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| WEX > SEC Filings for WEX > Form 10-Q on 12-Nov-2008 | All Recent SEC Filings |
12-Nov-2008
Quarterly Report
OVERVIEW
Winland Electronics Inc. is a manufacturer providing a variety of products to customers within the transportation, industrial, instrumentation, medical, telecom and consumer 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. Our 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
Organizational Realignment
As previously reported, during the first and second quarters of 2008, we initiated an organizational realignment of our manufacturing, operations and materials groups, and launched change initiatives to enhance program management, information systems, documentation, New Product Introduction (NPI), quotation and inventory management. This realignment included new employees with extensive experience in the EMS industry, who were charged with establishing operational practices and processes which could support a high growth business model combining organic growth and growth by future acquisitions. By reducing variations in our manufacturing processes, we have further improved quality and on-time delivery for our customers. As a result, gross margin performance has also improved from 9.8% for the second quarter this year to 16.0% in the third quarter. Although gross margins historically fluctuate based on product and customer mix, we believe the methodology and business practices implemented earlier in the year will have a favorable impact on our performance and our objective to achieve class-leading EMS industry status.
Sales Efforts
We continue our efforts to expand and further diversify our EMS customer portfolio which currently includes products in the transportation, industrial, instrumentation, medical, telecom and consumer market sectors. By targeting customers across multiple market and product categories where we believe our value proposition and capability best aligns with prospective customers' needs, we intend to help mitigate the risk of customer or industry concentration.
As announced on September 9, 2008, Winland hired a new Director of Sales with over 25 years of experience in the EMS industry. He is well into the process of transforming Winland's sales practices to accommodate our growth strategy.
Winland's order backlog remains strong. As of September 30, 2008, our OEM customers have given us purchase orders with an aggregate value of $16.1 million for delivery during the remainder of 2008 and early 2009. For comparative purposes, we had purchase orders with an aggregate value of $15.1 million as of June 30, 2008, $11.4 million as of March 31, 2008, $17.4 million as of December 31, 2007 and $17.0 million as of September 30, 2007. The current backlog helps validate the strategic direction we have taken during the last several quarters, as well as the value proposition we offer our customers.
Our design engineering capability continues to be a significant differentiator from EMS providers similar in size to Winland, and helps customers lower costs and mitigate the risk of manufacturing new products by tightly integrating design engineering, prototyping, test engineering and the manufacturing process. During the third quarter, we completed a major engineering design project for a new customer, and have transitioned that product into manufacturing. Subsequently, the customer engaged our design engineering department for a second design project that is slated to commence manufacturing in the first quarter of 2009. In addition, we have three other engineering design customers whose projects are expected to transition to Winland manufacturing.
Our focus is to work with all of our OEM customers in order to meet the requirements of their product(s) and lifecycles by using our manufacturing and design engineering services. Historically, the Company receives additional build-to-order and recurring blanket orders from its current OEM customers for future production and engineering services. The value and timing of these purchase orders can vary during the year due to the volume and type of project needs of the customer.
A Decrease in Sales
Positive impact of recent new customer relationships and design engineering projects are being offset by the combined effect of declines from two of our three largest customers during the first three quarters of 2008 totaling $4.1 million, and the lack of approximately $3.3 million of sales which occurred in 2007 from two customers whose expectations and business management systems did not align well with Winland's value proposition.
Current Economic Climate
Winland's balance sheet, income statement and cash flow statement improvements during the last quarter all reflect our efforts to build resilience and flexibility during a highly unstable economic period. As previously stated, certain customers' business is sharply down, while orders for engineering design and manufacturing services from other customers show sales increases and future prospects for growth. We will continue our efforts to preserve credit capacity for growth initiatives and customer acquisition, while improving cash through cost savings and better operational metrics.
RESULTS OF OPERATIONS
Three months and nine months ended September 30, 2008 vs. Three months and nine months ended September 30, 2007
The Company reported net income of $118,000 or $0.03 per basic and diluted share for the three months ended September 30, 2008 compared to net income of $487,000 or $0.13 per basic and diluted share for the same period in 2007. The Company reported a net loss of $1.0 million or $0.28 per basic and diluted share for the nine months ended September 30, 2008 compared to the $0.3 million net loss or $0.07 per basic and diluted share for the same period in 2007. The loss was driven by a $6.4 million decrease in net sales compared to a year ago. Under utilization of manufacturing fixed costs due to lower sales was the primary reason for the year to date loss.
Net Sales
Net sales for the three months ended September 30, 2008 were $7.0 million, down $2.9 million or 29% compared to the same period in 2007. EMS net sales declined $3.0 million compared to last year's $9.1 million, a 33% drop. Reduced sales of $1.6 million were caused by continued declines in customer demand from two of our three largest customers compared to a year ago. In addition, phase out of sales from two customers caused sales to decline $1.5 million compared to the same period one year ago. Proprietary Products net sales rose 23% to $1.0 million, a $0.2 million increase compared to a year ago.
Net sales for the nine months ended September 30, 2008 were $20.9 million down $6.4 million or 23% compared to the same period in 2007. EMS net sales declined 27%, or $6.8 million to $18.2 million during the nine months ended September 30, 2008 compared to a year ago. Of this decrease, $4.1 million is due to decreased customer demand from two of our three largest customers compared to a year ago. In addition, phase out of sales from two customers caused sales to decline $3.3 million compared to the same nine month period of 2007. These sales were offset in part by increased sales to our largest customer and sales to new customers compared to the same period last year. Proprietary Products net sales rose 17% to $2.7 million, a $0.4 million increase compared to a year ago. Sales to our largest distributor were up $119,000 and $339,000, respectively for the three and nine months ended September 30, 2008 when compared to the same periods in 2007.
Operating Income
The Company reported operating income of $107,000 and $603,000 for the three months ended September 30, 2008 and 2007, respectively. Gross margins decreased 0.6% to 16.0% for the three months ended September 30, 2008 compared to the same period in 2007. The Company's EMS segment operating income decreased $492,000 or 47% to $553,000 for the three months ended September 30, 2008 compared to operating income reported a year ago. EMS gross margins declined 2.1% from 13.4% in 2007 to 11.3% for the three months ended September 30, 2008 due to increased material costs and under utilization of manufacturing fixed costs. Operating expenses were reduced $41,000 primarily due to the vacancy of the Company's Senior Vice President of Sales and Marketing. The Company's Proprietary Products segment operating income increased $23,000 or 21.5% to $130,000 for the three months ended September 30, 2008. Increased sales contributed consistent gross margin dollars as the overall percentage dropped 10.5% to 39.8% in 2008 due to higher manufacturing costs. In addition, increased salaries expense and travel related expenses were more than offset by reductions in new product development costs allowing the small increase to operating income.
The Company reported an operating loss of $1,079,000 and $431,000 for the nine months ended September 30, 2008 and 2007, respectively. Gross margin percentages of 11.6% for the nine months ended September 30, 2008 were consistent with those reported during the same period in 2007. The Company's EMS segment operating income was down $696,000 or 53% to $630,000 for the nine months ended September 30, 2008 compared to operating income reported a year ago primarily due to decreased sales. EMS gross margins fell from 7.3% in 2007 to 6.1% for the nine months ended September 30, 2008 due to under utilized fixed manufacturing costs and increased material costs offset by reduced warranty and obsolete inventory expenses. Operating expenses were reduced $21,000 primarily due to decreased professional fees. The Company's Proprietary Products segment operating income decreased $78,000 for the nine months ended September 30, 2008, to $60,000 compared to a year ago. Increased manufacturing costs caused gross margins to fall from 51% in 2007 to 40% in 2008. Additionally, operating income was reduced by increased salaries expense, travel related expenses and advertising expenses offset by reduced new product development expenses.
For the three months ended September 30, 2008, General and Administrative expenses increased $27,000 due to the recognition and payment of business and opportunity taxes, penalties and interest to the State of Washington for tax years 2005 through June 30, 2008. These expenses were offset by reductions in bad debts and tax preparation fees compared to the same period a year ago. For the nine months ended September 30, 2008, General and Administrative expenses decreased $126,000 due to reduced bad debt expense, consulting expense and travel related expenses partially offset by increased legal and tax preparation fees and business and opportunity tax expenses noted above.
Interest Expense and Other, Net
Interest expense and other consists primarily of interest expense and miscellaneous income. Interest expense for the three and nine months ended September 30, 2008 was $34,000 and $98,000, respectively, compared to $53,000 and $226,000, respectively, during the same period a year ago. The Company had $55,000 outstanding on its revolving line-of-credit as of September 30, 2008 with no outstanding balance at September 30, 2007.
Income Tax
As discussed in Note 9 to the Condensed Financial Statements, income tax benefits were calculated using an estimated annual blended federal and state income tax rate of 21% and 56% for the nine months ended September 30, 2008 and 2007, respectively. For the three months ended September 30, 2008, the Company recognized an income tax benefit of $33,000, primarily the result of the change in valuation allowance on its net deferred tax assets. We record a tax valuation allowance when it is more likely than not that we will not be able to recover the value of our deferred tax assets.
LIQUIDITY AND CAPITAL RESOURCES
Operating activities used cash of $166,000 for the nine months ended September 30, 2008 compared to cash provided by operating activities of $2,642,000 for the nine months ended September 30, 2007. The net loss was a driving factor in the use of cash for the nine month period ended September 30, 2008 offset by $611,000 of depreciation expense and $202,000 of non-cash stock based compensation for the period. For the nine months ended September 30, 2007, cash provided by changes in working capital of $2,098,000 and depreciation expense of $662,000 was partially offset by the net loss of $270,000 for the period. Cash used in investing activities was used to acquire capital equipment of $130,000 and $220,000 for the nine months ended September 30, 2008 and 2007, respectively. Cash used in financing activities for the payment of long term debt was $397,000 for the nine months ended September 30, 2008 compared to $486,000 for the same period in 2007. For the nine months ended September 30, 2008, cash was provided by borrowing against the revolving line of credit in the amount of $55,000 compared to cash used of $1,924,000 to pay down the line of credit during the same period in 2007.
The current ratio was 2.5 to 1 at September 30, 2008 and 3.1 to 1 at December 31, 2007. Working capital was $6.1 million at September 30, 2008 and $7.0 million at December 31, 2007. The Company had $55,000 outstanding on its revolving line-of-credit as of September 30, 2008. At September 30, 2008, $3,500,000 was available for borrowings under the revolving line-of-credit agreement which expires June 30, 2009, if not renewed. Subsequently, Amendment No. 12 to the Credit Agreement was executed on October 27, 2008 to reduce the inventory eligible to borrow against from $2,500,000 to $1,000,000, in addition to reducing the minimum tangible net worth from $9,250,000 to $8,500,000. If this amendment had been in place as of September 30, 2008, the amount available for borrowing under the revolving line-of-credit agreement would have been $2,400,000. Amendment No. 12 is incorporated into this Form 10-Q as Exhibit 10.1.
We believe that our cash balance, funds available under the line of credit agreement, if renewed, and anticipated cash flows from operations will be adequate to fund our cash requirements for at least the next twelve months.
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, including, among others, those discussed below. 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 the following important factors, among others, 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.
Winland derives a significant portion of its revenues from a small number of major OEM customers that are not subject to any long-term contracts with Winland. If any major customers should for any reason decrease the volume of their business or stop doing business with Winland, its business would be adversely affected. Some of Winland's customers are not large well-established companies, and the business of each customer is subject to various risks such as market acceptance of new products and continuing availability of financing. To the extent that Winland's customers encounter difficulties or it is unable to meet the demands of its OEM customers, Winland could be adversely affected.
Winland's ability to increase revenues and profits is dependent upon its ability to retain valued existing customers and obtain new customers that fit its customer profile. Winland competes for new customers with numerous independent contract design and manufacturing firms in the United States of America and abroad, many of whom have greater financial resources and more established reputations. Winland's ability to compete successfully in this industry depends, in part, upon the price at which Winland is willing to manufacture a proposed product and the quality of its design and manufacturing services. There is no assurance that Winland will be able to continue to obtain contracts from existing and new customers on financially advantageous terms, and the failure to do so could prevent it from achieving the growth it anticipates.
Winland's ability to execute its initiatives to increase sales and expand market share depends upon its ability to develop additional value added capabilities and/or proprietary products and technologies and on the availability of sufficient financing, both equity and debt, to meet fixed and variable costs associated with such growth. In the current economic environment, banks and other sources of financing are conservative in their lending and investment policies. There is no assurance that Winland will be able to obtain the financing necessary to achieve its goals.
Winland's success in providing an improved mix of higher margin products and services depends on the effectiveness of its new product development and planning efforts as well as the timing of such and the availability and costs of any competing products or services on the market.
Winland's ability to comply with European Union directives RoHS and WEEE depends upon its ability to develop and implement compliant processes and products. The continued cost of such efforts, the degree to which Winland will be expected to absorb such costs and liability for non-compliant product could adversely affect its financial results.
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