Merix Corporation F2Q09 (Qtr End 11/29/08) Earnings Call Transcript

Jan. 7.09 | About: Merix Corp. (MERX)

Merix Corporation (MERX) F2Q09 Earnings Call January 7, 2009 5:00 PM ET

Executives

Michael Burger - President and Chief Executive Officer

Kelly Lang - Chief Financial Officer

Tom Ingham - Executive Vice President of Global Sales and Marketing

Allen Muhich - Vice President of Finance.

Analysts

Brian White - Jefferies & Co.

Joe Wooten - Unidentified Company

Matthew Sheerin - Thomas Weisel Partners

Ryan Jones - Unidentified Company

Rich Kugele - Needham & Company

Nick Powel - Bank of America

Operator

Good afternoon everyone and welcome to the Merix Corporation second quarter 2009 earnings conference call. Today’s call is being recorded.

Comments made during the course of this call that state the company’s or manager’s intentions, goals, beliefs, plans, projections, expectations or predictions are forward-looking statements within the meaning of the Securities Litigation Reform Act of 1995. Many factors could cause actual results to differ materially from the forward-looking statements, including the factors discussed in the press release announcing our results, the company’s annual report on Form 10-K for the year ending May 31, 2008 and Form 10-Q for the quarter ending August 30, 2008 that are on file with the SEC and those discussed from time to time in the company’s other SEC filings.

I would now like to turn the call over to Mr. Michael Burger, President and Chief Executive Officer of Merix Corporation; please go ahead, sir.

Michael Burger

Good afternoon everybody. Joining me on the call today is Kelly Lang our Chief Financial Officer; Tom Ingham, Executive Vice President of Global Sales and Marketing; and Allen Muhich, Vice President of Finance.

Earlier today we reported our fiscal 2009 second quarter financial results that included revenues of $76.9 million, representing a 15% decline when compared to the first quarter and a net loss of $6.1 million. Included in the second quarter loss was a $1.1 million restructuring cost, primarily associated with the small reduction in force, taken at the beginning of the second quarter.

Overall, gross margins declined 3.5 percentage points from the first quarter to 7.8% of revenue. The reduction in revenue and its resulting decrease in variable contribution margins outpaced cost reductions, adversely impacting our gross profit in the quarter.

SG&A expense declined to $8 million or 10.4% of revenue, which is our lowest level in nearly three years. Second quarter SG&A benefited from approximately $750,000 of one-time reversals in management bonus accruals and bad debt expense resulting from improved collections of past due receivables. These financial results are especially disappointing to Merix, its shareholders and employees as over the last year and a half, we undertook a major restructuring and integration effort that was essentially completed as of November.

As the remainder of this restructuring included building significant technology capabilities in Southern China, as well as shutting down in underutilized capacity in both North America and Hong Kong. Further we completed the realignment of our global support organizations and successfully implemented a major ERP rollout to manage our global business.

Unfortunately, the current global financial crisis we are in has adversely impacted the end customer demand, primarily in the communications end market segment, further delaying our return to profitability. The only market that has not been affected by the global economy is our defense and aerospace business which grew 1% over the first quarter.

Although current demand trends are not fully utilizing the new capacity in our HY factory, the higher technology is a significant differentiator and continues to help us win in this marketplace. One indication of this differentiation is our synergy business, which is a measure of new business to Merix Asia, which did decline in the quarter in absolute terms, but increased as a percentage of Merix Asia’s revenue mix.

I don’t believe anyone knows how long or deep the current economic challenges will last. We have made and will continue to make the difficult but necessary decisions to weather the storm. In making these decisions, we are focused on maintaining our product quality and reliability, while at the same time continuing to build upon our recent service level improvements to ensure that we meet our customers requirements.

During the first week of December, we reduced our labor force by over 200 people or roughly 5% of the total, bringing our total reduction for North America and Asia to approximately 11% since August. We anticipate that December actions will result in further cost reductions of approximately $1 million per quarter and will help shore up our financials during this difficult period.

Finally, over the last few weeks, we have gone through the necessary planning of what further steps will be taken if the market trends continue to show decline. I hope you can appreciate that we will not be discussing these additional actions and what these additional actions may be at this time.

In summary, we continue to believe we have the adequate liquidity to weather the storm, our relationship with Bank of America remains strong and our customers continue to value our quality, technology and unique value proposition which results in us continuing to win new work.

After Kelly makes a few comments regarding the details of Q2, I will briefly comment on what we’re seeing in the marketplace and our actions for returning to profitability.

Kelly Lang

Thanks Mike and good morning everyone. Our consolidated second quarter revenues of $76.9 million decreased 15% when compared to the first quarter. North America second quarter revenues decreased 20% to $36.2 million from the first quarter levels. This reduction is primarily due to the following: Approximately $9 million was caused by revenue declines in the communication and networking segment. A portion of this change was driven by Merix’s decision in May 2008 to reduce its capacity commitment to one customer in this segment.

Excluding the impact of the communications networking segment, the remaining premium services revenue were down $2 million during the quarter due to the slowing demand environment. These declines were offset in part by higher revenues from the balance of our customer base.

Turning to Asia, our revenue decreased nearly 11% in the second quarter to $40.7 million when compared to the first quarter. Almost all of Asia’s $5 million revenue decline was a result of the ERP go-live in the region. You may recall that Asia’s first quarter revenue was abnormally high which enabled us to meet customer commitments during the first week of the second quarter as we temporarily shut down our Asia production for an ERP implementation. Consequently the second quarter revenue was adversely affected by the lost revenue during the August shutdown.

Consolidated backlog ex in the quarter was $38.1 million, reflecting a book-to-bill of 0.76. Consolidated second quarter gross margins declined 3.5 percentage points to 7.8% of revenue. The gross margin decline was primarily driven by lower factory utilization caused by the slowing demand environment.

Our operating expenses amounted to $10.3 million or 13.4% of revenue included in the second quarter operating expenses offsetting one-time items. Expenses increased due to cost related to restructuring actions taken at the beginning of the second quarter. The results were a write-down of excess assets of our Oregon facility.

Operating expenses declined due in part to the reversal of management bonuses accrued in the first quarter and there was also a reversal of bad debt expense on past receivables that have been collected. We believe that second quarter overall net expense of about $10 million approximates the underlying expense rate of the company.

Our cash and investment balance rose during the quarter to $11.5 million. We generated $4 million in cash from operations during the quarter and have anticipated our capital expenditures declined $4 million from the first quarter to $5.4 million in the second. We have now substantially paid for all of our capital projects and our facilities are in excellent condition. We currently anticipate operating the business on minimal 1, some $83 million per quarter maintenance, only capital spending over the foreseeable future.

During the quarter we borrowed $7 million from the Bank of America revolving credit facility, an inexpensive method of funding the remaining capital in our Asia operation; as well as it allows us to repay profits from this region very efficiently. We have an additional $43.9million of unused borrowing availability as of the end of the second quarter.

As a further source of cash, we continue to actively market our idle Hong Kong manufacturing facility and are receiving a good level of interest, but as of today a transaction is not imminent. We continue to believe that the net proceeds from the sale could be in the range of $10 million to $15 million.

Mike will address the current demand environment in his closing comments, but with respect to operating expenses, the underlying expense level of approximately $10 million is expected to remain relatively unchanged in the third quarter. The third quarter expense will roughly include $500,000 of cash, severance costs associated with the reduction and force Mike mentioned earlier. Other expenses and taxes are not anticipated to show significant changes from the second quarter level.

I’ll now return the call back to Mike who will make some closing remarks.

Michael Burger

Thank you, Kelly. As I mentioned earlier, we’re pleased with the operational and strategic progress we’ve made as a company, as we completed the necessary steps to strategically position the company for profitable growth. However, today we’re extremely frustrated with the global demand environment in which we now find ourselves, as it has delayed us from achieving our financial objectives.

The only consoling part that we have is that we are hearing from many industry sources that other companies in our space are experiencing similar demand concerns; a point that is also supported by eight straight months of the North American industry book-to-bill ratio running below parity as reported by IPC. As mentioned earlier we are seeing the greater softness in the communication sectors and anticipate continued weakness in the automotive sector. Conversely, defense and aerospace, as well as quick turn revenues continue to hold up reasonably well.

Despite the softness we’re seeing in our market, our sales team continues to be energized about the prospects for driving incremental business. The combination of capacity and technology in both North America and Asia and quick turn in North America has created a plat form that is unique in the industry and truly adds value to our customer base.

While we’re seeing pockets of success, it is currently not anticipated that we’ll overcome the impact of the overall demand environment in the near term. As always, we’re continuing reviewing our operations for ways in which we can become more efficient at our current production levels. We are leveraging some creative opportunities for labor savings that are enabled through our local state governments that result in cost savings while maintaining a flexible work force in order to meet spikes in demand as they occur.

We are actively managing our factory attrition levels and also trimming overhead to support structure to more closely align with the current demand environment. Through these and other actions, we believe we will maintain adequate liquidity to weather this soft demand environment and believe the company will be approximately free cash flow neutral in the third quarter.

As I’ve indicated, I’ve invited Tom Ingham our Executive Vice President of sales and marketing and Allen Muhich, our Vice President of Finance to help answer any questions that you may have. With that I’ll open up the line for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Brian White - Jefferies & Co.

Brian White - Jefferies & Co.

Could you talk a little bit about customers over 10% in the quarter?

Michael Burger

Yes, we had one customer over 10% and that was Motorola.

Brian White - Jefferies & Co.

Okay, and last quarter you had had two customers over 10%?

Michael Burger

Yes.

Brian White - Jefferies & Co.

Who were those two customers?

Michael Burger

That was Motorola and Cisco.

Brian White - Jefferies & Co.

Okay and when we think about this February quarter, you talked about comp continuing to be soft, auto continuing to weaken; should we look at the same type of rates of decline that you just experienced in both markets or is some of that artificial? I know comp you had a reason why it went down as much as it did. You think it will go down similar in the February quarter?

Michael Burger

First of all I think the rate of decline just first of all was not completely driven by necessarily the market factors and that in and of itself as you recall back in our fiscal fourth quarter that ended in May, we closed our factory here in Oregon which was a high layer count factory that was really targeted for high volumes of product that went into that communication sector.

When we shut that factory down, we made the difficult decision to actually reduce the commitment to one of our key customers in that area which we continue to view as key and is strategic to us as well as continuing, but because of that change in and of itself we wouldn’t anticipate that that effect we would see in the third quarter.

I think from just a demand standpoint, really for the last probably quarter and a half excluding December, because December you might recall as a very difficult month to really kind of asses demand. I’ve been here now and this is my third December with the company and December is always just very difficult, there’s ups and downs and this particular December has been even more difficult because I think almost all of our customers took some form if not all took at least a week plus in shutdown at not only factories but their offices.

So kind of borrowing the December number, I think that we’ve really seen a relatively kind of steady demand in North America. I think in the Asia business we’ve seen a greater decline in the kind of, I’ll just call it the second quarter standpoint, principally in the automotive sector and not really the HY factory necessarily where we have the higher technology products that we’re all actually able sort of really feel and frankly it’s very nice to have that facility up and running and it’s again helping us win in the market place in this difficult market.

Tom do you want to add anything to that?

Tom Ingham

No, I think that’s essentially that and I would say that Brian, the question is if we expect it to be down, the continuing percentage in each market like that, I would not anticipate that at all in the comps market. However, I would agree with what Kelly said and this is no surprise; I think anybody in the automotive sector, it’ll be anybody’s guess; all the automotive guys have stopped giving any kind of guidance whatsoever. There’s even more extended shutdown in the automotive sector, so I would actually anticipate a little more decline in the automotive sector in the third quarter.

Brian White - Jefferies & Co.

Greater than the 10% you just saw in the second quarter in auto, you’ll probably see something great in the February quarter.

Com you were down 23% you’re saying. Part of that was artificial, so you probably won’t see as much of a decline?

Tom Ingham

Correct. We even do have one of our customers; they actually have a part shortage on a fairly major order for us and that’s delayed some of the shipment. We haven’t had a tremendous amount of push-outs, but there’s a little bit of a push-out on that particular order. I actually think we’re going to solidify in the comp segment during the quarter.

Michael Burger

Brian, I will say that across the board though, our visibility into what our customers are going to require from us has really gotten worse. So while the demand, as Kelly mentioned before the holidays was relatively steady, our visibility is relatively weak and hasn’t gotten any better. So it’s really extremely difficult for us to give you any credibility around what we think is going to happen here in the next several weeks. I don’t think any of us have actually ever seen it this bad before. Is that a fair statement?

Tom Ingham

But I think that’s also too, I mean we highlighted that we’ve done some cost actions and we’ve got some other things kind of lined up if in effect we continue to see softness to mitigate the effects of this.

Brian White - Jefferies & Co.

Right, and can you differentiate at all in the comp area between kind of the wireless area versus wire line/networking?

Michael Burger

Yes, we’re actually seeing it pretty equal in both. We actually see some potential upside, particularly in Q4 on the wireless side, on the infrastructure side. You might recall Brian, we don’t really participate in the cell phone business at all, but on the infrastructure side we do.

Brian White - Jefferies & Co.

So just the take-away in the comp, it won’t be as bad, but do you thing it will decline quarter-on-quarter in the February quarter?

Michael Burger

I think that’s probably a good assumption. Again we’re not giving you specific guidance, but we’re expect there’ll be some softness.

Tom Ingham

There is also one week of Chinese New Year in our Q3 also, as well as almost two weeks of holiday shutdown.

Operator

Your next question comes from [Joe Wooten - Unidentified Company]

Joe Wooten - Unidentified Company

I was hoping you could give some commentary on maybe the linearity of how the second quarter tracked and I guess I ask that because at the time of the last call, you said demand was generally steady at that point, so I’m assuming things kind of fell off after that point?

Michael Burger

Yes. Yes. I mean, you might recall I think a lot of the financial issues that we started to hear and read about kind of happened late September, early October. Our call I believe was the sixth or seventh of October last time and it was coincidental and I think that’s probably the best way to say it and we started to see a drop.

Again I’d like to just mention that I think again in the North America segment we’ve seen early pretty much steady demand kind of in summer rather than kind of the softening we saw in December which we’re attributing again to the holiday season. I think most of it what we saw was more I’d call it, the surprise and kind of decline as really the higher volume stuff in our Asian factories to be automotive I think as Tom mentioned, but also other areas as well.

Joe Wooten - Unidentified Company

Okay and then secondly, could you provide an idea of what utilization is right now and I guess any business unit detail would be appreciated?

Michael Burger

Kind of for the quarter that we just finished, we’re roughly running at about 70%, a little below in North America and our Asia facility is running at 85% to 95%. Today, our North American facilities are probably similar to where they were in Q2, maybe a little bit lower. Asia it would be lower than that, they’re probably running more utilization rate somewhere, probably 75%, probably close to North America.

Joe Wooten - Unidentified Company

Okay and then lastly, any commentary you could provide on price dynamics for the quarter. I mean, are you seeing abnormal pressures out there? And over the last couple of quarters you were seeing some positive pricing, but it was mostly mix related I think versus panel increases. So any commentary you can give on what happened during the quarter and maybe what you expect here, assuming continued softness?

Tom Ingham

Yes, this is Tom Ingham. Pricing actually held fairly well during the quarter, but you’re right, a lot of that was mix related. We do think that it’s going to be certainly a challenging environment coming up in the upcoming quarters. We don’t have any intentions to get into price wars or sell products at unprofitable levels, but we’re certainly going to be doing the best we can with the cost structure we have to remain competitive in the marketplace.

Michael Burger

I think it’s probably fair that we look to kind of our average pricing for the quarter. I think we actually saw that we were net up kind of on average panel pricing, but I think it had more to do with technology changes both in North America and Asia. I think the key is it’s competitive, but I’d also say I think our competitors have been rational. They obviously appreciate what’s going on. I think it’s just the dynamics that are going on there, so it’s competitive but it hasn’t gotten to be ugly I guess. I think we’re genuinely I guess surprised it hasn’t gotten uglier.

Joe Wooten - Unidentified Company

Okay and then maybe just a spring board off of that and I mean raw materials are down pretty significantly. If you look copper itself is down. I think during the last quarter, it’s about a half of what it was during the previous quarter. I mean, did you see a benefit of that in the second quarter?

Allen Muhich

Not a dramatic benefit. We’re obviously in hard negotiations with our vendor set, so we’re anticipating to see some improvements.

Operator

Your next question comes from Matthew Sheerin - Thomas Weisel Partners.

Matthew Sheerin - Thomas Weisel Partners

So just piggy-backing on the last question regarding pricing and materials costs, because I think there could be a connection there, as your customers start to see the benefits in your cost of goods or maybe they’re asking already, whether they should see some pass-through in savings in terms of pricing.

Then also, because now business is pretty tough, I’m sure the orders you’re getting are sort of piecemeal and as we get volumes coming back in a more normal fashion, do you think that’s when you’re likely to see customers try to hit you on pricing?

Tom Ingham

Matt, this is Tom; that’s a really good question. In fact you’re entirely correct. It’s sometimes a little bit difficult. As Mike had mentioned we had some really just kind of modest cost gains so far. It’s hard to give lower prices on lower volumes. I think you’re correct that as maybe the market firms up a little bit and some of the volumes associated with it are a little bit more robust, we’ll have more opportunities to pass some of the anticipated savings on to the customers. As of today, like you mentioned it’s very difficult in a reduced demand environment to also reduce pricing.

Matthew Sheerin - Thomas Weisel Partners

Exactly; and just clarifying on the book-to-bill, I know you talked about the industry; did you give a book-to-bill for the company or by region?

Tom Ingham

Yes, we gave a consolidated one which was 0.76.

Matthew Sheerin - Thomas Weisel Partners

And was that at the end of the November quarter?

Tom Ingham

Yes.

Matthew Sheerin - Thomas Weisel Partners

And could you tell us where it is now?

Tom Ingham

We don’t report that on a month-to-month basis.

Matthew Sheerin - Thomas Weisel Partners

Okay and I imagine that the book-to-bill is not as material as it was because as you mentioned, the visibility is so limited right?

Michael Burger

I think too is one thing we’re looking at was, myself and Allen we were taking a peek at this the other day. We were just trying to look at demand and our book-to-bill and stuff and it’s interesting, the North America book-to-bill I think we’ve had now eight sequential months, when you use the three month rolling average of the book-to-bill declining in North America. When we kind of looked, the last time it was in a parody.

You use the simple math and I don’t know if it’s the right way to look at it, but you basically say the demand from six months ago is kind of off kind of roughly 40% and so it’s kind of interesting when you’re seeing that. I think it’s the first time we’ve seen eight sequential months of below book-to-bill. We were back top 2004 and didn’t see it, so it’s obviously somewhat unprecedented times that we’re dealing with at this point.

Matthew Sheerin - Thomas Weisel Partners

Sure and just a question on profitability without trying to pin you down on a specific quarter when you return to profitability and I agree that the visibility is so limited, but given the cost cutting that you have in place now and as you play through the next quarter or so and assuming that mix is the same or maybe a little bit better because of the high tech move in Asia, what kind of revenue run rate would we need to see a return to profitability for the business?

Allen Muhich

Matt, this is Allen Muhich. I think that historically we’ve said that we needed our revenue to be somewhere in the $90 million to $95 million revenue level to have us be at breakeven, but again given the cost reductions that we’ve taken over the last couple of quarters, we think we’ve brought that down probably somewhere into the 85’ish range and if things continue to soften, certainly as Kelly and Mike alluded to a second ago, we’ve got other things kind of wind up that we don’t want to discuss the details of, but we think we can take it even a little bit lower than that, so.

Matthew Sheerin - Thomas Weisel Partners

Okay and I know you’ve cut Wood Village and some others, some reductions in North America, but not to the extent that you’re like shutting down the rest of your operations, but would that be the part of your strategy to maybe down size in Oregon and just to concentrate in San Jose or just one of those areas or would that be too drastic or something that you haven’t looked at yet?

Michael Burger

Honestly Matt, we’ve looked at everything and we’ve basically have done a great deal of homework around this. It would have to get really, really bad for us to close either one of those facilities frankly, and we don’t anticipate that and as I said earlier where internally we’re projecting our next quarter to end up, we’ll be effectively cash flow breakeven and that’s kind of our mantra if you will through the downturn, to basically protect and manage the capacity such that when this does turn back we’re in a situation to capitalize.

Matthew Sheerin - Thomas Weisel Partners

Okay, that helps, and just in terms of that sort of cash flow neutral and this quarter I know you had some free cash flow and you’ve made some nice progress on the working capital front; is that really where you’re going to get it next quarter? Because I’m assuming with revenue down and also the SG&A returning to the $10 million level that on an operating profit basis, the operating loss will be greater next quarter. So where do you get to neutral and mostly on the working capital side?

Michael Burger

Most will be on the working capital side. There maybe some upside of some other expense activities and stuff that we’ll do, but a piece of it will be on the working capital. Again, like a good point too from a free cash flow standpoint, we not really are spending little of any CapEx on anything new going forward. So I think that’s also a nice benefit for us. We said in the script that the factory themselves are in very good shape, so that’s one thing that’s been going in our favor I guess.

Matthew Sheerin - Thomas Weisel Partners

Just lastly and sure I respect if you really can’t answer this, but I’m sure it’s on the mind of a lot of your investors, which is whether or not you’ve looked at any sort of mergers or any sort of deals where you would sell assets or sell the company or partner with somebody else in order to get the scale and get to profitability more quickly?

Michael Burger

Matt you’re absolutely right, we can’t talk about it.

Operator

Your next question comes from Ryan Jones - Unidentified Company.

Ryan Jones - Unidentified Company

I was just wondering as you look at your ARH and if you’ve experienced any credit issues among your customer base and if you see any risks there.

Tom Ingham

No, we haven’t. Our DSO did extend a couple of days from where there’ll be some improvement that we made in the first quarter and part was due to just frankly a couple of customers we are working with and frankly got cleaned up just a week or two after the end of the quarter, but overall it’s been pretty good. As you expected, a number of the customers have been asking for extended terms and stuff and I think we’ve done a pretty good job of holding the line on that, but then again we’re using kind of stop shipment type things when necessary and that tends to get customers back in line.

So again, we’ve had some small things, but again as you probably saw from our comments, we actually released some bad debt reserves just because we had a number of things that were greater than the 150 days that have frankly been on the books for a long time. We got some new folks that are running our credit group; they’re doing an outstanding job and our sales team are helping us there and I touch wood when I say this, but we’ve actually had some pretty good success over the last six months or so and there’s certainly a lot of work ahead of us, but we feel good right now I’d say, cautiously good.

Ryan Jones - Unidentified Company

And then looking at AP, have any of your suppliers tightened payment terms at all or have you seen any expansion in early payment incentives to date?

Michael Burger

We had a couple of small little ones where people are trying to get DPO probably. They’re DSO proven at the end of the quarter, just more quarter end incentive type stuff and nothing meaningful and I’d say any type of effect from suppliers, we’ve really seen little if any from any suppliers whatsoever. So we’re going to stay pretty close to them as well as we go through the challenges we have here in the market.

Ryan Jones - Unidentified Company

Okay and then I was also wondering if you could remind us again about the covenants on the revolver and the sub notes and kind of assess where you are relative to those covenants and maybe point out to some that investors maybe are paying attention to at this point.

Michael Burger

Yes, I think on the notes themselves there really are no covenants and really there are no covenants on the revolver that we have today, other than when we get to…

Ryan Jones - Unidentified Company

The fixed charge one, isn’t that right?

Michael Burger

I was just going to finish that. Once there’s $20 million left on the revolver there’s a fixed charge coverage ratio, but other that that, it doesn’t even come into play until we’re to reach that level.

Ryan Jones - Unidentified Company

Alright and then another question I was wondering about was how much of your sales this quarter were to EMS providers and I was wondering as volumes drop with the macro slowdown, have you seen any of these guys in-source more PCB manufacturing to their own production lines?

Michael Burger

I’ll let Tom answer this, if we’ve seen it on the sales, but as far as the EMS sales, they were roughly 46% this quarter, which is about 10 points down from what we’ve historically seen from the EMS guys, so a little heaviered OEM.

Tom Ingham

I think to answer your question Ryan, we have not seen any more in sourcing. We certainly do sell to a couple of the major EMS providers that have in source PCB shops. Having said that, even though 46% of our sales goes to EMS providers, a great deal of that is OEM directed and so there really is the flexibility at those guys to take that type of work and just put it in your own facility. So, we haven’t seen any creep on that.

Operator

Your next question comes from Rich Kugele - Needham & Company.

Rich Kugele - Needham & Company

Most of the questions have been asked so I’ll just be brief about Asia. When you look at the gross margin there that you did in the quarter, stable, roughly sequentially, given the utilization rate that you have there and the improvements you’ve made in consolidating all the facilities, do you think that it’s got more stability than the North American operations now in holding that gross margin level? I guess how bad do you think Asia can get since that’s kind of buoying the company on an overall basis?

Allen Muhich

Yes, this is Allen. I think that just to comment on the stable gross margins for a second, one of the things that we had to do as we were exiting the first quarter is we spent money on outsourcing costs, just to get ready for our ROI’s and therefore we didn’t spend those in the second quarter and even though we had a little bit of decrease in revenue, our margins stayed relatively constant quarter-to-quarter.

I would say that from an overall margin standpoint that due to the lower fixed cost nature of the Asia environment that as revenue flexes you will see less variability in the gross margin in Asia as compared to North America. I can’t necessarily give you any specifics in terms of how variable that is, but you certainly do not see the same variability in that region, compared to North America.

Rich Kugele - Needham & Company

Okay and just lastly on an OpEx basis, some of the questions were a little conflicting. So can you just reiterate what actually we should be expecting for this quarter OpEx on a pro forma basis, ex charges?

Allen Muhich

Yes, I guess from an operating expense standpoint, this quarter as we talked about, we had some restructuring charges within our operating expenses; some due to the severance actions that we took early in the second quarter and some due to some asset impairment charges that we found or some assets that we located, identified, that we can sell as we are scrubbing the books for some incremental cash.

We believe that those expenses that we took related to again those restructuring activities, pretty much offset the one-time benefits that we have related to bad debt reversals and some management bonus reversals and therefore the operating expenses, even though it includes those one time items, is really reflective of what we’re anticipating our operating expenses to be moving forward at that roughly $10 million level.

Michael Burger

Assuming no other actions or whatever go, roughly 10.

Operator

Your next question comes from Nick Powel – Bank of America.

Nick Powel – Bank of America

Can you give us an update on the size of the revolver and I think you mentioned the balance that was remaining on it or the balance you’ve drawn down and I’m sorry I missed that.

Michael Burger

The revolver itself is at $55 million. We have I believe it’s roughly $44 million left on it as of the end of the quarter. We borrow in and out of it all the time. Today for example we have cash of $19 million, so I mean it just goes up and down, kind of wherever we’re at on it, but the $55 million availability on the revolver is really based on receivables, the outstanding receivable balance that we have. We also have security related to the fixed assets in North America. None of the Asian assets are securing anything on that, but that’s pretty much kind of how it’s set up.

Nick Powel – Bank of America

When do you renegotiate that?

Michael Burger

We actually thank God coincidentally here, giving the credit to him on this one, was back in May we did the revolver, which right now I think would be pretty tough I think to be doing the revolver, because the other one by –the-way was to expire in February. So this one was renegotiated in May and we have until February 2013.

Nick Powel – Bank of America

I noticed you drew $7 million down on the revolver; what was the reason behind that in the quarter?

Michael Burger

A couple of reasons; I mean just to be very frank one of them is, when we set the revolver up, it’s really one revolver but there’s really kind of two trenches; one of which is really the North America Trench, one is the Asian. As you and probably others on the phone are aware, getting money into China is little difficult, but getting money out of China can be a challenge, except if you’re repaying debt and stuff.

So as you know we spent a meaningful amount of money in Asia over the last year as we put a small piece of the debt into using the revolver and you can do so as long as the money is targeted towards capital investments. You can’t just throw it in there just because you want to put money into China, if you will. So we structured it as that so we can actually take money out of China from a much more tax efficient manner, where we don’t have any holding on that; that was the main reason.

The second reason very frankly is that we’d actually had people question whether or not we had the ability to use the revolver, so we made sure at the end of the quarter we showed that there was activity on the revolver and that it’s been used and so again it’s more to show that there was some ability there, so the bottom line of those are the two things.

Nick Powel – Bank of America

I assume you paid some of that back down as the quarters…?

Michael Burger

Yes, it goes up and down; again it just depends. For example, our first month after the end of each quarter tends to be a high utilization of cash just because we have a couple of our venders that ask for certain payment terms, that ask for some accelerated payments at the end of their calendar quarter and so we consume cash typically then and we generate cash a lot to adjust the kind of working on that.

Nick Powel – Bank of America

Did the part of the revolver then go towards paying CapEx in Asia; is that how you…?

Michael Burger

Yes, essentially. I mean really if you notice the capital line is $5.4 million. There was a little bit of a timing there, but most of it essentially it went to fund the $18 million we spent in Asia over the last year. Funding a piece of that essentially was how we were able to justify it and lend it into China, using I think it’s called safe as the government agency over there were basically allowing us to lend money through that so that we can easily get it out.

Nick Powel – Bank of America

Then I’m not sure how you look at it internally, but looking at the incremental margin, that is a delta of a 15% decline in sales volume, resulting in a 40% decline roughly in your gross profit. How did that compare sort of with your expectations and the restructuring of the company, North America and Asia.

Michael Burger

A couple things I think I’d point out. One thing we did going into the quarter, our quarter the way it ended, it started in September and ends in November and Asia it has the one month reporting, but for us as we went in this time and as I mentioned earlier, this whole financial challenge that we’re in really kind of started late September, early October just as our quarter ended.

As we saw it begin and like many people we were unsure how deep and how long it was going to go, so we intentionally planned to kind of maintain capacity both in North America and Asia, because the last thing we wanted to do was to reduce capacity and all of a sudden demand was to come back up.

So one of the things that perhaps we could be criticized in the quarter is that our protection of capacity, but in that what we did is we used some pretty interesting things, particularly North America where we used this kind of a workshop program where we worked the state of Oregon in here and essentially were able to get some relief from the actual cost of keeping those employees on our payroll.

I say a part of the reason we saw the big decline is we do have a relatively fixed cost structure somewhat and our capacity is somewhat fixed. Labor is variable, but it is more fixed than you would appreciate, so that would be one comment I’d make.

I think the final one is and it kind of hit me too as we were kind of looking at the numbers. If you look at last year for example, we had $97 million in revenue, we lost $5 million around the quarter. We just did $76 million of revenue and locked basically a $1 million more, so we don’t like loosing $1 million more, but I think what we have been doing is taking costs out without hurting the business and making sure that we’re maintaining good cash flow and again, more than just surviving the downturn that we’re in, but I think that’s in a healthy fashion.

So again, sorry if that’s a little defensive in nature, but I wanted to give you some color on kind of what we’ve done and kind of the thought processes we went through.

Nick Powel – Bank of America

Actually if you add back the million bucks, you basically lost $5 million and it seemed to me that under the circumstances of a high fixed cost business, that’s actually a better incremental margin than say the airline business if you lost a comparable amount, but I don’t know how you guys look at it. What I think is not relevant.

Michael Burger

We look at it, but again our goal here is as Mike said in our last call; we’re really after kind of the restructuring we went through. We structured this business to be a growth business with high technology in North America and Asia and guys we’ve got it today. Again, it’s helping us win some nice business today in Asia, but the darn thing is this global market is on it’s way and there’s nothing we can do about it, but again try to hunker down and we will win and fight another day.

Nick Powel – Bank of America

Can you remind me when you expect to report Asia and North America on a comparable basis? Is it year end, this fiscal year end?

Michael Burger

We’re going to get on the same basis. It’ll actually be our first quarter of this next fiscal year, so August of ’10, so roughly about nine months from now. Oracle went live in August. Actually today we’re essentially operating without a one month LIBOR. We’re just trying to make sure that the numbers are predictable and good and it also gives us the comparability we need when we put our Q’s and K’s together next year.

Nick Powel – Bank of America

So, you’re live Oracle across the organization; San Jose, Asia, Oregon.

Michael Burger

That’s correct, all sides.

Nick Powel – Bank of America

And how do you handle; will you stub that last month into fiscal ’09?

Michael Burger

There will be a stub, but we’re not sure if there’s a stub at the end of ‘08 or early ‘09. We have a woman that works for us that has actually told me that once before and I’ve got to be honest, I don’t recall how we had decided to do that, but there will be a stub period.

Nick Powel – Bank of America

Okay and so you’re just probably running through your equity at some point in time.

Michael Burger

Yes.

Nick Powel – Bank of America

And start clean in fiscal ‘10.

Michael Burger

I’ll probably get criticized when I get off the call here, but something to that effect. We are looking at it.

Nick Powel – Bank of America

In terms of looking at Oracle now, when you’re looking at the numbers, are you completely on Oracle or are you still running it side-by-side?

Michael Burger

No, we’re completely on Oracle.

Nick Powel – Bank of America

Okay and you’re finding that your adjustments are I presume diminishing; I hope dramatically.

Michael Burger

Correct.

Nick Powel – Bank of America

Okay, I mean one last thing. You mentioned you had a risk in August and another in December, what was the size roughly in August and where’s your headcount today.

Tom Ingham

If you actually take August as a baseline, we said we were down 11% from August and our total headcount today I think is…

Michael Burger

We got about 440 people. So we’re around 3600 roughly.

Tom Ingham

I’m sorry, I don’t have the exact number.

Nick Powel – Bank of America

So you’re roughly 3600 today on a full-time equivalent basis.

Tom Ingham

Correct.

Operator

Your next question comes from Matthew Sheerin - Thomas Weisel Partners.

Matthew Sheerin - Thomas Weisel Partners

Just a quick follow-up Kelly. On the tax structure, you had some tax liability this quarter and is that because of the profitability in Asia? What should we think about the tax rate for next quarter and going forward?

Michael Burger

The rate that we really apply over there really is a 25% flat rate today and it is all associated with the taxes that we generate from the profits in our two Chinese businesses. As demand declines, particularly in HZ we would anticipate the tax expense to be less and I think when I made my comments in the script, as you model it, if you’re anticipating the decline in Asia, you’d probably see some decline in the tax expense for those businesses as well. So it’s about a 25% flat rate for all intents and purposes.

Tom Ingham

Well, I guess that is it in terms of questions. We really do appreciate everyone’s attention and interest in Merix. We will talk to you next quarter. Thank you very much.

Operator

Ladies and gentlemen, this conference will be available for replay today after 04:00 pm Pacific Time, through January 16 at midnight. You may access the AT&T teleconference replay system at any time by dialing 1800-475-6701 and entering the access code of 978810. International participants may dial 320-365-3844. Again those numbers are 1800-475-6701 and 320-365-3844. The access code is 978810.

That does conclude our conference for today. Thank you for your participation and for using the AT&T executive teleconference. You may now disconnect.

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