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MULTI FINELINE ELECTRONIX INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations

February 6, 2014

This Quarterly Report on Form 10-Q ("Quarterly Report") contains forward-looking statements that involve a number of risks and uncertainties. These forward-looking statements include, but are not limited to, statements and predictions as to our expectations regarding our revenues, sales, sales growth, net income and losses, inventory levels, production build plans, restructuring and reorganization efforts and related charges, operating expenses, research and development expenses, earnings, operations, gross margins, including without limitation, our targeted gross margin range, achievement of margins within or outside of such range and factors that could affect gross margins, yields, anticipated cash needs and uses of cash, credit lines, including compliance with covenants and usage of such lines, capital requirements and capital expenditures, payment terms, expected tax rates, results of audits of us in China and the U.S., needs for additional financing, use of working capital, the benefits and risks of our China operations, anticipated growth strategies, ability to attract customers and diversify our customer base, our sources of net sales, anticipated trends and challenges in our business and the markets in which we operate, trends regarding the use of flex and assemblies in smartphones, tablets and other consumer electronic devices, the adequacy of our facilities, capability, capacity and equipment, the impact of economic and industry conditions on our customers and our business, current and upcoming programs and product mix and the learning curves associated with our programs, market opportunities, customer demand, our competitive position, labor issues in the jurisdictions in which we operate, the commercial success of our customers and their products, critical accounting policies and the impact of recent accounting pronouncements. Additional forward-looking statements include, but are not limited to, statements pertaining to other financial items, plans, strategies or objectives of management for future operations, our financial condition or prospects, and any other statement that is not historical fact, including any statement which is preceded by the word "may," "might," "will," "intend," "should," "could," "can," "would," "expect," "believe," "anticipate," "estimate," "predict," "aim," "potential," "plan," or similar words. For all of the foregoing forward-looking statements, we claim the protection of the Private Securities Litigation Reform Act of 1995. Actual events or results may differ materially from our expectations. Important factors that could cause actual results to differ materially from those stated or implied by our forward-looking statements include, but are not limited to, our ability to successfully restructure our business and reduce our costs, the impact of changes in demand for our products, our success with new and current customers, our ability to be competitive in terms of price, technology, capability and manufacturing, our ability to maintain or grow our market share, our ability to diversify our customer base, the success of our customers and their products in the marketplace, our effectiveness in managing manufacturing processes, inventory levels and costs and reorganizations of our operations, the degree to which we are able to utilize available manufacturing capacity, achieve expected yields and obtain expected gross margins, the impact of competition, the economy and technological advances, and the other risks set forth below under "Part II, Item 1A - Risk Factors." These forward-looking statements represent our judgment as of the date hereof. We disclaim any intent or obligation to update these forward-looking statements.

Overview

We are a global provider of high-quality, technologically advanced flexible printed circuits and value-added component assembly solutions to the electronics industry. We believe that we are one of a limited number of manufacturers that provide a seamless, integrated flexible printed circuit and assembly solution from design and application engineering and prototyping through high-volume fabrication, component assembly and testing. We currently target our solutions within the electronics market and, in particular, our solutions enable our customers to achieve a desired size, shape, weight or functionality of the device. Current examples of applications for our products include mobile phones, smartphones, tablets, personal computers, consumer products, wearables, portable bar code scanners, computer/data storage and medical devices. We provide our solutions to original equipment manufacturers ("OEMs") such as Apple, Inc. and to electronic manufacturing services ("EMS") providers such as Foxconn Electronics, Inc., Protek (Shanghai) Limited and Flextronics International Ltd. Our business model, and the way we approach the markets which we serve, is based on value added engineering and providing technology solutions to our customers facilitating the miniaturization of portable electronics. We currently rely on a core mobility end-market for nearly all of our revenue. We believe this dynamic market offers fewer, but larger, opportunities than other electronic markets do, and changes in market leadership can occur with little to no warning. Through early supplier involvement with customers, we look to assist in the development of new designs and processes for the manufacturing of their products and, through value added component assembly of components on flex, we seek to provide a higher level of product within their supply chain structure. This approach is relatively unique and may or may not always fit with the operating practices of all OEMs. Our ability to add to our customer base may have a direct impact on the relative percentage of each customer's revenue to total revenues during any reporting period.

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We typically have numerous programs in production at any particular time, the life cycle for which is typically around one year. The programs' prices are subject to intense negotiation and are determined on a program by program basis, dependent on a wide variety of factors, including without limitation, competitor pricing, expected volumes, assumed yields, material costs, and the amount of third party components within the program. Our profitability is dependent upon how we perform against our targets and the assumptions on which we base our prices for each particular program. Our volumes, margins and yields also vary from program to program and, given various factors and assumptions on which we base our prices, are not necessarily indicative of our profitability. In fact, some lower-priced programs have higher margins while other higher-priced programs have lower margins. Given that the programs in production vary from period to period and the pricing and margins between programs vary widely, volumes, while important for overhead absorption, are not necessarily indicative of our performance. For example, we could experience an increase in volumes for a particular program during a particular period, but depending on that program's margins and yields and the other programs in production during that period, those higher volumes may or may not result in an increase in overall profitability. In the mobility market, the first few months of production are the most critical in terms of growth and profitability opportunities.

Critical Accounting Policies

Information with respect to our critical accounting policies which we believe have the most significant effect on our reported results and require subjective or complex judgments of management are contained on page 32 in "Management's Discussion and Analysis of Financial Condition and Results of Operations" of our Annual Report on Form 10-K for the fiscal year ended September 30, 2013.

Comparison of the Three Months Ended December 31, 2013 and 2012

The following table sets forth our Statement of Operations data expressed as a percentage of net sales for the periods indicated:

Three Months Ended December 31, 2013 2012 Net sales 100.0 % 100.0 % Cost of sales 98.8 91.5 Gross profit 1.2 8.5 Operating expenses: Research and development 0.7 0.7 Sales and marketing 2.8 2.2 General and administrative 1.6 2.0 Total operating expenses 5.1 4.9 Operating (loss) income (3.9 ) 3.6 Other income (expense), net: Interest income 0.1 0.0 Interest expense (0.1 ) (0.0 ) Other income (expense), net 0.1 0.0 (Loss) income before income taxes (3.8 ) 3.6 Provision for income taxes (0.7 ) (0.7 ) Net (loss)income (4.5 )% 2.9 %



Net Sales. Net sales decreased to $211.7 million for the three months ended December 31, 2013, from $289.7 million for the three months ended December 31, 2012, a decrease of $78.0 million, or 26.9%. In addition to the decline in net sales from our customer that is undergoing a business transition, we are being impacted by weaker end-market demand for certain programs with our other major customers. As a result, sales volumes during our first fiscal quarter of 2014 were lower than the same period a year ago. Net sales into our smartphones, tablets and consumer electronics sectors decreased, as further quantified below.

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Net sales into our smartphones sector decreased to $156.2 million for the three months ended December 31, 2013, from $196.6 million for the three months ended December 31, 2012. The decrease of $40.4 million, or 20.5%, was primarily due to decreased sales volumes to one major customer in this sector of 35.4% as a result of weaker demand for current programs and end of life of certain programs, partially offset by new program ramps. The decrease in sales in this sector is partially offset by increased sales volumes to our newer customers in this sector of 170.1%, primarily resulting from new programs and increased allocations with these newer customers. For the three months ended December 31, 2013 and 2012, our smartphones sector accounted for approximately 74% and 68% of total net sales, respectively.

Net sales into our tablets sector decreased to $36.5 million for the three months ended December 31, 2013, from $70.7 million for the three months ended December 31, 2012. The decrease of $34.2 million into this sector was due primarily to decreased sales volumes to one of our major customers in this sector as a result of us not pursuing certain new programs due to anticipated reduced gross margins for such programs. For the three months ended December 31, 2013, and 2012, the tablets sector accounted for approximately 17% and 24% of total net sales, respectively.

Net sales into our consumer electronics sector decreased to $13.6 million for the three months ended December 31, 2013, from $21.1 million for the three months ended December 31, 2012. The decrease was primarily due to decreased sales volumes of $10.5 million to one of our major customers in this sector as a result of certain programs approaching the end of their life cycle. The decrease was partially offset by program ramps for a newer customer in this sector of $3.2 million in the first fiscal quarter of 2014. Shipments into the consumer electronics sector accounted for approximately 6% and 7% of total net sales for the three months ended December 31, 2013 and 2012, respectively.

Cost of Sales and Gross Profit. Cost of sales as a percentage of net sales increased to 98.8% for the three months ended December 31, 2013 versus 91.5% for the three months ended December 31, 2012. The increase in cost of sales as a percentage of net sales of 7.3% was primarily attributable to lower overhead absorption due to reduced production levels. Production levels were reduced due to lower demand. In fiscal 2012 and early in fiscal 2013, we had increased capacity to approximately $340 million of net sales on a quarterly basis to meet anticipated customer demand. Based on this capacity, our capacity utilization was approximately 62.3% for the three months ended December 31, 2013. As a percentage of net sales, gross profit decreased to 1.2% for the three months ended December 31, 2013 from 8.5% for the three months ended December 31, 2012.

Research and Development. Research and development expense decreased by $0.5 million to $1.5 million for the three months ended December 31, 2013, from $2.0 million for the three months ended December 31, 2012. The decrease was primarily due to decreased variable spending of $0.4 million. As a percentage of net sales, research and development expense remained consistent at 0.7% for the three months ended December 31, 2013 and 2012.

Sales and Marketing. Sales and marketing expense decreased by $0.6 million to $5.9 million for the three months ended December 31, 2013, from $6.5 million in the comparable period of the prior year. The decrease was primarily attributable to lower variable expenses due to sales mix. As a percentage of net sales, sales and marketing expense increased to 2.8% versus 2.2% in the comparable period of the prior year.

General and Administrative. General and administrative expense decreased by $2.4 million to $3.3 million for the three months ended December 31, 2013, from $5.7 million in the comparable period of the prior year, resulting in a decrease of 42.1%. The decrease was primarily due to lower wages, benefits and other employee related expenses of $1.8 million and a $1.1 million gain on disposal of equipment, partially offset by increased professional fees of $0.4 million. As a percentage of net sales, general and administrative expense decreased to 1.6% versus 2.0% in the comparable period of the prior year.

Other Income (Expense), Net. Other income (expense), net increased to an income of $0.3 million for the three months ended December 31, 2013, from an expense of less than $0.1 million for the three months ended December 31, 2012. The increase in income was primarily attributable to fluctuations from foreign exchange due to the movement of the U.S. dollar versus the Chinese Renminbi ("RMB") and other foreign currencies, as well as gains from foreign currency programs (such as forward contracts) to help mitigate the risk of foreign currency movements.

Income Taxes. The effective tax rate for three months ended December 31, 2013 and 2012 was (18.6)% and 19.8%, respectively. The change in our effective tax rate was primarily due to establishing a valuation allowance against deferred tax assets related to one of our entities as well as our income and tax expense distribution by region. We expect future tax rates to vary if current tax regulations change.

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Guidance

Net Sales. For our second quarter of fiscal 2014, we expect net sales to range between $120 and $135 million based on the anticipated product mix, net sales volume and production build plan.

Gross Margin. For our second quarter of fiscal 2014, we expect gross margin to be between negative 11% and negative 13% based on the anticipated product mix, net sales volume and production build plans.

Operating Expenses. We expect operating expenses to be approximately $11 million to $12 million during the second fiscal quarter of 2014.

Impairment and Restructuring. We are in the process of finalizing our plans to reduce excess manufacturing capacity, and we expect the second quarter results to reflect significant asset impairment and restructuring charges as a result of a change from held-for-use to held-for-sale of long-lived assets determined to be in the disposal group.

Income Taxes. We expect the effective tax rate, on average, to be in the low twenties in the long-term.

Capital Expenditures. For our second quarter of fiscal 2014, we are anticipating capital expenditures to be less than $10 million. For the foreseeable future, we intend to limit our capital expenditures to normal equipment replacement and investments in automation.

These projections are based on several business assumptions and are therefore subject to substantial uncertainty. See Item 1A of Part II, "Risk Factors."

Liquidity and Capital Resources

Our principal sources of liquidity have been cash provided by operations and our ability to borrow under our various credit facilities. Our principal uses of cash have been to finance working capital, facility expansions, stock repurchases and other capital expenditures. We anticipate these uses will continue to be our principal uses of cash in the future. Global financial and credit markets have been volatile in recent years, and future adverse conditions of these markets could negatively affect our ability to secure funds or raise capital at a reasonable cost, if needed.

It is our policy to carefully monitor the state of our business, cash requirements and capital structure. We believe that funds generated from our operations and available from our borrowing facilities will be sufficient to fund current business operations over at least the next twelve months, without the need to repatriate earnings.

Changes in the principal components of operating cash flows during the three months ended December 31, 2013 were as follows:

Our net accounts receivable balance increased to $147.4 million as of December 31, 2013 from $132.2 million as of September 30, 2013, or 11.5%. Days sales outstanding on a quarterly basis remained consistent at 63 days at both December 31, 2013 and September 30, 2013. Our inventory balance decreased to $80.3 million as of December 31, 2013 from $86.9 million as of September 30, 2013, a decrease of 7.6%. Days in inventory on a quarterly basis decreased 5 days from 40 days at September 30, 2013 to 35 days at December 31, 2013 as a result of increased pull-through of inventory from our hub locations from one of our major customers in December, coupled with decreased production at the end of December. Our accounts payable balance increased to $175.0 million as of December 31, 2013 from $166.5 million as of September 30, 2013, an increase of 5.1%, due to the expected higher production volume in our first fiscal quarter of 2014 versus our fourth fiscal quarter of 2013. Days payable on a quarterly basis decreased 2 days to 75 days, primarily as a result of the timing of inventory purchases. Depreciation and amortization expense was $12.8 million for the three month ended December 31, 2013, versus $14.4 million for the comparable period of the prior year, primarily due to decreased capital expenditures in the prior fiscal year.



Our principal investing and financing activities during the three months ended December 31, 2013 were as follows:

Net cash used in investing activities was $1.3 million for the three months ended December 31, 2013 and consisted of cash purchases of capital equipment and other assets of $6.6 million, partially offset by proceeds of $1.1 million from sale of equipment and a receipt of a $4.2 million cash grant from the local government in Chengdu, China, related to our capital investment in our Chengdu facility in calendar 2011 and 2012. 16



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Table of Contents Net cash provided by financing activities was less than $0.1 million for the three months ended December 31, 2013 and consisted primarily of proceeds from exercise of stock options of less than $0.1 million. Our loans payable and borrowings outstanding against credit facilities were zero at December 31, 2013 and September 30, 2013.


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Source: Edgar Glimpses


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