Multi-Fineline Electronix F2Q09 (Qtr End 3/31/09) Earnings Call Transcript

Multi-Fineline Electronix, Inc. (MFLX)

F2Q09 (Qtr End 3/31/09) Earnings Call

May 07, 2009 5:30 PM ET

Executives

Reza Meshgin - President and Chief Executive Officer

Lasse Glassen - Investor Relations

Tom Liguori - Executive Vice President, Chief Financial Officer

Analysts

Matthew Sheerin - Thomas Weisel Partners

Richard Kugele - Needham & Company

Ryan Jones

Jiwon Lee - Sidoti and Company

Presentation

Operator

Ladies and gentlemen, thank you for standing-by. Welcome to the MFLEX Fiscal 2009 Second 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, May 7, 2009.

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

Reza Meshgin

Thank you. Welcome to MFLEX's fiscal 2009 second 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 second 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 this 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, DSO, DIO, gross margin, the pricing environment, cost reductions, expenses, yields, labor efficiency growth and diversification of the company's customer base, expected demand from the company's customers and for products within different market including the effect of the economy on such demand, market opportunities and competitive advantages; expected benefits from the acquisition of Pelikon; the utilization of flex and flex assemblies; programs and product mix; the cost and benefits of new programs; the company's manufacturing facilities, capabilities, capacity, and expansion thereof; including the MFC3 project and solid operation, the company's ability to ramp production; uses of the company's cash; credit facilities; and liquidity.

Additional forward-looking statements include but they are not limited to statements pertaining to other financial items plans, strategies, objectives of management, the future operations, the company's operations and financial conditions or prospects and any other statement that is not include 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 expectation. 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 day of this call. The company disclaims any intent or obligation to update these forward-looking statements.

And with that, I would now like to turn the call back over to Reza. Reza?

Reza Meshgin

Thank you, Lasse. Second quarter operating results were generally inline with our expectation, with customer orders reflective of the ongoing sluggish global economic condition. During the second quarter, we generated net sales of $174.1 million, which was an increase of 6% compared to net sales of $163.9 million in the same period last year, but down from the recognized sales of $216.6 million we achieved in the first quarter.

At the bottom-line, we recorded net income of $8.7 million or $0.34 per diluted share. This compares to net income of 10.4 million or $0.41 per diluted share in the second quarter of fiscal 2008 and $14.1 million or $0.56 per diluted share in the previous quarter.

In addition, our businesses continue to generate a significant amount of cash. Cash flow from operating activities was $46 million for the quarter or more than 40% higher than the same quarter last year. And while we continue to invest in our company through our stock repurchase program as of March 31, 2009, cash and cash equivalents increased to $106 million or more than $4 per diluted share. From a demand standpoint there were not many surprises either positive or negative during the quarter.

As expected, the sequential decline in revenues was due to the slumping macroeconomic condition coupled with the normal seasonal effect of the December holidays and the Chinese New Year in late January.

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

During the second quarter, customer A represented 5% of net sales, customer B represented 8% customer C represented about 35% and customer D represented approximately 48% of net sales.

Sales to customer C and D increased significantly from the prior year, while sales to customer A and B declined significantly. These results are a continued reflection of our success in supplying flex assemblies to the high-end portable electronic device market, including smartphones that continue to experience a healthy demand.

In addition to smartphones, we're also having success with programs for other popular consumer handheld electronic devices.

During the first quarter of fiscal 2009, the net sales from this type of device comprised approximately one quarter of our overall business. We have worked diligently over the past few years to demonstrate the broad applications for our technology beyond mobile phones and expect these efforts will continue to provide meaningful growth opportunities for MFLEX in the future.

Our gross margin was 14.2% during the second quarter, which was inline with a gross margin guidance range we provided of 13% to 15%. The 14.2% gross margin underscores the product mix shift we have experienced over the past year. In the second quarter of last year, the majority of our revenue was derived from flex assembles for traditional mobile phone. This year our revenue is weighted heavily towards flex assemblies for smartphones and portable consumer electronic devices. The higher material content inherent in flex assemblies for these devices has put pressure on our gross margin.

In addition, we have begun to experience a more competitive pricing environment which has also put pressure on our gross margin. In response to reduced cost and improve our operational performance as a world-class technology manufacturing company, we have initiated ambitious lean-manufacturing and Six Sigma quality improvement initiative. These are expected to enhance our operational performance in both the short and long term.

As a result, we have improved our responsiveness to customer demand and shorter order cycles while reducing our total head count by approximately 35% since the beginning of fiscal 2009. We are also working aggressively with our supply chain to reduce their costs.

We believe these actions will help us to offset the near-term pressure on our gross margin without comprising our long-term growth plans, which continue to include capacity expansion.

In that regard, we are moving forward with the development of our new facility in Suzhou China called MFC3 and last month we broke ground on the new building. One benefit of temporarily delaying the construction was that it provided us the opportunity to renegotiate some of the costs involved. We continue to expect that this facility will be online during calendar 2010.

In addition to providing increased capacity the new facility will allow us to advance our technology capability to enable us to produce the more sophisticated products that customers will need in the future.

Within Mfc3, we believe, we will focus on advanced flex manufacturing capabilities, but facilitating high density interconnect rigid-flex and possibly we'll also roll over an auto high (ph) highly automated flex manufacturing capabilities. It is noteworthy to mention, that within our Satellite Assembly facility, we've had the opportunity to upgrade our assembly technology with the highest standard and this new facility enable us to do the same with respect to our flex manufacturing operation.

With our capacity expansion initiatives moving forward as we are also making good headway in our efforts to expand our base of customers. We're currently involved in meaningful discussions with additional portable electronics device OEMs and we currently have several product qualifications in progress.

I am pleased that the technology we acquired from the Pelikon transaction which we discussed in detailed in the first quarter conference call has been helpful in building relationships with some of the OEMs we're pursuing. Although, it is difficult to predict the timing of when we would be in a position to announce new major customers; over the longer-term, we're optimistic about our opportunities to continue to profitably grow our customer base.

Before wrapping up my prepared remarks, I would like to provide our guidance and business outlook. We expect third quarter net sales to be in the range of $160 to $180 million. We expect the sales mix to be relatively consistent with the second quarter. Gross margins are expected to range between 13% to 15% in the third quarter based on the projected, product mix and leveraging of manufacturing costs.

We are well positioned with our existing customers and expect to be involved in a number of new and upcoming programs. Based on the volume of new programs starting up in the second half of calendar 2009 we currently expect to see a gradual rebound in net sales beginning in the fourth quarter fiscal 2009, unless economic conditions deteriorate further. Despite some near-term challenges, we remain optimistic about the long-term growth opportunities with both our existing customers and the other major handset device makers we're targeting.

With that, I will now turn the call over to Tom for a more detailed discussion on our second quarter financial results. Tom?

Tom Liguori

Thank you, Reza. As Reza summarized our net sales performance, I will begin with some additional comments on the gross margin and operating expense. Our gross margin was 14.2% this quarter compared to 17.6% in the same quarter last year.

The 340 basis point reduction breakdown as follows; 720 basis points due to higher material content in the second quarter's product mix. Generally speaking smartphones in our consumer product programs have more and higher value components and that's the higher material content. 200 basis points due to higher fixed cost primarily for the Satellite Facilities we added in 2008, to increase capacity.

These items were partially offset by 410 basis point improvement in yields and 170 point improvement in labor efficiencies. I think it is important to note that our factories have achieved some significant improvements in labor productivity, cycle time reduction, throughput and yields. All of these have enabled us to maintain a respectable gross margin during the period of lower sales volume, competitive pricing and higher material content.

On a sequential basis, gross margins declined 110 basis points from 15.3% in the first quarter of fiscal 2009, primarily due to the deleveraging of fixed manufacturing costs resulting from a lower level of sales. As Reza mentioned, second quarter gross margins were within our expected range.

Second quarter R&D expense of 1.2 million increased 0.7 million year-over-year and was unchanged on a sequential quarter basis. The year-over-year increase is primarily due to higher head count for development activities and the additional R&D costs associated with the Pelikon subsidiary.

Sales and marketing expense was $6.1 million in the most recent quarter compared to $4.5 million in the second quarter of last year and $5.3 million in the first quarter of fiscal 2009. The higher sales and marketing expense is due primarily to increased wages and benefits from marketing and program management as well as the Pelikon subsidiary. Despite the current global recession, we are continuing to invest in expanding our sales and marketing activities that we believe will bear fruit as conditions stabilize.

G&A expense declined to $6.3 million in the most recent quarter compared to $7.8 million in the second quarter last year. The year-over-year decrease was due in part to lower bonus accrual, professional service fees and travel cost.

The second quarter included a first full quarter of operating expense related to Pelikon, which we acquired in mid-December last year. Ongoing operating expense associated with Pelikon, is expected to be 1.1 million per quarter or approximately 4.4 million on an annual basis. Other income in the current quarter totaled 0.2 million. This compares to an expense of $2.1 million in the same period last year.

Last year's expense was impacted by $1.8 million foreign exchange loss and $0.5 million write-down for a small investment we had made in the startup that did not result in material business.

The effective tax rate in the second quarter was 23.7% compared to 27.6% last year. The lower tax rate was primarily due to the startup of our Singapore office. Late in fiscal 2008, 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.

Moving onto the balance sheet and liquidity position. Our cash balance increased by about $35 million during the quarter to $106.5 million. In the quarter, the company generated cash flow from operations of $46 million. The capital expenditures for the quarter totaled $3.5 million. CapEx was lower than expected and construction of MFC3 did not start until after the quarter end. We were managing our capacity build out to match our customer demands, therefore expenditures can accelerate or decelerate accordingly.

For the third quarter, we expect CapEx to be in the range of $12 million to $14 million. Our debt balance is $10.6 million which is comprised of notes payable related to the Pelikon transaction. With the completion of our new 30 million facility with Bank of America we have accessed to untapped revolving credit facilities totaling approximately $80 million.

We continue to focus on our receivables, inventory, and payables management in light of the general economic environment. Our DSO declined to 59 days in the second quarter and days inventory declined to 18 days.

Net working capital days were approximately 28 days. This metric is an historical low for the company and has significantly contributed to the increase in cash balance. Inventory days benefited from operations activities to reduce cycle time as well as different time sourcing through raw materials. While we are working to continue to keep our working capital low, we currently view working capital in the low 30 days range as a reasonable go forward expectation.

In January, we announced the stock repurchase plan for up to 2.25 million shares. During the second quarter, we completed the first tranche of our stock repurchase plan spending $8.4 million to repurchase 562,500 shares of common stock at an average price of $14.95 per share. We established a new 10b5-1 plan to implement the second tranche of the repurchase program, which also consist of 562,500 shares.

In conclusion, although we are in uncertain economic times, we are continuing to generate solid financial results. Revenues increased year-over-year and we have an extremely healthy balance sheet. We are benefiting from our emphasis on the high-end of the portable electronic device market where our customers have seen strong demand for their products. Given our strong customer relationships, we are optimistic on the future earnings and cash flow percents over the company.

This concludes the financial review. I will turn the call over to the operator so that Reza, Phil, and I can take your questions.

Reza Meshgin

Actually before we take question I have one quick correction to make. I mentioned that the other consumer handheld electronic devices were 25% for the first quarter of 2009, it is actually for the first half of fiscal 2009.

With that correction we're ready for questions. Operator?

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.

Matthew Sheerin - Thomas Weisel Partners

Yes thanks and good afternoon everyone. So just a question Reza regarding your guidance, it looks like you are seeing some seasonal patterns but are there any specific changes there you see in terms of the make up of your sales mix by customer, any up or down more significantly than others?

Reza Meshgin

No, we actually as we mention we see the mix in quarter three to be very similar to quarter two.

Matthew Sheerin - Thomas Weisel Partners

And are you seeing basically seasonal orders from your customers or you are seeing some particularly, your two largest customers go through some product transitions, which is why you are flat, because if you look at some of are customers they do have some product ramps that are expected. So, trying to figure out whether you are building or you're going through some product transitions now that you are at somewhat of a low and then you'll see somewhat of a snapback later in the year?

Reza Meshgin

All right. We have we're in middle of actually starting new programs which will translate into production and ramp up after this quarter; that's what our expectation is at this point of time.

Matthew Sheerin - Thomas Weisel Partners

Okay. And then as you do ramp those new programs later in the year, and I imagine that their extensions of existing platforms will have probably have some new technology, new components. So what I'm getting at is, as you ramp those, will you see margin pressure, because of lower yields or higher dollar content of components?

Reza Meshgin

Well we -- actually this is something that we've been very diligent about and work very hard to shorten our cycle of yield improvement. In other words as we go though program ramp-ups, its used to be that it would take us longer to get to our optimum yield. And we work very hard to shorten that cycle and as a matter of fact all the initiatives that we've put in place in our high volume operations have been resulting in very favorable quicker to optimum yield and shorter ramp-up. So, the answer to your question is that no, in particular we don't expect to see margin deterioration mainly because of these start ups, but that's always a possibility.

Matthew Sheerin - Thomas Weisel Partners

Okay. And then just lastly here, before you do bring that new capacity online, can you remind us what the sort of revenue capacity limit is here. I think I remember last fall you were talking about with that new Satellite Facilities you're about 220 million a quarter. Is that about right still?

Reza Meshgin

220 and we said that we have some more room to bring that up to upwards of more than 200 may be. But again that will highly depend on the mix at the time, so when we get closure to that time obviously we'll have to update what that number is, should actually know at the time based on the product mix.

Matthew Sheerin - Thomas Weisel Partners

Okay. I'll get back in the queue. Thank you.

Reza Meshgin

Thank you.

Operator

Thank you. (Operator Instructions). Our next question comes from the line of Rich Kugele of Needham & Company. Please go ahead.

Richard Kugele - Needham & Company

Thank you. Good afternoon, gentleman. I guess just to follow up on that question on the seasonality effect. Do you see any inventory work downs going on? And I guess those top two customers on the smartphone side, do they get shipped to you directly? Do they go directly to their EMS companies or do you hold any of that inventory in a jet hub?

Reza Meshgin

Richard, we don't talk about the details of our arrangements or business with customers. But in general our inventories are very low and at a very healthy level. We do have always remains with a number of our customers that's where I'll leave it at. Majority of our products gets also shipped to the EMS company.

Richard Kugele - Needham & Company

And can you just remind us what in general the lead times are between when you ship your product and when you think it might go into final production?

Reza Meshgin

Well, I think it's not an exact number for all the products, but my guess would be something between eight to 10 weeks. This is my guess.

Richard Kugele - Needham & Company

Okay. And then...

Reza Meshgin

You said from where we start or where we ship?

Richard Kugele - Needham & Company

When you ship?

Reza Meshgin

Okay. Then that's shorter than that, probably a month.

Richard Kugele - Needham & Company

Okay. That's helpful. And again follow-up on last question on when the new product is being ramped by whoever customer. Is it fair to say that that period right before that quarter right before as you're still making the old may be your yields and your margins can tick-up before ticking down with any potential yield hit, is that the progression we should think of?

Reza Meshgin

And our margins would higher before we have a yield hit?

Richard Kugele - Needham & Company

Well, because and like in this quarter for example because you're ramping new products more after the quarter. Should we assume that may be your margins would be towards the upper end of 13% to 15% guidance you are providing?

Reza Meshgin

I think I don't know what else I can say other than we've looked at the product mix and we've looked at what's in the ramp up and the range of 13% to 15% is a very good range and we're within that range is going to be. I think that's a very detailed fine tuning that's not really possible for us today at this point of time.

Richard Kugele - Needham & Company

Okay. And then just a last question, just on the tax. Obviously, there are tax advantages that you have by being in Asia, and the government, our government has been looking at changing how it handles those foreign companies who have income following through subsidiaries. Can you just give us your kind of initial gut reaction to your structure versus what's being discussed and how we should think about, and want potential impact there could be?

Tom Liguori

Sure Rich. At this time, we still anticipate we're achieving our target tax rate which is below 20% range. We are going to have to see the specifics of what's getting proposed. I mean I can tell you that when you look at the details that happened almost wouldn't have a material effect on our target tax rate. But, I think this is very early in the process and there is going to be a lot changes between now and what's finally approved so we'll have to see how that progresses?

Richard Kugele - Needham & Company

Okay. That's very helpful. Thank you very much.

Reza Meshgin

Thank you.

Operator

Thank you. (Operator Instructions). We have a question from the line of Ryan Jones with RBC Capital Markets. Please go ahead.

Ryan Jones - RBC Capital Markets

RBC Capital Markets:} Hi. Thank you. I am just wondering if you could comment at all about your share among your top four OEMs?

Reza Meshgin

I don't think we have given comments of our share of customers business but we play a significant role in their product as again some of the details that we're not, we don't have the liberty of discussing because of confidentiality reason.

Ryan Jones - RBC Capital Markets

Have you seen any pick up or loss in any of them, in the last quarter?

Reza Meshgin

No. Not, not in particular.

Ryan Jones - RBC Capital Markets

Okay. The other question any thoughts on additional acquisitions cash balance is getting very large I wanted to see you might deploy there and addition of the buyback toward something similar to Pelikon?

Reza Meshgin

We always look for opportunities and if we find a target that's inline with our strategy, we will move forward with it; but at this point of time, we don't have anything in particular in mind to.

Ryan Jones - RBC Capital Markets

All right. Thank you.

Operator

Thank you. And we have a follow-up question from the line of Matt Sheerin with Thomas Weisel Partners. Please go ahead.

Matthew Sheerin - Thomas Weisel Partners

Yes, thanks. I wanted to just ask about the new customer pipeline that you talked about Reza, and given that the new capacity won't be online I think you said until sometime in calendar '10? And you're doing some testing I know with pilots with customers now. Is it possible that you'll have some capacity in place to see any volume business with that new customer or customers by the end of this calendar year?

Reza Meshgin

Well I am not actually sure that we would need that additional capacity for that. But, one of things that we've done very well is to bring up the capacity as we need it and expedite it and with that in mind if we need to accelerate the building of the new MFC3, we will. On the contrary if we need to slow it down, because of the economy we can do that as well. So nonetheless for bringing up new customers I think at least the way it looks at this point of time, we're fine with the capacity. If we need to expedite and bring up to new building, we will.

Matthew Sheerin - Thomas Weisel Partners

Okay. And then you talked about in the press release about some competition and I am just trying to get if you're seeing any pricing competition out there, whether from competitors or having issues with other customers in trying to take share from you or are you starting to see your OEM customers be a little bit aggressive with you given the macro environment?

Reza Meshgin

Yeah, its actually I guess the price pressure is the better word for it and its mainly the result of the macroeconomic condition. It's not anything related to a particular competitor that's coming up. So, it's the general economy and price pressures on the supply chain and it's not unique to MFLEX in particular.

Matthew Sheerin - Thomas Weisel Partners

Okay, makes sense. Okay, thank you.

Reza Meshgin

Thank you.

Operator

Thank you. Our next question comes from the line of Jiwon Lee with Sidoti and Company. Please go ahead.

Jiwon Lee - Sidoti and Company

Thank you. I jumped into the call really late. I missed some of the comments, but if you can sort of kind of go back, and talk about the MFC3 expansion plan. Did you talk about the scale of it, in addition to the calendar 2010 capacity coming up and running. I think previously you scaled it down to above 70% to 80% of the original plan. Are we still at that level or we over or below?

Tom Liguori

Jiwon this is Tom. That's a good question. No, we didn't go into a lot of detail. We did break ground on the new plant and that was just a week or two ago. Right now we're building the shell. We provided a good lead end for our CapEx as the building will be about $25 million between now and the end of the year and the equipment in other 25 million which should be at the beginning of the calendar year, next year.

Okay. So your 70% to 80% yield that's probably about rate what we scaled it down to. But that's basically where it stands we're still optimistic on long-term just through demand and that's why we broke ground and are moving forward.

Jiwon Lee - Sidoti and Company

Okay, that's very helpful. And then I also missed the commentary on the other consumer electronics being 25% of your first half of fiscal '09 sales. What were they?

Reza Meshgin

They are affordable and house consumer electronics. We've not been very specific about saying anymore detail about that.

Jiwon Lee - Sidoti and Company

But are they kind of the same as where you've been doing before, so why break it out?

Reza Meshgin

They're different from smartphones and they go in a different I guess product segment if you're to separate them.

Jiwon Lee - Sidoti and Company

I see. And then I guess following on the previous question again. Have you in your mind and seeing the landscape that you are seeing has there been some share erosion with the some of your key customers as far as you're aware or is that just a sort of kind of a demand shift before the new models coming up?

Reza Meshgin

Well. It's a competitive market I don't -- I mean it's always been a competitive market. I can't point out any particular share erosion with customers.

Tom Liguori

Jiwon, we don't think, we'll lose -- we're not losing share at our customers.

Reza Meshgin

At least that's what, we believe.

Jiwon Lee - Sidoti and Company

Okay. Thank you.

Reza Meshgin

Thank you.

Operator

Thank you. And we have a follow-up question from the line of Ryan Jones, with RBC Capital Markets. Please go ahead.

Ryan Jones

Hi, just one final follow-up. I was wondering next year as we can't see through your mind. Is a plan to draw down on some of the revolvers and if you do plan to draw down on the revolvers which you would be drawing out down on the Bank of China line or the SPDB?

Tom Liguori

Right now, we don't have any plans to draw down on the lines. With 106 million in the CapEx numbers we just talked about for MFC3 plus our continuing generating cash going forward, we should be fine.

Ryan Jones

Okay. Thank you.

Operator

Thank you. And at this time I am showing no further questions in the queue. I'd like turn the call back over to Mr. Meshgin.

Reza Meshgin

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

Operator

And ladies and gentlemen, that does conclude the MFLEX Fiscal 2009 Second Quarter Conference Call. If you would like to listen to a replay of today's conference, please dial 303-590-3030 or 800-406-7325 with the access code of 4064179 pound.

Thank you for your participation. And at this time you may now disconnect.

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