporting footnote disclosure amounts for the three and nine months ended September 30, 2009 have been reclassified to be consistent with the classifications adopted for the same periods ended September 30, 2010.  These reclassifications had no impact on operating loss, net loss or retained earnings.

Note 2.  Segment Reporting

Accounting Standards Codification (“ASC”) 280, Segment Reporting, requires an enterprise to report segment information in the same way that management internally organizes its business for assessing performance and making decisions regarding the allocation of resources.  The Company evaluates the performance of operating segments and allocates resources based on profit and loss from operations.

The Company’s EMS segment consists of the design and manufacturing of printed circuit board assemblies and higher level products sold mainly to Original Equipment Manufacturer (OEM) customers.  Winland offers complete solutions to OEM customer needs by providing value-added services that complement its contract manufacturing capabilities.  This is part of a “concept to product realization” strategy, the elements of which may include product concept studies, product design, printed circuit board design, design for manufacturing, higher level assembly and box build, repair service, and legacy support.  These services differentiate Winland from many competitors and are intended to increase customer satisfaction, confidence, and loyalty.  Winland views EMS customers as strategic partners and works to provide these partners with high level customer care and technical services.
 
Page 6

 
Winland Electronics, Inc.
Notes to Condensed Financial Statements
 
Note 2.  Segment Reporting (Continued)

The Company’s Proprietary Products segment represents an established family of environmental security products that can monitor critical environments including simple and sophisticated microprocessor and mechanically controlled sensors and alarms.  These products monitor and detect critical environmental changes, such as changes in temperature or humidity, water leakage and power failures.

The Company’s remaining activities are included in “Other”.  These are unallocated corporate level expenses, which include costs related to the administrative functions performed in a centralized manner and not attributable to particular segments (e.g., executive compensation expense, accounting, human resources and information technology support), are reported in the reconciliation of the segment totals to consolidated totals as “Other” items.

Segment assets or other balance sheet information are not presented to the Company’s chief operating decision maker.  Accordingly, the Company has not presented information relating to segment assets.

The following table presents nets sales and operating income (loss) by reportable segment:
 
WINLAND ELECTRONICS, INC.
 
SEGMENT REPORTING
 
                         
($ in thousands)
 
EMS
   
Proprietary
   
Other
   
Total
 
 Three months ended September 30, 2010                      
Net sales
  $ 3,540     $ 838     $ -     $ 4,378  
Gross profit
    (17 )     396       -       379  
Operating income (loss)
    (86 )     170       (440 )     (356 )
                                 
 Three months ended September 30, 2009                            
Net sales
  $ 4,228     $ 894             $ 5,122  
Gross profit
    (112 )     403               291  
Operating income (loss)
    (227 )     171       (611 )     (667 )
                                 
 Nine months ended September 30, 2010                            
Net sales
  $ 11,603     $ 2,450     $ -     $ 14,053  
Gross profit
    (63 )     1,055       -       992  
Operating income (loss)
    (366 )     319       (1,629 )     (1,676 )
                                 
 Nine months ended September 30, 2009                            
Net sales
  $ 15,636     $ 2,372             $ 18,008  
Gross profit
    755       1,100               1,855  
Operating income (loss)
    405       328       (2,030 )     (1,297 )
 
Page 7

 
Winland Electronics, Inc.
Notes to Condensed Financial Statements
 
Note 3.  Major Customers

The Company has a number of customers that accounted for 10 percent (10%) or more of net sales for the three and nine months ended September 30, 2010 and 2009 as follows:
   
For the Three Months Ended September 30,
 
Sales percentage:
 
2010
   
2009
 
   Customer A
    20 %     25 %
   Customer B
    9 %     7 %
   Customer C
    12 %     11 %
                 
   
For the Nine Months Ended September 30,
 
Sales percentage:
    2010       2009  
   Customer A
    32 %     38 %
   Customer B
    12 %     13 %
   Customer C
    10 %     11 %

The Company had net receivables (as a percentage of total receivables) from the above customers at September 30, 2010 and 2009 as follows:
 
Accounts receivable percentage:
 
2010
   
2009
 
   Customer A
    16 %     30 %
   Customer B
    2 %     16 %
   Customer C
    26 %     15 %

Note 4.  Loss per Common Share

Loss per common share: Basic loss per common share is computed by dividing the net loss by the weighted-average number of common shares outstanding during the period. Diluted loss per common share is computed by dividing the net loss by the weighted-average number of common shares outstanding during the period, including potentially dilutive shares such as the options and warrants to purchase shares of common stock at various amounts per share (see Note 7).  For the three and nine months ended September 30, 2010 and 2009, the diluted loss per share was the same as basic loss per share since the effects of options and warrants would have been anti-dilutive. The diluted share calculation excluded 336,500 weighted average shares for the three and nine months ended September 30, 2010 and excluded 390,000 weighted average shares for the three and nine months ended September 30, 2009.

Note 5.  Inventories

The components of inventories were as follows net of reserves:
 
             
($ in thousands)
 
September 30, 2010
   
December 31, 2009
 
Raw materials
  $ 2,541     $ 2,202  
Work in progress
    320       275  
Finished goods
    458       562  
Total
  $ 3,319     $ 3,039  
                 

Winland estimates excess, slow moving and obsolete reserves for inventory on a quarterly basis based upon order demand and production requirements for its major customers and annual reviews for other customers.  Management’s estimated valuation reserve for slow moving and obsolete raw and finished goods inventories was $777,000 at September 30, 2010 and $562,000 at December 31, 2009.
 
Page 8

 
Winland Electronics, Inc.
Notes to Condensed Financial Statements
 
Note 6.  Allowance for Rework and Warranty Costs

Winland provides a limited warranty to its OEM customers who require Winland to repair or replace product that is defective, due to Company workmanship issues, at no cost to the customer.  In addition, Winland provides a limited warranty for its Proprietary Products for a period of one year, which requires Winland to repair or replace defective product at no cost to the customer or refund the purchase price.  The reserve reflecting historical experience and potential warranty issues is determined based on specific customer experience factors including rate of return by item, average weeks outstanding from production to return, average cost of repair and relation of repair cost to original sales price.  Any specific known warranty issues are considered individually.  These are analyzed to determine the probability and the amount of financial exposure, and a specific reserve is established.  The allowance for rework and warranty costs was $56,000 and $45,000 at September 30, 2010 and December 31, 2009, respectively, and is included in Accrued expenses, Other, on the balance sheet.

Changes in the Company’s warranty liability were approximately as follows:
 
   
For the Three Months Ended September 30,
($ in thousands)
 
2010
   
2009
 
Balance, Beginning
  $ 50     $ 45  
Accruals for products sold
    17       36  
Expensing of specific warranty items
    (17 )     (36 )
Change in estimate
    6       6  
Balance, Ending
  $ 56     $ 51  
                 
   
For the Nine Months Ended September 30,
      2010       2009  
Balance, Beginning
  $ 45     $ 80  
Accruals for products sold
    70       86  
Expensing of specific warranty items
    (70 )     (83 )
Change in estimate
    11       (32 )
Balance, Ending
  $ 56     $ 51  
                 

Note 7. Stock-Based Awards

For the nine months ended September 30, 2010, the Company granted 22,000 options which had weighted average grant date fair values of $0.59.  For the nine months ended September 30, 2009, the Company granted 34,000 options which had weighted average grant date fair values of $0.51.  No options were granted for the three months ended September 30, 2010 or 2009.
 
For the nine months ended September 30, 2010, the Company recognized expense of $23,000 related to compensation expense for stock based compensation awards compared to compensation expense of $72,000 for the nine months ended September 30, 2009.  At September 30, 2010, there was $37,000 of unrecognized compensation cost related to share-based payments which is expected to be recognized over a weighted-average period of 1.72 years.
 
Page 9

 
Winland Electronics, Inc.
Notes to Condensed Financial Statements

Note 7.  Stock-Based Awards (Continued)

The following table summarizes information about stock options outstanding at September 30, 2010:
 
     
Options Outstanding
         
Options Exercisable
 
Range of Exercise Prices
   
Number of Shares
   
Weighted-Average Remaining Contractual Life (Years)
   
Weighted-Average Exercise Price
   
Number of Shares
   
Weighted-Average Exercise Price
 
$ 0.448 - $1.344       65,000       8.1     $ 0.74       48,200     $ 0.76  
$ 1.344 - $1.792       105,000       4.3       1.63       58,800       1.65  
$ 1.792 - $2.240       5,500       7.3       2.23       5,500       2.23  
$ 2.240 - $2.688       23,000       2.6       2.48       12,200       2.43  
$ 2.688 - $3.584       79,500       3.2       3.26       54,300       3.26  
$ 3.584 - $4.032       24,000       1.9       3.62       19,200       3.62  
$ 4.032 - $4.480       22,000       5.1       4.30       22,000       4.30  
          324,000       4.6     $ 2.25       220,200     $ 2.34  
                                             

Note 8.  Income Taxes

The Company calculates its income tax expense by estimating the annual effective tax rate and applying that rate to the year-to-date ordinary income (loss) at the end of the period.  The Company records a tax valuation allowance when it is more likely than not that it will not be able to recover the value of its deferred tax assets.

As of September 30, 2010 and 2009, the Company calculated its estimated annualized effective tax rate at 4% and -7%, respectively.  The Company recognized an income tax benefit of $87,000 based on its $1,754,000 pre-tax loss for the nine months ended September 30, 2010.  The $86,000 tax benefit was for recognizing previous uncertain tax positions related to the Company’s research and development credits.  The Company recognized an income tax expense of $150,000 for uncertain tax positions and AMT taxes based on its $1,384,000 pre-tax loss for the nine months ended September 30, 2009.  The Company recorded a valuation allowance of $679,000 and $871,000 for the nine months ended September 30, 2010 and 2009 respectively.

Winland recognizes the financial statement benefit of a tax position only after determining that the relevant tax authority would more likely than not sustain the position following an audit.  For tax positions meeting the more-likely-than-not threshold, the amount recognized in the financial statements is the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement with the relevant tax authority.

The Company files income tax returns in the U.S. federal and state jurisdictions and is currently under examination by the Internal Revenue Service (IRS) for its 2004 through 2007 tax years and the State of Minnesota for its 2003 through 2006 tax years. The Company recognized a $301,000 reduction in income tax expense as of December 31, 2007 for credits filed with the Internal Revenue Service and the State of Minnesota for tax years 2003 through 2007, net of $129,000 reserve for ASC 740, Income Taxes.  An additional $129,000 of unrecognized tax benefits was recorded for the three and nine months ended September 30, 2009 for changes in judgment on positions taken in these open years. An additional $10,000 of unrecognized tax benefits was recorded for the three and nine months ended September 30, 2010 for changes in judgment on positions taken on Minnesota income tax returns these open years. The unrecognized tax benefits were reduced by $200,000 due to a settlement reached with the IRS. The years 2004 through 2009 remain open for examination by other state agencies.

The Company recognizes interest accrued on uncertain tax positions as well as interest received from favorable tax settlements within interest expense.  The Company recognizes penalties accrued on unrecognized tax benefits within general and administrative expenses.  As of September 30, 2010 and 2009, the Company recognized no interest or penalties related to uncertain tax positions due to their insignificance to its financial position and results of operations.
 
Page 10

 
Winland Electronics, Inc.
Notes to Condensed Financial Statements
 
Note 8.                      Income Taxes (Continued)

Given the fact that the Company is currently under audit by the State of Minnesota, it is possible that changes in the gross balance of unrecognized tax benefits may occur within the next year.  An estimate of the range of such gross changes cannot be made at this time.   Any changes could have an impact on its effective tax rate and expected cash receipts for income taxes refundable within the next year.

Note 9. Financing Arrangement

On August 18, 2010, Winland and PrinSource Capital Companies, LLC ("PrinSource") entered into an Accounts Receivable Agreement (the "Agreement").  The Agreement continues in full force and effect until August 18, 2011 ("Initial Termination Date") and shall automatically and continually renew for successive periods of twelve months (each such period referred to as a "Renewal Period") from the Initial Termination Date or the end of a Renewal Period subject to certain conditions contained in the Agreement.   
 
The Agreement allows PrinSource to purchase from Winland certain eligible accounts based on PrinSource's sole and absolute discretion.  Upon approval and acceptance by PrinSource, PrinSource will pay Winland seventy-five percent (75%) of the eligible account (the "Part Payment") prior to such receivable actually being paid to Winland.  Upon the payment of such receivable to Winland, PrinSource will pay to Winland one hundred percent (100%) of such eligible account, reduced by a per diem fee equal to 1/18th (one eighteenth of one percent) per day from the time that the Part Payment was made by PrinSource to Winland and a one-time processing fee equal to 1/4% (twenty-five hundredths of one percent).  Winland agreed to generate a minimum of fees monthly ("Monthly Minimum") equal to $2,500.00 for per diem and processing fees.  Winland retains the ultimate responsibility for collection of the receivable, and thus has accounted for the Agreement as a secured borrowing transaction. 

The Agreement replaced the revolving line-of-credit Winland had with Marshall & Ilsley Bank.  The $1,248,000 outstanding balance on the revolving line-of-credit as of June 30, 2010 was paid in full and the revolving line-of-credit closed.

The outstanding balance under the Agreement was $948,000 as of September 30, 2010.
 
Page 11

 
 
ITEM 2:                      MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

OVERVIEW

Winland Electronics, Inc. is a manufacturer providing a variety of products to customers predominantly within the transportation, industrial, instrumentation and medical market sectors primarily in North America.  The Company operates in two business segments:  Electronic Manufacturing Services (EMS) and Proprietary Products.  EMS provides complete product realization services to OEM customers by providing value-added services which include product concept studies, product design, printed circuit board design, design for manufacturing, higher level assembly and box build, and legacy support.  Proprietary Products develops and markets an established family of environmental security products that can monitor critical environments.  The Company’s security products include simple and sophisticated microprocessor and mechanically controlled sensors and alarms that monitor and detect critical environmental changes, such as changes in temperature or humidity, water leakage and power failures.

EXECUTIVE SUMMARY

Winland’s third quarter operating performance primarily reflects declines in sales to our three largest customers totaling $1,242,000. This was due to the delayed availability of a primary electronic component for our largest customer, a postponement in the launch of significant new product by our second largest customer, and reduced end-user demand by our third largest customer. Sales to customers acquired during the past several quarters were not sufficient to offset this decline and continue in low-volume build quantities that do not yet reflect normal production volumes.

During the quarter, our gross margins continued to suffer from the under utilization of fixed overhead resulting from lower sales, as well as the higher costs associated with a large quantity of new customers’ qualification builds.

Sales performance for Winland’s Proprietary Products segment was marginally lower for the third quarter, although operating margin was consistent with prior quarters. We believe results for our Proprietary Products segment reflect routine adjustments to product inventories by our distributors.


RESULTS OF OPERATIONS

Three and nine months ended September 30, 2010 vs.
Three and nine months ended September 30, 2009

The Company reported a net loss of $305,000 or $0.08 per basic and diluted share for the three months ended September 30, 2010 compared to a net loss of $695,000 or $0.19 per basic and diluted share for the same period in 2009.  The Company reported a net loss of $1,667,000 or $0.45 per basic and diluted share for the nine months ended September 30, 2010 compared to a net loss of $1,534,000 or $0.42 per basic and diluted share for the same period in 2009.

Net Sales

Net sales for the three months ended September 30, 2010 were $4,378,000, down $744,000 from the same period in 2009.  EMS net sales of $3,540,000 were down $688,000 compared to the same period last year, a 16% decrease.  Sales to Customer A, a Minnesota based onboard fleet management solutions provider, were down $884,000.  Sales to Customer B, a Florida based medical products company, decreased $137,000.  Customer C, a global leader in the manufacture of compact, professional test tools based in Washington, had sales decrease $221,000.  Sales to new customers, acquired within the past twelve months, were $1,075,000 for the three months ended September 30, 2010.  These sales are the culmination of a long sales cycle and qualification builds for these customers.  Net sales of Proprietary Products for the three months ended September 30, 2010 were $838,000, down 6% from the same period in 2009.
 
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Net sales for the nine months ended September 30, 2010 were $14,053,000, down $3,955,000 from the same period in 2009.  EMS net sales of $11,603,000 were down $4,033,000 compared to the same period last year, a 26% decrease.  Sales to Customer A, B and C were down $2,343,000, $672,000 and $609,000, respectively, compared to the same period a year ago.  Sales to new customers, acquired within the past twelve months, were $2,226,000.  Net sales of Proprietary Products increased $78,000 or 3% to $2,450,000.

Operating Loss

The Company reported an operating loss of $356,000 and $667,000 for the three months ended September 30, 2010 and 2009, respectively.  Gross margins increased from 5.7% to 8.7% for the three months ended September 30, 2010 compared to the same period in 2009.  The Company’s EMS segment reported an operating loss of $86,000 for the three months ended September 30, 2010 compared to operating loss of $227,000 reported for the same period a year ago.  EMS gross margins were -0.5% for the three months ended September 30, 2010 up from -2.6% in 2009 due to under utilization of fixed overhead expenses, higher production costs related to qualification builds which were partially offset by reduced indirect wages and benefits of $198,000 and reduced obsolescence expenses of $177,000.  Operating expenses were also reduced $34,000 compared to last year primarily due to reductions in wages and benefits.  The Company’s Proprietary Products segment operating income was $170,000 for the three months ended September 30, 2010 consistent with operating income for the same period last year.  Proprietary Products gross margins were 47.3% compared with 45.1% for the same period last year.
 
The Company reported an operating loss of $1,676,000 and $1,297,000 for the nine months ended September 30, 2010 and 2009, respectively.  Gross margins decreased from 10.3% to 7.1% for the nine months ended September 30, 2010 compared to the same period in 2009.  The Company’s EMS segment reported an operating loss of $366,000 for the nine months ended September 30, 2010 compared to operating income of $405,000 reported a year ago.  EMS gross margins were down from 4.8% a year ago to -0.5% for the nine months ended September 30, 2010 due to under utilization of fixed overhead expenses, higher production costs related to qualification builds, increased warranty expenses of $27,000 which were partially offset by reduced indirect wages and benefits of $718,000.  The Company’s Proprietary Products segment operating income was $319,000 for the nine months ended September 30, 2010 compared to operating income of $328,000 last year.  Proprietary Products gross margins were 43.1% down from 46.4% due to under utilization of fixed overhead expenses.

General and Administrative expenses were $368,000 for the three months ended September 30, 2010 compared to $468,000 for the same period a year ago, primarily the result of headcount reductions totaling $64,000 of reduced wages and benefits.  General and Administrative expenses were $1,339,000 for the nine months ended September 30, 2010 compared to $1,636,000 for the same period a year ago, due to cost controlling measures including headcount reductions reducing wages and benefits by $181,000, more effective and inexpensive investor relations spending reducing expenses by $17,000, reducing office supply inventories and expenses by $11,000 and diligent spending of dues and subscriptions expenses reducing costs by $7,000 partially offset by increased professional expenses of $24,000.

Research and Development expenses were $72,000 for the three months ended September 30, 2010 compared to $143,000 for the same period a year ago, the result of reduced wages and benefits of $92,000 partially offset by reduced labor and overhead expenses transferred to Engineering Cost of Goods Sold of $31,000.  Research and Development expenses were $290,000 for the nine months ended September 30, 2010 compared to $394,000 for the same period a year ago, the result of reduced wages and benefits of $201,000, reduced new product development expense of $15,000 partially offset by reduced labor and overhead expenses transferred to Engineering Cost of Goods Sold of $129,000.

Interest Expense and Other, Net

Interest expense and other consists primarily of interest expense and income and miscellaneous income and expense.  Interest expense for the three and nine months ended September 30, 2010 was $52,000 and $100,000, respectively, compared to $30,000 and $75,000, respectively, during the same period a year ago.  The Company had $948,000 outstanding on its accounts receivable agreement as of September 30, 2010 compared to $367,000 outstanding balance on revolving line-of-credit at December 31, 2009.  The Company recorded $17,000 of interest income for the three and nine months ended September 30, 2010 related to funds received from the IRS for the carry-back of the Company’s net operating loss for tax year 2009.

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Income Tax

As discussed in Note 8 to the Condensed Financial Statements, income tax benefits were calculated using an estimated annual blended federal and state income tax rate of 4% and -7% for the nine months ended September 30, 2010 and 2009, respectively.  The Company recognized an income tax benefit of $87,000 based on its $1,754,000 pre-tax loss for the nine months ended September 30, 2010.  The $87,000 tax benefit was for recognizing previous uncertain tax positions related to the Company’s research and development credits.  The Company recognized an income tax expense of $150,000 for uncertain tax positions and AMT taxes based on its $1,384,000 pre-tax loss for the nine months ended September 30, 2009.

LIQUIDITY AND CAPITAL RESOURCES

Operating activities used cash of $155,000 and $209,000 for the nine months ended September 30, 2010 and 2009, respectively.  For the nine months ended September 30, 2010, the net loss of $1,667,000 and increased inventory balances of $280,000 for new product introductions were partially offset by collection of 2009 loss carry-back from the IRS of $628,000, non-cash depreciation expense of $589,000, collection of $297,000 accounts receivable balances in excess of third quarter sales as a result of the improvement in days sales outstanding of 4 days and increased accounts payable balances of $324,000 due to increased raw material inventory levels.  For the nine months ended September 30, 2009, the $1,534,000 net loss and payments to vendors of $929,000 of the accounts payable balance in excess of receipts were partially offset by collection of $968,000 of accounts receivable balances in excess of sales for the third quarter of 2009, depreciation expense of $615,000 and sales of $520,000 of inventory in excess of production for customer order requirements.

Cash used in investing activities was used to acquire capital equipment of $31,000 and $75,000 for the nine months ended September 30, 2010 and 2009, respectively.  Cash used in financing activities for the payment of long-term debt was $282,000 for the nine months ended September 30, 2010 compared to $302,000 for the same period in 2009.  For the nine months ended September 30, 2010 cash was provided by the Agreement, described below, and the revolving line-of-credit in the amount of $581,000 compared to $506,000 cash provided solely by the revolving line-of-credit as of September 30, 2009.

The current ratio was 2.0 to 1 at September 30, 2010 and 3.1 to 1 at December 31, 2009, respectively, with working capital equaling $3.2 million and $4.9 million at September 30, 2010 and December 31, 2009, respectively.  The Company had $948,000 outstanding on its accounts receivable agreement with PrinSource Capital Companies, LLC with $1,252,000 available for borrowings as of September 30, 2010.

On August 18, 2010, Winland and PrinSource Capital Companies, LLC ("PrinSource") entered into an Accounts Receivable Agreement (the "Agreement").  The Agreement continues in full force and effect until August 18, 2011 ("Initial Termination Date") and shall automatically and continually renew for successive periods of twelve months (each such period referred to as a "Renewal Period") from the Initial Termination Date or the end of a Renewal Period subject to certain conditions contained in the Agreement.   
 
The Agreement allows PrinSource to purchase from Winland certain eligible accounts based on PrinSource's sole and absolute discretion.  Upon approval and acceptance by PrinSource, PrinSource will pay Winland seventy-five percent (75%) of the eligible account (the "Part Payment") prior to such receivable actually being paid to Winland.  Upon the payment of such receivable to Winland, PrinSource will pay to Winland one hundred percent (100%) of such eligible account, reduced by a per diem fee equal to 1/18th (one eighteenth of one percent) per day from the time that the Part Payment was made by PrinSource to Winland and a one-time processing fee equal to 1/4% (twenty-five hundredths of one percent).  Winland agreed to generate a minimum of fees monthly ("Monthly Minimum") equal to $2,500 for per diem and processing fees.  Winland retains the ultimate responsibility for collection of the receivable, and thus has accounted for the Agreement as a secured borrowing transaction. 

The Agreement replaced the revolving line-of-credit Winland had with Marshall & Ilsley Bank.  The outstanding balance as of June 30, 2010 of $ 1,248,000 was paid in full and the revolving line-of-credit closed.
 
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The Company’s future liquidity needs will depend on many factors, including the timing and amount of its revenues and its investment decisions, which may affect the Company’s ability to generate additional cash.  If cash generated from operations and financing activities, through the use of the Company’s accounts receivable agreement is insufficient to satisfy working capital requirements during the next twelve months, the Company will seek additional funding through bank borrowings or other means.  There can be no assurance that the Company will be able to secure such additional funding on acceptable terms or at all.

The Company is in the process of evaluating strategic alternatives, on-going operations, and growth initiatives in light of the current economic conditions.


FORWARD-LOOKING STATEMENTS

Certain statements contained in this Form 10-Q and other written and oral statements made from time to time by Winland do not relate strictly to historical or current facts.  As such, they are considered “forward-looking statements” that provide current expectations or forecasts of future events.  Such statements can be identified by the use of terminology such as “anticipate,” “believe,” “estimate,” “expect,” “intend,” “may,” “could,” “possible,” “plan,” “project,” “should,” “will,” “forecast” and similar words or expressions.  Winland’s forward-looking statements generally relate to its purchase order levels, building market share in the EMS market, growth strategies, financial results, product development, sales levels, sales efforts and sufficiency of capital.  One must carefully consider forward-looking statements and understand that such statements involve a variety of risks and uncertainties, known and unknown, and may be affected by inaccurate assumptions.  Consequently, no forward-looking statement can be guaranteed, and actual results may vary materially from results or circumstances described in such forward-looking statements.  As provided for under the Private Securities Litigation Reform Act of 1995, Winland wishes to caution investors that its forward-looking statements in some cases have affected and in the future could affect Winland’s actual results of operations and cause such results to differ materially from those anticipated in forward-looking statements made in this document and elsewhere by or on behalf of Winland.

Please refer to forward-looking statements as previously disclosed in our report on Form 10-K for fiscal year ended December 31, 2009.


ITEM 3.                      QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

None.


ITEM 4.                      CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

As of September 30, 2010, the end of the period covered by this report, management, including the Chief Executive Officer (“CEO”) and the Chief Financial Officer (“CFO”) evaluated the effectiveness of disclosure controls and procedures (as defined in the Exchange Act Rules 13a-15(e) and 15d-15(e)) as of such date. Based on that evaluation, the CEO and CFO have concluded that the Company’s disclosure controls and procedures were effective as of September 30, 2010.

Changes in Internal Control over Financial Reporting

There were no changes in the Company’s internal control over financial reporting that occurred during the nine months ended September 30, 2010 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
 
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PART II – OTHER INFORMATION


ITEM 1.                      LEGAL PROCEEDINGS

None.


ITEM 1A.                      RISK FACTORS

Please refer to the risk factors as previously disclosed in the Company’s report on Form 10-K for fiscal year ended December 31, 2009.


ITEM 2.                      UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

None.
 
 
ITEM 3.                      DEFAULTS UPON SENIOR SECURITIES

None.


ITEM 4.                      SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None.


ITEM 5.                      OTHER INFORMATION

None.


ITEM 6.                      EXHIBITS

See Exhibit Index following the signature page.
 
 
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SIGNATURES

Pursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, the Company has caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.



 
  Winland Electronics, Inc.  
       
Date:  November 12, 2010
By:
/s/ Thomas J. de Petra  
    Thomas J. de Petra  
   
President and Chief Executive Officer
(Principal Executive Officer)
 
 
 
       

     
       
 
By:
/s/ Glenn A. Kermes  
    Glenn A. Kermes  
    Chief Financial Officer  
     (Principal Financial and Accounting Officer)  

 
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C.  20549


EXHIBIT INDEX TO FORM 10-Q




For the fiscal quarter ended September 30, 2010
Commission File No. 0-15637

__________________________

WINLAND ELECTRONICS, INC.
__________________________

Exhibit No.
Description
   
31.1
 
 
31.2
 
 
32.1
 
 
32.2
 
 

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