##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
   FORM 10-QSB QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF
THE SECURITIES EXCHANGE ACT OF 1934 For the Quarter Ended March 31, 2004 Commission File Number: 0-18393 WINLAND ELECTRONICS, INC.  Minnesota
    
    41-0992135(state or other jurisdiction of
incorporation or organization)
    
    (I.R.S. Employer
Identification Number)
 1950 Excel Drive, Mankato, Minnesota 56001
(Address of principal executive offices) (507) 625-7231
(Issuers telephone number)   Check whether the Issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for
such shorter period that the Issuer was required to file such reports) and
(2) has been subject to such filing requirements for the past 90 days.
Yes   þ   No   o There were 3,359,155 shares of Common Stock, $.01 par value, outstanding as of
March 31, 2004. Transitional Small Business Disclosure Format (check one):   Yes   o   No   þ 1




---



TABLE OF CONTENTS  PART I-FINANCIAL INFORMATIONITEM 1: FINANCIAL STATEMENTSBALANCE SHEETSSTATEMENTS OF INCOMESTATEMENTS OF CASH FLOWSNOTES TO THE INTERIM FINANCIAL STATEMENTSNote 5. Earnings Per ShareITEM 3. CONTROLS AND PROCEDURESPART II  OTHER INFORMATIONITEM 6. EXHIBITS AND REPORTS ON FORM 8-KSIGNATURESEXHIBIT INDEX TO FORM 10-QSBEmployment Agreement - Dale NordquistCertification of Chief Executive OfficerCertification of Chief Financial OfficerCertification of Chief Executive OfficerCertification of Chief Financial Officer    Table of Contents  
 PART I-FINANCIAL INFORMATION 
 ITEM 1: FINANCIAL STATEMENTS WINLAND ELECTRONICS, INC.
BALANCE SHEETS March 31,
    
    December 31,2004
    
    2003(UNAUDITED)ASSETSCurrent AssetsCash
    
    $
    467,494
    
    
    $
    1,412,058Accounts receivable, net
    
    
    2,368,915
    
    
    
    2,255,003Income tax receivable
    
    
    12,500
    
    
    
    138,234Inventories
    
    
    2,590,024
    
    
    
    1,861,135Prepaid expenses
    
    
    302,069
    
    
    
    195,278Deferred taxes
    
    
    186,300
    
    
    
    179,500Total current assets
    
    
    5,927,302
    
    
    
    6,041,208Other Assets
    
    
    109
    
    
    
    174Total other assets
    
    
    109
    
    
    
    174Property and Equipment, at cost:Land and land improvements
    
    
    272,901
    
    
    
    272,901Building
    
    
    2,983,586
    
    
    
    2,983,586Machinery and equipment
    
    
    4,833,386
    
    
    
    3,905,882Data processing equipment
    
    
    1,334,888
    
    
    
    1,323,660Office furniture and equipment
    
    
    332,708
    
    
    
    364,715Total property and equipment
    
    
    9,757,469
    
    
    
    8,850,744Less accumulated depreciation
    
    
    (5,393,093
    )
    
    
    (5,258,004
    )Net property and equipment
    
    
    4,364,376
    
    
    
    3,592,740Total assets
    
    $
    10,291,787
    
    
    $
    9,634,122
 See Notes to the Interim Financial Statements 2




---



##### Table of Contents



WINLAND ELECTRONICS, INC.
BALANCE SHEETS March 31,
    
    December 31,2004
    
    2003(UNAUDITED)LIABILITIES AND STOCKHOLDERS EQUITYCurrent LiabilitiesCurrent maturities of long-term debt
    
    $
    1,316,877
    
    
    $
    408,833Accounts payable
    
    
    1,994,727
    
    
    
    1,192,391Accrued expenses:Compensation
    
    
    449,827
    
    
    
    612,590Other
    
    
    235,434
    
    
    
    245,765Total current liabilities
    
    
    3,996,865
    
    
    
    2,459,579Long Term LiabilitiesDeferred taxes
    
    
    87,100
    
    
    
    94,300Deferred revenue
    
    
    168,783
    
    
    
    170,818Long-term debt, less current maturities
    
    
    155,180
    
    
    
    1,248,671Total long-term liabilities
    
    
    411,063
    
    
    
    1,513,789Total liabilities
    
    
    4,407,928
    
    
    
    3,973,368Stockholders EquityCommon stock
    
    
    33,592
    
    
    
    33,570Additional paid-in capital
    
    
    3,891,275
    
    
    
    3,886,717Retained earnings
    
    
    1,958,992
    
    
    
    1,740,467Total stockholders equity
    
    
    5,883,859
    
    
    
    5,660,754Total liabilities and stockholders equity
    
    $
    10,291,787
    
    
    $
    9,634,122
 See Notes to the Interim Financial Statements 3




---



##### Table of Contents



WINLAND ELECTRONICS, INC. STATEMENTS OF INCOME
For the Three Months Ended March 31, 2004 and 2003
(UNAUDITED) 2004
    
    2003Net sales
    
    $
    5,159,559
    
    
    $
    5,443,154Cost of sales
    
    
    3,792,590
    
    
    
    4,028,911Gross profit
    
    
    1,366,969
    
    
    
    1,414,243Operating expenses:General and administrative
    
    
    467,587
    
    
    
    379,093Sales and marketing
    
    
    316,538
    
    
    
    231,919Research and development
    
    
    210,399
    
    
    
    196,437994,524
    
    
    
    807,449Operating income
    
    
    372,445
    
    
    
    606,794Other income (expenses):Interest expense
    
    
    (30,030
    )
    
    
    (43,330
    )Other, net
    
    
    8,110
    
    
    
    227(21,920
    )
    
    
    (43,103
    )Income before income taxes
    
    
    350,525
    
    
    
    563,691Income tax expense
    
    
    (132,000
    )
    
    
    (205,000
    )Net income
    
    $
    218,525
    
    
    $
    358,691Earnings per share data:Basic
    
    $
    0.07
    
    
    $
    0.11Diluted
    
    
    0.06
    
    
    
    0.11Weighted-average number of common shares outstanding:Basic
    
    
    3,357,148
    
    
    
    3,275,976Diluted
    
    
    3,585,163
    
    
    
    3,353,967
 See Notes to the Interim Financial Statements 4




---



##### Table of Contents



WINLAND ELECTRONICS, INC. STATEMENTS OF CASH FLOWS
For the Three Months Ended March 31, 2004 and 2003
(UNAUDITED) 2004
    
    2003Cash Flows From Operating ActivitiesNet income
    
    $
    218,525
    
    
    $
    358,691Adjustments to reconcile net income to net cash
provided by operating activities:Depreciation and amortization
    
    
    152,457
    
    
    
    176,808Loss on disposal of equipment
    
    
    858
    
    
    
    641Investor relations expense, warrants issued
    
    
    5,397
    
    
    
    2,425Changes in assets and liabilities:Accounts receivable
    
    
    (113,912
    )
    
    
    (639,090
    )Income tax receivable
    
    
    125,734
    
    
    
    Inventories
    
    
    (728,889
    )
    
    
    (39,818
    )Prepaid expenses
    
    
    (112,188
    )
    
    
    (52,872
    )Accounts payable
    
    
    802,336
    
    
    
    540,328Accrued expenses, including deferred
revenue and income taxes payable
    
    
    (189,129
    )
    
    
    80,025Net cash provided by operating activities
    
    
    161,189
    
    
    
    427,138Cash Flows From Investing ActivitiesPurchases of property and equipment
    
    
    (924,886
    )
    
    
    (43,618
    )Net cash used in investing activities
    
    
    (924,886
    )
    
    
    (43,618
    )Cash flows From Financing ActivitiesPayments on long-term borrowings, including capital
lease obligations
    
    
    (185,447
    )
    
    
    (109,440
    )Proceeds from issuance of common stock
    
    
    4,580
    
    
    
    Net cash used in financing activities
    
    
    (180,867
    )
    
    
    (109,440
    )Net increase (decrease) in cash
    
    
    (944,564
    )
    
    
    274,080CashBeginning
    
    
    1,412,058
    
    
    
    692,700End
    
    $
    467,494
    
    
    $
    966,780Supplemental Disclosures of Cash Flow InformationCash payments for:Interest
    
    $
    29,992
    
    
    $
    42,815Income tax
    
    
    20,500
    
    
    
    157,421Supplemental Schedule of Noncash Financing ActivitiesWarrants Issued in Connection with Investors RelationsServices to be Provided
    
    $
    
    
    
    $
    43,178
 See Notes to the Interim Financial Statements 5




---



##### Table of Contents



WINLAND ELECTRONICS, INC.
NOTES TO THE INTERIM FINANCIAL STATEMENTS
(UNAUDITED) Note 1. Basis of Presentation The accompanying unaudited financial statements have been prepared by the
Company in accordance with generally accepted accounting principles in the
United States of America, pursuant to the rules and regulations of the
Securities and Exchange Commission. In managements opinion all adjustments
necessary for a fair presentation of the results for the interim period have
been reflected in the interim financial statements. The results of operations
for any interim period are not necessarily indicative of the results for a full
year. All adjustments to the financial statements are of a normal recurring
nature. Certain information and footnote disclosures normally included in
financial statements have been condensed or omitted. Such disclosures are
those that would substantially duplicate information contained in the most
recent audited financial statements of the Company, such as significant
accounting policies, lease and license commitments and stock options.
Management presumes that users of the interim statements have read or have
access to the audited financial statements included in the Companys most
recent annual report on Form 10-KSB. Note 2. Inventories Major components of inventory at March 31, 2004 and December 31, 2003 as
follows: March 31, 2004
    
    December 31, 2003Raw Materials
    
    $
    1,669,386
    
    
    $
    1,091,213Work In Process
    
    
    451,461
    
    
    
    146,307Finished Goods
    
    
    669,177
    
    
    
    786,615Obsolescence reserve
    
    
    (200,000
    )
    
    
    (163,000
    )Total
    
    $
    2,590,024
    
    
    $
    1,861,135
 Note 3. Financing Arrangement The Company has a $2,500,000 annual revolving line-of-credit agreement with M&I
Bank of Minneapolis, Minnesota through June 28, 2004. Interest on advances
accrues at the banks reference rate and is due monthly and is subject to
certain restrictive requirements. There were no advances outstanding on the
revolving line-of-credit agreement at March 31, 2004 or December 31, 2003. On April 15, 2004 the Company signed an amendment to the original credit
agreement that will provide the Company with a $1.5 million dollar term loan
for the purpose of purchasing capital equipment. As of April 15, the Company
had drawn $1,000,000 under this agreement, which amount is to be repaid in
monthly installments of $20,833 plus interest at 4.91% through March of 2008.
This agreement is subject to the same restrictive covenants as the revolving
line of credit agreement. Under the revolving line-of-credit agreement with M&I Bank, advances are due on
demand, secured by substantially all assets of the Company, and are subject to
a defined borrowing base equal to 75 percent of qualified accounts receivable,
50 percent of qualified inventory, and 25 percent of net book value of
unencumbered equipment. The total availability on the line of credit was
$2,500,000 at March 31, 2004. 6




---



##### Table of Contents



Note 4. Major Customers and Enterprisewide Disclosures Major Customers:The Company has customers that accounted for more than 10
percent of net sales for the three and nine months ended March 31, 2004 and
2003, as follows: Three Months Ended
    
    Three Months EndedMarch 31, 2004
    
    March 31, 2003Sales percentage:Customer A
    
    
    62
    %
    
    
    52
    %Customer B
    
    
    5
    %
    
    
    21
    %
 The above customers had net receivables at March 31, 2004 and December 31, 2003
as follows: March 31, 2004
    
    December 31, 2003Accounts receivable percentage:Customer A
    
    
    53
    %
    
    
    51
    %Customer B
    
    
    6
    %
    
    
    22
    %
 Enterprisewide Disclosures:The following table presents revenues from
external customers for each of the Companys groups of products and
services: Three Months Ended
    
    Three Months EndedMarch 31, 2004
    
    March 31, 2003Proprietary microprocessors and mechanically
controlled sensors and alarms
    
    $
    721,852
    
    
    $
    673,614Electronic controls and assemblies for
OEM customers
    
    
    4,437,707
    
    
    
    4,769,540$
    5,159,559
    
    
    $
    5,443,154
 7




---



##### Table of Contents



Note 5. Earnings Per Share Basic earnings per share is computed by dividing net earnings by the
weighted-average number of common shares outstanding during the period. Diluted
earnings per share is computed by dividing net earnings 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. The dilutive effect of the additional
shares for the three months ended March 31, 2004 and 2003, was to increase the
weighted-average shares outstanding by 228,015 and 77,991 respectively. Note 6. Stock Options, Warrants and Stock-Based Compensation Plans Warrants:On February 19, 2003, the Company granted to Hayden Communications,
Inc., an investor relations firm, warrants to purchase 36,000 shares, which
became 39,697 shares of common stock after the split. Warrants to purchase
1,654 shares of common stock vest each month beginning March 19, 2003 and
continuing during the two-year contractual period. The warrants term will
extend three years from the date of full vesting. The contract for services to
be provided by Hayden Communications, Inc. does provide both parties with a
cancellation right. Such a cancellation would limit the warrants to those
vested up to the time of termination. On March 31, 2004, warrants to purchase
39,697 shares of common stock were outstanding, of which 21,542 shares were
exercisable. The exercise price of such outstanding warrants is $1.85 per
share. The warrants were valued using the Black-Scholes pricing model. Because the
contract can be terminated, the Company is reflecting the value of the warrants
as a prepaid expense and amortizing the expense as investor relations expense
over the life of the contract. In addition, the total value of the outstanding
warrants, $43,178, is reflected in the stockholders equity section at March
31, 2004. Stock-Based Compensation Plans:The Company has a stock-based compensation
plan. The Company accounts for this plan under the recognition and measurement
principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and
related interpretations. Accordingly, no stock-based employee compensation cost
has been recognized, as all options granted under this plan had an exercise
price equal to the market value of the underlying common stock on the date of
grant. There were no options to purchase shares issued to an employee during
the three months ended March 31, 2004. The effect on net income and earnings
per share for the compensation cost for the stock-based compensation plan has
been determined based on the grant date fair values of awards (the method
described in FASB Statement No. 123, Accounting for Stock Based Compensation)
and is reflected in the table below. Three Months EndedMarch 31,2004
    
    2003Net Income:As reported
    
    $
    218,525
    
    
    $
    358,691Deduct total stock-based employee compensation
expense determined under the fair value-based
method for all awards net of related tax effects
    
    
    (8,173
    )
    
    
    (8,173
    )Pro forma
    
    $
    210,352
    
    
    $
    350,518Basic Earnings per shareAs reported
    
    $
    0.07
    
    
    $
    0.11Pro forma
    
    $
    0.06
    
    
    $
    0.08Diluted Earnings per per shareAs reported
    
    $
    0.06
    
    
    $
    0.11Pro forma
    
    $
    0.06
    
    
    $
    0.08
 8




---



##### Table of Contents



Note 7. Product Warranties: The Company provides a limited warranty for a period of one year for its
products. The Companys standard warranties require the Company to repair or
replace defective products during such warranty period at no cost to the
customer. The Company estimates the costs that may be incurred under its basic
limited warranty and records a liability in the amount of such costs at the
time product revenue is recognized. Factors that affect the Companys warranty
liability include the number of units sold, historical and anticipated rates of
warranty claims, and cost per claim. The Company periodically assesses the
adequacy of its recorded warranty liabilities and adjusts the amounts as
necessary. The Company utilizes historical trends and actuarial analysis tools
to assist in determining the appropriate loss reserve levels. Changes in the Companys warranty liability, which is included in other
accruals on the balance sheets, during the period are approximately as follows: Three Months Ended March 31,2004
    
    2003Balance, Beginning
    
    $
    131,000
    
    
    $
    95,000Accruals for products Sold
    
    
    32,139
    
    
    
    79,786Charges in accruals for pre-existing warranties
    
    
    (39,139
    )
    
    
    (22,786
    )Balance, Ending
    
    $
    124,000
    
    
    $
    152,000
 Note 8. New Accounting Standards In January 2003, the FASB issued Interpretation No. 46, Consolidation of
Variable Interest Entities. This interpretation establishes standards for
identifying a variable interest entity and for determining under what
circumstances a variable interest entity should be consolidated with its
primary beneficiary. Until now, a company generally has included another entity
in its consolidated financial statements only if it controlled the entity
through voting interests. Interpretation No. 46 changes that by requiring a
variable interest entity to be consolidated by a company if that company is
subject to a majority of the risk of loss from the variable interest entitys
activities or is entitled to receive a majority of the entitys residual
returns or both. As of March 31, 2004 the requirements of Interpretation No. 46
do not apply to the Company. In May 2003, the Financial Accounting Standards Board (FASB) issued Statement
No. 150, Accounting for Certain Financial Instruments With Characteristics of
Both Liabilities and Equity, which requires the issuer to classify certain
freestanding financial instruments as liabilities. Under the provisions of
Statement No. 150, common stock issued with mandatory redemption features that
require the Company to repurchase the shares upon an event that is certain to
occur, such as termination of employment or death of the stockholder, is no
longer classified as equity; instead, these shares will be reported as shares
subject to mandatory redemptionand classified as a liability in the balance
sheet. In such circumstances, disclosure of the components of this liability
will be included in the notes to the financial statements. The requirements of
Statement No. 150 will apply to the Company for its quarter ending September
30, 2004. The effect of the adoption of this standard will be reported as a
cumulative effect of a change in accounting principle in the year of adoption,
and restatement of previously issued financial statements is not permitted.
The Company does not believe that the adoption of this pronouncement will have
a material effect on its financial statements. 9




---



##### Table of Contents



ITEM 2: MANAGEMENTS DISCUSSION AND ANALYSIS OR PLAN OF OPERATION RESULTS OF OPERATIONS
Three months ended March 31, 2004 v.
Three months ended March 31, 2003 Net Sales: The Company recorded net sales of $5,159,559 for the three months
ended March 31, 2004, a decrease of $283,595, or 5.2%, from $5,443,154 for the
same period in 2003. The decrease in sales for the three months ended March 31,
2004 is primarily attributed to a decline in sales to original equipment
manufacture (OEM) customers, specifically sales to Johnson Outdoors, Inc.
Sales of Winlands proprietary products primarily for the security/industrial,
motor controls and utility controls, increased 7.2% for the three months ended
March 31, 2004, compared to 2003. The Companys OEM customers have given the Company purchase orders having an
aggregate value of $14.5 million for delivery during the remainder of 2004 and
into 2005. The Company expects to receive additional orders from current OEM
customers for future production. Although the Company has purchase orders in
place for many of its OEM customers that are scheduled to be fulfilled in 2004,
these customers may terminate their relationship with the Company at any time
pursuant to certain cancellation provisions. Therefore, there is no assurance
that the Company will continue to be engaged by any of these customers. In
June of 2003 the Company announced that orders from Johnson Outdoors, Inc.
(JOI) would be reduced in the coming years. Sales to JOI represented 5% of
total sales for the quarter ended March 31, 2004 compared to 21% for the same
period in 2003. The Company has continued to provide a full range of Electronic Manufacturing
Services (EMS) to OEM customers, delivering product needs from early concept
through product realization. The Company continues to explore additional
geographic regions to market its OEM services, primarily through networking
with referral sources in the Chicago and Minneapolis areas. In addition to the
networking and referral sources, the Company has signed representative
agreements with two manufacturers representative firms in the Illinois and
Kansas areas. The loss of any significant OEM customer would likely have an
adverse effect on the Companys short-term, and potentially long-term, results. Gross Profits: Gross profit dollars declined 3.4% to $1,366,969 or 26.5% of
net sales for the three months ended March 31, 2004, compared to $1,414,243 or
26.0% of net sales for the same period in 2003. The decline in gross profit
dollars for the quarter ended March 31, 2004 is attributed in part to the
decline in net sales. During the first quarter of 2004 the Company experienced
increased manufacturing variances caused by the increase in volume of new
product designs, as well as increased costs associated with billable
engineering projects, offset in part by reduced warranty expenses for the
period. Operating Expenses: General and administrative expense was $467,587 or 9.1% of
net sales for the three months ended March 31, 2004, compared to $379,093 or
7.0% of net sales for the same period in 2003. The increase in general and
administrative expense for the three months ended March 31, 2004 is attributed
to increased salaries and related expenses, investor relations and directors
and officers insurance expense, offset in part by a decline in bad debt expense
when compared to the same period in 2003. Sales and marketing expense (including project management) was $316,538 or 6.1%
of net sales for the three months ended March 31, 2004, compared to $231,919 or
4.3% of net sales for the same period in 2003. The increase in sales and
marketing expense for the three months ended March 31, 2004 are directly
associated with increased salaries and related expenses, commissions expense
and travel expense, offset in part by a reduction in leased vehicle expense and
employee training expense. Winlands sales and marketing efforts are focused on building long-term
relationships with targeted OEM strategic accounts in the markets that it
serves. The Company relies on direct sales people along with a referral
network to promote its services and uncover new opportunities. Management
believes that augmenting its direct sales force with a referral network and
utilizing independent sales representatives on a limited basis will effectively
provide Winland an opportunity to build market share in the EMS (Electronic
Manufacturing Services) market. In 2003, the Company added the new sales
position of EMS business 10




---



##### Table of Contents



development manager to focus exclusively on strategic account development at
select targeted accounts that best align with the products and services offered
by the Company. Winlands proprietary products in the Environmental Sensors and Security Retail
sectors are marketed through a network of dealers and distributors and
supported by internal staff. In an effort to develop the Environmental and
Security Retail portion of the business, the Company added the position of
Manager for Environmental Security Products and initiated strategic planning
for its proprietary products in late 2003. Research and development expense (including the development of new Company
products as well as design services and support to the OEM customer base) was
$210,399 or 4.1% of net sales for the three months ended March 31, 2004,
compared to $196,437 or 3.6% of net sales for the same period in 2003. The
increase in research and development expense for the first quarter of 2004
compared to the same period in 2003 is primarily attributed to increased design
failure guarantee expense associated with designs for customers, offset in part
by amounts allocated to billable engineering projects. Interest Expense: Interest expense was $30,030 or 0.6% of net sales for the
three months ended March 31, 2004, compared to $43,330 or 0.8% of net sales
for the same periods in 2003. The decline in interest expense for the first
quarter of 2004 was due to a reduction in long-term debt. During the first
quarter of 2004 the Company has not borrowed on its revolving line-of-credit
and has paid down $185,447 of long-term debt. All of the cash used to reduce
debt was generated from the Companys operating activities. Net Earnings: The Company reported net income of $218,525 or $0.07 per basic
share and $0.06 per diluted share for the three months ended March 31, 2004,
compared to net income of $358,691 or $0.11 per basic and diluted share for
the same period in 2003. The decline in net income for the first quarter of
2004 is primarily attributed to a decline in sales and gross profits, increased
operating expenses, offset in part by a reduction in interest and income tax
expense. The Company believes inflation has not significantly affected its results of
operations. The Company uses a 39% blended federal and state income tax rate. Year-to-date
pre-tax net income was $350,525 for 2004 and $563,691 for 2003, resulting in
income tax expense of $132,000 and $205,000, respectively. LIQUIDITY AND CAPITAL RESOURCES Cash provided by operating activities was $161,189 for the three months ended
March 31, 2004, compared to $427,138 for the same period in 2003, a decline of
$265,949. This change was primarily due to decreased net income levels and
increases in inventory levels, accounts receivables, prepaid expenses as well
as a decline in accrued expenses, offset in part by increased accounts payable
balances. Cash provided by operations was used primarily to pay down $185,447
of the Companys long-term debt. The Company also saw a reduction in cash
levels due to temporarily funding the purchase of $924,886 of capital
equipment, which was subsequently funded through a term loan with the M&I Bank. The Company has funded its current operations with cash provided by operations. The current ratio at March 31, 2004 was 1.48 to 1, compared to 2.46 to 1 at
December 31, 2003. Working capital equaled $1,903,437 on March 31, 2004,
compared to $3,581,629 on December 31, 2003. The decline in working capital is
primarily attributed to a decrease in cash used to purchase capital equipment,
and increased current maturities of long term debt associated with the maturity
date on the mortgages with the City of Mankato in January of 2005, offset in
part by increased inventory levels and increased prepaid expenses. On June 30, 2003 the Company entered into a revolving credit agreement with the
M&I Bank of Minneapolis, Minnesota. There were no advances outstanding on the
revolving line-of-credit agreement at March 31, 2004 or December 31, 2003. The
agreement with M&I Bank is also subject to certain restrictive requirements.
On April 15, 2004 the Company signed an amendment to the original credit 11




---



##### Table of Contents



agreement that will provide the Company with a $1.5 million dollar term loan
for the financing of its capital equipment purchases. M&I Bank has advanced
$1,000,000 to the Company as of April 15, 2004, the stated interest rate is
fixed at 4.91% on this advance. The loan will be amortized in full over 48
months. Management believes that our cash balance, availability of funds under a new
line of credit agreement, the amendment adding the $1.5 million dollar term
loan and anticipated cash flows from operations will be adequate to fund our
cash requirements for the next twelve months. A summary of our contractual cash obligations at March 31, 2004 is as follows: Payments due by periodRemainder
    
    
    
    
    
    
    
    
    
    2007Of
    
    
    
    
    
    
    
    
    
    andContractual Obligations
    
    Total
    
    2004
    
    2005
    
    2006
    
    ThereafterLong-term debt,
including interest
    
    $
    1,682,000
    
    
    $
    388,700
    
    
    $
    1,129,700
    
    
    $
    105,600
    
    
    $
    58,300Total contractual cash
obligations
    
    $
    1,682,000
    
    
    $
    388,700
    
    
    $
    1,129,700
    
    
    $
    105,600
    
    
    $
    58,300
 There are no off balance sheet contractual cash obligations. CRITICAL ACCOUNTING POLICIES AND ESTIMATES The critical accounting policies and estimates to follow include, but are not
limited to, revenue recognition, income taxes, product warranties, depreciation
and long-lived assets. Some of the most critical policies and estimates are
also discussed below. The Company derives revenue from primarily two sources: (1) product sales and
out of warranty repair revenue, which includes custom electronic controls and
assemblies for original equipment manufacturers and proprietary products in the
security/industrial and motor control markets and (2) engineering design
services that may include programming and prototypes. The Company recognizes
revenue from the sale of products and out of warranty repairs when the product
is delivered to a common carrier for shipment to a customer. A portion of the
Companys business involves the Company shipping product to a primary
customers location where it is held in a separate warehouse. Revenue is
recognized when the customer notifies the Company that the inventory has been
removed from that warehouse and title to the product is transferred. Revenue
recognition occurs for engineering design services as the progress billings are
made and at the conclusion of the project. For all sales, the Company uses
either a binding purchase order or customer accepted and signed engineering
quote as evidence of the arrangement. The allowance for doubtful accounts is estimated at $20,000 at March 31, 2004.
The Company has not experienced significant bad debt write offs the last
several years, therefore, the current allowance is believed to be adequate for
any exposures to loss on March 2004 accounts receivable. Factors considered in
establishing the reserves include economic conditions and customer financial
strength. The Company has established a reserve for slow moving and obsolete inventories
and believes the reserve of $200,000 at March 31, 2004 is adequate. The
reserve is based on an analysis of the existing inventory, including applying
probability of obsolescence percentages to the aged inventory brackets and
specific identification of obsolete inventory in connection with decisions to
exit certain markets. In addition, the Company has established a reserve of $124,000 for rework and
warranties. This reserve is based on historical experience and analysis of
specific known and potential warranty issues. A portion of the reserve is
based on a percentage of the sales for the six-month period ended March 31,
2004. The percentage used reflects historical experience. Specifically
identified or potential warranty issues are analyzed to determine the
probability and the Companys financial exposure and the reserve is
established. The Company believes that the estimated reserve at March 31, 2004
is adequate. 12




---



##### Table of Contents



At March 31, 2004, the financial statements reflect deferred tax assets of
$186,300 and deferred tax liabilities of $87,100. 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
carryforwards, 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
carryforwards are to be available to reduce taxable income. The Company depreciates property and equipment over its estimated useful life.
There were no impairment charges taken for the three months ended March 31,
2004. CAUTIONARY STATEMENTS Certain statements contained in this Quarterly Report on Form 10-QSB and other
written and oral statements made from time to time by the Company 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. The Companys forward-looking statements
generally relate to the Companys 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. As provided for under the Private Securities Litigation
Reform Act of 1995, the Company wishes to caution investors that the following
important factors, among others, in some cases have affected and in the future
could affect the Company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 the Company. The Company 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 the
Company. If any major customers should for any reason decrease the volume of
their business or stop doing business with the Company, the Companys business
would be adversely affected. Some of the Company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 the Companys customers
encounter difficulties, or the Company is unable to meet the demands of its OEM
customers, the Company could be adversely affected. The Company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. The Company competes for new customers with numerous
independent contract design and manufacturing firms in the United States and
abroad, many of whom have greater financial resources and more established
reputations. The Companys ability to compete successfully in this industry
depends, in part, upon the price at which the Company is willing to manufacture
a proposed product and the quality of the Companys design and manufacturing
services. There is no assurance that the Company 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 the Company from achieving the
growth it anticipates. 13




---



##### Table of Contents



The Company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 the Company will
be able to obtain the financing necessary to achieve its goals. The Company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. 
 ITEM 3. CONTROLS AND PROCEDURES (a) Evaluation of Disclosure Controls Procedures. The Companys Chief Executive Officer, Lorin E. Krueger, and Chief
Financial Officer, Jennifer A. Thompson, have reviewed the Companys
disclosure controls and procedures as of the end of the period
covered by this report. Based upon this review, these officers
believe that the Companys disclosure controls and procedures are
effective in ensuring that information that is required to be
disclosed by the Company in reports that it files under the
Securities Exchange Act of 1934 is recorded, processed and
summarized and reported within the time periods specified in the
rules of the Securities and Exchange Commission. (b) Changes in Internal Controls. There were no changes in the Companys internal controls over
financial reporting that occurred during the period covered by this
report that have materially affected, or are reasonably likely to
materially affect, the Companys internal control over financial
reporting. 
 PART II  OTHER INFORMATION 
 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K  (a)
    
    Exhibits. See Exhibit Index following the
signature page.(b)
    
    Reports onForm 8-K.A Form 8-K dated February
24, 2004 announcing annual earnings for 2003 was filed. 14




---



##### Table of Contents



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.
(Company)Dated: May 5, 2004
    
    /s/ Lorin E. KruegerLorin E. Krueger, President and Chief ExecutiveOfficer (Principal Executive Officer)/s/ Jennifer A. ThompsonJennifer A. Thompson, Chief Financial Officer (PrincipalFinancial and Accounting Officer)
 15




---



##### Table of Contents



SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549 
 EXHIBIT INDEX TO FORM 10-QSB For the fiscal quarter ended
March 31, 2004
    
    Commission File No. 0-18393
   WINLAND ELECTRONICS, INC.
 
 Exhibit No.
    
    Description10.1
    
    Employment Agreement dated January 1, 2003 between the Company and Dale
Nordquist*31.1
    
    Certification of Chief Executive Officer Pursuant to Section 302 of the
Sarbanes-Oxley Act of 200231.2
    
    Certification of Chief Financial Officer Pursuant to Section 302 of the
Sarbanes-Oxley Act of 200232.1
    
    Certification of Chief Executive Officer Pursuant to Section 906 of the
Sarbanes-Oxley Act of 200232.2
    
    Certification of Chief Financial Officer Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
 *Management agreement or compensatory plan or arrangement 16