Multi-Fineline Electronix, Inc. F1Q09 (Qtr End 12/31/08) Earnings Call Transcript

Multi-Fineline Electronix, Inc. (NASDAQ:MFLX)

F1Q09 (Qtr End 12/31/08) Earnings Call Transcript

February 5, 2009 5:30 am ET

Executives

Reza Meshgin – President & CEO

Lasse Glassen – IR, Financial Relations Board

Tom Liguori – EVP and CFO

Analysts

Matt Sheerin – Thomas Weisel Partners

Rich Kugele – Needham & Company

Aaron Husock – Lanexa Global

Rob Time [ph] – Robert W. Baird & Company

Jiwon Lee – Sidoti & Company

Operator

Good afternoon, ladies and gentlemen. Welcome to the MFLEX Fiscal 2009 First Quarter Conference Call. During today's presentation, all parties will be in a listen-only mode. Following the presentation, the conference will be open for questions. (Operator instructions) This conference is being recorded today, Thursday, February 5th of 2009.

I would now like to turn the conference over to Reza Meshgin, President and CEO of MFLEX. Please go ahead.

Reza Meshgin

Thank you. Welcome to MFLEX's 2009 first quarter conference call. Today, I will discuss our operational highlights and business outlook and Tom Liguori; our CFO will discuss our financial results for the first quarter of fiscal 2009. Phil Harding, our Chairman, Tom and I will be available to answer your questions at the conclusion of our presentation. Lasse Glassen from the Financial Relations Board will now review our forward-looking statements before we begin our discussion.

Lasse Glassen

Thank you, Reza, and good afternoon, everyone. I would like to remind you all that certain statements made in the conference call are forward-looking statements that involve a number of risks and uncertainties. These forward-looking statements include but are not limited to statements and predictions regarding revenues; sales; net income; earnings; operating expenses; capital expenditures; cash flow; tax rates and the benefits expected from the Company's reorganization, value of auction rate securities; DSO; DIO; gross margin including factors which may affect gross margin; yields; growth of the Company's customer base; expected demand and order from the Company's customers, including effects of the economy and seasonality on demand; market opportunities and competitive advantages; expected benefits from the acquisition of Pelikon; the utilization of flex and flex assemblies; program and product mix; the cost and benefits of new programs; the Company's manufacturing facilities, capabilities, capacity, and expansion thereof; the Company's ability to ramp production; uses of the Company's cash; credit facilities; and liquidity.

Additional forward-looking statements include but are not limited to, statements pertaining to other financial items; plans, strategies, objectives of management or future operations; the Company's operations and financial conditions or prospects; and any other statement that is not historical fact, including any statement which is preceded by the words “assume,” “can,” “will,” “plan,” “expect,” “estimate,” “aim,” “intend,” “project,” “foresee,” “target,” “anticipate,” “may,” “believe,” or similar words.

For all of the foregoing forward-looking statements the Company claims the protection of the Private Securities Litigation Reform Act of 1995. Actual events or results may differ materially from the Company's expectations. Important factors that could cause actual results to differ materially from those stated or implied by the Company's forward-looking statements include the risks detailed from time to time in the Company's SEC reports and in this afternoon's news release. Forward-looking statements represent the Company's judgment as of the date of this call. The Company disclaims any intent or obligation to update these forward-looking statements.

And with that, I'll turn the call back over to Reza. Reza?

Reza Meshgin

Thank you, Lasse. I am pleased to report that the operating momentum we generated in the second half of last year carried over in to fiscal 2009, helping produce record breaking first quarter results that exceeded our expectation for most of the key metrics.

During the first quarter, we generated net sales of $216.6 million, which were the highest quarterly net sales in our Company's history. This broke the previous net sales record of $213.1 million established in the fourth quarter of fiscal 2008. We recorded net income of $14.1 million or $0.56 per diluted share, an increase compared to $0.54 per diluted share recorded in the first quarter of fiscal 2008.

And our business continues to generate a significant amount of cash. Cash flow from our operating activities exceeded $20 million or more than 65% higher than the same quarter last year.

As you know, we were somewhat cautious about our outlook on our last conference call. At the time of the call, we had good visibility on the first two months of the quarter. However, we believe the third month of the quarter was at risk due to the possibility of customers reducing orders due to the weakening economy.

We were very pleased that we did not see any deferrals and shipments remained consistent throughout the entire quarter, which reflected the strong end-user demand for many of the products.

Similar to recent prior quarters, we continued to benefit from our focus on the high end of the portable electronics device market. Smartphones are an attractive market opportunity for MFLEX. As a category, smartphones experienced strong growth in fiscal 2008 and industry analysts project they will continue generating strong growth in 2009 despite the overall economy challenges.

Having more complex product designs, smartphones tend to have higher flex content than the ordinary mobile phone, which increases our revenue per device. We believe the technology that's required to package these more complex flex assemblies differentiates MFLEX and gives us a competitive advantage in the marketplace.

In addition to smartphone, we also have had success with programs for other popular consumer handheld electronic devices. In the first quarter, net sales from this type of device comprise a significant portion of our overall business and more than doubled compared to the fourth quarter of fiscal 2008.

We have worked hard over the past few years to demonstrate the broad application for our technology beyond mobile phones and expect these efforts will continue to provide meaningful growth opportunities for MFLEX in the future.

During the first quarter, our four largest customers generated approximately 96% of our net sales, which was similar to the last several quarters. As you are probably aware, for competitive and customer confidentiality reasons, we do not disclose these large customers by name, but instead refer to them as customers A, B, C and D. During the first quarter, customer A represented 9% of net sales, customer B represented 20%, customer C about 34%, and customer D represented approximately 33% of net sales.

Sales to two of these four customers increased significantly compared to the same period last year. As a result, our year-over-year net sales increased nearly 18% in the first quarter. On a sequential quarter basis, our sales increased slightly by 1.7%. Net sales in the first quarter of fiscal 2009 were positively impacted by large programs associated with the smartphone device as well as a popular handheld consumer electronic device.

As you know, it is vitally important for companies in our industry to optimize capacity utilization. On the other hand, to bring in new business, we must be able to demonstrate to our current and prospective customers that we have the available capacity required to take on new programs. In the past, we have been very successful at this strategy.

To attract new programs and customers, we plan to move forward with our previously announced plans to expand our capacity with a new facility in Suzhou, China called MFC3. We currently expect that this facility will be online during calendar 2010. However, because we are managing the development activities and the requisite capital expenditures in discrete phases, we have the flexibility to accelerate or pull back as customer demand dictates.

In addition to increasing our capacity, MFC3 will enable us to advance our technology capabilities to enable us to produce the more sophisticated products that our customers will need in the future.

Operationally, we were very pleased with our execution this quarter. Although startup programs typically tend to reduce our overall gross margin percentage, we were able to efficiently ramp up production of startup programs in the quarter. This helps us to generate a gross margin of 15.3%, which was within our updated gross margin guidance range of 14% to 16%.

There were two primary factors that favorably impacted gross margin in the first quarter. First, we tasked our operation team to improve the production ramp on startup programs. The operational team executed very well on this task and we realized better than anticipated use on these new programs.

Since each new program startup has unique challenges, there is no assurance that we will always be able to produce steadier improvement during the initial production phase, but we are making encouraging progress nonetheless. And second, the higher than expected net sales volume had a favorable impact on leveraging our fixed overhead.

As we discussed in the past, there are a number of factors that can impact our gross margin percentage. Primarily these include product mix, efficiency of production, leverage of our fixed overhead, competitive pricing pressures, material content and maturity of the program within the context of the product life cycle.

Last December, we completed the acquisition of Pelikon Limited, a privately held technology company focused on development of thin flexible printed displays that are visible in all light levels and from all viewing angles.

Pelikon's proprietary technology is used to create reconfigurable or morphing keypads or input devices. Simple to integrate with other standard components, the display provides full tactile feedback not available with more expensive current touch screen display, and allows a single key to have multiple function. We believe this technology enhances the user interface and positions MFLEX to become a leader in human interface design.

One of the major areas of opportunity for enhancement of current touch screen displays when used entirely as an input device is the ability to provide accurate, tactile feedback and the reassurance that the user is determining when they hit a letter or button.

We believe that Pelikon offers a descriptive technology with a compelling alternative to current touch screen displays, both in terms of functionality and cost consideration while also being fully compatible for use with touch screen displays for enhanced functionality.

For example, in mobile phone applications, in addition to providing accurate tactile feedback, the display keypad will reconfigure itself depending upon whether the user is using SMS texting for composing e-mail or quoti [ph] function, calling, numeric function, listening to music, music player function or taking a picture. Users only view the controls rather than to the task in which they are engaged, making complex devices easy to use, and multiple features easy to access.

The acquisition of Pelikon complements our strategy of being a leading technology solution and integration provider for our expanding customer base and by providing MFLEX's customers with unique differentiation in product solutions and industrial design.

Prior to the acquisition by MFLEX, Pelikon was already in discussion with a number of major OEMs. With the scale and proven capabilities of MFLEX behind it Pelikon is making progress towards the integration of its technology with these companies and we're excited about the potential opportunities.

Before wrapping up my prepared remarks, I would like to provide our guidance and business outlook. We continue to be concerned regarding the potential impact that a prolonged economic slowdown could have on customer demand and recently we have begun to see softness in customer orders.

Based on our current forecast, we expect second quarter net sales to be in the range of $170 million to $190 million. Although this reflects expected year-over-year net sales growth, the sequential decline is due in part to softer customer demand coupled with the seasonal effects of the December holidays and the Chinese New Year in late January.

Gross margins are expected to range between 13% to 15% in the second quarter based on the projected product mix and leveraging of manufacturing costs.

Longer term, we are optimistic about our opportunities to continue to profitably grow our business while pursuit of new relationships with OEMs has been enhanced by the new technology we can offer as a result of the Pelikon acquisition. With our strong design capabilities, proven manufacturing excellence and unique solutions, we believe MFLEX is well positioned in the coming years.

With that, I will now turn the call over to Tom for more detailed discussion on our first quarter's financial results.

Tom Liguori

Thank you, Reza. Since Reza summarized our net sales performance I'll begin with some additional color on the gross margin and operating expense. I would like to remind you that as we discussed in last quarter's conference call, in the first quarter, we changed the classification of some costs among cost of sales, R&D, sales and marketing, and G&A.

The change will tend to lower the reported G&A cost and increase cost of sales, R&D, and sales and marketing. G&A historically included all IT, human resource, and other support costs that will now be assigned to the P&L line item it supports. In the first quarter, the change resulted in an increase in cost of sales of $0.5 million, an increase in R&D of $0.1 million, an increase in sales and marketing of $0.2 million and a decrease in G&A of $0.8 million. Going forward, we anticipate operating expense being the 7% to 8% of revenue range depending on sales volume.

As we indicated, the gross margin was 15.3% this quarter compared to 16.7% in the same quarter last year. The 140 basis point reduction breaks down as follows

100 basis points due to higher material content in the queue on product mix; 171 basis points due to higher fixed costs, including wages, benefits, and depreciation, for the satellite facilities we added in 2008 to increase capacity; 26 basis points for severance cost as we reduced our indirect work force in select factory areas; and 23 basis points for the change in cost classifications. These were partially offset by a 180 basis point improvement due to lower labor costs.

On a sequential quarter basis, gross margins also declined 80 basis points from 16.1% in the fourth quarter of 2008 primarily due to higher material and severance costs, which were partially offset by lower labor cost. Despite the sequential decline, the first quarter gross margin exceeded our original guidance primarily due to better than expected yields on start-up programs.

First quarter R&D expense of $1.2 million increased year-over-year as well as sequentially. The increase is primarily due to higher headcount for development activities and the additional R&D costs associated with the Pelikon acquisition.

Sales and marketing expense was 5.3 million in the most recent quarter, compared to 4.6 million in the first quarter of last year and 3.8 million in the fourth quarter of 2008. The fourth quarter of 2008 included a favorable adjustment of $0.4 million for renegotiated commission. The higher sales and marketing expense is due primarily to increased wages and benefits from marketing and program management.

G&A expense increased to $7 million in the most recent quarter compared to $6.8 million in the first quarter last year. The year-over-year increase was due to added wages as we increased infrastructure to support the growing business and employee training initiatives. On a sequential quarter basis, first quarter G&A expense was down from $8.4 million in the fourth quarter primarily due to lower tax, audit, and legal expenses.

The first quarter included a partial amount of operating expense related to Pelikon, which we acquired in early December. Ongoing operating expense associated with Pelikon, we expect it to be $1.1 million per quarter or approximately $4.4 million on an annual basis.

Restructuring costs of $0.3 million relate to the consolidation of Tucson into Anaheim operations. This effort is substantially complete. Included in other income loss is a charge of $1.1 million related to the impairment of auction rate securities due to the ongoing credit market turmoil.

The effective tax rate in the first quarter was 22.2%. The lower than normal tax rate was primarily due to the startup of our Singapore office. During the previous quarter, we began the process of transitioning various business functions to Singapore to better align these activities with the Company's Asian operations. In addition to enhancing operational efficiencies, the action is expected to reduce our annual effective tax rate to the low 20% range on a consistent basis.

Moving on to the balance sheet and liquidity position, our cash balance increased by more than $9 million during the quarter to $71.5 million. In the quarter, the Company generated cash flow from operations of $20.2 million and capital expenditures for the quarter totaled $9.6 million.

As Reza noted earlier, we are managing our capacity buildout to match our customer demand for expenditures can accelerate or decelerate accordingly. For the second quarter, we expect CapEx to be in the range of $10 million to $13 million.

MFLEX continues to carry no debt and has access to untapped revolving credit facilities totaling approximately $50 million. While we believe our current liquidity is sufficient for anticipated cash needs, we are continuing to review and may modify or expand our credit lines in the future.

We continue to focus on our receivables and inventory management in light of the general economic environment. Our DSO declined to 62 days in the first quarter and days inventory declined to 22 days. Both metrics are the lowest they have been in over two years.

Inventory days benefited from operations management activities and just in time for raw materials, reduction of work in process cycle times as well as reduced inventory receipts at year-end. We do anticipate some level of increase in days inventory going forward.

We announced a stock repurchase plan for up to 2.25 million shares in January. We have put in place a 10b5-1 program to execute the first tranche of 562,500 shares.

In conclusion, MFLEX enjoyed another strong quarter of growth. Although we are in uncertain economic times, we have strong financial results, solid balance sheet and excellent liquidity. We are optimistic on the future earnings and cash flow potential of the Company. We have benefited from our emphasis on the high end of the portable electronic device market where several of our customers have seen strong demand for their products.

Our financial strength and balance sheet puts us in an enviable position and we believe gives us the financial flexibility to weather the current economic uncertainty as well as to capitalize on opportunities that may be presented to us. This concludes the financial review.

I will now turn the call over to the operator so that Reza, Phil, and myself can take your questions.

Question-and-Answer Session

Operator

Thank you, sir. (Operator instructions) Our first question comes from the line of Matt Sheerin with Thomas Weisel Partners. Please go ahead.

Matt Sheerin – Thomas Weisel Partners

Yes, thank you. Just a question regarding your outlook, on January 5th, when you pre-announced the upside to the last quarter, you said that strong customer demand had continued into the fiscal second quarter. Yet, here we are about a month later and you are saying that you have seen softness in orders. So is that something that you have seen in the last couple of weeks? And is it coming across your four key customers or just one or two?

Reza Meshgin

Matt, this is Reza. Yes, to answer your question, this is more recent. So your reference in the last couple of weeks is accurate. And part of it is also seasonality, but the difference between what we had in mind and where we are now is just that, the recent softness in the last couple of weeks. And the softness, although it is across the board, and uniform with almost all customers, more exaggerated for certain products. I – because of confidentiality of customers, obviously, I cannot expand anymore on that. But it is across the board more or less.

Matt Sheerin – Thomas Weisel Partners

Okay. And is that softness in products that had been strong or products that haven't been strong, just continue to get weaker?

Reza Meshgin

It's mostly for the products that were running stronger.

Matt Sheerin – Thomas Weisel Partners

Okay. That's helpful. And then on the gross margin, I know that's difficult I mean, you do the best you can in terms of providing a range yet I believe in at least four quarters of the last five quarters, you have exceeded that gross margin range that you have given. So just trying to get a sense of your comfort level going into this quarter that you are going to be in the 13% to 15% as opposed to be higher or lower than that?

Tom Liguori

Matt this is Tom. We feel good about that range and we have tried to narrow the range and be a little bit more concise on the guidance we're giving you on both revenues and margin, but right now that margin range is based on the product mix and the leveraging of our fixed overhead at that current sales volume.

Matt Sheerin – Thomas Weisel Partners

Okay. And then regarding the expansion plans, I know that you want to bring on new business and new customers. Are there any customers that you've identified that potentially could be 10% customer in the next two quarters to three quarters? And if you have any progress in terms of additional – customers in addition to those four key customers where you think you've got some good opportunities near-term, let's say in the next two quarters to three quarters?

Reza Meshgin

Yes. The answer is yes, we have already begun working on new programs with new customers. Would they have the potential to be a 10% customer? Definitely. I couldn't really guess if it's going to be two quarters or three quarters, I would say it would definitely be more than two quarters. Now whether its three quarters or four quarters, it should be somewhere around that and obviously it will all depend on the market and how well the consumer market will bounce back.

Matt Sheerin – Thomas Weisel Partners

Okay. And then my last question, just regarding those satellite facilities that you put in place to handle the added volume from new customers in the last two quarters or three quarters. When you bring on MFC3, is your plan to continue to run out of those satellite facilities?

Reza Meshgin

Well, as much as possible, we will concentrate on consolidating our operation. On the other hand, depending on what the customer need is at the time we will have to time the consolidation as best as we can. But long term we will have some consolidation.

Matt Sheerin – Thomas Weisel Partners

Okay. Thanks very much.

Reza Meshgin

Thank you.

Operator

Thank you. Our next question is from the line of Rich Kugele with Needham & Company. Please go ahead.

Rich Kugele – Needham & Company

Thank you. Good afternoon. A couple of questions. I guess, first, in terms of Pelikon, do you expect the first Pelikon deals that are under your banner to be with your existing customers, Pelikon's existing customers or new ones?

Reza Meshgin

Pelikon has product in the market currently that is based on some of the IT and electronics that they sell. So as far as the part that we would actually manufacture in terms of flex assemblies and the value add that we will be able to add, most likely it will be with new customers.

Rich Kugele – Needham & Company

Okay. So you offer this as an a la cart type of thing that you're not going to force them to go and buy the rest of your solution?

Reza Meshgin

That's correct. The idea is integration and adding more value in the supply chain and a better solution to our customers.

Rich Kugele – Needham & Company

Okay. And then in terms of the yields on the new products, I guess just if you can explain for me, I know when you first started ramping materially the whole smartphone and other consumer elements, how there was a great impact to yields as you moved up that learning curve. But just directionally as you look at the next generation smartphones versus what's out there today, is the leap as great in the learning curve or should we think that maybe the downtick in the yields as you learn is less of a downtick?

Reza Meshgin

The learning curve has been shortened and at least for the foreseeable future we feel very encouraged and comfortable that we can continue to repeat this shortened learning curve. I think your question is will there be a technology that outside of the current capabilities that can make an impact for us? At least for the short-term, I would say, no. I can't – I don't see that at this point of time. And at the same time, maybe this would be a good reference to the fact that we want to bring on MFC3 because main reason for that is not just the capacity, but the fact that we want to stay up-to-date and ahead of the technology requirements.

Rich Kugele – Needham & Company

Okay. Yes, and actually that's my – part of my last question. Has there been any additional change beyond what you talked about last quarter on the timing of MFC3? I know in the most recent quarter, you talked about there being some slowing of purchases and you scaled it back a little bit, but has there been any additional slowing and purchases of equipment or timing of when you expect? And how much revenue should we expect and when?

Reza Meshgin

Well, we would expect that MFC3 will be in operation in 2010. So, again, it's a matter of how we need to time it and I think it's a little bit early for us to say that we're on the verge of going out and expediting the project. But we do see that we need to get it started now to be on time for the future requirements.

Rich Kugele – Needham & Company

Okay. Alright. Thank you very much.

Operator

Thank you. (Operator instructions) Our next question is from the line of Aaron Husock with Lanexa Global. Please go ahead.

Aaron Husock – Lanexa Global

Thanks for taking my question. First I want to say thank you probably for everyone on the call for the clearer guidance. It's nice to see guidance in numbers from you guys again. I may have missed this, I hopped on a little bit late, but did you say what your percentage of sales were from your different A, B, C and D customers?

Reza Meshgin

Yes, we did. I'll repeat that. Just give me one second.

Tom Liguori

Aaron, customer A was 9%; customer B, 20%; customer C, 34%; customer D about 33%.

Aaron Husock – Lanexa Global

Okay, great. Thank you. And then Reza, I wanted to ask you, with Sony Ericsson closing down their North Carolina design center and closing design centers in Europe, and the Japan design center growing in importance within Sony Ericsson – two part question. How are you responding to that in the way you approach that customer? And then has there been a change in the competitiveness of your Japanese competitors in terms of flex assembly? Because I remember one of the issues that drove Sony Ericsson to you about two years ago was your flex assembly capabilities.

Reza Meshgin

Well, let me break up your question into two parts. I think the first part of your question covers how we support our customers and our theme and our approach to customers have been always on a global level. In other words we've – one of the things that we have been very successful in to be able to provide a seamless coverage on a global basis to customers. So regardless of where the center of gravity shift, we have been very successful in readdressing and redirecting our resources. So whether our customers move to Asia, Japan in particular, then we would have the resources from Asia and the proximity of China to cover that. I can't comment much more than this. Again, as you know, we are very respectful regarding our confidentiality of customers so this is best I can say.

Aaron Husock – Lanexa Global

Okay.

Reza Meshgin

And the second part, I guess was regarding the competitiveness in the Japan market. Yes, we do see an improvement in the prices from our Japanese competitors. This isn't related to any particular customer, and some of it may have some – because of the price of the Yen exchange, some favorable terms, I'm not really sure. But the cause of this – some of it could be because of excess capacities. Nonetheless, in this market, price pressures are high and it isn't only from the Japanese competitors, it's an overall theme that we see in today's market.

Aaron Husock – Lanexa Global

Maybe to follow up on those, not too much – I'm not talking so much about price competitiveness out of the Japanese suppliers; I'm talking more about competitiveness in terms of assembly capabilities, because historically, they were really bare flex shops, very high-end bare flex shops. Have you seen a change in their ability to do high-end flex assembly work over the past two years?

Reza Meshgin

Well, our think of model of flex assembly has proven in our marketplace, so I wouldn't be surprised if other people mimic that. However, again, as a part of our competitive advantage and sustainability of that, we've always invested in also moving up the supply chain and also doing more sophisticated assemblies. So that's that today is definitely a competitive advantage for us.

Aaron Husock – Lanexa Global

And then in terms of – you were talking about pricing pressure being rather intense right now, I'm a little surprised to hear that, I know your customers are under some pressure, but at the same time, it seems like lot of your competitors, especially the smaller shops in China are going out of business. Is that having any support for pricing?

Reza Meshgin

Yes and no, because some of the businesses that those companies were in are not things that we historically have gotten involved with. As you know, we tend to focus to the higher tier types of electronics devices. So the fact that some companies have gone or are on the verge of going out of business really hasn't had that much of an impact or favorable impact for us.

Aaron Husock – Lanexa Global

Okay. One last one for me, you were talking about the new customers. Are those in the cell phone space or the broader consumer electronics space?

Reza Meshgin

Primarily in the cell phone.

Aaron Husock – Lanexa Global

Okay. Great. Thank you.

Reza Meshgin

Thank you.

Operator

Thank you. Our next question is from the line of Rob Time [ph] with Robert W. Baird & Company. Please go ahead.

Rob Time – Robert W. Baird & Company

Hi. Thanks for taking my question. What is the general level of program maturity now versus what you might expect six months from now? In other words, are your programs more mature and then some of those will sunset or is it more of a constant level of maturity?

Reza Meshgin

The way I see between now and six months from now, if I were to give you a comparison to last year I see more new programs as compared to last year.

Rob Time – Robert W. Baird & Company

More new programs in six months versus the period six months ago is that what you are saying?

Reza Meshgin

Correct.

Rob Time – Robert W. Baird & Company

Okay. And then regarding the investment in MFC3, what does the curve of that look like? If you were going to start in, say, the first fiscal quarter of 2010, when do the majority of those investments take place?

Reza Meshgin

Closer to the time that we actually go into production, because we have already purchased the land, so we have paid for that and that was about little over $3 million, I believe. And so the rest of it will come into building construction and renovation and that we pay as we go basically. And then as far as the equipment we tend to bring in the equipment just in time for qualification and getting the lines up and running prior to volume production, which would coincide with actual time of the production, nut it will be closer to the time of production in 2010.

Rob Time – Robert W. Baird & Company

Okay. Does any of that expense fall in the G&A category or is that all capitalized?

Reza Meshgin

No, most of it is capitalized. Very little would be G&A.

Rob Time – Robert W. Baird & Company

Okay.

Reza Meshgin

Now, one thing to keep in mind is that, again, as we said in our remarks, if we need to accelerate that, we will accelerate that. But as of now, we think it's going to be 2010.

Rob Time – Robert W. Baird & Company

Okay. Thank you.

Operator

Thank you. Our last question is from the line of Jiwon Lee with Sidoti & Company. Please go ahead.

Jiwon Lee – Sidoti & Company

Thank you. Good afternoon. Couple of questions, please. Could you give us some expectations about this popular handheld device that doubled quarter-over-quarter, whether you expect this program could still double next quarter? And what was the peak margin structure be like if you compare that against your smartphone?

Reza Meshgin

I'm sorry; can you repeat the last part, please?

Jiwon Lee – Sidoti & Company

What does the peak margin be like of this program if you compare it with your smartphone?

Reza Meshgin

You are referring to the peak gross margin?

Jiwon Lee – Sidoti & Company

Correct.

Reza Meshgin

Okay. The material content of those types of devices tend to be higher than typical cell phone. So, although gross margins are not significantly lower, they tend to be slightly lower. As far as would we expect it to continue to double, no. And partly that has to do with the seasonality of how such devices get sold in the market. It will continue to be a line of product that we are expecting to do well in, but nonetheless, there is no reason for it to double quarter-over-quarter.

Jiwon Lee – Sidoti & Company

Okay. That's helpful. Back to the Pelikon deal, when would you optimistically expect meaningful design win from an OEM here?

Reza Meshgin

Well, that's rather difficult to answer, because again we are just in the process of integrating Pelikon into MFLEX's operation and vice versa. And I think it will be a few quarters before we – we can be anything that's sizable and contribute to our sales.

Jiwon Lee – Sidoti & Company

So when you talked about the product from Pelikon out in the commercial space that is not in the handset side?

Reza Meshgin

It is in the handset. On the other hand, these are in the electronics and the – as far as the size of that revenue compared to the revenues of MFLEX, it's not sizable. I was just referencing to distinguish between new and existing customers. That's the only reason I mentioned it.

Jiwon Lee – Sidoti & Company

Okay. That's helpful. Thank you.

Operator

Thank you. Our next question is a follow-up question from the line of Matt Sheerin with Thomas Weisel Partners. Please go ahead.

Matt Sheerin – Thomas Weisel Partners

Yes, just a quick follow-up regarding your comments on SG&A and also the operating expenses of Pelikon. You said that 7% to 8% of – SG&A would be 7% to 8% of revenue. Does that include that $1.1 million?

Tom Liguori

Yes, that includes it.

Matt Sheerin – Thomas Weisel Partners

Okay. Fine. Thank you.

Reza Meshgin

Thank you.

Operator

Thank you. This concludes our question-and-answer session for today's call. I would like to turn it back over to management for any closing remarks.

Reza Meshgin

Thanks, again, for joining us today and we look forward to your ongoing interest in MFLEX. Good-bye.

Operator

Thank you. Ladies and gentlemen, this concludes the MFLEX fiscal 2009 first quarter conference call. If you would like to listen to a replay of today's conference, you can dial 303-590-3000 or you can dial 1-800-405-2236 and enter access code 11125964 followed by the pound sign. We thank you for your participation. You may now disconnect.

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