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MFLX > SEC Filings for MFLX > Form 10-K on 16-Nov-2012All Recent SEC Filings

Show all filings for MULTI FINELINE ELECTRONIX INC | Request a Trial to NEW EDGAR Online Pro

Form 10-K for MULTI FINELINE ELECTRONIX INC


16-Nov-2012

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

You should read this discussion together with the financial statements, related notes and other financial information included in this Annual Report. The following discussion may contain predictions, estimates and other forward-looking statements that involve a number of risks and uncertainties, including those discussed under Part I, Item 1-A-"Risk Factors" and elsewhere in this Annual Report. These risks could cause our actual results to differ materially from any future performance suggested below.

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 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, consumer products, 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., Jabil Circuit, Inc., 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, 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.

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, expected volumes, assumed yields, material costs, actual yields, 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 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.

From our inception in 1984 until 1989, we were engaged primarily in the manufacturing of flexible printed circuits for military and aerospace applications. In early 1990, we began to develop the concept of attaching components on flexible printed circuits for Motorola. Through these early efforts, we developed the concept of the value-added approach with respect to integrating our design engineering expertise with our component assembly capabilities. This strategy has enabled us to capitalize on two trends over the course of the 1990s, the outsourcing by OEMs of their manufacturing needs and the shift of manufacturing facilities outside of the United States. In 1994, we formed a wholly owned Chinese subsidiary to better serve customers that have production facilities in Asia and provide a cost-effective, high-volume production platform for the manufacture of our products. Our Chinese subsidiary provides a complete range of capabilities and services to support our global


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customer base, including design engineering and high-volume production of single-sided, double-sided and multi-layer flexible printed circuits and component assemblies. In fiscal 2002, we formed a second wholly owned subsidiary in China to further expand our flexible printed circuit manufacturing and assembly capacity and we merged these two subsidiaries into one in fiscal 2010. In addition, we formed another wholly owned subsidiary in Chengdu, China, and in fiscal 2011, completed construction on our third and fourth manufacturing facilities in China as part of our continued capacity expansion initiative.

Net Sales

We design and manufacture our products to customer specifications. As of September 30, 2012, we engaged the services of certain non-exclusive sales representatives to provide customer contacts and market our products directly to our global customer base. These sales representatives were located throughout the North America, Europe and Asia. The variety of products our customers manufacture are referred to as programs. The majority of our sales are made to customers outside of the United States, and therefore sales volumes may be impacted by customer program and product mix changes and delivery schedule changes imposed on us by our customers. All sales from our Irvine, California executive office, Singapore regional office and our United Kingdom facility are denominated in U.S. dollars. All sales from our China facilities are denominated in U.S. dollars for sales outside China or RMB for sales made in China.

Cost of Sales

Cost of sales consisted of four major categories: material, overhead, labor and purchased process services. Material cost relates primarily to the purchase of copper foil, gold, polyimide substrates and electronic components. Overhead costs included all materials and facility costs associated with manufacturing support, processing supplies and expenses, support personnel costs, stock-based compensation expense related to such personnel, utilities, amortization of facilities and equipment and other related costs. Labor cost included the cost of personnel related to the manufacture of the completed product. Purchased process services related to the subcontracting of specific manufacturing processes to outside contractors. Cost of sales may be impacted by timing of wage increases at our manufacturing facilities, capacity utilization, manufacturing yields, product mix and production efficiencies. Also, we may be subject to increased costs as a result of changing material prices because we do not have long-term fixed supply agreements, inflation may occur in countries in which we produce and market wage rate increases may also occur in these countries.

Research and Development

Research and development costs are incurred in the development of new products and processes, including significant improvements and refinements to existing products and processes and are expensed as incurred.

Sales and Marketing

Sales and marketing expense included commissions paid to sales representatives, personnel-related and travel costs associated with sales and marketing, program management, corporate development and engineering support groups, sales support, trade shows, freight out, market studies and promotional and marketing brochures.

General and Administrative

General and administrative expense primarily included personnel-related and travel costs associated with finance/accounting, tax, internal audit, legal, human resources, information services and executive personnel along with other expenses related to external accounting, legal and professional expenses, business insurance, management information systems, investor relations, Board of Directors and other corporate office expenses.


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Impairment and Restructuring

Asset impairment is the difference between the fair market value, based on the estimated future cash flows of the underlying assets, and the carrying value, or net book value, of the assets. Impairment occurs when the carrying value exceeds the fair market value of the underlying assets. Restructuring expense represents severance, relocation, and other costs and recoveries related to the closure or disposal of a business unit or location.

Interest Income

Interest income consisted of interest income earned on cash, cash equivalents balances and previously held short-term investments.

Interest Expense

Interest expense consisted of expense incurred on unused line fees on our revolving facilities, interest related to our deferred financing costs and interest on our previously held long-term debt.

Other Income (Expense), Net

Other income (expense), net, consisted primarily of the gain or loss on foreign currency exchange and the gain or loss on derivative financial instruments.

Provision for Income Taxes

We record a provision for income taxes based on the statutory rates applicable in the countries in which we do business, subject to any tax holiday periods granted by the respective governmental authorities. We account for income taxes under the Financial Accounting Standards Board ("FASB") authoritative guidance which requires recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred tax assets and liabilities are determined based on the differences between the financial reporting and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse.

Critical Accounting Policies and Estimates

This "Management's Discussion and Analysis of Financial Condition and Results of Operations" section is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America ("U.S. GAAP"). The preparation of consolidated financial statements requires that we make estimates and judgments that affect the reported amounts of assets, liabilities, net sales and expenses and related disclosures. On an ongoing basis, we evaluate our estimates, including, but not limited to, those related to inventories, income taxes, accounts receivable allowance and warranty. We base our estimates on historical experience, performance metrics and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results will differ from these estimates under different assumptions or conditions.

We apply the following critical accounting policies in the preparation of our consolidated financial statements:

Revenue Recognition. Revenues, which we refer to as net sales, are generated from the sale of flexible printed circuit boards and assemblies, which are sold to OEMs, subcontractors and EMS providers to be included in other electronic products. An EMS provider may or may not be an OEM subcontractor. We recognize revenue when there is persuasive evidence of an arrangement with the customer that includes a fixed or determinable sales price, when title and risk of loss transfers, when delivery of the product has occurred in accordance with the terms of the sale and collectability of the related account


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receivable is reasonably assured. Our remaining obligation to customers after delivery is limited to our warranty obligations on our product. We report revenues net of an allowance for returns, refunds and credits, which we estimate based on historical experience.

Inventories. We value our inventory at the lower of the actual cost to purchase and/or manufacture the inventory or the current estimated market value of the inventory. We regularly review our inventory and record a provision for excess or obsolete inventory based primarily on historical usage and our estimate of expected and future product demand. Our estimates of future product demand will differ from actual demand; therefore, our estimates of the provision required for excess and obsolete inventory may change, which we will record in the period such determination is made.

Income Taxes. We determine if our deferred tax assets and liabilities are realizable on an ongoing basis by assessing our need for a valuation allowance and by adjusting the amount of such allowance, as necessary. In determining whether a valuation allowance is required, we have considered taxable income in prior carry back years, expected future taxable income and the feasibility of tax planning initiatives. If we determine that it is more likely than not that we will realize certain of our deferred tax assets for which we previously provided a valuation allowance, an adjustment would be required to reduce the existing valuation allowance. Conversely, if we determine that we would not be able to realize our recorded net deferred tax asset, an adjustment to increase the valuation allowance would be charged to our results of operations in the period such conclusion was reached.

We operate within multiple domestic and foreign taxing jurisdictions and are subject to audit in these jurisdictions. These audits can involve complex issues, which may require an extended period of time for resolution. Although we believe that adequate consideration has been made for such issues, it is possible that the ultimate resolution of such issues could be significantly different than originally estimated.

Accounts Receivable Allowance. We perform ongoing credit evaluations of our customers and adjust credit limits and their credit worthiness, as determined by our review of their current credit information. We continuously monitor collections and payments from our customers and maintain an allowance for doubtful accounts based on our historical experience, our anticipation of uncollectible amounts and any specific customer collection issues that we have identified. While our credit losses historically have been within our expectations and the allowance provided, we may not continue to experience the same credit loss rates that we have in the past. The majority of our receivables are concentrated in relatively few customers; therefore, a significant change in the liquidity or financial position of any one customer could make it more difficult for us to collect our accounts receivable and require us to increase our allowance for doubtful accounts.

Warranty Reserves. Our warranty period is generally twelve months, though can be as long as thirty-six months, depending on the related product. We provide a warranty reserve for estimated product warranty costs at the time the net sales are recognized. While we engage in quality programs and processes, up to and including the final product, our warranty obligation is affected by product failure rates, the cost of the failed product and the inbound and outbound freight costs incurred in replacing defective parts. We continuously monitor and analyze product returns for warranty and maintain a reserve for the related warranty costs based on historical experience and assumptions. If actual failure rates and the resulting cost of replacement vary from our historically based estimates, revisions to the estimated warranty reserve would be required.

Long-Lived Asset Impairment. We test for impairment whenever circumstances or events may affect the recoverability of long-lived assets. The evaluation is primarily dependent on the estimated future cash flows of the assets and the fair value of these items, as determined by management based on a number of estimates, including future cash flow projections, discount rates and terminal values. In determining these estimates, management considered internally generated information and information obtained from discussions with market participants. The determination of fair value requires significant judgment both by management and outside experts engaged to assist in this process.


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The impairment test for long-lived assets is a two-step process. The first step is to assess if events or changes in circumstances have affected the recoverability of long-lived assets. If management believes that recoverability has been affected, then step two requires management to calculate the undiscounted future cash flow related to the asset or asset group and to compare the cash flow to the carrying value of the asset or asset group. If undiscounted future cash flows exceed the carrying value, there is no impairment.

Restructuring Charges. We recognize restructuring charges related to plans to close or consolidate duplicate manufacturing and administrative facilities. In connection with these activities, we record restructuring charges for employee termination and relocation costs and other exit-related costs.

The recognition of restructuring charges requires that we make certain judgments and estimates regarding the nature, timing and amount of costs associated with the planned exit activity. To the extent that actual results differ from these estimates and assumptions, we may be required to revise the estimates of future liabilities, requiring the recognition of additional restructuring charges or the reduction of liabilities already recognized. Such changes to previously estimated amounts may be material to the consolidated financial statements. At the end of each reporting period, we evaluate the remaining accrued balances to ensure that no excess accruals are retained and the utilization of the provisions are for their intended purpose in accordance with developed exit plans.

In conjunction with the closure of certain of our facilities during the reporting periods, we estimated the restructuring costs that would result from the closures. Those costs included, but were not limited to, (a) termination benefits provided to current employees that are involuntarily terminated under the terms of a benefit arrangement that, in substance, is not an ongoing benefit arrangement or an individual deferred compensation contract, (b) costs to terminate a contract that is not a capital lease, and (c) costs to consolidate facilities or relocate employees. Based on our analysis and review of the relevant FASB authoritative guidance, we recorded pre-tax restructuring charges composed of severance, relocation, and other costs related to the closure of these facilities, as well as severance costs as a result of a reduction in force at certain of our other facilities.

Goodwill. We evaluate the carrying value of goodwill during the fourth quarter of each fiscal year and between annual evaluations if events occur or circumstances change that would more likely than not reduce the fair value of the reporting unit below its carrying amount. Such circumstances could include, but are not limited to: (i) a significant adverse change in legal factors or in business climate, (ii) unanticipated competition, or
(iii) an adverse action or assessment by a regulator. In performing the impairment review, we determine the carrying amount of each reporting unit by assigning assets and liabilities, including the existing goodwill, to those reporting units. A reporting unit is defined as an operating segment or one level below an operating segment. A component of an operating segment is deemed a reporting unit if the component constitutes a business for which discrete financial information is available and management regularly reviews the operating results of that component.

To evaluate whether goodwill is impaired, we compare the fair value of the reporting unit to which the goodwill is assigned to the reporting unit's carrying amount, including goodwill. We determine the fair value of each reporting unit using the present value of expected future cash flows for that reporting unit. If the carrying amount of a reporting unit exceeds its fair value, then the amount of the impairment loss must be measured. The impairment loss would be calculated by comparing the implied fair value of reporting unit goodwill to its carrying amount. In calculating the implied fair value of reporting unit goodwill, the fair value of the reporting unit is allocated to all of the other assets and liabilities of that unit based on their fair values. The excess of the fair value of a reporting unit over the amount assigned to its other assets and liabilities is the implied fair value of goodwill. An impairment loss would be recognized when the carrying amount of goodwill exceeds its implied fair value. To date, we have had no impairments of goodwill.


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Stock-Based Compensation. We recognize compensation expense related to stock options, restricted stock units ("RSUs") and stock appreciation rights ("SSARs") granted to employees based on the grant date fair value. Our assessment of the estimated fair value of the stock options and SSARs granted is affected by our stock price as well as assumptions regarding a number of complex and subjective variables and the related tax impact. We utilize the Black-Scholes model to estimate the fair value of stock options and SSARs granted. Generally, our calculation of the fair value for stock options and SSARs granted under the relevant FASB authoritative guidance is similar to the calculation of fair value under the original guidance with the exception of the treatment of forfeitures. Expected forfeitures of stock options and SSARs are estimated based on the historical turnover of our employees. The fair value of RSUs granted is based on the grant date price of our common stock.

The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. This model also requires the input of highly subjective assumptions including:

(a) the expected volatility of our common stock price, which we determine based on historical volatility of our common stock;

(b) expected dividends, which are zero, as we do not currently anticipate issuing dividends;

(c) expected life of the stock option and SSAR, which is estimated based on the historical stock option and SSAR exercise behavior of our employees; and

(d) risk free interest rate, which is based on observed interest rates (zero coupon U.S. Treasury debt securities) appropriate for the expected holding period.

An award with a market condition is accounted for and measured differently than an award that has a performance or service condition. The effect of a market-based valuation is reflected in the award's fair value on the grant date (e.g., a discount may be taken when estimating the fair value of an RSU to reflect the market condition). The fair value may be lower than the fair value of an identical award that has only a service or performance condition because those awards will not include a discount on the fair value. All compensation costs for awards that have only a market condition will be recognized if the requisite service period is fulfilled, even if the market condition is never satisfied.

In the future, we may elect to use different assumptions under the Black-Scholes valuation model or a different valuation model, which could result in a significantly different impact on our net income or loss.


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Results of Operations

The following table sets forth our consolidated statements of income data, expressed as a percentage of net sales for the periods indicated.

                                            Fiscal Years Ended September 30,
                                         2012              2011            2010
       Net sales                           100.0 %           100.0 %         100.0 %
       Cost of sales                        89.9              87.4            85.7

       Gross profit                         10.1              12.6            14.3
       Operating expenses:
       Research and development              0.9               1.3             1.8
       Sales and marketing                   3.0               3.0             3.0
       General and administrative            2.4               2.3             2.7
       Impairment and restructuring         (0.3 )             0.5             1.5

       Total operating expenses              6.0               7.1             9.0

       Operating income                      4.1               5.5             5.3
       Other income (expense), net:
       Interest income                       0.2               0.1             0.1
       Interest expense                     (0.1 )            (0.0 )          (0.1 )
       Other income (expense), net           0.2               0.0             0.0

       Income before income taxes            4.4               5.6             5.3
       Provision for income taxes           (0.8 )            (1.1 )          (1.5 )

       Net income                            3.6 %             4.5 %           3.8 %

Fiscal Year Ended September 30, 2012 Compared to Fiscal Year Ended September 30, 2011

Net Sales. Net sales decreased to $818.9 million in the fiscal year ended September 30, 2012, from $831.6 million in the fiscal year ended September 30, 2011. The decrease of $12.7 million, or 1.5%, was primarily due to decreased net sales into our smartphone sector, partially offset by increased net sales into our tablet and consumer electronics sectors, as further quantified below.

Net sales into our smartphones sector decreased to $564.5 million in the fiscal year ended September 30, 2012, from $686.0 million in the fiscal year ended September 30, 2011. The decrease of $121.5 million, or 17.7%, was primarily due to lower sales volumes to one of our major customers. For the fiscal years ended September 30, 2012 and 2011, our smartphones sector accounted for approximately 69% and 83% of total net sales, respectively.

Net sales into our tablets sector increased to $219.6 million in the fiscal year ended September 30, 2012, from $110.4 million in fiscal 2011. The increase of $109.2 million, or 98.9%, was primarily due to increased volumes of 103% as a result of increased demand for products from one of our key customers in this sector. Average selling prices were relatively flat year over year in this sector. For the fiscal years ended September 30, 2012 and 2011, our tablets sector accounted for approximately 27% and 13% of total net sales, respectively.

Net sales into our consumer electronics sector increased to $15.2 million in the . . .

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