##### 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 September 30, 2004
    
    Commission File Number: 001-15637
 WINLAND ELECTRONICS, INC.  Minnesota
(state or other jurisdiction of
incorporation or organization)
    
    41-0992135
(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 x     No o There were 3,376,971 shares of Common Stock, $.01 par value, outstanding as of
October 21, 2004. Transitional Small Business Disclosure Format (check one):     Yes o     No x    1




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TABLE OF CONTENTS  PART I-FINANCIAL INFORMATIONITEM 1: FINANCIAL STATEMENTSITEM 2: MANAGEMENTS DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONITEM 3. CONTROLS AND PROCEDURESPART II  OTHER INFORMATIONITEM 6. EXHIBITSSIGNATURESCertification of CEO Pursuant to Section 302Certification of CFO Pursuant to Section 302Certification of CEO Pursuant to Section 906Certification of CFO Pursuant to Section 906    Table of Contents  
 PART I-FINANCIAL INFORMATION 
 ITEM 1: FINANCIAL STATEMENTS WINLAND ELECTRONICS, INC.
BALANCE SHEETS September 30,
    
    December 31,ASSETS
    
    2004
    
    2003(UNAUDITED)Current AssetsCash
    
    $
    525,116
    
    
    $
    1,412,058Accounts receivable, net
    
    
    3,206,417
    
    
    
    2,255,003Income tax receivable
    
    
    15,485
    
    
    
    138,234Inventories
    
    
    3,482,885
    
    
    
    1,861,135Prepaid expenses
    
    
    283,603
    
    
    
    195,278Deferred taxes
    
    
    186,300
    
    
    
    179,500Total current assets
    
    
    7,699,806
    
    
    
    6,041,208Other Assets
    
    
    90
    
    
    
    174Total other assets
    
    
    90
    
    
    
    174Property and Equipment, at cost:Land and land improvements
    
    
    272,901
    
    
    
    272,901Building
    
    
    2,983,586
    
    
    
    2,983,586Machinery and equipment
    
    
    4,700,667
    
    
    
    3,905,882Data processing equipment
    
    
    1,378,616
    
    
    
    1,323,660Office furniture and equipment
    
    
    334,908
    
    
    
    364,715Total property and equipment
    
    
    9,670,678
    
    
    
    8,850,744Less accumulated depreciation
    
    
    (5,318,492
    )
    
    
    (5,258,004
    )Net property and equipment
    
    
    4,352,186
    
    
    
    3,592,740Total assets
    
    $
    12,052,082
    
    
    $
    9,634,122
 See Notes to the Interim Financial Statements 2




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WINLAND ELECTRONICS, INC.
BALANCE SHEETS
(UNAUDITED) September 30,
    
    December 31,LIABILITIES AND STOCKHOLDERS EQUITY
    
    2004
    
    2003Current LiabilitiesNote payable to bank
    
    $
    1,379,000
    
    
    $
    Current maturities of long-term debt
    
    
    488,685
    
    
    
    408,833Accounts payable
    
    
    923,411
    
    
    
    1,192,391Accrued expenses:Compensation
    
    
    716,522
    
    
    
    612,590Other
    
    
    271,839
    
    
    
    245,765Total current liabilities
    
    
    3,779,457
    
    
    
    2,459,579Long Term Liabilities
    
    
    87,100
    
    
    
    94,300Deferred taxes
    
    
    87,100
    
    
    
    94,300Deferred revenue
    
    
    164,714
    
    
    
    170,818Long-term debt, less current maturities
    
    
    1,654,368
    
    
    
    1,248,671Total long-term liabilities
    
    
    1,906,182
    
    
    
    1,513,789Total liabilities
    
    
    5,685,639
    
    
    
    3,973,368Stockholders Equity
    
    
    33,770
    
    
    
    33,570Common stock
    
    
    33,770
    
    
    
    33,570Additional paid-in capital
    
    
    3,917,862
    
    
    
    3,886,717Retained earnings
    
    
    2,414,811
    
    
    
    1,740,467Total stockholders equity
    
    
    6,366,443
    
    
    
    5,660,754Total liabilities and stockholders equity
    
    $
    12,052,082
    
    
    $
    9,634,122
 See Notes to the Interim Financial Statements 3




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WINLAND ELECTRONICS, INC.
STATEMENTS OF INCOME
For the Three Months Ended September 30, 2004 and 2003
(UNAUDITED) 2004
    
    2003Net sales
    
    $
    6,591,038
    
    
    $
    4,580,189Cost of sales
    
    
    5,056,642
    
    
    
    3,428,104Gross profit
    
    
    1,534,396
    
    
    
    1,152,085Operating expenses:General and administrative
    
    
    397,607
    
    
    
    326,681Sales and marketing
    
    
    315,789
    
    
    
    238,312Research and development
    
    
    151,753
    
    
    
    154,303865,149
    
    
    
    719,296Operating income
    
    
    669,247
    
    
    
    432,789Other income (expenses):Interest expense
    
    
    (46,413
    )
    
    
    (29,701
    )Other, net
    
    
    (4,880
    )
    
    
    6,062(51,293
    )
    
    
    (23,639
    )Income before income taxes
    
    
    617,954
    
    
    
    409,150Income tax expense
    
    
    (241,000
    )
    
    
    (151,000
    )Net income
    
    $
    376,954
    
    
    $
    258,150Earnings per share data:Basic
    
    $
    0.11
    
    
    $
    0.09Diluted
    
    
    0.11
    
    
    
    0.08Weighted-average number of common shares outstanding:Basic
    
    
    3,366,542
    
    
    
    2,996,046Diluted
    
    
    3,485,670
    
    
    
    3,069,170
 See Notes to the Interim Financial Statements 4




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WINLAND ELECTRONICS, INC.
STATEMENTS OF INCOME
For the Nine Months Ended September 30, 2004 and 2003
(UNAUDITED) 2004
    
    2003Net sales
    
    $
    17,526,476
    
    
    $
    14,370,370Cost of sales
    
    
    13,590,703
    
    
    
    10,817,645Gross profit
    
    
    3,935,773
    
    
    
    3,552,725Operating expenses:General and administrative
    
    
    1,223,025
    
    
    
    1,043,341Sales and marketing
    
    
    946,287
    
    
    
    694,357Research and development
    
    
    567,486
    
    
    
    530,8292,736,798
    
    
    
    2,268,527Operating income
    
    
    1,198,975
    
    
    
    1,284,198Other income (expenses):Interest expense
    
    
    (110,595
    )
    
    
    (108,692
    )Other, net
    
    
    16,964
    
    
    
    10,284(93,631
    )
    
    
    (98,408
    )Income before income taxes
    
    
    1,105,344
    
    
    
    1,185,790Income tax expense
    
    
    (431,000
    )
    
    
    (435,000
    )Net income
    
    $
    674,344
    
    
    $
    750,790Earnings per share data:Basic
    
    $
    0.20
    
    
    $
    0.25Diluted
    
    
    0.19
    
    
    
    0.25Weighted-average number of common shares outstanding:Basic
    
    
    3,360,980
    
    
    
    2,986,653Diluted
    
    
    3,535,633
    
    
    
    3,056,739
 See Notes to the Interim Financial Statements 5




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WINLAND ELECTRONICS, INC.
STATEMENTS OF CASH FLOWS
For the Nine Months Ended September 30, 2004 and 2003
(UNAUDITED) 2004
    
    2003Cash Flows From Operating ActivitiesNet income
    
    $
    674,344
    
    
    $
    750,790Adjustments to reconcile net income to net cash
provided by (used in) operating activities:Depreciation and amortization
    
    
    487,464
    
    
    
    532,525Loss on disposal of equipment
    
    
    3,196
    
    
    
    754Investor relations expense, warrants issued
    
    
    16,193
    
    
    
    13,219Deferred taxes
    
    
    (14,000
    )
    
    
    Changes in assets and liabilities:Accounts receivable
    
    
    (951,414
    )
    
    
    12,776Income tax receivable
    
    
    122,749
    
    
    
    Inventories
    
    
    (1,621,750
    )
    
    
    129,667Prepaid expenses
    
    
    (104,518
    )
    
    
    (96,211
    )Accounts payable
    
    
    (268,980
    )
    
    
    348,697Accrued expenses, including deferred
revenue and income taxes payable
    
    
    123,903
    
    
    
    34,620Net cash provided by (used in) operating activities
    
    
    (1,532,813
    )
    
    
    1,726,837Cash Flows From Investing ActivitiesPurchases of property and equipment
    
    
    (1,268,523
    )
    
    
    (210,280
    )Proceeds from the sale of equipment
    
    
    18,500
    
    
    
    Net cash used in investing activities
    
    
    (1,250,023
    )
    
    
    (210,280
    )Cash flows From Financing ActivitiesNet borrowings on revolving line of credit
    
    
    1,379,000
    
    
    
    Proceeds from long-term borrowings
    
    
    2,000,000
    
    
    
    Payments on long-term borrowings, including capital
lease obligations
    
    
    (1,514,451
    )
    
    
    (764,761
    )Proceeds from issuance of common stock
    
    
    31,345
    
    
    
    10,013Net cash provided by (used in) financing activities
    
    
    1,895,894
    
    
    
    (754,748
    )Net increase (decrease) in cash
    
    
    (886,942
    )
    
    
    761,809CashBeginning
    
    
    1,412,058
    
    
    
    692,700End
    
    $
    525,116
    
    
    $
    1,454,509Supplemental Disclosures of Cash Flow InformationCash payments for:Interest
    
    $
    110,480
    
    
    $
    108,082Income tax
    
    
    169,314
    
    
    
    537,421Supplemental Schedule of Noncash Financing ActivitiesWarrants Issued in Connection with Investors RelationsServices to be Provided
    
    $
    
    
    
    $
    43,178
 See Notes to the Interim Financial Statements 6




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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 September 30, 2004 and December 31, 2003 as
follows: September 30, 2004
    
    December 31, 2003Raw Materials
    
    $
    1,832,049
    
    
    $
    1,091,213Work In Process
    
    
    445,712
    
    
    
    146,307Finished Goods
    
    
    1,405,124
    
    
    
    786,615Obsolescence Reserve
    
    
    (200,000
    )
    
    
    (163,000
    )Total
    
    $
    3,482,885
    
    
    $
    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, 2005. 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
and 50 percent of qualified inventory. The total unused availability on the
line of credit was $1,121,000 at September 30, 2004. Interest on advances
accrues at the banks reference rate
(4 1/4 % at September 30, 2004) is due monthly and is subject to certain
restrictive covenants. There were advances of $1,379,000 outstanding on the
revolving line of credit agreement at September 30, 2004, and there were no
advances outstanding at December 31, 2003. On April 15, 2004, the Company signed an amendment to the original credit
agreement that provides the Company with a $1.5 million term loan for the
purpose of purchasing capital equipment. As of September 30, 2004, 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. On September 30, 2004, the Company entered into a ten-year mortgage agreement
with US Bank to refinance the previous debt with the City of Mankato that was
set to expire in early 2005. The interest rate is fixed at 6.44% with 119
installments of $11,373 plus the final payment to equal the unpaid principal
balance. 7




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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 September 30, 2004 and 2003 as follows: Three Months Ended
    
    Three Months EndedSales percentage:
    
    September 30, 2004
    
    September 30, 2003Customer A
    
    
    57
    %
    
    
    53
    %Customer B
    
    
    10
    %
    
    
    1
    %Customer C
    
    
    3
    %
    
    
    9
    %
 Nine Months Ended
    
    Nine Months EndedSales percentage:
    
    September 30, 2004
    
    September 30, 2003Customer A
    
    
    59
    %
    
    
    54
    %Customer B
    
    
    9
    %
    
    
    0
    %Customer C
    
    
    4
    %
    
    
    16
    %
 The above customers had net receivables at September 30, 2004 and December 31, 2003 as follows: Accounts receivable percentage:
    
    September 30, 2004
    
    December 31, 2003Customer A
    
    
    54
    %
    
    
    47
    %Customer B
    
    
    7
    %
    
    
    0
    %Customer C
    
    
    2
    %
    
    
    9
    %
 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 EndedSeptember 30, 2004
    
    September 30, 2003Proprietary microprocessors and mechanically
controlled sensors and alarms
    
    $
    843,967
    
    
    $
    715,364Electronic controls and assemblies for
OEM customers
    
    
    5,747,071
    
    
    
    3,864,825$
    6,591,038
    
    
    $
    4,580,189
 Nine Months Ended
    
    Nine Months EndedSeptember 30, 2004
    
    September 30, 2003Proprietary microprocessors and mechanically
controlled sensors and alarms
    
    $
    2,129,479
    
    
    $
    1,934,741Electronic controls and assemblies for
OEM customers
    
    
    15,396,997
    
    
    
    12,435,629$
    17,526,476
    
    
    $
    14,370,370
 8




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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 and nine months ended September 30, 2004 and 2003
increased the weighted-average shares outstanding by 119,128 and 174,653
compared to 73,124 and 70,086, 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 39,697 shares of common
stock. Warrants to purchase 1,654 shares of common stock vest each month
beginning March 19, 2003 and continuing for 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 September
30, 2004, warrants to purchase 39,697 shares of common stock were outstanding,
of which 31,426 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
September 30, 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 5,000 options to purchase shares issued to employees and
directors during the three months ended September 30, 2004, representing gross
compensation expense of $6,681. 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 Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Net Income:As reported
    
    $
    376,954
    
    
    $
    258,150
    
    
    $
    674,344
    
    
    $
    750,790Deduct total stock-based employee compensation
expense determined under the fair value-based
method for all awards net of related tax effects
    
    
    (13,715
    )
    
    
    (12,243
    )
    
    
    (50,675
    )
    
    
    (47,555
    )Pro forma
    
    $
    363,239
    
    
    $
    245,907
    
    
    $
    623,669
    
    
    $
    703,235Basic Earnings per shareAs reported
    
    $
    0.11
    
    
    $
    0.09
    
    
    $
    0.20
    
    
    $
    0.25Pro forma
    
    $
    0.11
    
    
    $
    0.08
    
    
    $
    0.19
    
    
    $
    0.24Diluted Earnings per shareAs reported
    
    $
    0.11
    
    
    $
    0.08
    
    
    $
    0.19
    
    
    $
    0.25Pro forma
    
    $
    0.10
    
    
    $
    0.08
    
    
    $
    0.18
    
    
    $
    0.23
 9




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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: Nine Months Ended September 30,2004
    
    2003Balance, Beginning
    
    $
    131,000
    
    
    $
    95,000Accruals for products Sold
    
    
    74,000
    
    
    
    152,000Charges in accruals for pre-existing warranties
    
    
    (103,000
    )
    
    
    (116,000
    )Balance, Ending
    
    $
    102,000
    
    
    $
    131,000
 10




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ITEM 2: MANAGEMENTS DISCUSSION AND ANALYSIS OR PLAN OF OPERATION RESULTS OF OPERATIONS
Three and nine months ended September 30, 2004 v.
Three and nine months ended September 30, 2003 Net Sales: The Company recorded net sales of $6,591,038 and $17,526,476 for
the three and nine months ended September 30, 2004, an increase of 44% and 22%
from $4,580,189 and $14,370,370 for the same periods in 2003, respectively.
The increase in sales for the three and nine months ended September 30, 2004 is
attributed to increased sales to original equipment manufacture (OEM)
customers, offset in part by the decline in sales to Johnson Outdoors, Inc for
the current quarter and the first nine months of 2004. Sales of Winlands
proprietary products primarily for the security/industrial sector, motor
controls and utility controls, increased 18% for the three months ended
September 30, 2004 and 10% for the first nine months of 2004, compared to 2003. The Company has received from its OEM customers purchase orders having an
aggregate value of $11.4 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 4.2% of
total sales for the first nine months of 2004 compared to 16% 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 increased slightly to $1,534,396 or 23.3%
of net sales for the three months ended September 30, 2004, compared to
$1,152,085 or 25.2% of net sales for the same period in 2003. Gross profit
dollars increased for the nine months ended September 30, 2004 to $3,935,773,
compared to $3,552,725 for the same period in 2003. Gross profit decreased as
a percentage of net sales from 24.7% for the nine month period in 2003 to 22.5%
for the nine month period in 2004. The decline in gross profit as a percentage
of net sales for the quarter and the nine months ended September 30, 2004 is
attributed to additional production costs, including component preparation,
manual component placements and manual testing associated with new product
introductions and ramp ups in the first nine months of 2004. During the third
quarter, the Company was reimbursed for some of the material overrun costs
associated with new product introduction from a specific customer. During the
third quarter and the nine months ended September 30, 2004, the Company
incurred additional labor costs due to overtime and the increased use of a
temporary labor force, as well as increased costs associated with billable
engineering projects and increased freight, offset in part by reduced warranty
and obsolescence expenses when compared to the same period in 2003. These
increased costs were associated with a higher volume of new product design as
compared to 2003. The Company saw an increase for the third quarter and a
reduction for the first nine months of 2004 in employee incentive plan accruals
when compared to 2003. Operating Expenses: General and administrative expense was $397,607 or 6.0% of
net sales and $1,223,025 or 7.0% of net sales for the three and nine months
ended September 30, 2004, compared to $326,681 or 7.1% of net sales and
$1,043,341 or 7.3% of net sales for the same periods in 2003. The increase in general and administrative expense for the three and nine
months ended September 30, 2004 is attributed to increased salaries and related
expenses, board of directors expense, directors and officers insurance expense,
increased banking fees, increased employee incentive plan accruals as well as 11




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donations expense and investor relations expense, offset in part by a reduction
in legal and professional fees and bad debt expense accruals when compared to
the same period in 2003. Sales and marketing expense (including project management) was $315,789 or 4.8%
of net sales and $946,287 or 5.4% of net sales for the three and nine months
ended September 30, 2004, compared to $238,312 or 5.2% of net sales and
$694,357 or 4.8% of net sales for the same periods in 2003, respectively. The
increases in sales and marketing expense for the three and nine months ended
September 30, 2004 are directly associated with increased salaries and related
expenses, commissions expense and increased employee incentive plan accruals,
offset in part by a reduction in leased vehicle expense and employee training
expense and promotional materials 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 development manager to focus exclusively on strategic
account development and 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 (primarily design services and support to the
OEM customer base) was $151,753 or 2.3% of net sales for the three months ended
September 30, 2004 and $567,486 or 3.2% of net sales for the first nine months
of 2004, compared to $154,303 or 3.4% of net sales and $530,829 or 3.7% of net
sales for the same periods in 2003. The increase in research and development
expense for the first nine months of 2004 compared to the same period in 2003
is primarily attributed to increased design failure guarantee expense
associated with designs for customers, increased employee incentive plan
accruals offset in part by amounts allocated to billable engineering projects
when compared to the same period in 2003. Expenses were down slightly for the
third quarter of 2004 due to reduction in salaries and related expenses as well
as amounts allocated to billable engineering projects, offset in part by
increased employee incentive plan accruals when compared to the same period in
2003. Interest Expense: Interest expense was $46,413 and $110,595 or 0.7% and 0.6%
of net sales for the three and nine months ended September 30, 2004,
respectively, compared to $29,701 and 108,692 or 0.6% and 0.8% of net sales for
the same periods in 2003, respectively. The increase in interest expense for
the third quarter and first nine months of 2004 was primarily due to the new
borrowings. With the increase in short-term and long-term borrowings the
Company expects to see an increase in interest expense for subsequent periods. Net Earnings: The Company reported net income of $376,954 or $0.11 per basic
and diluted share for the three months ended September 30, 2004 and $674,344 or
$0.20 per basic and $0.19 per diluted shared for the first nine months of 2004,
compared to net income of $258,150 or $0.09 per basic and $0.08 per diluted
share and $750,790 or $0.25 per basic shared and $0.25 per diluted share for
the same periods in 2003, respectively. The increase in net income for the
third quarter of 2004 is primarily attributed to an increase in gross profits,
offset in part by an increased operating expenses, interest expense and income
tax expense. The decline in income for the first nine months of 2004 is
attributed to increased operating expenses, offset in part by an increase in
gross profits. 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 $1,105,344 for 2004 and $1,185,790 for 2003, resulting
in income tax expense of $431,000 and $435,000, respectively. 12




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LIQUIDITY AND CAPITAL RESOURCES Cash used in operating activities was $1,532,813 for the nine months ended
September 30, 2004, compared to cash provided by operating activities of
$1,726,837 for the same period in 2003, a decline of $3,259,650. This change
was primarily due to increases in inventory levels, accounts receivable, and
prepaid expenses as well as a decline in accounts payable balances, offset in
part by increased accrued expenses and a reduction in income tax receivable.
Cash used in operations resulted in a decrease in cash reserves as well as
increases on the borrowings on the bank line-of-credit. The current ratio at September 30, 2004 was 2.04 to 1, compared to 2.46 to 1 at
December 31, 2003. Working capital equaled $3,920,349 on September 30, 2004,
compared to $3,581,629 on December 31, 2003. The increase in working capital
is primarily attributed to realigning of the current maturities related to
refinancing the mortgage with a ten year maturity, offset in part by a decrease
in cash, used to fund current operating activities, as well as by increased
inventory levels, accounts receivable and increased prepaid expenses. On June 25, 2004 the Company extended its revolving credit agreement with the
M&I Bank of Minneapolis, Minnesota with a renewal date of June 28, 2005. There
were $1,379,000 of advances outstanding on the revolving line-of-credit
agreement at September 30, 2004, with no advances outstanding at December 31,
2003. The interest rate on the revolving line of credit is at the banks
reference rate, 4.75% at September 30, 2004. The agreement with M&I Bank is
also subject to certain restrictive covenants. 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 financing of its capital
equipment purchases. M&I Bank has advanced $1,000,000 to the Company as of
October 21, 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 the 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 September 30, 2004 is as
follows: Payments due by periodRemainder
    
    
    
    
    
    
    
    
    
    2007Of
    
    
    
    
    
    
    
    
    
    andContractual Obligations
    
    Total
    
    2004
    
    2005
    
    2006
    
    ThereafterLong-term debt,
including interest
    
    $
    2,589,100
    
    
    $
    153,400
    
    
    $
    534,000
    
    
    $
    495,400
    
    
    $
    1,406,300
 Other commercial commitments as described below: Other Commercial
    
    
    
    
    
    Outstanding BalanceCommitment
    
    Total Amount Committed
    
    9/30/2004
    
    Date of ExpirationLine of Credit
    
    $
    2,500,000.00
    
    
    $
    1,379,000.00
    
    
    June 28, 2005
 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. 13




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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
customers 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 $10,000 at September 30,
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 September 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 September 30, 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 $102,000 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 nine-month period ended September
30, 2004. The percentage used reflects historical experience. Specifically
identified or potential warranty issues are analyzed to determine the
probability of an adverse event and the Companys financial exposure associated
with such event and the reserve is established accordingly. The Company
believes that the estimated reserve at September 30, 2004 is adequate. At September 30, 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 and nine months ended
September 30, 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 14




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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. 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. 15




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PART II  OTHER INFORMATION 
 ITEM 6. EXHIBITS See Exhibit Index following the signature page. 16




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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.
                 (Company)Dated: November 3, 2004
    /s/ Lorin E. KruegerLorin E. Krueger, President andChief Executive Officer (Principal
Executive Officer) /s/ Jennifer A. ThompsonJennifer A. Thompson, ChiefFinancial Officer (Principal
Financial and Accounting Officer) 17




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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549 EXHIBIT INDEX TO FORM 10-QSB For the fiscal quarter ended
September 30, 2004
    
    Commission File No. 0-18393
    WINLAND ELECTRONICS, INC.
   Exhibit No.
    
    Description31.1
    
    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
 18