UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

FORM 10-Q

 

(Mark One)

For the quarterly period ended June 30, 2014

OR

For the transition period from              to             

Commission file number 000-50812

 

MULTI-FINELINE ELECTRONIX, INC.

(Exact name of registrant as specified in its charter)

 

 

8659 Research Drive

Irvine, CA 92618

(Address of principal executive offices, Zip Code)

(949) 453-6800

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2).    Yes  ¨    No  x

The number of outstanding shares of the registrant’s Common Stock, $0.0001 par value, as of July 31, 2014 was 24,167,749.

 

 

 

 

 

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Multi-Fineline Electronix, Inc.

Index

 

 

 

 

 

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PART I. FINANCIAL INFORMATION

 

MULTI-FINELINE ELECTRONIX, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(In Thousands, Except Share Data)

(unaudited)

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

 

 

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MULTI-FINELINE ELECTRONIX, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(In Thousands, Except Share and Per Share Data)

(unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

 

 

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MULTI-FINELINE ELECTRONIX, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In Thousands)

(unaudited)

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

 

 

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MULTI-FINELINE ELECTRONIX, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In Thousands, Except Share and Per Share Data)

(unaudited)

MULTI-FINELINE ELECTRONIX, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In Thousands, Except Share and Per Share Data)

(unaudited)

 

1. Description of Business

Multi-Fineline Electronix, Inc. (“MFLEX” or the “Company”) was incorporated in 1984 in the State of California and reincorporated in the State of Delaware in June 2004. The Company is primarily engaged in the engineering, design and manufacture of flexible printed circuit boards along with related component assemblies.

United Engineers Limited (“UEL”) and its wholly owned subsidiary, UE Centennial Venture Pte. Ltd (“UECV”, and together with UEL, “UE”), through its affiliates and subsidiaries, beneficially owned approximately 61% and 62% of the Company’s outstanding common stock as of June 30, 2014 and September 30, 2013, respectively. This beneficial ownership of the Company’s common stock by UE provides these entities with control over the outcome of stockholder votes at the Company, except with respect to certain related-party transactions with UE or its subsidiaries, including WBL Corporation Limited (“WBL”), which require a separate vote of the non-UE stockholders.

 

2. Basis of Presentation

Principles of Consolidation

The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. The Company has two wholly owned subsidiaries located in China: MFLEX Suzhou Co., Ltd., (“MFC”) and MFLEX Chengdu Co., Ltd. (“MFLEX Chengdu”); one located in the Cayman Islands: M-Flex Cayman Islands, Inc. (“MFCI”); one located in Singapore: Multi-Fineline Electronix Singapore Pte. Ltd. (“MFLEX Singapore”); one located in Malaysia: Multi-Fineline Electronix Malaysia Sdn. Bhd. (“MFM”); one located in Cambridge, England: MFLEX UK Limited (“MFE”); one located in Korea: MFLEX Korea, Ltd. (“MKR”); and one located in the Netherlands: MFLEX B.V. (“MNE”). In 2010, the Company merged its subsidiary, Multi-Fineline Electronix (Suzhou) Co., Ltd (“MFC1”) into MFC; however, the Company is still in the process of deregistering MFC1. All significant intercompany transactions and balances have been eliminated in consolidation.

Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes contained in the Company’s 2013 Annual Report on Form 10-K. The financial information presented in the accompanying statements reflects all adjustments that are, in the opinion of management, necessary for a fair statement of the periods indicated. All such adjustments are of a normal recurring nature. The year-end condensed balance sheet data was derived from audited financial statements, but does not include all disclosures required by U.S. GAAP. Operating results for the three and nine months ended June 30, 2014 are not necessarily indicative of the results that may be expected for the fiscal year ending September 30, 2014. Unless otherwise indicated, the financial information in these notes is presented in thousands (except per share amounts).

Recently Issued Accounting Pronouncements Not Yet Adopted

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standard Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers, which requires a reporting entity to recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The guidance in this ASU affects any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets unless those contracts are within the scope of other standards. This standard will be effective for the Company beginning January 1, 2017. The Company is currently evaluating the impact of its pending adoption of this guidance on its financial position, results of operations and cash flows.

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MULTI-FINELINE ELECTRONIX, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In Thousands, Except Share and Per Share Data)

(unaudited)

Fair Value Measurements

The carrying amounts of certain of the Company’s financial instruments, including cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities approximated fair value due to their short maturities. For recognition purposes, on a recurring basis, the Company’s assets and liabilities related to money market funds and derivative financial instruments are measured at fair value at the end of each reporting period. The fair value of the Company’s money market funds were measured using Level 1 fair value inputs and the fair value of the Company’s derivative assets and liabilities were measured using Level 2 fair value inputs, which consisted of observable market-based inputs of foreign currency spot and forward rates quoted by major financial institutions.

 

The Company’s assets and liabilities measured at fair value on a recurring basis subject to the disclosure requirements as defined under the FASB authoritative accounting guidance were as follows:

 

 

 

As of June 30, 2014, assets held for sale were measured at fair value on a non-recurring basis. Based on the relevant FASB guidance, the carrying value of assets held for sale was written down to $7,360 after recording an impairment charge of $6,890 during the three months ended June 30, 2014 (refer to Note 8). The fair value of the assets was determined using Level 3 unobservable inputs not corroborated by market data, consisting of third-party offers for assets held for sale. Below is a summary of the Company’s assets measured at fair value on a non-recurring basis as of June 30, 2014:

 

No assets or liabilities were measured at fair value on a non-recurring basis as of September 30, 2013.

Inventories

Inventories, net of applicable write-downs, were composed of the following:

 

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MULTI-FINELINE ELECTRONIX, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In Thousands, Except Share and Per Share Data)

(unaudited)

Restricted Cash

As of June 30, 2014, the Company held $520 of cash restricted due to customs deposit requirements, which was segregated from cash and cash equivalents and included within other current assets. The restriction is expected to cease within twelve months.

Property, Plant and Equipment

Property, plant and equipment, net, were composed of the following:

 

 

Accrued Liabilities

Accrued liabilities were composed of the following:

Product Warranty Accrual

Changes in the product warranty accrual for the three months ended June 30, 2014 and 2013 were as follows:

 

Changes in the product warranty accrual for the nine months ended June 30, 2014 and 2013 were as follows:

 

 

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MULTI-FINELINE ELECTRONIX, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In Thousands, Except Share and Per Share Data)

(unaudited)

Net Income Per Share—Basic and Diluted

The following table presents a reconciliation of basic and diluted shares for the three and nine months ended June 30, 2014 and 2013:

 

 

Commitments and Contingencies

Litigation

The Company is involved in litigation from time to time in the ordinary course of business. Management does not believe the outcome of any currently pending matters will have a material adverse effect on the Company’s financial position, results of operations or cash flows.

Other Commitments

The Company has outstanding purchase and other commitments, which exclude amounts already recorded on the Condensed Consolidated Balance Sheets. The outstanding purchase commitments to acquire capital assets and other materials and services totaled $10,588 and $6,454 as of June 30, 2014 and September 30, 2013, respectively.

Pursuant to the laws applicable to the People’s Republic of China’s Foreign Investment Enterprises, the Company’s two wholly owned subsidiaries in China, MFC and MFLEX Chengdu, are restricted from paying cash dividends on 10% of after-tax statutory profit, subject to certain cumulative limits. These restrictions as of June 30, 2014 and September 30, 2013 were $19,823 and $19,838, respectively.

Significant Concentrations

 

The Company’s net sales into its largest industry sectors, as a percentage of total net sales, are presented below:

 

 

 

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MULTI-FINELINE ELECTRONIX, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In Thousands, Except Share and Per Share Data)

(unaudited)

3. Lines of Credit

During July 2013, MFC entered into a Line of General Credit Agreement (the “MFC Credit Line”) with Agricultural Bank of China, Suzhou Wuzhong Sub-branch (“ABC”), providing for a line of credit to MFC in an amount of 200,000 Chinese Renminbi (“RMB”) ($32,506 at June 30, 2014). The MFC Credit Line became effective on July 31, 2013 and will mature on July 30, 2016. At June 30, 2014, the Company had $20,000 outstanding under the MFC Credit Line at an interest rate of 3.1% and with a maturity date in August 2014.  

During May 2013, MFC entered into a Line of Credit Agreement (the “CCB Credit Line”) with China Construction Bank, Suzhou Industry Park Sub-Branch (“CCB”), which provides for a borrowing facility for 300,000 RMB ($48,758 at June 30, 2014). The CCB Credit Line will mature on May 5, 2016.

During March 2013, MFLEX Chengdu entered into a Line of Credit Agreement (the “MCH Credit Line”) with Bank of China Co., Ltd. Chengdu Development West Zone Sub-Branch (“BC”), providing for a line of credit to MFLEX Chengdu in an amount of $11,000. The MCH Credit Line matured on February 5, 2014.

During January 2012, MFLEX Singapore entered into a Facility Agreement (the “Facility Agreement”) with JPMorgan Chase Bank, N.A., Singapore Branch (“JPM”), as mandated lead arranger, the financial institutions from time to time party thereto, as lenders, and JPMorgan Chase Bank, N.A. acting through its Hong Kong Branch, as facility agent and as security agent. The Facility Agreement provided for a three-year, revolving credit facility, under which MFLEX Singapore may obtain loans and other financial accommodations in an aggregate principal amount of up to $50,000. As of December 31, 2013, the Company was not in compliance with one of the financial covenants under the Facility Agreement with JPM due to its trailing twelve-month net losses. No amounts were outstanding under the Facility Agreement with JPM as of December 31, 2013. Effective February 5, 2014, the Company terminated the Facility Agreement.

A summary of the lines of credit is as follows:

 

 

On August 6, 2014, the Company, as guarantor, and MFLEX Singapore, as borrower, entered into a Loan and Security Agreement with certain financial institutions, as lenders, and Bank of America, N.A., as agent, providing for a senior revolving credit facility in an amount up to $30,000. Refer to Note 9 for details.

As of June 30, 2014, the Company was in compliance with all applicable financial covenants.

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MULTI-FINELINE ELECTRONIX, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In Thousands, Except Share and Per Share Data)

(unaudited)

4. Segment Information

Based on the evaluation of the Company’s internal financial information, management believes that the Company operates in one reportable segment. The Company is primarily engaged in the engineering, design and manufacture of flexible circuit boards along with related component assemblies. For the periods presented, the Company operated in four geographical areas: United States, China, Singapore and Other (which includes Malaysia, Korea and the United Kingdom). Net sales are presented based on the country in which the sales originate, which is where the legal entity is domiciled. The financial results of the Company’s geographic segments are presented on a basis consistent with the condensed consolidated financial statements. Segment net sales and assets amounts include intra-company product sales transactions and subsidiary investment amounts, respectively, which are offset in the eliminations line.

Financial information by geographic segment is as follows:

 

 

 

 

 

 

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MULTI-FINELINE ELECTRONIX, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In Thousands, Except Share and Per Share Data)

(unaudited)

 

 

5. Stock-Based Compensation

At the Company’s annual meeting of stockholders on March 5, 2014, the stockholders approved the Company’s 2014 Equity Incentive Plan (the “2014 Plan”). Upon stockholder approval of the 2014 Plan, the Company’s 2004 Stock Incentive Plan, as amended and restated to date (the “2004 Plan”) was terminated. Under the 2014 Plan, the Company is authorized to issue up to 1,639,279 shares, increased by not more than 2,062,007 shares comprised of the aggregate number of shares of stock that remain available for the future grant of awards under the 2004 Plan immediately prior to its termination and the number of shares subject to any option or other award outstanding under the 2004 Plan that expires or is forfeited for any reason after March 5, 2014.

Stock Options

Stock option activity for the nine months ended June 30, 2014 under the Company’s 2004 Plan is summarized as follows:

 

 

The aggregate intrinsic value of stock options exercised was $147 and $177 during the three and nine months ended June 30, 2014, respectively, and was $6 and $278 during the three and nine months ended June 30, 2013, respectively. Unearned compensation for stock options was zero as of June 30, 2014.

Service and Performance-Based Restricted Stock Units

During the three and nine months ended June 30, 2014 and 2013, the Company granted service-based restricted stock units (“RSUs”) under the 2004 Plan and 2014 Plan to certain employees (including executive officers) and directors at no cost to such individual. Each RSU represents one hypothetical share of the Company’s common stock, without voting or dividend rights. The RSUs granted to employees generally vest over a period of three years with one-third vesting on each of the anniversary dates of the grant date. Total compensation cost related to RSUs is determined based on the fair value of the Company’s common stock on the date of grant and is amortized into expense over the vesting period using the straight-line method.

The Company also grants performance-based RSUs to certain employees (including executive officers) from time to time. For such performance-based RSUs, the Company records stock-based compensation expense based on the grant-date fair value and the probability that the performance metrics will be achieved. Management generally considers the probability that the performance metrics will be achieved to be a 70% chance or greater (“Probability Threshold”). At the end of each reporting period, the Company evaluates the awards to determine if the related performance metrics meet the Probability Threshold. If the Company determines that the vesting of any of the outstanding performance-based RSUs does not meet the Probability Threshold, the stock-based compensation expense related to those performance-based RSUs is reversed in the period in which this determination is made. However, if at a future date conditions have changed and the Probability Threshold is deemed to be met, the previously reversed stock-based compensation expense, as well as all subsequent projected stock-based compensation expense through the date of evaluation, is recognized in the period in which this new determination is made.

On November 11, 2013, the Company granted 183,292 performance-based RSUs (the “November 2013 Awards”). On December 19, 2013, the Company granted 78,553 performance-based RSUs (the “December 2013 Awards”). Both the November 2013 Awards and the December 2013 Awards vest upon the achievement of defined performance and market objectives pertaining to such grants, with vesting estimated to occur between September 30, 2016 and November 30, 2016.

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MULTI-FINELINE ELECTRONIX, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In Thousands, Except Share and Per Share Data)

(unaudited)

 

 

Approximately two-fifths of the November 2013 Awards and the December 2013 Awards contained performance conditions whereby the Company recorded stock-based compensation cost based on the grant-date fair value and the probability that the performance metrics will be achieved. At the end of each reporting period, the Company evaluates the probability that the performance-based RSUs will vest. As of June 30, 2014, the Company considers the vesting of the November 2013 Awards and the December 2013 Awards to be probable.

Approximately three-fifths of the November 2013 Awards and the December 2013 Awards contained both market and performance conditions, whereby the market condition was measured by determining the Company’s total shareholder return (“TSR”) for the three-year period beginning November 30, 2013 through November 30, 2016 versus the TSR of the Nasdaq Total Return Index for the same period, using the three-month average daily closing price of each on November 30, 2013 as compared to November 30, 2016. An award with a market condition is accounted for and measured differently from an award that has only a performance or service condition. The effect of a market condition 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 such grant 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 an award that has a market condition will be recognized if the requisite service period is fulfilled, even if the market condition is never satisfied.

The grant date fair values of the portion of the November 2013 Awards and the December 2013 Awards containing both market and performance conditions were calculated utilizing the following assumptions:

 

RSU activity for the nine months ended June 30, 2014 under the 2004 Plan and 2014 Plan is summarized as follows:

 

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MULTI-FINELINE ELECTRONIX, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In Thousands, Except Share and Per Share Data)

(unaudited)

 

 

 

RSU details for the three and nine months ended June 30, 2014 and 2013 are summarized as follows:

 

 

Unearned compensation as of June 30, 2014 was $6,300 related to non-vested RSUs, which will be recognized into expense over the weighted-average remaining contractual life of the non-vested RSUs of 1.5 years.

Stock-based Compensation Expense Summary

The following table shows a summary of the stock-based compensation expense by expense type included in the Condensed Consolidated Statements of Comprehensive Income for the three and nine months ended June 30, 2014 and 2013:

 

 

6. Income Taxes

As of June 30, 2014, the Company’s liability for income taxes associated with uncertain tax positions increased to $18,250 from $15,425 as of September 30, 2013. The liabilities that would favorably affect the Company’s effective tax rate were $13,054 and $10,517, at June 30, 2014 and September 30, 2013, respectively. As of June 30, 2014, the Company received new information not previously available associated with uncertain tax positions related to prior year intercompany transactions.  After evaluation of such information, the Company changed its judgment on these uncertain tax positions and recorded additional liability in the amount of $2,515 as of June 30, 2014.  The Company anticipates that there will be other changes to the unrecognized tax benefit associated with uncertain tax positions due to the expiration of statutes of limitation, payment of tax on amended returns, audit settlements and other changes in reserves. However, due to the uncertainty regarding the timing of these events, other than the statute of limitation expiration, a current estimate of the range of changes that may occur within the next 12 months cannot be made.

For the three months ended March 31, 2014, the Company incurred significant losses in one of its entities. In addition, the changes in the Company’s forecasted results indicated a three-year cumulative loss by the fourth quarter of fiscal 2014 for another entity. Evidence such as cumulative losses in recent years represents sufficient negative evidence to require a valuation allowance. As a result, during the three months ended March 31, 2014, the Company recorded a charge of $5,001 to reflect a valuation allowance against the deferred tax assets previously recorded related to these two entities. The Company intends to maintain a valuation allowance on its deferred tax assets until sufficient positive evidence exists to support a reversal. Based on an evaluation of the positive and negative evidence, the Company concluded that no valuation allowances were required for its other entities as of June 30, 2014.

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MULTI-FINELINE ELECTRONIX, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In Thousands, Except Share and Per Share Data)

(unaudited)

 

 

The Company currently enjoys certain tax incentives for certain of its Asian operations. Certain Asian operations are subject to taxes at a rate lower than the statutory rates and for the three and nine months ended June 30, 2014, the Company realized tax savings for these operations. However, these tax holidays and tax incentives may be challenged, modified or even eliminated by taxing authorities or changes in law. The tax incentives for the Company’s operations in Singapore expired on June 30, 2013.

The Internal Revenue Service (“IRS”) is currently examining the Company’s income tax returns for fiscal years 2007 through 2010. On August 1, 2012, the Company received a Revenue Agent Report (the “Original Report”) from the IRS relating to its examination of the Company’s income tax returns for fiscal years 2007 and 2008. On February 6, 2013, the IRS withdrew the Original Report and issued a revised Revenue Agent Report (the “Revised Report”). In the Revised Report, the IRS reduced its proposed adjustments. The remaining proposed adjustments would result in $32,363 of additional taxable income for those two years. Management believes there are numerous errors in the Revised Report, does not agree with the proposed adjustments and has contested the proposed adjustments with the IRS Appeals Office. After reviewing the Revised Report, management continues to believe that an adequate provision has been made for all of the Company’s uncertain tax positions.

The Chinese tax authority is currently auditing the income tax returns of MFC and MFC1 for tax years 2005 through 2011. During fiscal year 2013, the Chinese tax authority raised questions related to transfer pricing on tangible goods sold by the Company to related parties. The questions primarily related to the transfer pricing methodology and the selection of comparable companies. Discussions with the Chinese tax authority surrounding this issue are ongoing. In the event that the audit results in proposed assessment by the Chinese tax authority, the Company may be required to remit the assessment regardless of whether the Company contests the proposed adjustments. Management believes that an adequate provision has been made related to this audit.

The outcome of these tax audits cannot be predicted with certainty. If any issues raised in the Company’s tax audits are resolved in a manner not consistent with management’s expectations, then the Company could be required to adjust its provision for income tax in the period such resolution occurs. Any significant adjustments from the tax authorities could have a material adverse effect on the Company’s results of operations, cash flows and financial position if not resolved favorably.

7. Derivative Financial Instruments

Foreign Currency Forward Contracts

The Company transacts business in various foreign countries and is therefore exposed to gains and losses resulting from fluctuations in foreign currency exchange rates relating to purchases, obligations, and monetary assets and liabilities that are denominated in currencies other than the Company’s reporting currency. The Company has established foreign currency risk management programs to attempt to protect against short-term volatility in the value of non-U.S. dollar denominated monetary assets and liabilities, and of future cash flows caused by changes in foreign currency exchange rates. As a result, from time to time, the Company enters into foreign currency forward contracts to hedge its aforementioned currency exposures.

The Company accounts for all of its derivative instruments in accordance with the relevant FASB authoritative accounting guidance for derivatives and hedges. The guidance requires companies to recognize all derivative instruments as either assets or liabilities at fair value in the Condensed Consolidated Balance Sheets.

As of June 30, 2014, the aggregate notional amount of the Company’s outstanding foreign currency forward contracts is summarized below:

 

The changes in fair value of the Company’s derivative instruments are recognized into earnings during the period of change as other income (expense), net in the Condensed Consolidated Statements of Comprehensive Income. The Company recognized net gains of $201 and $71 during the three and nine months ended June 30, 2014 and $530 and $480 during the three and nine months ended June 30, 2013, respectively, related to derivative financial instruments.

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MULTI-FINELINE ELECTRONIX, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In Thousands, Except Share and Per Share Data)

(unaudited)

 

 

8. Impairment and Restructuring

During the three months ended March 31, 2014, following a full review of its manufacturing footprint and in an effort to realign its manufacturing capacity and costs with expected net sales, the Company initiated its plan to consolidate its production facilities to reduce the total manufacturing floor space by approximately one-third (the “Restructuring”). As part of the Restructuring, MFLEX Chengdu, along with two satellite manufacturing facilities in Suzhou, China, will be consolidated into the Company’s two main manufacturing plants under MFC in Suzhou. In addition, as part of the Restructuring, the Company expects to close MFE located in Cambridge, United Kingdom and realign headcount at its other locations.

The Company’s manufacturing facility in Chengdu, China ceased operations and met the criteria to be classified as assets held for sale per the relevant authoritative FASB guidance as of March 31, 2014. In addition, machinery and equipment at the Chengdu location and certain machinery and equipment and other fixed assets located at facilities in Suzhou, China ceased use and met the held for sale criteria as of March 31, 2014.

During the three months ended June 30, 2014, certain machinery and equipment and other property, plant and equipment located at facilities in Suzhou, China ceased use and met the held for sale criteria as of June 30, 2014. Certain assets that the Company plans to dispose of as part of the Restructuring at the Company’s satellite facilities in Suzhou and the United Kingdom continue to meet the held for use criteria as of June 30, 2014.

As a result of the Restructuring, the Company recorded the following impairment and restructuring charges for the three and nine months ended June 30, 2014:

As the Company continues to execute the Restructuring, the Company may incur additional long-lived asset impairments and restructuring charges required for assets that will meet the held for sale criteria in future periods, one-time termination benefits for additional potential terminated employees and other charges, in the fourth quarter of fiscal 2014. Total charges in connection with the Restructuring are expected to be at the low end of the range of $40,000 to $60,000 previously disclosed.

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MULTI-FINELINE ELECTRONIX, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In Thousands, Except Share and Per Share Data)

(unaudited)

 

 

Long-Lived Asset Impairment

Based on the Company’s Restructuring plan, the Company determined that a triggering event to test its long-lived assets for recoverability existed during the second and third quarters of fiscal 2014. The Company’s long-lived assets consisted primarily of property, plant and equipment and other assets.

Assets Held For Use

For assets classified as held for use, consisting of all property and equipment not held for sale, the Company compared its calculation of the undiscounted cash flows to the carrying value of the assets and concluded that no instances of impairment were identified as of June 30, 2014. As the Company continues to execute the Restructuring, it will monitor its forecasted undiscounted cash flows in order to test held for use assets.

Assets Held For Sale

For assets classified as held for sale, consisting of the Company’s manufacturing facility in Chengdu and other property, plant and equipment in Chengdu and Suzhou, China, the Company compared the estimated fair value less costs to sell to the carrying value of the assets. If the estimated fair value less costs to sell exceeded the carrying amount, no impairment expense was recorded. However, if the estimated fair value less costs to sell was less than the carrying amount, an impairment expense of the difference was recorded. As a result, the Company concluded that certain assets held for sale were impaired, and pre-tax impairment charges of $6,890 were recorded during the three months ended June 30, 2014 (of which $719 was related to buildings and leasehold improvements, $6,100 was related to machinery and equipment and $71 was related to other property, plant and equipment).

During the nine months ended June 30, 2014, pre-tax impairment charges for assets held for sale of $18,439 were recorded (of which $9,860 was related to land use rights, building and leasehold improvements, $8,416 was related to machinery and equipment and $163 was related to other property, plant and equipment).

Other Restructuring-related Costs  

A pre-tax restructuring charge of $1,471 was recorded during the three months ended June 30, 2014, which included $972 of one-time termination benefits, $(400) of contract termination cost adjustment and $899 of other costs.

A pre-tax restructuring charge of $14,720 was recorded during the nine months ended June 30, 2014, which included $9,636 of one-time termination benefits, $803 of contract termination costs and $4,281 of other costs (of which $198 was non-cash).

The following table reflects the movement activity of the restructuring reserve for the nine months ended June 30, 2014:

 

 

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MULTI-FINELINE ELECTRONIX, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In Thousands, Except Share and Per Share Data)

(unaudited)

 

 

9. Subsequent Events

 

On August 6, 2014, the Company, as guarantor, and MFLEX Singapore, as borrower, entered into a Loan and Security Agreement with certain financial institutions, as lenders, and Bank of America, N.A., as agent, providing for a senior revolving credit facility in an amount up to $30,000. The credit facility has a three-year term, and availability under the credit facility is calculated based on a formula which takes into account multiple factors, including the accounts receivable of borrower, the geographic location of borrower’s customer, and whether the customer’s receivable is insured by a third party. Amounts outstanding will bear interest at either: (1) a rate equal to LIBOR or SIBOR, plus an applicable margin, which ranges from 125 to 275 basis points, or (2) a defined base rate plus an applicable margin ranging from 75 to 275 basis points. In either case, the applicable margin is based on the fixed charge coverage ratio of the Company and its subsidiaries, measured on a consolidated basis.

 

On August 4, 2014, the Board of Directors of the Company approved to change the Company’s fiscal year end from September 30 to December 31. The Company intends to file an Annual Report on Form 10-K for the period ending September 30, 2014 and a transitional report on Form 10-K for the three-month period ending December 31, 2014.

 

 

 

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

Overview

We are a global provider of high-quality, technologically advanced flexible printed circuits and value-added component assembly solutions to the electronics industry. We believe that we are one of a limited number of manufacturers that provide a seamless, integrated flexible printed circuit and assembly solution from design and application engineering and prototyping through high-volume fabrication, component assembly and testing. We currently target our solutions within the electronics market and, in particular, our solutions enable our customers to achieve a desired size, shape, weight or functionality of the device. Current examples of applications for our products include mobile phones, smartphones, tablets, personal computers, consumer products, wearables, portable bar code scanners, computer/data storage and medical devices. We provide our solutions to original equipment manufacturers (“OEMs”) such as Apple, Inc. and to electronic manufacturing services (“EMS”) providers such as Foxconn Electronics, Inc., Protek (Shanghai) Limited and Flextronics International Ltd. Our business model, and the way we approach the markets which we serve, is based on value added engineering and providing technology solutions to our customers facilitating the miniaturization of portable electronics. We currently rely on a core mobility end-market for nearly all of our revenue. We believe this dynamic market offers fewer, but larger, opportunities than other electronic markets do, and changes in market leadership can occur with little to no warning. Through early supplier involvement with customers, we look to assist in the development of new designs and processes for the manufacturing of their products and, through value added component assembly of components on flex, we seek to provide a higher level of product within their supply chain structure. 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, competitor pricing, expected volumes, assumed yields, material costs, and the amount of third party components within the program. Our profitability is dependent upon the extent of competitive pricing pressures, how we perform against our targets and the assumptions on which we base our prices for each particular program. Our volumes, margins and yields also vary from program to program and, given various factors and assumptions on which we base our prices, are not necessarily indicative of our profitability. In fact, some lower-priced programs have higher margins while other higher-priced programs have lower margins. Given that the programs in production vary from period to period and the pricing and margins between programs vary widely, volumes, while important for overhead absorption, are not necessarily indicative of our performance. For example, we could

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experience an increase in volumes for a particular program during a particular period, but depending on that program’s margins and yields and the other programs in production during that period, those higher volumes may or may not result in an increase in overall profitability. In the mobility market, the first few months of production are the most critical in terms of growth and profitability opportunities.

Critical Accounting Policies

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

Comparison of the Three Months Ended June 30, 2014 and 2013

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

 

 

Overview. During the three months ended March 31, 2014, we initiated a restructuring plan to substantially reduce costs and return to profitability. The restructuring plan includes consolidation of our production facilities to reduce the total manufacturing floor space by approximately one-third. Our facility in Chengdu, China, along with two satellite manufacturing facilities in Suzhou, China, will be consolidated into our two main manufacturing plants under MFC in Suzhou. In addition, we expect to close our facility located in Cambridge, United Kingdom and realign headcount at other locations. In connection with these restructuring actions, we anticipate annual cost savings of approximately $50.0 million, of which approximately 90 percent is expected to reduce cost of sales and approximately 10 percent is expected to lower operating expenses.

During the three months ended June 30, 2014, additional expenses were incurred as we continued to execute our plan of reducing square footage, reducing headcount and implementing other cost saving activities. These additional costs impacted our cost of sales and impairment and restructuring in our Condensed Consolidated Statements of Comprehensive Income. In addition, the activity of relocating production lines caused disruptions in manufacturing flows which lowered efficiencies and depressed margins. By the end of our third quarter of fiscal 2014, the restructuring activities were substantially complete.

Net Sales. Net sales decreased to $130.8 million for the three months ended June 30, 2014, from $136.1 million for the three months ended June 30, 2013. The decrease of $5.3 million, or 3.9%, was primarily due to decreased net sales into our smartphones and consumer electronics sectors, partially offset by increased sales into our tablets sector, as further quantified below. Net sales to our largest customer decreased $23.4 million to $56.7 million for the three months ended June 30, 2014, primarily the result of lower production volumes of certain products and lower share of business in certain programs.

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Net sales to our newer customers increased $43.1 million, or 214.4%, to $63.2 million for the three months ended June 30, 2014, from $20.1 million for the three months ended June 30, 2013. For the three months ended June 30, 2014, one of our newer customers accounted for approximately 23% of our total net sales.

Net sales into our smartphones sector decreased to $84.9 million for the three months ended June 30, 2014, from $105.5 million for the three months ended June 30, 2013. The decrease of $20.6 million, or 19.5%, was primarily due to decreased sales volumes to a major customer in this sector of approximately $30.8 million to near zero as a result of its significant reduction in market share, coupled with a decrease to our largest customer of approximately $18.0 million, partially offset by increased sales volumes to a few of our newer customers in this sector of approximately $24.3 million. For the three months ended June 30, 2014 and 2013, our smartphones sector accounted for approximately 65% and 78% of total net sales, respectively.

Net sales into our consumer electronics sector decreased to $8.5 million for the three months ended June 30, 2014, from $10.9 million for the three months ended June 30, 2013. The decrease of $2.4 million was primarily due to decreased sales volumes to our largest customer in this sector of approximately $3.7 million, partially offset by increased sales volumes to one of our newer customers of approximately $1.0 million. Net sales into our consumer electronics sector accounted for approximately 6% and 8% of total net sales for the three months ended June 30, 2014 and 2013, respectively.

Net sales into our tablets sector increased to $22.0 million for the three months ended June 30, 2014, from $17.1 million for the three months ended June 30, 2013. The increase of $4.9 million in net sales into the tablets sector was due primarily to increased sales volumes to a newer customer in this sector of approximately $7.6 million, partially offset by decreased sales volumes to our largest customer of approximately $1.7 million. For the three months ended June 30, 2014 and 2013, our tablets sector accounted for approximately 17% and 13% of total net sales, respectively.

Gross Margin. Cost of sales as a percentage of net sales increased to 105.5% for the three months ended June 30, 2014 versus 103.1% for the three months ended June 30, 2013. The increase in cost of sales as a percentage of net sales was attributable to additional costs associated with restructuring efforts to consolidate production lines into fewer facilities and lower overhead absorption due to excess production capacity. These additional costs included labor, supplies and parts necessary to start up relocated lines and lower direct labor efficiencies for production during the period in which lines were being moved. Gross loss was $7.2 million for the three months ended June 30, 2014 as compared to gross loss of $4.2 million for the three months ended June 30, 2013. As a percentage of net sales, gross margin decreased to (5.5%) for the three months ended June 30, 2014 from (3.1%) for the three months ended June 30, 2013.

Research and Development. Research and development expense decreased by $0.3 million to $1.7 million for the three months ended June 30, 2014, from $2.0 million for the three months ended June 30, 2013. The decrease is primarily related to continued reduced variable spending. As a percentage of net sales, research and development expense decreased to 1.3% from 1.5% in the comparable period of the prior year.

Sales and Marketing. Sales and marketing expense decreased by $1.2 million to $4.5 million for the three months ended June 30, 2014, from $5.7 million in the comparable period of the prior year. The decrease is primarily the result of reduced commissions resulting from reduced net sales as well as reduced variable spending. As a percentage of net sales, sales and marketing expense decreased to 3.5% from 4.2% in the comparable period of the prior year.

General and Administrative. General and administrative expense increased by $1.6 million to $4.2 million for the three months ended June 30, 2014, from $2.6 million in the comparable period of the prior year. During our third quarter of fiscal 2013, we had a gain of $1.5 million related to the disposal of certain fixed assets, which reduced our general and administrative expenses for that period. As a percentage of net sales, general and administrative expense increased to 3.2% from 1.9% in the comparable period of the prior year.

Stock-based compensation expense resulting from change in control. Stock-based compensation expense resulting from change in control was $0 and $9.6 million for the three months ended June 30, 2014 and 2013, respectively. This expense is related to the accelerated vesting of outstanding serviced-based restricted stock units (“RSUs”) and stock appreciation rights, as well as the conversion of performance-based RSUs to service-based RSUs for awards outstanding as of May 23, 2013 as part of our change in control that was deemed to have occurred in connection with United Engineers Limited’s acquisition of WBL Corporation Limited as of such date.

Impairment and Restructuring. During the three months ended June 30, 2014, we recorded impairment and restructuring of $8.4 million, which consisted of $6.9 million of asset impairments relating to our held-for-sale properties and equipment in Chengdu and Suzhou, China, $1.0 million of one-time termination benefits charges and $0.5 million of other restructuring-related costs. During the three months ended June 30, 2013, we recorded a goodwill impairment charge of $7.5 million.

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Other Income (Expense), Net. Other income, net increased to $0.7 million for the three months ended June 30, 2014, from other income, net of $0.1 million for the three months ended June 30, 2013. This increase was primarily the result of foreign exchange due to the movement of the U.S. dollar versus the RMB and other foreign currencies.

Income Taxes. The effective tax rate for three months ended June 30, 2014 and 2013 was (14.4)% and (0.2)%, respectively. The change in our effective tax rate was primarily due to additional tax provision recorded for certain uncertain tax positions, as well as our income and tax expense distribution by region. We expect future tax rates to vary if current tax regulations change.

Comparison of the Nine Months Ended June 30, 2014 and 2013

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

 

Net Sales. Net sales decreased to $460.3 million for the nine months ended June 30, 2014, from $599.4 million for the nine months ended June 30, 2013. The decrease of $139.1 million, or 23.2%, was primarily due to decreased net sales into our smartphones, tablets and consumer electronics sectors, as further quantified below. Net sales to our largest customer decreased $199.4 million to $257.0 million for the nine months ended June 30, 2014 as a result of lower production volumes and lower share of business in certain programs. Net sales to this customer accounted for approximately 56% of our total net sales. Net sales to our newer customers increased to $164.5 million for the nine months ended June 30, 2014, from $58.4 million for the nine months ended June 30, 2013.

Net sales into our smartphones sector decreased to $328.4 million for the nine months ended June 30, 2014, from $415.8 million for the nine months ended June 30, 2013. The decrease of $87.4 million, or 21.0%, was primarily due to decreased sales volumes to one major customer in this sector of approximately $71.0 million to near zero as a result of its significant reduction in market share and a decrease to our largest customer in this sector of approximately $126.0 million, partially offset by increased sales volumes to another major customer of approximately $19.1 million and to two of our newer customers of approximately $83.2 million. For the nine months ended June 30, 2014 and 2013, our smartphones sector accounted for approximately 71% and 69% of total net sales, respectively.

Net sales into our tablets sector decreased to $71.0 million for the nine months ended June 30, 2014, from $136.8 million for the nine months ended June 30, 2013. The decrease of $65.8 million in net sales into our tablets sector was due primarily to decreased sales volumes to our largest customer in this sector of approximately $57.0 million, coupled with decreased sales volumes to a newer customer in this sector of $16.7 million as a result of certain programs reaching their conclusion during our second fiscal quarter of 2014. These decreases were partially offset by increased sales volumes to one of our newer customers of approximately $8.8 million as a result of new program ramps. For the nine months ended June 30, 2014 and 2013, the tablets sector accounted for approximately 15% and 23% of total net sales, respectively.

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Net sales into our consumer electronics sector decreased to $34.0 million for the nine months ended June 30, 2014, from $40.3 million for the nine months ended June 30, 2013. The decrease in net sales into our consumer electronics sector of $6.3 million was primarily due to decreased sales volumes to our largest customer of approximately $16.4 million, partially offset by an increase in sales volumes for one of our newer customers of approximately $10.3 million. Shipments into our consumer electronics sector accounted for approximately 7% and 7% of total net sales for the nine months ended June 30, 2014 and 2013, respectively.

Gross Margin. Cost of sales as a percentage of net sales increased to 103.8% for the nine months ended June 30, 2014 from 99.2% for the nine months ended June 30, 2013. The increase in cost of sales was primarily attributable to lower overhead absorption due to reduced production levels. Gross loss was $17.7 million for the nine months ended June 30, 2014, versus gross profit of $4.9 million for the nine months ended June 30, 2013. As a percentage of net sales, gross margin decreased to (3.8)% for the nine months ended June 30, 2014 from 0.8% for the nine months ended June 30, 2013.

Research and Development. Research and development expense decreased by $1.1 million to $4.7 million for the nine months ended June 30, 2014, from $5.8 million for the nine months ended June 30, 2013. The decrease of 19.0% was primarily due to continued reduced variable spending. As a percentage of net sales, research and development expense remained consistent at 1.0% for the nine months ended June 30, 2014 and 2013.

Sales and Marketing. Sales and marketing expense decreased by $2.1 million to $14.8 million for the nine months ended June 30, 2014, from $16.9 million in the comparable period of the prior year, which is a decrease of 12.4%. The decrease is primarily the result of lower negotiated commission rates and lower net sales volumes in the comparable periods. As a percentage of net sales, sales and marketing expense increased to 3.2% from 2.8% in the comparable period of the prior year.

General and Administrative. General and administrative expense decreased by $1.5 million to $11.1 million for the nine months ended June 30, 2014 from $12.6 million in the comparable period of the prior year, which is a decrease of 11.9%. This decrease was primarily due to our continued efforts to reduce variable spending, partially offset by a $1.6 million gain on disposal of equipment recorded during the nine months ended June 30, 2013. As a percentage of net sales, general and administrative expense increased to 2.4% from 2.1% in the comparable period of the prior year.

Stock-based compensation expense resulting from change in control. Stock-based compensation expense resulting from change in control was $0 and $9.6 million for the nine months ended June 30, 2014 and 2013, respectively. This expense is related to the accelerated vesting of outstanding serviced-based RSUs and stock appreciation rights, as well as the conversion of performance-based RSUs to service-based RSUs for awards outstanding as of May 23, 2013 as part of our change in control that was deemed to have occurred in connection with United Engineers Limited’s acquisition of WBL Corporation Limited as of such date.

Impairment and Restructuring. During the nine months ended June 30, 2014, we recorded impairment and restructuring charges of $33.2 million, primarily to consolidate our manufacturing operations and to improve our cost structure. The $33.2 million consisted of $18.4 million of asset impairments relating to our held-for-sale properties and equipment in Chengdu and Suzhou, China, $9.6 million of one-time termination benefits and $5.1 million of other restructuring-related costs. During the nine months ended June 30, 2013, we recorded a goodwill impairment charge of $7.5 million.

Other Income (Expense), Net. Other income, net increased to $1.1 million for the nine months ended June 30, 2014, from $0.2 million for the nine months ended June 30, 2013. This increase was primarily due to foreign exchange due to the movement of the U.S. dollar versus the RMB and other foreign currencies.

Income Taxes. The effective tax rate for nine months ended June 30, 2014 and 2013 was (13.0)% and 0.5%, respectively. The change in our effective tax rate was primarily due to additional tax provision recorded for certain uncertain tax positions, as well as our income and tax expense distribution by region. We expect future tax rates to vary if current tax regulations change.

Guidance

Net Sales. For our fourth quarter of fiscal 2014, we expect net sales to range between $150 and $180 million.

Gross Margin. For our fourth quarter of fiscal 2014, we expect gross margin to be between 4% and 7%.

Operating Expenses. We expect normal operating expenses to be approximately $10 million or less during our fourth quarter of fiscal 2014.

Impairment and Restructuring. We expect our charges in connection with our restructuring plan incurred in our fourth quarter of fiscal 2014 to be minimal. Total charges in connection with the restructuring, including additional tax expenses related to the

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restructuring, are expected to be at or just below the low end of the range of $40 million to $60 million previously disclosed. As a result of the aforementioned cost savings, we expect to be profitable for the second half of the 2014 calendar year and to realize the majority of the anticipated $50 million of cost savings starting in our fiscal fourth quarter of 2014.

Income Taxes. We expect the effective tax rate (excluding restructuring), on average, to be in the mid to high teens for the coming year.

Capital Expenditures. For our fourth quarter of fiscal 2014, we anticipate capital expenditures to be between $5  and $8  million.

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

Liquidity and Capital Resources

Our principal sources of liquidity have been cash provided by operations. Our principal uses of cash have been to finance working capital, stock repurchases and capital expenditures. We anticipate these uses will continue to be our principal uses of cash in the future.

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

Changes in the principal components of operating cash flows during the nine months ended June 30, 2014 were as follows:

Our principal investing and financing activities during the nine months ended June 30, 2014 were as follows:

 

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Market Risk

Market risk represents the risk of loss arising from adverse changes in liquidity, market rates and foreign exchange rates. At June 30, 2014, $20.0 million was outstanding under our loan agreement with Agricultural Bank of China, and no amounts were outstanding under our agreement with China Construction Bank. The amounts outstanding under these loan agreements at any time may fluctuate and we may, from time to time, be subject to refinancing risk. We do not believe that a change of 100 basis points in interest would have a material effect on our results of operations or financial condition based on our current borrowing level.

Foreign Currency Risk

We derive a substantial portion of our sales outside of the U.S. Approximately $394.9 million, or 86%, of total shipments to these foreign manufacturers during the nine months ended June 30, 2014 were made in U.S. dollars with the remaining balance of our net sales denominated primarily in RMB. We currently have a significant portion of our expenses, more specifically cost of sales, denominated in RMB, whereby a significant appreciation or depreciation in the RMB could materially affect our reported expenses in U.S. dollars. The exchange rate for the RMB to the U.S. dollar has been an average of 6.14 RMB per U.S. dollar for the nine months ended June 30, 2014. To date, we attempt to manage our working capital in a manner to minimize foreign currency exposure and from time to time, we may engage in currency hedging activities through use of forward contracts but such activities may not be able to limit the risks of currency fluctuations. We continue to be vulnerable to appreciation or depreciation of foreign currencies against the U.S. dollar.

Liquidity Risk

With a strong cash position and no long-term debt, we believe our anticipated cash flows from operations are sufficient to fund our operations, including capital expenditure requirements and future cash restructuring charges, through at least the next twelve months. If there is a need for additional cash to fund our operations, we will continue to access our global credit lines, of which $61.3 million was available as of June 30, 2014.

 

Evaluation of Disclosure Controls and Procedures

Based on an evaluation carried out as of the end of the period covered by this Quarterly Report, under the supervision and with the participation of our management, including our Chief Executive Officer, or CEO, and Chief Financial Officer, or CFO, our CEO and CFO have concluded that, as of the end of such period, our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934) are effective.

Changes in Internal Control Over Financial Reporting

There were no changes in our internal control over financial reporting during the quarter ended June 30, 2014 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

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PART II. OTHER INFORMATION

 

FACTORS THAT MAY AFFECT OUR OPERATING RESULTS

Our business, financial condition, operating results and cash flows can be impacted by a number of factors, including, but not limited to those set forth below, any of which could cause our results to be adversely impacted and could result in a decline in the value or loss of an investment in our common stock. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also affect our business.

Risks Related to Our Business

We have experienced a decline in revenue over the last three fiscal years, as well incurred net losses in the last fiscal year and each of our six most recently completed fiscal quarters, and we may continue to incur net losses in future periods.

From fiscal year 2011 to fiscal year 2013, we experienced a decline in revenue from $831.6 million in 2011, to $818.9 million in 2012, to $787.6 million in 2013, resulting from a decline in sales to certain of our key customers. We believe this resulted from decline of business from one of our key customers, which has been undergoing a business transition, as well as loss of market share from another key customer. Although we are undertaking efforts to diversify our customer base and increase our sales, including to new customers, there can be no assurance that we will be successful in offsetting these losses with sales to other customers.

In addition, in fiscal year 2013, we incurred a net loss of $65.5 million on a full year basis, and incurred a net loss of $9.3 million in the first fiscal quarter of 2014, $52.4 million in the second fiscal quarter of 2014 and $28.8 million in the third fiscal quarter of 2014 on the basis of U.S. generally accepted accounting principles. These losses, among other things, adversely affect our stockholders’ equity and working capital. Although we are undergoing strategic restructuring efforts, we cannot be certain when, or if, our operations will return to profitability or, if we do return to profitability whether it can be sustained.

We are, and have historically been, heavily dependent upon the smartphone, tablet and consumer electronics industries, and any downturn in these sectors may reduce our net sales.

For the nine months ended June 30, 2014 and 2013, approximately 71% and 69%, respectively, of our net sales were derived from sales to companies for products or services into our smartphone sector; approximately 15% and 23%, respectively, of our net sales derived from sales were to companies for products or services into our tablet sector; and approximately 7% and 7%, respectively, of our net sales were derived from sales to companies for products or services into our consumer electronics sector. In general, these sectors are subject to economic cycles, changes in customer order patterns and periods of slowdown. Intense competition, relatively short product life cycles and significant fluctuations in product demand characterize these sectors, and these sectors are also generally subject to rapid technological change and product obsolescence. Fluctuations in demand for our products as a result of periods of slowdown in these markets (including the current economic downturn) or discontinuation of products or modifications developed in connection with next generation products could reduce our net sales.

We depend on a very limited number of key customers, and a limited number of programs from those customers, for significant portions of our net sales and if we lose business with any of these customers or if the products we are in are not commercially successful, our net sales could decline substantially.

For the past several years, a substantial portion of our net sales has been derived from products that are incorporated into programs manufactured by or on behalf of a very limited number of key customers and their subcontractors, including Apple Inc.. During the third fiscal quarter of 2014, we had only two customers each represent ten percent or more of our net sales. In addition, a substantial portion of our sales to each customer is often tied to only one program or a small number of programs. In the fiscal years ended September 30, 2013, 2012 and 2011, approximately 75%, 74% and 44%, respectively, of our net sales were to the same one customer, and in the three and nine months ended June 30, 2014, approximately 43% and 56%, respectively, of our sales were to this customer. Furthermore, in the fiscal years ended September 30, 2013, 2012 and 2011, approximately 86%, 90% and 86% of our net sales were to the same two customers, and approximately 90%, 94% and 94%, respectively, of our net sales were to only three customers in the aggregate. Our significant customer concentration increases the risk that our business terms with those customers may not be as favorable to us as those we might receive in a more competitive environment. The loss of a major customer or a significant reduction in sales to a major customer, including due to the loss of market share with the customer, the lack of commercial success by such customer or one or more of its products, a product failure of a customer’s program or limited flex content in a program, would seriously harm our business. Although we are continuing our efforts to reduce dependence on a limited number of customers, we have recently experienced a decline in sales to certain of our major customers and net sales attributable to a limited

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number of customers and their subcontractors are expected to continue to represent a substantial portion of our business for the foreseeable future.

We will have difficulty selling our products if customers do not design flexible printed circuits and assemblies into their product offerings or our customers’ product offerings are not commercially successful.

We sell our flexible printed circuits and assemblies directly or indirectly to OEMs, who include our flexible circuits and component assemblies in their product offerings. We must continue to design our products into our customers’ product offerings in order to remain competitive. However, our OEM customers may decide not to design flexible printed circuits into their product offerings (or may reduce the amount of flex in a product offering), or may procure flexible printed circuits from one of our competitors. If an OEM selects one of our competitors to provide a product instead of us or switches to alternative technologies developed or manufactured by one or more of our competitors, it becomes significantly more difficult for us to sell our products to that OEM because changing component providers after the initial production runs begin involves significant cost, time, effort and risk for the OEM. Even if an OEM designs one of our products into its product offering, the product may not be commercially successful or may experience product failures, we may not receive any orders from that manufacturer, the OEM may qualify additional vendors for the product or we could be undercut by a competitor’s pricing. Additionally, if an OEM selects one or more of our competitors, they may rely upon such competitors for the life of that specific offering and subsequent generations of similar offerings. Any of these events would result in fewer sales and reduced profits for us, and could adversely affect the accuracy of any forward-looking guidance we may give.

Changes in the products our customers buy from us can significantly affect our capacity, net sales and profitability.

We sell our flexible printed circuits and flex assemblies to a very limited number of customers, who typically purchase these products from us for numerous programs at any particular time. Customer programs differ in design and material content and our products’ prices and profitability are 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. If we lose sales for a program that has higher material content, we may have to replace it with sales for a program that has lower material content, thus requiring additional capacity to generate the same amount of net sales. We may not have such capacity available (or it may not be economically advantageous to acquire such capacity), which could then result in lower net sales. Furthermore, if we were unable to increase our capacity to match our customers’ requests, we may lose existing business from such customer, in addition to losing future sales. In addition, if we were to utilize our capacity to increase sales of bare flex (flex without assembly), this could also generate lower net sales at potentially different (higher or lower) profitability levels.

Our customers have in the past and likely will continue to cancel their orders, change production quantities, delay production or qualify additional vendors, any of which could reduce our net sales, increase our expenses and/or cause us to write down inventory.

Substantially all of our sales are made on a purchase order basis, and we are not always able to predict with certainty the number of orders we will receive or the timing or magnitude of the orders. Our customers may cancel, change or delay product purchase orders with little or no advance notice to us, and we believe customers are doing so with increased frequency. These changes may be for a variety of reasons, including changes in their prospects, their perception of the quality of our products, the competitiveness of our pricing, the success of their products in the market, reliance on a new vendor and the overall economic forecast. In general, we do not have long-term contractual relationships with our customers that require them to order minimum quantities of our products, and our customers may decide to use another manufacturer or discontinue ordering from us in their discretion, potentially even after we have begun production on their program. In addition, many of our products are shipped to hubs, and we often have limited visibility and no control as to when our customers pull the inventory from the hub. We have recently seen an increase in the use of hubs by our customers, and our hub balances have been growing. We also have increased risks with respect to inventory control and potential inventory loss, and must rely on third parties for recordkeeping, when our products are shipped to a hub. In addition, whether products are pulled from our hub, or the hub of one of our competitors is not within our control, and the EMS companies who make such decisions may favor one of our competitors over us, particularly if such competitor is affiliated with the EMS company. As a result of these factors, we are not always able to forecast accurately the net sales that we will make in a given period. Changes in orders can also result in layoffs and associated severance costs, which in any given financial period could materially adversely affect our financial results.

In addition, we are increasingly being required to purchase materials, components and equipment before a customer becomes contractually committed to an order so that we may timely deliver the expected order to the customer. We may increase our production capacity, working capital and overhead in expectation of orders that may never be placed, or, if placed, may be delayed, reduced or canceled. As a result, we may be unable to recover costs that we incur in anticipation of orders that are never placed or are cancelled without liability after placed, such as costs associated with purchased raw materials, components or equipment. Delayed, reduced or canceled orders could also result in write-offs of obsolete inventory. Although we estimate inventory reserve amounts, the

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amount reserved may not be sufficient for such write-offs. In addition, we may underutilize our manufacturing capacity if we decline other orders because we expect to use our capacity for orders that are later delayed, reduced or canceled.

Our industry is extremely competitive, and if we are unable to respond to competitive pressures we may lose sales and our market share could decline.

We compete primarily with large flexible printed circuit board manufacturers located throughout Asia, including Taiwan, China, Korea, Japan and Singapore. We believe that the number of companies producing flexible printed circuit boards has increased materially in recent years and may continue to increase. In addition, certain former competitors are in the process of re-instituting their flexible printed circuit production which will increase competition in our market. Certain EMS providers have developed or acquired their own flexible printed circuit manufacturing capabilities or have extensive experience in electronics assembly, and in the future may cease ordering products from us or even compete with us on OEM programs. In addition, the number of customers in the market has been decreasing through consolidation and otherwise and the smartphone and tablet markets continue to become more competitive in terms of pricing. Furthermore, many companies in our target customer base may move the design and manufacturing of their products to original design manufacturers in Asia. These factors, among others, make our industry extremely competitive. If we are not successful in addressing these competitive aspects of our business, we may not be able to grow or maintain our market share, net sales, or profitability.

Our products and their terms of sale are subject to various pressures from our customers, competitors and market forces, any of which could harm our gross profits.

Our selling prices are affected by changes in overall demand for our products, changes in the specific products our customers buy, pricing of competitors’ products, our manufacturing efficiency, our products’ life cycles and general economic conditions. In addition, from time to time we may elect to reduce the price of certain products we produce in order to gain additional orders on a particular program. A typical life cycle for one of our products has our selling price decrease as the program matures. To offset price decreases during a product’s life cycle, we rely primarily on higher sales volume and improving our manufacturing yield and productivity to reduce a product’s cost. If we cannot reduce our manufacturing costs as prices decline during a product’s life cycle, or if we are required to pay damages to a customer due to a breach of contract or other claim, including due to quality or delivery issues, our cost of sales as a percentage of net sales may increase, which would harm our profitability and could affect our working capital levels.

In addition, our key customers and their subcontractors are able to exert significant pricing pressure on us and often require us to renegotiate the terms of our arrangements with them, including increasing or removing liability and indemnification thresholds and increasing the length of payment terms, among other terms. Increases in our labor costs, especially in China where we may have little or no advance notice of such increases, changes in contract terms and regular price reductions have historically resulted in lower gross margins for us and may continue to do so in future periods. Furthermore, our competitive position is dependent upon the yields and quality we are able to achieve on our products and our level of automation as compared to our competitors. We believe our competitors have been rapidly investing in more efficient and higher capability processes and automation, and if we do not match such investments, this could negatively impact our ability to compete on price, technology and capability. These trends and factors may harm our business and make it more difficult to compete effectively, and grow or maintain our net sales and profitability.

Significant product failures or safety concerns about our or our customers’ products could harm our reputation and our business.

Continued improvement in manufacturing capabilities, quality control, material costs and successful product testing capabilities are critical to our growth. Our efforts to monitor, develop, modify and implement stringent testing and manufacturing processes for our products may not be sufficient. If any flaw in the design, production, assembly or testing of our or our customers’ products were to occur or if our, or our customers’ products were believed to be unsafe, it could result in significant delays in product shipments by, or cancellation of orders or, substantial penalties from, our customers and their customers, substantial refund, recall, repair or replacement costs, an increased return rate for our products, potential damage to our reputation, or potential lawsuits which could prove to be time consuming and costly. Pronouncements by the World Health Organization listing mobile phone use as possibly carcinogenic may affect our customers’ sales and in turn affect our sales to our customers. Because we normally provide a warranty for our products, a significant claim for damages related to a breach of warranty could materially affect our financial results.

Problems with manufacturing yields and/or our inability to ramp up production could impair our ability to meet customer demand for our products.

We could experience low manufacturing yields due to, among other things, design errors, manufacturing failures in new or existing products, the inexperience of new employees, component defects, or the learning curve experienced during the initial and ramp up stages of new product introduction. If we cannot achieve expected yields in the manufacture of our products, this could result

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in higher operating costs, which could result in higher per unit costs, reduced product availability and may subject us to substantial penalties by our customers. Reduced yields or an inability to successfully ramp up products can significantly harm our gross margins, resulting in lower profitability or even losses. In addition, if we were unable to ramp up our production in order to meet customer demand, whether due to yield or other issues, it would impair our ability to meet customer demand for our products, which could cause us to lose an order for such product, or lose the customer altogether, and our net sales and profitability would be negatively affected.

We must invest in and develop or adopt new technology and update our manufacturing processes in order to remain an attractive supplier to our customers, and we may not be able to do so successfully.

Our long-term strategy relies in part on timely adopting, developing and manufacturing technological advances and new processes to meet our customers’ needs and to expand into new markets outside the mobility market. However, any new technology or process adopted or developed by us may not meet the expectations of our existing or potential customers, or customers outside the mobility market may not select either our current or new process capabilities for their offerings. Customers could decide to switch to alternative technologies or materials, adopt new or competing industry standards with which our products are incompatible or fail to adopt standards with which our products are compatible. If we are unable to obtain customer qualifications for new processes or product features, cannot qualify our processes for high-volume production quantities or do not execute our operational and strategic plans for new developments in advanced technologies in a timely manner, our net sales or profitability may decrease. In addition, we may incur higher manufacturing costs in connection with new technology, materials, products or product features, as we may be required to replace, modify, design, build and install equipment, all of which would require additional capital expenditures. Also, due to financial constraints, we may not be able to invest in such new technology advancements and as a result, could fall behind our competition and/or not be able to satisfy our customers’ requirements, which could result in loss of sales and profitability.

We must continue to be able to procure raw materials and components on commercially reasonable terms to manufacture our products profitably.

Generally we do not maintain a large surplus stock of raw materials or components for our products because the specific assemblies are uniquely applicable to the products we produce for our customers; therefore, we rely on third-party suppliers to provide these raw materials and components in a timely fashion and on commercially reasonable terms. In addition, we are often required by our customers to seek components from a limited number of suppliers that have been pre-qualified by the customer. We, or our customers, may not be able to obtain the components or flex materials that are required for our customers’ programs, which in turn could forestall, delay, or halt our production or our customers’ programs. We expect that delays may occur in future periods for a variety of reasons, including but not limited to, natural disasters. Furthermore, the supply of certain precious metals required for our products is limited, and our suppliers could lose their export or import licenses on materials we require, any of which could limit or halt our ability to manufacture our products. We may not be successful in managing any shortage of raw materials or components that we may experience in the future, which could adversely affect our relationships with our customers and result in a decrease in our net sales or litigation by our customers against us. Component shortages could also increase our cost of goods sold because we may be required to pay higher prices for components in short supply. In addition, suppliers could go out of business, discontinue the supply of key materials, or consider us too small of a customer to sell to directly, and could require us to buy through distributors, increasing the cost of such components to us.

Our manufacturing and shipping costs may also be impacted by fluctuations in the cost of oil and gas. Any fluctuations in the supply or prices of these commodities could have an adverse effect on our profit margins and financial condition.

If we are unable to attract or retain personnel necessary to operate our business, our ability to develop and market our products successfully could be harmed.

We believe that our success is highly dependent on our current executive officers and management team. We do not have an employment contract with Reza Meshgin, our president and chief executive officer, or any of our other key personnel, and their knowledge of our business and industry would be extremely difficult to replace. The loss of any key employee or the inability to attract or retain qualified personnel, including engineers, sales and marketing personnel, management or finance personnel could delay the development and introduction of our products, harm our reputation or otherwise damage our business.

Furthermore, we have experienced very high employee turnover in our facilities in China, and we are experiencing increased difficulty in recruiting employees for these facilities. In addition, we are noting the signs of wage inflation, labor unrest, increased unionization in China and new regulations regarding the usage of contract workers, and expect these to be ongoing trends for the foreseeable future, which could cause employee issues, including work stoppages, excessive wage increases and increased activity of labor unions, at our China facilities. A large number of our employees works in our facilities in China, and our costs associated with hiring and retaining these employees have increased over the past several years. The high turnover rate, increasing wages, new regulations regarding contract workers, our difficulty in recruiting and retaining qualified employees and the other labor trends we are

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noting in China have resulted in an increase in our employee expenses, and a continuation of any of these trends could result in even higher costs or production disruptions or delays or the inability to ramp up production to meet increased customer orders, resulting in order cancellation, imposition of customer penalties if we were unable to timely deliver product or a negative impact on net sales and profits for us.

Our manufacturing capacity may be interrupted, limited or delayed if we cannot maintain sufficient utility sources in China.

The flexible printed circuit fabrication process requires a stable utility source. As our production capabilities increase in China and our business grows, our requirements for a stable source of electricity, gas and steam in China will grow substantially. We have periodically experienced and expect to continue to experience insufficient supplies of electrical power from time to time, especially during the warmer summer months in China. In addition, China has instituted energy conservation regulations which ration the amount of electricity that may be used by enterprises such as ours. Although we have purchased a few generators and could lease additional generatiors, such generators do not produce sufficient electricity supply to run our manufacturing facilities and they are costly to operate. Power or steam interruptions, electricity shortages, the cost of diesel fuel to run our back-up generators or government intervention, particularly in the form of rationing, are factors that could restrict our access to electricity at our Chinese manufacturing facilities. Any such insufficient access to electricity, gas, steam or other utility could affect our ability to manufacture and related costs. Any such shortages could result in delays in our shipments to our customers and, potentially, the loss of customer orders and penalties from such customers for the delay.

Our global operations expose us to additional risk and uncertainties.

We have operations in a number of countries, including the United States, China, Korea, Taiwan, the United Kingdom and Singapore. Our global operations may be subject to risks that may limit our ability to operate our business. We manufacture the bulk of our products in China and sell our products globally, which exposes us to a number of risks that can arise from international trade transactions, local business practices and cultural considerations, including:

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We also face risks associated with currency exchange and convertibility, inflation and repatriation of earnings as a result of our foreign operations. In some countries, economic, monetary and regulatory factors could affect our ability to convert funds to U.S. dollars or move funds from accounts in these countries. We are also vulnerable to appreciation or depreciation of foreign currencies against the U.S. dollar. Although we have significant operations in Asia, a substantial portion of transactions are denominated in U.S. dollars, including approximately 96% of the total shipments made to foreign manufacturers during the fiscal year 2013. The balance of our net sales is denominated in RMB. As a result, as appreciation against the U.S. dollar increases, it will result in an increase in the cost of our business expenses in China. Further, downward fluctuations in the value of foreign currencies relative to the U.S. dollar may make our products less price competitive than local solutions. From time to time, we may engage in currency hedging activities, but such activities may not be able to limit the impact or risks of currency fluctuations.

In addition, our activities in China are subject to administrative review and approval by various national and local agencies of China’s government. Given the changes occurring in China’s legal and regulatory structure, we may not be able to secure required governmental approval for our activities or facilities, or the government may not apply real property or contract rights in the same manner as one may expect in other jurisdictions.

Our restructuring initiatives may not achieve the expected cost reductions or other benefits we expect, and we expect to incur substantial restructuring and impairment charges as we restructure our business and rationalize our manufacturing operations.

We are in the process of consolidating and reorganizing certain of our operations in an effort to realign our organization to more efficiently support customer demand while decreasing operating expenses. Our ability to achieve the anticipated cost savings and other benefits from these initiatives within the expected time frame is subject to many risks and uncertainties, which include, but are not limited to:

There can be no assurance that we will be successful in our restructuring efforts or that any consolidation or reorganization will result in cost savings, and failure to do so could adversely impact our financial condition, results of operations, or cash flows, and may otherwise cause disruption to our business. In addition, we expect to incur substantial asset impairment and severance charges and other costs that are being recognized as our reorganization plans are implemented and obligations are incurred, which will adversely affect our financial condition and results of operations.

From time to time, we restructure our manufacturing capacity, and we may have difficulty managing these changes.

From time to time, we engage in a number of manufacturing expansion and contraction projects, based on the then-current and forecasted needs of our business. In addition, from time to time, we are engaged in international restructuring efforts in order to better align our business functions with our international operations and transition to other lower cost locations in continuation of our cost reduction efforts. These efforts can require significant investment by us, and have in the past and could continue to result in increased expenses, inefficiencies and reduced gross margins.

Our management team may have difficulty managing our manufacturing capacity and transition projects or otherwise managing any growth or downsizing in our business that we may experience. Risks associated with right-sizing our manufacturing capacity may include those related to:

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Our management team may not be effective in restructuring our manufacturing facilities, and our systems, procedures and controls may not be adequate to support such changes in manufacturing capacity. Any inability to manage changes in our manufacturing capacity may harm our profitability and growth.

United Engineers Limited is deemed to have an indirect beneficial ownership in approximately 61% of our outstanding common stock and is able to exert influence over us and our major corporate decisions.

United Engineers Limited (“UEL”) through its subsidiaries (which include WBL Corporation Limited (“WBL”) as result of UEL’s stock acquisition of WBL in 2013) (collectively the “UE Group”) is deemed to indirectly beneficially own approximately 61% of our outstanding common stock. As a result, the UE Group has influence over the composition of our board of directors and our management, operations and potential significant corporate actions. The board or executive management composition of the UE Group could change, and such change could affect the strategic direction of the UE Group and the way the UE Group influences our corporate actions. For example, so long as the UE Group continues to control more than a majority of our outstanding common stock, it will have the ability to control who is elected to our board of directors each year. Furthermore, the strategic direction of the UE Group may influence how, when and if the WBL Entities (defined below) elect to sell its stock in us under the Registration Statement on Form S-3 that has been filed by the Company to cover such sales.

In addition, for so long as WBL or its subsidiaries (collectively, the “WBL Entities”) effectively own at least one-third of our voting stock, it has the ability, through a stockholders’ agreement with us, to approve the appointment of any chief executive officer or the issuance of securities that would reduce the WBL Entities’ effective ownership of us to a level that is below a majority of our outstanding shares of common stock, as determined on a fully diluted basis. As a result, UEL and/or WBL could preclude us from engaging in an acquisition or other strategic opportunity that we may want to pursue if such acquisition or opportunity require the issuance of our common stock. This concentration of ownership may also discourage, delay or prevent a change of control of our company, which could deprive our other stockholders of an opportunity to receive a premium for their stock as part of a sale of our company, could harm the market price of our common stock and could impede the growth of our company. The UE Group could also sell a controlling interest in us, or a portion of their interest, to a third party, including a participant in our industry, which could adversely affect our operations or our stock price.

The UE Group and its representatives on our board of directors may have interests that conflict with, or are different from, the interests of our other stockholders. These conflicts of interest could include potential competitive business activities, corporate opportunities, indemnity arrangements, debt covenants, sales or distributions by the UE Group of our common stock and the exercise by the UE Group of its ability to influence our management and affairs. In general, our certificate of incorporation does not contain any provision that is designed to facilitate resolution of actual or potential conflicts of interest. If any conflict of interest is not resolved in a manner favorable to our stockholders, it could adversely affect our operations and our stockholders’ interests may be substantially harmed.

UEL may be unable to vote its shares in us on certain matters that require stockholder approval without obtaining approval from the stockholders of UEL and/or regulatory approval and it is possible that such stockholders or the relevant regulators may not approve the proposed corporate action.

UEL’s ordinary shares are listed on the Singapore Securities Exchange Trading Limited (the “Singapore Exchange”). Under the rules of the Singapore Exchange, when we submit a matter for the approval of our stockholders, UEL may be required to obtain the approval of its own respective stockholders for such action before UEL can vote its shares with respect to our proposal or dispose of our shares of common stock. Examples of corporate actions we may seek to take that may require UEL to obtain its stockholders’ approval may include certain amendments of our certificate of incorporation, an acquisition or a sale of our assets the value of which exceeds certain prescribed thresholds under the rules of the Singapore Exchange, and certain issuances of our capital stock.

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To obtain stockholder approval, UEL must prepare a circular describing the proposal, submit it to the Singapore Exchange for review and send the circular to its stockholders, which may take several weeks or longer. In addition, UEL is required under its corporate rules to give its stockholders advance notice of the meeting. Consequently, if we need to obtain our stockholders’ approval for a matter which also requires the approval of the stockholders of UEL, the process of seeking stockholder approval from UEL may delay our proposed action and it is possible that the stockholders of UEL may not approve our proposed corporate action. It is also possible that we might not be able to establish a quorum at our stockholder meeting if UEL is unable to vote at the meeting if the approval of the stockholders of UEL is not obtained. The rules of the Singapore Exchange that govern WBL and UEL are subject to revision from time to time, and policy considerations may affect rule interpretation and application. It is possible that any change to or interpretation of existing or future rules may be more restrictive and complex than the existing rules and interpretations.

Our business requires significant investments in capital equipment, facilities and technological improvements, and we may not be able to obtain sufficient funds to make such capital expenditures.

To remain competitive we must continue to make significant investments in capital equipment, facilities and technological improvements. We expect that substantial capital may be required to expand our manufacturing capacity and fund working capital requirements in the future. In addition, we expect that new technology requirements may increase the capital intensity of our business. We may need to raise additional funds through further debt or equity financings in order to fund our anticipated growth and capital expenditures, and we may not be able to raise additional capital on reasonable terms, or at all, particularly given our recent financial performance. If we are unable to obtain sufficient capital in the future, we may have to curtail our capital expenditures. Any curtailment of our capital expenditures could result in a reduction in net sales, reduced quality of our products, increased manufacturing costs for our products, harm to our reputation, reduced manufacturing efficiencies or other harm to our business. Furthermore, our board has authorized a stock repurchase program, and may authorize additional stock repurchases in the future, and the funds we expend for any such repurchase may later be needed for the operation of our business.

In addition, under our stockholder agreement with the WBL Entities, approval from a “WBL Director” on our board (as defined in such agreement) is required for the issuance of securities that would reduce its effective ownership of us to below a majority of the outstanding shares of our common stock as determined on a fully diluted basis. If such approval is required for a proposed financing, it is possible that we may not be able to obtain the approval for the financing and we may not be able to complete the transaction, which could make it more difficult to obtain sufficient funds to operate and expand our business.

We are subject to covenants in our credit agreements and any failure to comply with such covenants could result in our being unable to borrow under the agreements and other negative consequences.

Our credit agreements contain customary covenants. There can be no assurance that we will be able to comply with any borrowing conditions or other covenants in our current or future credit agreements. Our failure to comply with these covenants could cause us to be unable to borrow under the agreements and may constitute an event of default which, if not cured or waived, could result in the acceleration of the maturity of any indebtedness then outstanding under that, or other, credit agreements, which would require us to pay all amounts outstanding. Due to our cash and cash equivalent position and the fact that we have no long-term borrowings currently outstanding under our lines, we do not currently anticipate that our failure to comply with any of the covenants under our credit lines would have a significant impact on our ability to meet our financial obligations in the near term. Termination of one of our credit lines because of a failure to comply with such covenants, however, would be a disclosable event and may be perceived negatively. Such perception could adversely affect the market price for our common stock and our ability to obtain financing in the future.

Tax positions we have taken may be challenged and we are subject to the risk of changing income tax rates and laws.

From time to time, we may be subject to various types of tax audits, during which tax positions we have taken may be challenged and overturned. If this were to occur, our tax rates could significantly increase and we may be required to pay significant back taxes, interests and/or penalties. The outcome of tax audits cannot be predicted with certainty. If any issues addressed in our tax audits are resolved in a manner not consistent with management’s expectations, we could be required to adjust our provision for income tax in the period such resolution occurs. Any significant proposed adjustments could have a material adverse effect on our results of operations, cash flows and financial position if not resolved favorably.

In addition, a change in tax laws, treaties or regulations, or their interpretation, of any country in which we operate could result in a higher tax rate. For example, there has been increased scrutiny by the U.S. government on tax positions taken, and during March 2014, the United States Department of the Treasury issued a high-level outline of proposed modifications to international tax laws for fiscal year 2015. If any of these, or similar, proposals are passed, our statements of financial position and results of operations could be negatively impacted.

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Also, a number of countries in which we are located allow for tax holidays or provide other tax incentives to attract and retain business. For example, we currently enjoy tax incentives and holidays for certain of our facilities in Asia. However, any tax holiday or incentive we have could be challenged, modified or even eliminated by taxing authorities or changes in law. In addition, the tax laws and rates in certain jurisdictions in which we operate (China, for example) can change with little or no notice, and any such change may even apply retroactively. Any of such changes could adversely affect our effective tax rate.

If we fail to secure or protect our intellectual property rights, competitors may be able to use our technologies, which could weaken our competitive position and harm our business.

We rely primarily on trade secrets and confidentiality procedures relating to our manufacturing processes to protect our proprietary rights. Despite our efforts, these measures can only provide limited protection. Unauthorized third parties may try to copy or reverse engineer portions of our products or otherwise obtain and use our intellectual property. If we fail to protect our proprietary rights adequately, our competitors could offer similar products using processes or technologies developed by us, potentially harming our competitive position. In addition, other parties may independently develop similar or competing technologies.

We also rely on patent protection for some of our intellectual property. Our patents may be expensive to obtain and there is no guarantee that either our current or future patents will provide us with any competitive advantages. A third party may challenge the validity of our patents, or circumvent our patents by developing competing products based on technology that does not infringe our patents. Further, patent protection is not available at all in certain countries and some countries that do allow registration of patents do not provide meaningful redress for patent violations. As a result, protecting intellectual property in those countries is difficult, and competitors could sell products in those countries that have functions and features that would otherwise infringe on our intellectual property. If we fail to protect our intellectual property rights adequately, our competitors may gain access to our technology and our business may be harmed.

We may be sued by third parties for alleged infringement of their proprietary rights.

From time to time, we have received, and expect to continue to receive, notices of claims of infringement, misappropriation or misuse of other parties’ proprietary rights. We could also be subject to claims arising from the allocation of intellectual property rights among us and our customers. Any claims brought against us or our customers, with or without merit, could be time-consuming and expensive to litigate or settle, and could divert management attention away from our business plan. Adverse determinations in litigation could subject us to significant liability and could result in the loss of our proprietary rights. A successful lawsuit against us could also force us to cease selling or require us to redesign any products or marks that incorporate the infringed intellectual property. In addition, we could be required to seek a license from the holder of the intellectual property to use the infringed technology, and it is possible that we may not be able to obtain a license on reasonable terms, or at all. If we fail to develop a non-infringing technology on a timely basis or to license the infringed technology on acceptable terms, our business, financial condition and results of operations could be harmed.

Complying with environmental laws and regulations or the environmental policies of our customers may increase our costs and reduce our profitability.

We are subject to a variety of environmental laws and regulations relating to the storage, discharge, handling, emission, generation, manufacture, use and disposal of chemicals, solid and hazardous waste and other toxic and hazardous materials used in the manufacture of flexible printed circuits and component assemblies in our facilities in the United States, Europe and Asia. In addition, certain of our customers have, or may in the future, have environmental policies with which we are required to comply that are more stringent than applicable laws and regulations. A significant portion of our manufacturing operations are located in China, where we are subject to constantly evolving environmental regulation. The costs of complying with any change in, or interpretation of, such regulations or customer policies and the costs of remedying potential violations or resolving enforcement actions that might be initiated by governmental entities could be substantial.

In the event of a violation, we may be required to halt one or more segments of our operations until such violation is cured or we may be fined by a customer. The costs of remedying violations or resolving enforcement actions that might be initiated by governmental authorities could be substantial. Any remediation of environmental contamination would involve substantial expense that could harm our results of operations. In addition, we cannot predict the nature, scope or effect of future regulatory or customer requirements to which our operations may be subject or the manner in which existing or future laws or customer policies will be administered or interpreted. Future regulations may be applied to materials, products or activities that have not been subject to regulation previously. The costs of complying with new or more stringent regulations or policies could be significant.

Compliance with new regulations and customer demands regarding “conflict minerals” could significantly increase costs and affect the manufacturing and sale of our products.

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Section 1502 of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2013 (the Dodd-Frank Act) required the SEC to establish new disclosure and reporting requirements regarding specified minerals originating in the Democratic Republic of the Congo or an adjoining country that are necessary to the functionality or production of products manufactured by companies required to file reports with the SEC. The SEC adopted disclosure rules for companies that use conflict minerals in their products, with substantial supply chain verification requirements in the event that the materials come from, or could have come from such areas. These rules may affect sourcing at competitive prices and availability of sufficient quantities of minerals used in the manufacture of our products. In addition, there are costs associated with complying with the disclosure requirements, such as costs related to determining the source of such minerals used in our products. Also, because our supply chain is complex, we may face commercial challenges if we are unable to sufficiently verify the origins for all metals used in our products through the due diligence procedures that we implement. Moreover, we may encounter challenges to satisfy those customers who require that all of the components of our products be certified as conflict free, which could place us at a competitive disadvantage if we are unable to do so.

Potential future acquisitions or strategic partnerships or business alliances could be difficult to integrate, divert the attention of key management personnel, disrupt our business, dilute stockholder value and adversely affect our financial results.

As part of our business strategy, we intend to continue to consider acquisitions of, or partnerships or business alliances with, companies, technologies and products that we feel could enhance our capabilities, complement our current products or expand the breadth of our markets or customer base. We have limited experience in acquiring or partnering with other businesses and technologies. Potential and completed acquisitions and strategic alliances involve numerous risks, including:

Acquisitions also frequently result in the recording of goodwill and other intangible assets which are subject to potential impairments in the future that could harm our financial results. In addition, if we finance acquisitions by issuing convertible debt or equity securities, our existing stockholders may be diluted, which could affect the market price of our stock. As a result, if we fail to properly evaluate acquisitions or partnerships, we may not achieve the anticipated benefits of any such acquisitions or partnerships, and we may incur costs in excess of what we anticipate.

We face potential risks associated with loss, theft or damage of our property or property of our customers.

Some of our customers have entrusted us with proprietary equipment or intellectual property to be used in the design, manufacture and testing of the products we make for them. In some instances, we face potentially millions of dollars in financial exposure to those customers if such equipment or intellectual property is lost, damaged or stolen. Although we take precautions against such loss, theft or damage and we may insure against a portion of these risks, such insurance is expensive, may not be applicable to any loss we may experience and, even if applicable, may not be sufficient to cover any such loss. Further, deductibles for such insurance may be substantial and may adversely affect our operations if we were to experience a loss, even if insured.

Litigation may distract us from operating our business.

Litigation that may be brought by or against us could cause us to incur significant expenditures and distract our management from the operations and conduct of our business. Furthermore, there can be no assurance that we would prevail in such litigation or resolve such litigation on terms favorable to us, which may adversely affect our operations.

If we fail to maintain an effective system of internal controls, we may not be able to accurately report our financial results.

Effective internal controls are necessary for us to provide reliable financial reports. This effort is made more challenging by our significant overseas operations. If we cannot provide reliable financial reports, our operating results could be misstated, current and potential stockholders could lose confidence in our financial reporting and the trading price of our stock could be negatively affected. There can be no assurance that our internal controls over financial processes and reporting will be effective in the future.

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Risks Related to Our Common Stock

Sales of our common stock by our majority stockholder could depress the price of our common stock or weaken market confidence in our prospects.

Pursuant to a Registration Rights Agreement between us and the WBL Entities, we have filed a Registration Statement on Form S-3, covering the re-sale of all 14,817,052 of our shares held by the WBL Entities. The WBL Entities may sell all or part of the shares of our common stock that it owns (or distribute those shares to its shareholders). A large influx of shares of our common stock into the market as a result of such sales, or the mere perception that these sales could occur, could cause the market price of our common stock to decline, perhaps substantially, and may weaken market confidence in us or our prospects, which could have an adverse effect on our financial condition, results of operation or stock price. If there is a disposal by the WBL Entities of their shares of our common stock with value that exceeds certain prescribed thresholds and constitutes a major transaction under the rules of the Singapore Exchange, then such disposal may require the approval of the stockholders of UEL. The WBL Entities may be able to sell part of their shares of our common stock without requiring such stockholders’ approval if such thresholds are not met; however, even such sale could impact the market price of our common stock. Further, these sales, or the possibility that these sales may occur, also might make it more difficult for us to sell equity securities in the future at a time and at a price that we deem appropriate.

The trading price of our common stock is volatile.

The trading prices of the securities of technology companies, including the trading price of our common stock, have historically been highly volatile. During the twelve-month period from July 1, 2013 to June 30, 2014, our common stock price closed between $9.76 and $17.24 per share. Factors that could affect the trading price of our common stock include, but are not limited to:

In addition, although we have approximately 24.2 million shares of common stock outstanding as of June 30, 2014, approximately 14.8 million of those shares are held by the WBL Entities. As a result, there is a limited public float in our common stock. If any of our significant stockholders were to decide to sell a substantial portion of its shares the trading price of our common stock could decline. See “Risk Factors—Sales of our common stock by our majority stockholder could depress the price of our common stock or weaken market confidence in our prospects” for more information.

If the initial decision of an SEC Administrative Law judge, which determined that the Chinese members of certain accounting firms’ networks should be suspended from practicing before the SEC for a period of six months, goes into effect, it may have an adverse effect on our Company.

The SEC has requested access to the audit documents of Chinese US-listed companies from their accountants. Many of the accounting firms, including the Chinese members of the so-called Big Four accounting firms’ networks, have refused to provide these records citing China’s state law which states that certain Chinese company records can be claimed as state secrets. An SEC Administrative Law judge recently made an initial decision which determined that the Chinese members of the Big Four firms’ networks, including PricewaterhouseCoopers Zhong Tian LLP (“PwC China”), among others, should be suspended from practicing before the SEC for a period of six months, which includes, but is not limited to, performing audits of subsidiaries of companies that are registered with the SEC. We have substantial operations in China that are currently audited by PwC China, a member firm of the PwC Network, of which our auditor, PricewaterhouseCoopers LLP is also a member. If this ruling goes into effect, we would be unable to use PwC China, or any of the other affected accounting firms, to perform audits of our operations in China, and may have difficulty finding another firm with the sufficient resources or experience to competently audit our Chinese entities. This could cause us to not meet our financial reporting obligations and result in potential delisting of our stock, which could negatively influence investor perceptions and cause a decline in our stock price.

Delaware law and our corporate charter and bylaws contain anti-takeover provisions that could delay or discourage takeover attempts that stockholders may consider favorable.

Provisions in our certificate of incorporation and bylaws may have the effect of delaying or preventing a change of control or changes in our management including, among other things, provisions providing for a classified board of directors, authorizing the

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board of directors to issue preferred stock and the elimination of stockholder voting by written consent. In addition, because we are incorporated in Delaware, we are governed by the provisions of Section 203 of the Delaware General Corporation Law, which may discourage, delay or prevent certain business combinations with stockholders owning 15% or more of our outstanding voting stock. These provisions in our charter, bylaws and under Delaware law could discourage delay or prevent potential takeover attempts that stockholders may consider favorable.

 

 

On August 6, 2014, the Company, as guarantor, and MFLEX Singapore, as borrower, entered into a Loan and Security Agreement (the “Agreement”) with certain financial institutions, as lenders, and Bank of America, N.A., as agent (in such capacity as “Agent”), providing for a senior revolving credit facility (the “Facility”) in an amount up to $30,000,000 (the “Revolver Commitment”).

 

Availability under the Facility is calculated based on a formula which takes into account multiple factors, including the accounts receivable of borrower, the geographic location of borrower’s customer, and whether the customer’s receivable is insured by a third party.

 

Amounts outstanding under the Facility will bear interest at either: (1) a rate equal to LIBOR or SIBOR, plus an applicable margin ranging from 225 to 275 basis points, or (2) a defined base rate (which may be Agent’s prime rate), plus an applicable margin ranging from 75 to 275 basis points. In either case, the applicable margin is based on the fixed charge coverage ratio of the Company and its subsidiaries, measured on a consolidated basis.

 

The Facility has a three-year term, subject to earlier termination by borrower in its discretion, upon 90 days’ notice to Agent, or by Agent upon the occurrence of an event of default.

 

As security for the obligations under the Facility, (1) the Company has granted Agent a security interest in certain of the Company’s assets (which excludes, among other things, its equipment, real property, and intellectual property) and pledged 66% of its voting stock in MFCI, (2) MFLEX Cayman has pledged its voting stock in MFLEX Singapore to secure non-U.S. obligations, and (3) MFLEX Singapore has granted Agent a security interest in substantially all of its assets (which excludes, among other things, its equipment, real property and intellectual property) to secure non-U.S. obligations. The Company also guaranteed all of MFLEX Singapore’s obligations under the Agreement.  

 

The Agreement imposes customary affirmative, negative and financial covenants on the Company, MFLEX Singapore and their subsidiaries. The negative covenants impose limitations on, among other things, the Company’s ability to make distributions on its capital stock or repurchase equity interests unless certain requirements are met, with limited exceptions.  In periods where (i) a default or event of default is continuing or the aggregate availability under the Agreement is less than a specified amount and (ii) either (a) any revolving loans are outstanding or (b) the outstanding letters of credit exceed $3,000, a financial covenant requires the borrower to maintain a fixed charge coverage ratio of 1.0 to 1.0 for each period of 12 fiscal months.

 

The Agreement also contains customary events of default. An event of default is also triggered if the Singapore Minister of Finance declares MFLEX Singapore to be a “declared company” under the Singapore Companies Act. A “declared company” is one over which the Minister of Finance may exercise certain powers to investigate such company to protect the public, shareholders or creditors. Upon the occurrence and continuance of an event of default, the Agent may, without notice or demand, declare all obligations under the Facility immediately due and payable, terminate or reduce the Revolver Commitment, adjust the borrowing base or proceed against the collateral, among other rights and remedies.

 

The foregoing description of the Agreement does not purport to be complete and is qualified in its entirety by reference to the full Agreement, a copy of which will be filed with the Company’s Annual Report on Form 10-K for the period ending September 30, 2014.

 

On August 4, 2014, the Board of Directors of the Company approved to change the Company’s fiscal year end from September 30 to December 31. The Company intends to file an Annual Report on Form 10-K for the period ending September 30, 2014 and a transitional report on Form 10-K for the three-month period ending December 31, 2014.

 

The exhibit list required by this Item 6 is incorporated by reference to the Exhibit Index immediately following the signature page of this report.

 

 

 

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SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

 

 

 

 

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MULTI-FINELINE ELECTRONIX, INC.

EXHIBIT INDEX

 

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