Operations Review

GROUP FlNANCIAL PERFORMANCE IN FY2008

For the financial year ended 31 December 2008 ("FY2008"), Group revenue slipped 7.8% year-on-year to S$227.0 million as both the Mechatronics and EMS Divisions reported lower sales due to weakening global economic conditions during the year. However, Group net profit fell a faster 36.2% to S$14.7 million as rising cost and price pressures in the global technology supply chain led to a contraction in profit margins.

The Group ended the financial year with a healthy balance sheet. Total assets amounted to S$212.9 million while shareholders' equity improved to S$179.7 million. Net asset value per share was 59 cents, of which 15 cents or a 25.4% comprised net cash (including short term funds placed with a Malaysian financial institution).

MECHATRONICS DIVISION

In FY2008, revenue from the Mechatronics Division eased by 8.2% to S$157.3 million. The medical and analytical business segments turned in resilient sales performances despite the slowing business environment. Due to its emphasis on a balanced revenue mix between its various business segments, the division was cushioned from the impact of a significant 48.1% decline in sales in S$29.0 million at its semiconductor business segment.

Sales in the medical segment benefited from the introduction of a new product for a major customer in the third quarter of FY2007 and grew by 17.5% to S$67.8 million on the back of a ramp-up in production in meet higher order flows in FY2008.

Sales of the analytical business segment were also marginally higher at S$47.2 million in FY2008 on the back of steady demand from customers throughout the year. Sales to the medical and analytical business segments could have been higher in FY2008 if not for the adverse effects of the global credit crisis in the later part of the year, which saw customers reschedule orders, resulting in delays of product shipments.

The sudden and sharp deterioration in the operating environment during the fourth quarter also had a severe impact on the profitability of the Mechatronics Division in FY2008. The division faced price pressure for some cf its products as it worked with customers to institute their cost reduction programs in response to the more challenging business condions. As a result, the division's net profit fell 31.6% to S$12.9 million.

In spite of the tougher landscape, the Mechatroics Division continued to make encouraging progress on the sales and marketing front during the year under review. The division has recentiy started commercial production in small volumes of a development project that it completed for a new customer in the semiconductor business segment. Additionally, the division also secured a number of new development projects in the medical and analytical business segments that are expected to be commercially launched from late 2009 onwards.

In line with its strategy to continuously expand its operations and take advantage of the lower production costs available in Malaysia, the Group has established a new subsidiary namely, Frencken Mechatronics (M) Sdn Bhd, which has taken over the mechatronics operations in Penang since December 2008. With the kind support of the Malaysian Government, this new subsidiary has been accorded the Pioneer Status incentive. This incenive will provide the new company with the benefit of a 10-year tax holiday as it progressively expands its operations through the transfer of more products and systems from the main plant in The Netherlands, as well as broadens its customer base in Asia. Besides allowing the division io take advantage of the ongoing trend for capital equipment manufacturers to seek high quality contract manufacturers in lower cost regions, the expansion of the Malaysian mechatronics operations will also free up resources and capacity at The Neiheriands plant to focus on new prolects under development.

The division is progressing well in its strategy to transfer suitable products and systems to its Penang plant. In the last quarter of FY2008, production volume was ramped up for the first medical module transferred from the plant in The Netherlands. The queliflcation and transfer process of other modules for the medical, semiconductor and analytical business segments to the Penang plant is also underway.

The Group's proposed merger with ETLA Limited ("ETLA") is expected to be a major milestone in the development of the Mechatronics Division as this strategic merger will substantially strengthen the mechatronics business by adding new manufacturing capabilities, as well as enlarging its footprint in terms of both new geographical markets and customers. When the acquisition is completed, the division will place priority on executing an exercise that will gradually integrate its operations with that of ETLA's.

On the sales front, the proposed merger is expected io greatly enhance the Mechatronics Division's competitiveness in the global market place. In view of the increasing complexity and scale of the division's business development funotion, a Group Sales Director was appointed in July 2008. He assumes the responsibility for improving coordination of all business development and sales activities within the Mechatronics Division, as well as providing customers with clear, direct and easy access to the division's offerings, capabilities and expanded global capacities.

EMS DIVISION

As the global economy slumped and business sentiment weakened in the later part of 2008, the EMS Division witnessed a contraction in customer orders for existing products while new product launches were deferred. in spite of this, revenue of the EMS Division in FY2008 dipped a marginal 7.0% to S$69.6 million, from S$74.8 million in FY2007. This can be attributed to the respectable growth in sales of the automotive and office automation business segments which lessened the impact of a 32.9% decline in sales at the keypad/telco business segment to S$28.1 million in FY2008. This was mainly due to challenging conditions in the keypad business, whlch continued to face intense competition and significant, pricing pressure throughoutthe global mobile handset supply chain.

During FY2008, the EMS Division continued executing its strategy to build a more balanced and stable revenue mix by diversifying to higher-value products with longer life cycles while reducing its dependence on the volatile keypad business segment. Sales to the automotive segment leapt 76.8% to S$13.5 million, from S$7.6 million in FY2007, on the back of a larger number of industrialisation projects that moved into commercial production during the year. Meanwhile, the office automation segment posted a 23.9% increase in sales to S$15.9 million, lifted primarily by the start of mass production of a project that entails mailing system products.

As a result, the automotive and office automation segments accounted for 42.2% of sales of ihe EMS Division, while revenue contribution from the keypad/telco business was pared to 40.4% in FY2008, compared to 56.0% in the previous financial year.

However, this transition process towards a more balanced revenue mix at the EMS Division was hampered towards the end of FY2008 by the fallout of the global economic downturn. With the US economy tipping into recession, sales to the automotive and office automation segments were affected as the US market is the designated market for most of the newly launched automotive and mailing system products.

The higher costs associated with scaling up the automotive and office automotive segments, coupled with selling price pressure and volatility in orders of the keypad business, led to a decline in gross profit margin of the EMS Division to 11.2% in FY2008, from 13.6% previously. Consequently, the lower sales and narrower gross profit margins resulted in a 54.4% decline in net proiit at the EMS Division to S$2.0 million in FY2008.

Despite the setbacks caused by the slowing business environment, the EMS Division will continue to stay the course in its strategy to develop a stable revenue base for the longterm by shifting its product mix towards higher-value products with longer life cycles. Additionally, the EMS Division will continue to work towards cost efficiencies to ride through these difficult times.

The hard work put into developing the automotive business over the years has resulted in the EMS Division's success in progressing from supplying parts to a higher level of producing module assemblies for automotive customers. The mass production of the first major module assembly project (with a product life cycle of around 5 years) is expected to commence in smaller volumes from June 2009 and lead to substantial volumes commencing from January 2010 onwards. Addiiionally, the EMS Division also crossed a miiesione when it was awarded a module project as a Tier-1 automotive supplier by one of the world's most reputable car makers in Europe. This pmject is planned to enter mass production in the later half of 2009.

The EMS Division is also making headway in developing the office automation business with a number of ongoing industriailsatlon projects. Following the launch of its first mailing system prolect, the division is close to completing the industrialisation process of its second major project. Commercial production of this second project is anticipated to take dace around the middle of 2009.

While there are still a number of industrialisation projects in the pipeline, the Group will be prudent with capital expenditure in light of the current business conditions. Accordingly, the division plans to continue working on enhancing its capabilities to support these new projects.

The division will also be looking at managing variable costs and improving business processes to achieve better cost efficiencies. At the same time, the EMS Division will be making use of this period to invest in people and improve operations so as to be better positioned when the business environment improves. To this end, the division intends to accelerate the implementation of certain key human resource development programs, as well as continue working on attaining the OSHA certification in compliance with safety and health standards.