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Multi-Fineline Electronix (NASDAQ:MFLX)

Q1 2014 Earnings Call

February 06, 2014 5:30 pm ET

Executives

Reza A. Meshgin - Chief Executive Officer, President and Director

Stacy Feit

Thomas Liguori - Chief Financial Officer, Principal Accounting Officer and Executive Vice President

Analysts

Steven Bryant Fox - Cross Research LLC

Matthew Sheerin - Stifel, Nicolaus & Co., Inc., Research Division

David Rold - Needham & Company, LLC, Research Division

Jiwon Lee - Sidoti & Company, LLC

Operator

Good day, ladies and gentlemen, and thank you for standing by. Welcome to the MFLEX Fiscal 2014 First Quarter Financial Results Conference Call. [Operator Instructions] I would now like to turn the conference over to Reza Meshgin, President and CEO. Please go ahead.

Reza A. Meshgin

Thank you. Welcome to MFLEX's fiscal 2014 first quarter conference call. Today I will discuss our business and operational highlights and Tom Liguori, our CFO, will provide additional details on our financial results. Tom and I will be available to answer your questions at the conclusion of our prepared remarks.

Stacy Feit, from the Financial Relations Board, will now review our forward-looking statements before we begin our discussion. Stacy?

Stacy Feit

Thank you, Reza, and good afternoon, everyone. A copy of the press release we issued this afternoon can be found on the IR section of the company's website at www.mflex.com. As a reminder, certain statements made in this conference call are forward-looking statements within the meaning of the U.S. Federal Securities laws. These forward-looking statements are based upon a number of risks, uncertainties and other factors that are difficult to predict. Actual results may differ materially from the company's expectations. More complete disclosure regarding forward-looking statements can be found at the bottom of the company's press release issued today.

MFLEX disclaims any obligation to update any of this forward-looking information.

And with that, I will turn the call back over to Reza.

Reza A. Meshgin

Thank you, Stacy. Our Q1 net sales of $211.7 million were in line with our pre-announcement last month and within our guidance range. Gross margin of 1.2% was slightly higher than our expectations. Tom will go over this in more detail in a few minutes.

Our net sales mix continues to be primarily comprised of flex assemblies for smartphones and tablets. In Q1, smartphones comprised 74% of our net sales while tablet contribution was 17%. We also had approximately 6% contribution from our consumer-electronics sector in the quarter.

Regarding customer mix, during the first quarter, customer C represented approximately 71% of net sales. Customer D only contributed about 1% of net sales. With this customer undergoing a business transition, we're not anticipating much, if any, sales contribution from them going forward. Our relationships with our key customers, legacy or new, remains strong, though we believe our overall share with one large customer has recently declined. This is in line with our thought process in focusing on more profitable programs which, in conjunction with our restructuring, we expect will return us to profitability.

Net sales to our newer customers, which comprised of a group of 8, more than doubled sequentially to approximately $48 million, contributing about 22% of net sales. Within this group, we had one customer approaching the 10% level and another customer just under 9%. We anticipate both of these customers to exceed the 10% threshold in the fiscal second quarter. And we expect strong contribution from the group of 8 again in the fiscal second quarter. However, we do not believe this will be sufficient to offset the reduced near-term demand we are seeing from our key customers. We therefore anticipate a material decline in revenue during the fiscal second quarter which, combined with the impact of our excess capacity, is anticipated to result in a substantial net loss for the quarter.

As we indicated in our pre-announcement last month, we have undertaken a review of our manufacturing capacity in an effort to consolidate our capacity to align our cost of structure with net sales levels while maintaining the long-term capacity necessary to support our growth objectives. We have developed our implementation plans and are in the process of finalizing those plans, including obtaining the necessary approval. We expect to be in a position to communicate the details of the planned restructuring later this month.

We plan to execute the restructuring as quickly as possible, expecting to have most of the cost reductions in place by the fiscal third quarter with the balance in the fiscal fourth quarter. We anticipate returning to profitability in the fiscal fourth quarter. Once the restructuring is completed, we expect to have a significantly improved cost structure to support profitability and competitiveness. With approximately $112 million in cash at December 31 and no debt, we believe we have a very strong balance sheet to support us through this transition period.

Although our business remains challenging, we're working towards reducing our revenue volatility by continuing to diversify our customer base and transitioning to a broader and more profitable product mix. We've made good progress in these areas and are optimistic about the opportunities that lie ahead. We believe our market-leading technology continues to position us well for the long-term.

With that, I will turn the call over to Tom to provide a more detailed discussion on our first quarter results. Tom?

Thomas Liguori

Thank you, Reza. Net sales of $211.7 million during the fiscal first quarter declined 27% year-over-year, primarily due to lower net sales to a key customer, partially offset by a $23.5 million increase in net sales to our newer customers to approximately $48 million.

Gross margin of 1.2%, compared to 8.5% in the same period a year ago. The year-over-year decline of 730 basis points breaks down as follows; 600 basis points due to lower overhead absorption, primarily due to excess manufacturing capacity; 150 basis points due to an inventory write-down for excess inventory associated with a customer that is undergoing a business transition; and 90 basis points due to higher wage and benefit rates. These were partially offset by 110 basis-point improvement mainly due to a better product mix as we focus on more profitable programs and exiting lower-margin ones.

Moving down the income statement. Operating expenses were $10.7 million, or 5% of net sales. This was below the $13 million to $14 million range we expected due to additional spending reductions and a $1.1 million gain on sales of some older equipment that is included in G&A.

We expect normal OpEx of approximately $11 million to $12 million during the March quarter. We recorded a $1.5 million tax expense for income earned in an international region during the fiscal first quarter. We did not record a tax benefit for regions with losses.

We generated over $8 million in operating cash flow in the fiscal first quarter, and our cash balance increased to $112 million, or $4.65 per share. We continued to maintain a strong balance sheet with no debt.

Total net working capital days declined to 22 days from 26 days in the prior quarter. Receivables remain lean and inventory days declined to almost 6 days. We continue to maintain a target of days net working capital in the low 30s, which we have been recently achieving or doing better than.

Consistent with our cost containment efforts, we minimized capital expenditures during the quarter. They totaled approximately $7 million. We expect the March quarter CapEx to be under $10 million. For the foreseeable future, we tend to limit our CapEx to normal equipment replacement and investments in automation.

Turning to our March quarter outlook. We anticipate net sales to be between $120 million and $135 million. We expect gross margin to range between negative 11% and 13%. This gross margin range is a result of the lower sales volume and under-absorbed overhead; the start and stop of production for the China new year, which impact efficiencies; and in addition, we anticipate initiating our restructuring plan late in the quarter which may require some transition activities that could also hinder manufacturing efficiencies.

As we indicated in our pre-announcement last month, we expect our March quarter result to reflect significant impairment and restructuring charges associated with our planned capacity consolidation. These are not included in the gross margin guidance.

The cash component of these charges should be $20 million or less and we expect these cash cost to be partially offset in future quarters as we dispose of assets. We expect the restructuring to have a meaningful impact on our cost structure. And as Reza discussed, we expect to communicate the details associated with restructuring later this month.

Our immediate focus is on finalizing and executing our restructuring plan and continuing the growth momentum of our newer customers. Once our capacity consolidation is complete, we expect to return to profitability while earning an ROIC that exceeds our cost of capital as we historically have.

We expect to return to profitability in our September quarter. As we move through this transition period and reduce our cost structure, minimize our CapEx, and return to profitability, we expect to exit the year with strong operating cash flow. This should position us well for a positive fiscal 2015.

Before Reza and I turn the call over for Q&A, I'd like to remind you that at the request of our customers, we will not comment on specific customers or programs in response to your questions. Calvin, we are now ready for the first question.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question comes from the line of Steven Fox with Cross Research.

Steven Bryant Fox - Cross Research LLC

A few questions for me. First off, on the new customers, you basically highlighted 2 as sort of dominating the group of 8 that you continue to sort of emphasize over the last couple of quarters. Can you sort of dig into a little bit why we're talking about 8 customers. Is there a potential that the other 6 actually become meaningful in the next couple of quarters? Or do you expect these 2 customers to continue to be the bulk of sort of the new business? And any color around what kind of programs you're on would be helpful.

Reza A. Meshgin

Sure. So within the 8 customers, we do have an expectation that more than these 2 will become sizable and meaningful within the next few quarters. It's just a matter of the timing of the programs and the size of the programs that we're in with them. And most of them, the types of products are still in the mobility market, smartphones, tablets and potentially, some of the wearable devices.

Steven Bryant Fox - Cross Research LLC

Great. That's helpful. And then I understand you're still finalizing your restructuring actions. But is it possible you have to sort of talk about a break even point or how much capacity you think is excess? Or any sort of general guidelines around what you are thinking in terms of the business going forward after the restructuring?

Reza A. Meshgin

Let me see if I can help with answering that. Our goal is to make sure that we have a sizable-enough reduction that would bring us back into profitability. Having said that, we're also mindful of our opportunities going towards our next year. And what we've basically done is we've looked at the seasonality of our business and looked at the high season and targeting those as our benchmark for what capacity do we need in terms of an annual run rate to make sure that we have the headroom to grow. So in simple terms, I think this reduction of capacity will be significant. It's a consolidation, so we're not necessarily removing all of our equipment in line. We're more -- we're thinking of more into consolidating them into less facilities. And Tom, you want to add anything?

Thomas Liguori

I think that's the best we can say at this point of time.

Steven Bryant Fox - Cross Research LLC

Great. That's helpful. And Tom, I think I might have missed this, but I thought I heard you talk about sort of operating expense levels going forward for this quarter? Can you just, if you didn't, if you could sort of give us a range. If you did, if you could you repeat it.

Thomas Liguori

Yes. Steve, I said $11 million to $12 million for the March quarter.

Operator

And our next question comes from the line of Matt Sheerin with Stifel.

Matthew Sheerin - Stifel, Nicolaus & Co., Inc., Research Division

So just a question, well actually following up on Steve's question, if I can ask it another way. Is there a revenue number sort of where we should be looking at for you to break even in terms of volumes? Obviously, it would be higher in theory than what it is now, but is it like $150 million a quarter? Do you have a number there?

Reza A. Meshgin

Matt, we're working on that at this point of time. And I think it will be best for us to talk about that when we are ready to come out and basically discuss our new model and the new operating parameters, which should be in the next few weeks within this month.

Matthew Sheerin - Stifel, Nicolaus & Co., Inc., Research Division

Okay fair enough, I appreciate that. And if I can ask a question regarding your customers seed at at 71% customer. I know you're looking -- focusing on these growth areas. But obviously, this has been a very important customer for you. I did notice that you were down in the last 2 quarters on a year-over-year basis, down double-digits with that customer. And I'm just trying to understand if that means there's market share issues? Are you focusing on more profitable programs with you? I know you've done both tablets and smartphones in the past for that customer. I guess the question is, are you focusing more narrowly on that customer?

Reza A. Meshgin

Well, yes. And I guess you kind of said the answer to your question. As we mentioned, we are looking at how much capacity we have and how we can divvy that up in terms of profitability of programs, go-forward opportunity, and most importantly the diversification of the customer base. And that we expect to be a continued way of thinking for us even after we go through our restructuring.

Matthew Sheerin - Stifel, Nicolaus & Co., Inc., Research Division

Okay. And then just lastly, Tom, you talked about OpEx this quarter. What -- with this cost cutting program, are you going to be targeting OpEx as well? Or is it mostly on the cost of goods side?

Thomas Liguori

Well it'll be mostly on the capacity and cost of sales, but there will be some on CapEx. And when we announce it, we'll give you some more insight into that.

Operator

And our next question comes from the line of Richard Kugele with Needham.

David Rold - Needham & Company, LLC, Research Division

David Rold on for Richard. Can you hear me? Several kind of high-profile failures recently in the smartphone world, one of them affecting your major customer. Without going to specifics though, can you tell us if there's any kind of ongoing inventory write-down risk we should worry about?

Reza A. Meshgin

Well, as Tom mentioned, one thing we're very sensitive about is the level of discussion that we have about our customer programs. The best we can tell you is that at December 31, we've made our best judgment in terms of determining what's subject to a potential write-down. And at this point of time, although that risk always exists, we don't really think there is anything that we have not considered.

Operator

[Operator Instructions] And our next question comes from the line of Jiwon Lee with Sidoti.

Jiwon Lee - Sidoti & Company, LLC

Just wanted to ask on -- how do you manage the business as your customer base is now becoming more diversified and that concentration profile will substantially change? I'm asking in terms of your next phase of the investment and whatnot?

Reza A. Meshgin

That's an excellent question, Jiwon. And we have actually thought through that in our thinking process in terms of consolidating and how do we factor that into our business model. As you said, historically in the last 4 or 5 years, we've had 1 or 2 customers that have added up to a very, very significant percentage of our business. We foresee that changing going forward. And as a result of that, as part of our planning for the future, we're actually planning our restructuring around that, to be able to handle more customers and more programs.

Jiwon Lee - Sidoti & Company, LLC

Okay. Be that as it may, Reza, near-term, you will have a substantial revenue decline with your key customer. And I'm just kind of trying to kind of get to -- you mentioned some share loss. Did that come more from that pricing pressure? Or perhaps the low ASP the customer was seeking? Or was it more to do with your decision to not engage in sort of a falling margin business?

Reza A. Meshgin

Okay. Just for clarity, we have not referenced anything in, like, any quarter after this. So I guess I'm not quite sure if we understood the question. Is your concern a question about gaining back share? Or are you concerned about -- your question is about the level of business from any one customer?

Jiwon Lee - Sidoti & Company, LLC

Well I guess, yes, my angle was more on the first, whether or not there was a prospect.

Reza A. Meshgin

Okay. Well, our expectation is to continue to grow with our new customers. I guess there was -- the first set of questions, one question was, so do you expect any other one of the questions in that basket of 8 to grow and be more significant? And the answer to that is yes. So even though we do have about 8 customers that we're working on and cultivating at this point of time, it's not like we have like tens of customers. And again, our thinking in terms of go-forward captures, how we need to organize our operation to be able to support more customers.

Jiwon Lee - Sidoti & Company, LLC

Okay. And lastly, you mentioned the wearable device and it's still early in the phase. But if those programs were to ramp, what type of investment would you need, compared to the previous cycle when you had a substantial mix shift?

Reza A. Meshgin

Well we don't anticipate any significant investment, at least in the foreseeable future. And the wearable devices are slightly different in nature, in types of assemblies that may be involved with them. But effectively, they're not much different from what we need in terms of CapEx and facilities that we have at this point of time. So we don't really anticipate any significant investments for those.

Operator

And I'm showing no questions at this time. I'd like to turn the call back over to management.

Reza A. Meshgin

I'd like to thank you for your continued interest in MFLEX and we look forward to speaking with you on our next call. Goodbye.

Operator

Thank you, ladies and gentlemen. That does end our call for today. You may now disconnect.

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