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| WEX > SEC Filings for WEX > Form 10-K on 17-Mar-2009 | All Recent SEC Filings |
17-Mar-2009
Annual Report
EXECUTIVE SUMMARY
Organizational Realignment
Following a January 2008 CEO transition; we initiated a significant organizational realignment of our manufacturing, operations and materials groups late in the first quarter. The objective of the realignment was to improve financial performance by reducing inefficiencies in manufacturing and operations, improving quality and on-time delivery to customers, enhancing customer retention and improving our customers' overall experience with Winland. This realignment required building a more experienced, effective leadership team by attracting new talent with extensive experience in the EMS industry, better utilizing existing talent and providing the team with more timely and relevant data to monitor and manage the business. During the first half of 2008, our leadership team was tasked to establish "best in class" manufacturing and operations practices and processes that could support a high growth business model combining organic growth and future growth by acquisitions. The result was the first phase of change initiatives to enhance program management, information systems, documentation, new product introduction (NPI), quotation and inventory management. This organizational realignment was followed by the September 2008 hire of an experienced EMS sales professional, who was promoted to Vice President of Sales and Marketing in December 2008.
During the third and fourth quarters of 2008, we further expanded productivity and quality enhancement programs through the adoption of formal Lean/Six Sigma manufacturing and focused investment in employee development programs. All such programs are designed to reduce variations in our manufacturing processes and reduce or eliminate negative variances in the cost of labor and materials compared to estimated costs.
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Evidence of Operational Improvements and Leadership Team Changes on Third and Fourth Quarter Financial Performance
Both long lead-times for the procurement of many electronic components, as well as the long sales cycles associated with OEM customers changing electronic supply chain partners can delay by many months the financial impact of operational improvement programs and leadership team changes. However, improvement programs related to program management, quality and waste elimination that were initiated during the year enabled us to reduce warranty expense and obsolete inventory expense by nearly $1 million in 2008 compared to the previous year. Overall operational improvements enabled us to maintain gross profit margin performance at a level state, despite a reduction of net sales of approximately $6 million from 2007.
Sales Efforts
Under the leadership of our new Vice President of Sales and Marketing, 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. We will continue to be proactive and strategic in understanding current and prospective customer's business models, global design and manufacturing fulfillment needs and business drivers to improve the success of the customer with their respective product market share as well as strengthening our position with each customer and growth within targeted market segments.
Our design engineering capability continues to be a significant differentiator from EMS providers similar to our size, 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 2008, we completed a major engineering design project for a new customer, and transitioned that product into manufacturing. 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 in 2009.
During the fourth quarter, we established new marketing programs for Winland's proprietary products and realigned sales responsibilities for both domestic and international sales activities by creating separate eastern and western sales regions. In addition, we hired an experienced eastern sales manager and, subsequent to year end, hired a second sales professional to manage the western region.
As of December 31, 2008, our OEM customers had placed purchase orders with an aggregate value of $12.6 million for delivery during 2009. For comparative purposes, we had purchase orders with an aggregate value of $16.1 million as of September 30, 2008, $15.1 million as of June 30, 2008, $11.4 million as of March 31, 2008 and $17.4 million as of December 31, 2007. Historically, we receive additional build-to-order and recurring blanket orders from our current OEM customers for future production and engineering services. While the value and timing of purchase orders can vary during the year, our order backlog is down primarily due to Select Comfort's expiring contract and timing of purchase orders received from another significant customer.
A Decrease in Sales
The positive impact of existing customer growth, new customer relationships and design engineering projects are being offset by the combined effect of declining orders from two of our three largest customers during 2008 totaling $5.6 million, and the lack of approximately $4.3 million of sales which occurred in 2007 from two customers whose expectations and business management systems did not align well with our value proposition.
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RESULTS OF OPERATIONS - 2008 vs. 2007
The Company reported a net loss of $1,028,000 or $0.28 per basic and diluted share for the twelve months ended December 31, 2008 compared to the $263,000 net loss or $0.07 per basic and diluted share for the same period in 2007. The increase in net loss was driven by a $6,081,000 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 increased loss.
Net Sales
Net sales for the twelve months ended December 31, 2008 were $28,665,000 down $6,081,000 or 22% compared to the same period in 2007. EMS net sales declined 20%, or $6,289,000 to $25,295,000 during 2008, compared to a year ago. Of this decrease, $5,648,000 is due to decreased customer demand from two of our three largest customers. In addition, phase out of sales from two customers caused sales to decline $4,270,000 compared to the same period a year ago. These reductions were offset in part by increased sales of $2,840,000 to our largest customer and sales to a new medical customer of $964,000. Proprietary Products net sales rose 7% to $3,281,000, a $206,000 increase compared to a year ago. Sales to our largest distributor were up $266,000 compared to 2007.
Operating Loss
The Company reported an operating loss of $1,017,000 and $620,000 for the years ended December 31, 2008 and 2007, respectively. Gross margin percentage of 12.2% in 2008 was consistent with the 12.1% reported for 2007. Year over year gross margin consistency was the result of significantly reduced warranty and obsolescence expenses of $909,000, reductions in wages and benefits of $130,000 and lower depreciation expenses of $66,000. These reductions offset the under utilization of manufacturing fixed costs for 2008.
The Company's EMS segment operating income was down $660,000 or 37.5% to $1,099,000 for 2008 compared to operating income reported a year ago primarily due to decreased sales and the underutilization of manufacturing fixed costs. EMS gross margins were 7.3% and 7.8% for 2008 and 2007, respectively. Included in the gross margin percentage of 7.3% are two specific charges totaling $379,000. The first of these specific reserves relate to the valuation adjustment of $134,000 on inventory expected to be sold to Select Comfort's single source supplier. The other reserve relates to a customer who, due to a lack of payment history and future finished goods purchase orders, management determined the customer will not be able to honor its obligations to the Company. As a result, the Company reserved for one hundred percent (100%) of both of this customer's delinquent aged receivables of $102,000 and raw and finished goods inventories of $143,000 as of December 31, 2008.
The Company's Proprietary Products segment operating income decreased $173,000 for 2008, to $127,000 compared to a year ago. Increased manufacturing costs caused gross margins to fall from 50.9% in 2007 to 40.7% 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 2008, General and Administrative expenses decreased $374,000 due to reduced salaries expense, professional fees, consulting expense and travel related expenses partially offset by business and occupation tax expense. The reduced salaries expense was related to the CEO severance package included in the December 31, 2007 financial statements. These expenses are shown as "Other" as discussed in Note 2 to the Financial Statements.
Interest Expense and Other, Net
Interest expense and other consists primarily of interest expense and miscellaneous income. Interest expense for 2008 was $126,000 compared to $261,000 during the same period a year ago. This decrease relates to the reduced usage of the Company's revolving line-of-credit during 2008 compared to 2007.
Income Tax
Winland 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. During 2008, Winland recorded a $271,000 tax valuation allowance related to its deferred tax assets. For 2008, the Company recognized income tax benefit of $89,000, primarily the result of the valuation allowance on its net deferred tax assets. As discussed in Note 6 to the Financial Statements, income tax benefits were calculated using an estimated annual blended federal and state income tax rate of (8)% and (67)% for 2008 and 2007, respectively.
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LIQUIDITY AND CAPITAL RESOURCES
For 2008, the Company's operating activities used cash of $74,000 as its net operating loss and changes in working capital were almost entirely offset by non-cash adjustments for depreciation, stock compensation and deferred taxes. In comparison, operating activities provided cash of $3,833,000 from the reduction of accounts receivable and inventory balances offset by decreases in accounts payable for 2007. Cash used in investing activities was used to acquire capital equipment with a book cost of $237,000 and $228,000 for 2008 and 2007, respectively. Cash of $512,000 and $660,000 for 2008 and 2007, respectively, was used to pay down long term debt. For 2007, $1,924,000 of cash was used to pay down the Company's revolving line-of-credit. Cash provided from the exercise of stock options and issuance of common stock was $27,000 and $51,000 for 2008 and 2007, respectively.
The current ratio was 2.8 to 1 at December 31, 2008 and 3.1 to 1 at December 31, 2007. Working capital equaled $6.0 million on December 31, 2008, compared to $7.0 million on December 31, 2007.
On June 30, 2008 Winland extended its revolving credit agreement to June 30, 2009. No advances were outstanding on the revolving credit agreement at December 31, 2008 or 2007. At December 31, 2008, $3,193,000 was available for borrowing under the terms of this agreement compared to $4,000,000 available as of December 31, 2007.
Management believes that its cash balance, availability of funds under the line of credit agreement with M&I Bank, and anticipated cash flows from operations will be adequate to fund our cash requirements for working capital, investing and financing activities during the next twelve months assuming the line of credit is extended at June 30, 2009. Current conditions in the capital markets are uncertain; however, management believes the Company will have adequate access to capital markets to fund such cash requirements.
CRITICAL ACCOUNTING ESTIMATES
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and related disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Winland cannot assure you that actual results will not differ from those estimates. Winland believes the following are the most critical judgments and estimates used in the preparation of its financial statements.
Revenue Recognition. In most cases, revenue is recognized from the sale of products and out of warranty repairs when the product is delivered to a common carrier for shipment and title transfers.
A portion of the Company's business involves shipping product to a primary customer's location where it is held in a separate warehouse. Revenue is recognized when that customer notifies Winland that the inventory has been removed from the warehouse and title to the product is transferred.
Revenue recognition occurs for engineering design services as services are completed. Winland has an agreement with one particular customer to amortize the cost of engineering design services as part of the piece part cost of the manufactured unit. For the years ended December 31, 2008 and 2007, the customer has paid Winland approximately $31,000 and $181,000, respectively for these services which have yet to be amortized into manufactured units. These payments are classified as unearned revenue and recorded in Other Accrued Expenses on the balance sheet as of December 31, 2008 and 2007, respectively.
Shipping and handling charges billed to customers are included in net sales, and shipping and handling costs incurred by the Company are included in cost of goods sold. For all sales, Winland either has a binding purchase order or customer accepted and signed engineering quote as evidence of the arrangement. Winland does not generally accept returns but does provide a limited warranty as outlined below under Allowance for Rework and Warranty Costs.
Inventory Valuation. Raw component and finished goods inventories are stated at the lower of cost, using the first-in, first-out (FIFO) method, or market value. 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 reserve for slow moving and obsolete inventories was $569,000 and $460,000 as of December 31, 2008 and 2007, respectively.
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Allowance for Doubtful Accounts. Winland evaluates its allowance for uncollectible accounts on a quarterly basis and reviews any significant customers with delinquent balances to determine future collectability. Winland bases its determinations on legal issues, past history, current financial and credit agency reports, and experience. Winland reserves for accounts deemed to be uncollectible in the quarter in which the determination is made. Management believes these values are estimates and may differ from actual results. Winland believes that, based on past history and credit policies, the net accounts receivable are of good quality. Bad debt expenses for the year ended December 31, 2008 and 2007 were $109,000 and $31,000, respectively. The Allowance for Doubtful Accounts was $127,000 and $25,000 at December 31, 2008 and 2007, respectively.
Allowance for Rework and Warranty Costs. Winland provides a limited warranty to its OEM customers who require us 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. Reserves are established based on historical experience and analysis for specific known and potential warranty issues. 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 $80,000 and $160,000 as of December 31, 2008 and 2007, respectively. The product warranty liability reflects management's best estimate of probable liability under Winland's product warranties and may differ from actual results.
Deferred Taxes. Deferred taxes are provided on an asset and liability method, whereby deferred tax assets are recognized for deductible temporary differences and operating loss and tax credit carry-forwards, and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax basis. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Realization of deferred tax assets is dependent on future taxable income during the period that deductible temporary differences and carry-forwards are to be available to reduce taxable income. As of December 31, 2008, Winland recorded a $271,000 tax valuation allowance related to our deferred tax assets.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In December 2007, the FASB issued SFAS No. 141R, Business Combinations ("SFAS 141R"). Among other things, SFAS 141R requires the acquiring entity in a business combination to recognize all the assets acquired and liabilities assumed in the transaction at fair value as of the acquisition date. SFAS 141R is effective for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. This standard will change our accounting treatment for business combinations on a prospective basis.
In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements ("SFAS 160"). SFAS 160 requires all entities to report noncontrolling interests as equity in the consolidated financial statements. SFAS 160 is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008. The Company does not expect the adoption of this statement will have a significant impact on its financial position or results of operations.
CAUTIONARY STATEMENTS
Certain statements contained in this Annual Report on Form 10-K 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 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.
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? Winland derives a significant portion of its revenues from a limited number of OEM customers that are not subject to long-term contracts with Winland;
? although Winland constantly strives to diversify its customer base, currently if any significant customers should materially decrease the volume of their business or stop doing business with Winland, for whatever reason, Winland's business could 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;
? the current economic crisis in the United States has had a negative impact on nearly all businesses, including Winland's customers;
? Winland's current customers may choose to delay or postpone purchases of products from Winland until the economy and their businesses strengthen and this may affect Winland's operating results, financial condition and delay and lengthen sales cycles;
? an overall decline in economic activity may also have a negative impact on Winland's customer's ability to pay it for the products or services they purchase from Winland;
? 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's ability to compete successfully 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;
? due to the current economic crisis in the United States, there can be no assurances that Winland will have access to sufficient financing to support increased sales or an expanding market; and
? 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.
In addition, see "Risk Factors" under Item 1A, which includes a discussion of additional risk factors and a more complete discussion of some of the cautionary statements noted above.
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