Merix Corporation F2Q08 (Qtr End 11/30/07) Earnings Call Transcript

Merix Corporation (MERX)

F2Q08 Earnings Call

January 9, 2008, 10:00 am ET

Executives

Michael D. Burger – President and Chief Executive Officer

Kelly E. Lang – Executive Vice President of Finance and Chief Financial Officer

Thomas R. Ingham – Executive Vice President of Global Sales and Marketing

Analysts

Matthew Sherrin – Thomas Weisel Partners

Brian White - Jefferies

Kevin Kessel - Bear Stearns

Amit Daryanani - RBC Capital Markets

Joe Wittine – Longbow Research

Jeff Walkenhorst - Banc of America

Sean Hannan - Needham

Presentation

Operator

Welcome to Merix Corporation second quarter 2008 earnings conference call. Today’s call is being recorded. Comments made during the course of this call that state the company’s or management’s intentions, goals, beliefs, plans, projects, expectations, or predictions are forward-looking statements within the meaning of 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 26, 2007, and quarterly report on Form 10-Q for the quarter ending September 1, 2007 that are on file with the SEC and those discussed from time to time in the company’s other SEC filings.

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

Michael D. Burger

Good morning.

Good morning everybody, joining me on the call today is Kelly Lang, our Chief Financial Officer; and Tom Ingham, Executive Vice President of Global Sales. By now you have likely read the press release that we issued earlier this morning releasing our financial results for the second quarter of fiscal 2008 and guidance for the third quarter.

During the call we will review our second quarter financial results and provide an update on the progress that we have made on our strategic objectives and briefly discuss our third quarter guidance. Before I start I want to remind everyone that Merix 13-week reporting convention results and one additional week of reporting approximately every five years in order for us to catch up in the days in each year that the convention does not account for. Therefore consolidated first quarter results and Asia’s second quarter results contain 14-weeks. For simplicity in making comparisons throughout our discussion today we have normalized North America’s 14-week first quarter to 13-weeks where appropriate.

In reviewing the second quarter’s results from continuing operations, our reported revenues of $97.4 million came in at the low end of the guidance range we provided for during our last conference call. As we entered the second quarter we expected modest North American customer demand increases experienced in the first quarter to continue and to grow further into the second quarter.

Unfortunately during the second quarter our overall booking dates slowed, resulting in revenue performance at the low end of our expectations. Kelly will comment more fully on our perception of the current state of the North American market, but first let me comment on our profitability and immediate actions we are taking to return us to profitability.

For the second quarter the company reported a $5 million net loss for the quarter which included a $1 million in restructuring costs associated with the previously announced Hong Kong factory closure. Excluding this amount we reported a net loss of $4 million or $0.19 a share, which was below the lower end of the guidance range that we provided during our last conference call.

I am very disappointed in our second quarter financial performance and believe that much of the variance from this estimated range could have been mitigated. Our results were impacted by a number of factors including the lower than expected demand, combined with unfavorable change in mix of business coming from several end markets which caused gross margins generated by our Oregon factory to decline by nearly 4 points to 10% of revenue contributing to virtually all of our profit variance in the quarter.

In my mind our North America operations team reacted too slowly to the change in order flow. If we had responded more quickly and aggressively we would have mitigated most of the impact on our financials.

A month ago we believed we were on track in producing good and consistent results given our marked improvement and progress made in our expansion efforts in Asia. However as the quarter ended, I found that our North America operations were not as fundamentally sound as first believed. From our investigation I have a better understanding of North American operations and now believe that we must move quickly to correct some fundamental issues and will perform similar restructuring activities as we’ve done at Merix Asia.

During the last six weeks, we have looked deep into the North American operations and critically analyzed our capabilities as well as again reviewed the market data to insure that my team agrees upon what North American market will bear. From this review we have concluded that, unlike Asia where we needed additional capacities and improved high-end capabilities, we believe North America needs to be more narrowly focused on what it does best, as well as what our customers are willing to pay us for.

We see two phases to the Merix North America restructuring effort. Phase One is what we call “Triage”. Our objective is to quickly size our capacity to a level that we can more easily be filled with a reasonable mix of product given the current market conditions. Servicing our key customers will be our first priority.

I believe our sales force and operations team are doing an excellent job transitioning our customers to our Asia factories, but that is also creating a hole in North America. This hole is currently being filled by a mix of business which is not well suited for the Oregon operation. Once rectified, we believe execution in Asia, the restructuring activities in North America, and the new factory leadership in Oregon, can get us to break even to modestly profitable by our August quarter. This of course assumes that market conditions do not show significant deterioration from where it is today, and frankly we don’t anticipate this occurring.

Phase Two is to create a more lean and efficient machine similar to our Asian operation. Instead of being the Jack-of-all-trades as we have evolved to, my believe is that we will need to narrow our focus in the United States. Our strengths are high layer count, and high aspect ratio, and we are improving HDI capabilities.

Further I remain convinced that we have the sales team and the relationships needed to win with these tier-one customers who are looking for this strength and capabilities will pay for our quality. These customers also like the fact that we have an Asian factory and as they migrate their production to a low-cost region we can provide service and economy one-stop-shop for our customer base.

Besides focusing on certain technologies and markets, our factories are going to increase their use of lean manufacturing principles that assure that our average cycle times are in the single digits for all products.

Looking at pricing trends and factory set-ups as described, I continue to believe the North American model described in earlier conference calls is reasonable. Our review of what is needed makes us believe that we have the necessary capital, equipment and skill, but do require a shift in philosophy particularly in our Forest Grove factory.

There is certainly a lot of work to be done to fully develop this plan but I am optimistic that given the changes we are making we can accomplish our goal. In the near term my team and I are focused on the Asian expansion and performing triage on the North America operation. Let me give you some specifics on the near term actions in North America.

This week we are reducing the North America headcount by roughly 180. This reduction in force results from four primary activities. We are reducing our SG&A expense headcount by approximately 30, which combined with sales restructuring efforts will reduce our overhead structure by approximately $4 million or almost 1% of revenue on an annualized basis. Unlike prior reductions in force where we simply reduced headcount by seniority or simple percentages of functional groups, we have used an element of performance management system that I have mentioned to you in my first discussion with you whereby we basically rate and rank our employees to identify those who are not delivering to expected performance levels.

By using this principle our goal is to insure that the reduction of the least productive parts of our team occurs. Although this is a difficult decision and impacts many of our employees and their families who have helped begin the Merix transition, we do believe that it is a necessary step to successfully evolve our company.

We are researching and reducing our Oregon operation staff by approximately 10 headcount, and removing one layer of management from the cost structure. While at the same time [full-stream] the management team. This action will not only save cost but I also believe that it does something even more important and that it helps us change our culture. We have become complacent in our Oregon factory in terms of daily metrics management. This must change if we are to create a new culture that proactively addresses variances on a real-time basis versus waiting for our normal period in reporting cycles.

This change in the operations teams structure, while difficult, has actually been well received by many of our Oregon factory employees as they recognize the need for changes required to maintain our competiveness. We are accelerating in leveraging our lean manufacturing initiatives which we have reduced Oregon cycle times by over 50% in several specific manufacturing processes. We continue to roll out this program and will be completing the remainder of the factory processes over the next few months.

Efficiencies realized today will enable us to reduce our labor by approximately 60 people, resulting in an additional $3 million in annualized savings. We have also made the difficult decision to close our Wood Village mass lamination operation. You recall that the Wood Village operation is a high-layer count, inner layer production facility that was primarily used to provide a low-cost North American solution to our high-layer count customers. As a result of our impending increase of inner-layer capacity in Huiyang, China, we anticipate being able to provide most of this production capability to our customers in a lower cost region of the world.

Our plan calls for a complete closure of the factory by March 1 however some of under utilized equipment will begin moving immediately to either our Forest Grove facility or to two of our China based factories. The transfer of equipment between Wood Village and Huiyang will enable over $4 million of capital savings and when the closure is complete will reduce our overall North American headcount by approximately 80 people. The headcount reduction as well as the elimination of other fixed operating costs will improve our fixed cost structure by approximately $7 million annually.

Finally our Oregon engineering team has been working on several initiatives including the transition of key process technology to our Asian factories as well as an increased focus on reduction of cost, usage of supplies, chemists, and chemistries consumed in the manufacturing process. These initiatives are intended to yield savings of over $1 million a quarter beginning in our fourth quarter ending May, 2008.

Overall these changes are anticipated to improve our cost structure by $18 million through an approximate $14 million cost of sales reduction and $4 million in reduction of operating expense.

The actions are announced to help mitigate our impact on the changing North American market, however we are not done. Over the next 90 days we will continue to drive for improvements in our cost structure, and the mix of business to enable the returns required by our shareholders. I look forward to reporting further progress to you in April.

Just a little over a month ago I anticipated that this call would be focused on our success in Asia. That is one of the most disappointing aspects of our recent North American issues is that we have overshadowed the continued progress we are making in China. Demand in our Chinese factories has remained steady and is improving. In fact, comparing our Asian revenues to a year ago, our sales have grown 7% on a 13-week adjusted basis and are at the highest quarterly level since we bought the assets two years ago.

We continue to believe much of the demand in improvement reflects our customers’ recognition of the investments that we have made and are making to improve technology, capabilities, quality, on-time delivery, and customer service, as well as their appreciation for the overall value proposition. We are excited about the capacity ramp in China and remain ahead of schedule as outlined in our July 2007 conference call.

After Kelly makes a few comments regarding the details of Q2 and Q3, I will reinforce some of the next steps to be taken to return Merix to an acceptable financial model.

Kelly E. Lang – Executive Vice President of Finance and Chief Financial Officer

Thanks Mike and good morning everyone. As Mike mentioned, I will provide a review of the second quarter in comparison to the first quarter and then I will make a few comments regarding the outlook for the third quarter.

Consolidated revenue for the second quarter of fiscal 2008 decreased 2% to $97.4 million from $99.4 million in the first quarter of 2008. However adjusted for an extra week of reporting, our fiscal 2008 second quarter results increased 2% from the first quarter.

In North America our second quarter revenue increased 1% to $52.9 million from a 13-week adjusted first quarter. This increase in revenue is due to primarily to a modest reduction in our backlog as reflected in prior North America book-to-bill of just below parity of .98.

Our view of the North America market is that it has moderated slightly from our first quarter ending in August. As we mentioned during our October call we saw our order pattern improve as the first quarter ended. This trend continued through September and October, however the order pace has essentially flattened out rather than been continuing in its upward trajectory. This flattening can be attributed to customers in the communications segments which showed meaningful quarterly reductions in demand.

We attributed the demand reductions to the transfer of a portion of the production to the Merix Asia as well as we think that we have in overall decreased the end user demand for certain products that were not offset by their improvements in demand. These customers were also major contributors to the previously mentioned change in mix in the North America which reduced our profitability.

Overall our North America business experienced a 3 percentage point sequential decline in gross margin from the first quarter. Quick-turn pricing fell due to competitive [trackers] for a higher margin service. However our quick-turn revenue grew 8% sequentially and we believe this growth increased our market share.

Premium pricing also declined from the first quarter due in part to the product mix as mentioned above, as well as there is plenty of market apathy which impacts our ability to raise prices. Full lead time prices declined but showed the least amount of change on the sequential quarterly basis.

Turning to Asia, both demand and revenue grew in the quarter. This fiscal second quarter revenue was up as expected by 3% to $44.5 million compared to the first quarter of 2008.

As Mike mentioned earlier, our Chinese expansion is going well. The first phase of our HY expansion was completed near the end of the second quarter, which enabled an increase in revenue.

From a demand perspective with Merix Asia’s booking pace continues to improve as backlog shippable in the next 90 days will increase by $7.5 million or 24% from the first quarter, resulting in a book-to-bill of 1.17.

Average prices in Asia increased by 3% due primarily to the improved product mix and increases in our synergy business. It is worth noting that last full month’s our overall Merix Asia prices have increased by 19% from year ago, which reflects the growth in our synergy business, better technical capabilities, improving our product mix, and higher pricing on selected products that reported price in the past.

In reviewing our customer concentrations, Cisco Systems was our only customer representing greater than 10% of revenue for our second quarter.

Turning to gross margins, our second quarter margin averaged 11.6%, representing a 1.4 percentage decline as compared to the first quarter of fiscal 2007. The cause of the decrease in gross margin was primarily lower average pricing, most of which was caused by the mix change North America.

Margins in North America declined 3.1 percentage points. Also as Mike noted, we believe that the North America operations team had the ability to mitigate most, if not all, of its declines but reacted too slowly.

Somewhat offsetting the North America lower performance was a modest and expected 0.6 of a point increase in Asia. Asia’s gross margin reflected an increase in revenue, pricing and improving manufacturing efficiencies.

Excluding the Asia restructuring cost, operating expenses amounted to $13.5 million or 13.9% of revenues for the second quarter of 2008, compared to $14.6 million or 14.7% of revenue for the first quarter. The reduction in operating expense dollars is a result of one week less reporting in the second quarter as compared to the first.

We are continuing to believe that we can exit fiscal 2008 with operating expenses in the 11-11.5% range. That excludes engineering costs, which would be a comparable classification to our peers.

Income taxes in the second quarter of 2008 were $0.5 million or an effective tax rate of negative 13%. As we mentioned before, normally you would expect that reporting a pre-tax loss would result in tax benefits for quarter. However our second quarter tax expense results from the variation in jurisdictions where the taxable profits or losses were generated. For example, the Chinese based facilities were profitable, and their income is not shielded by losses in other tax jurisdictions.

Looking at the company’s cash flow and financial position during the second quarter of fiscal 2008, we consumed $1.2 million of cash from operations. We spent $6.5 million on capital equipment, translating in a negative $7.7 million of free cash flow compared to $1.8 million in the first quarter of 2008. This decrease in cash flow was directly related to the company’s decreased profitability as well as one-time first quarter benefit received of approximately $7 million due to improved headcounts payable management.

As the quarter ended the company had $16.7 million of cash and investments and continued to have $55 million available credit under its borrowing agreement. We are putting increased emphasis on our working capital management and if it’s better in the next few quarters, it will be aided by improved cash flow in North America for the restructuring activity, improved profitability in Asia.

And in addition we are focusing on our DSO, which is degraded over the last year, and I have put one of my senior people on my team to personally develop a lead to process changes that are needed to drive its improvement.

As Mike mentioned earlier, we believe we have two steps to take in fixing our North America business. The long-term goal is to have sustainable business focused on a set of technologies and services that can be profitable in North American market.

I know that you can appreciate our focus during the last six weeks has been on the North America triage plan. However, we have spent considerable time looking at the long-term strategies for North America, and many of the objectives previously laid out are correct.

Further we continue to think that North American business model remains achievable. The biggest step is the set-up, lay-out, and management practices of our factory. Looking forward, given the actions that we have described today and the integration plans previously in place, we are optimistic that we can be at or break even our August quarter.

As many of you know that our third quarter is an inherently difficult period to estimate particularly when majoring the market strengths. This challenge has brought about by the holiday buying cycles that are historically tapped in December. With that in mind we currently estimate revenue for the third quarter will be in the range of $94-98 million.

We anticipate that Merix Asia’s revenues will show modest improvements over the second quarter level due to the combination of improving demand on the factory, and the modest increase in capacity that was added in the second quarter.

We estimate that North America revenues will decline slightly from Q2 caused by the moderating demand and slightly lower production rates caused by the restructuring activities.

We estimate that Asia’s third quarter gross margins will continue and improve and approach the mid-teens resulting in improved factory utilization and higher revenue. As we said earlier we are very pleased with the progress that we are making in this region and we are executing well to the plan that we laid out just six months ago.

North American margins are difficult to predict. We are taking meaningful cost out of our factories but we also appreciate that destruction often occurs when there is a large reduction in force which can impact our output.

Further we believe one of the fundamental changes that need to occur is to reduce the amount of whip in our factories. The higher whip levels hampered our abilities to leverage many of the lean improvements that we have made to date. We estimate that a whip reduction will generate roughly $1 million in cash flow but also adversely impact margins in the quarter coming up as these costs that aren’t tied up on the P&L will be fleshed out, what we have tied up on the balance sheet will be fleshed on the P&L.

Consolidated operating expenses showed approximately 13-14% of revenue including intangible amortizations of 0.5%. It also reflected the previously discussed cost reduction activity. Interest and other expenses for quarter remain relatively flat with the first quarter at approximately $1.4 million. Our third quarter estimated tax expense approximates the second quarter levels. In summary, we believe our third quarter results from our continued ops will likely be similar to what we reported in Q2.

From a capital expenditure standpoint, we should realize some savings from the Wood Village closure as a meaningful amount of its equipment will be transferred to Asia and Forest Grove. The capital spending for the year will be lower than previously estimated and be in the range of $25-30 million.

Our second half results will also reflect an approximate $14-18 million charge for all the restructuring activities that Mike discussed earlier today. In addition we will incur approximately $500,000 to $1 million in charge associated with previously announced Asia restructuring.

With that I will turn the call back to you, Mike, for some closing comments.

Michael D. Burger – President and Chief Executive Officer

Thank you, Kelly. As I mentioned earlier, despite our disappointing financial results in North America, we have made good progress throughout many of the objectives that we laid out for you in October.

Our Chinese expansion is going well and it remains ahead of schedule. As we have discussed previously, this expansion must be completed in order to enable the closure of our Hong Kong facility. Which we now believe is an opportunity to close the facility sooner perhaps as early as spring of 2008. If this comes to fruition the expedited closure will enable the realization of an additional $1-1.5 million on a quarterly run rate exiting the fourth quarter of fiscal 2008. And that will obviously benefit the complete fiscal 2009.

I remain convinced that our value proposition is unique and compelling to our customers, however today the value proposition remains sub-optimized. We thought from last quarter that our value proposition is enabled by providing a seamless transition from quick-turn to high volume PCB manufacturing across a wide range of technologies on a global scale. Central to the success of executing this proposition is the need to be functionally aligned.

As of about 90 days ago we announced the centralization of technology and our front-end tooling teams that will support all customers’ transitions into all of our factories. Today I am announcing the creation of a centralized production planning team from existing resources that will be lead by a new VP of supply chain. The charter of this team is to bridge the sales and manufacturing organizations and to enable the optimum loading of our customer demand amongst all of our global factories.

Our customer demand can vary widely on a day-to-day basis by technology, and lead time, and material time. This new team will help facilitate the entry of our customers into our factory regardless of the service we are providing and where we are providing that service, hence realizing the value proposition.

Central to integrating these three businesses is one ERP system and as of December 4^th, we are now live on all North America on our Oracle ERP system. I am very pleased with the ERP implementation to date as it has gone better than expected due to the tireless efforts of an extremely dedicated team. Through the efforts we now have one system in North America and it is already providing new insights into the dynamics of our business. Our goal is to have one system throughout our company by the end of May, 2008.

In summary, while disappointed in our first half of fiscal 2008 fiscal performance, I am generally pleased with the progress this organization has achieved strategically. And I am confident that the changes that we are making in North America will result in a much stronger Merix.

We have additional unforeseen challenges in the future we are sure, however Kelly and I are committed to transforming Merix business model into one that achieves solid financial returns for our shareholders in all market conditions. We have much more to do and I look forward to reporting further progress to you in April.

As I have indicated, I have invited Tom Ingham, our Executive Vice President of Global Sales, to help answer any questions, and with that I would like to open up the line to any questions assuming that you are still on the phone.

Operator

Thank you. (Operator instructions) Thank you. Our first question is coming from Matt Sherrin of Thomas Weisel.

Matthew Sherrin – Thomas Weisel Partners

Yes, thank you. Quite an eventful call, Mike, so far, just a few questions here on the demand front. You talked about communications, and also if you could just further elaborate what you are seeing there. Is it a true end market? Are there share issues shifting production to Asia?

And then also, you talked about in hindsight having been able to mitigate some of the falloff in sales in the operations and help profitability. Could you just expand on that? What could have been done to mitigate that and what controls are you putting in place so that you don’t have further missteps going forward?

Michael D. Burger

Absolutely. Let me answer the second part of your question first, and then I will ask Tom to comment on the market.

The reality is that North America has run pretty smoothly for a relatively long period time, and has developed business practices which have morphed into probably what I used in the script as effectively, complacency.

The process was really basically a financial forecast and then the objective was to drive to a forecast. But we were not checking on a real-time basis changes in many of the assumptions made. Frankly, the North American market has kind of bumped along relatively consistent here for the last several quarters.

So I think we were lulled into a false sense of security. When we actually did see a demand burp, if you will, we were not in the situation where we actually responded. What we have done is we are now forcing -- and by the way this is not just in North America, this is around the world -- metrics reviews on a weekly basis across a wide range that include not only demand, but also include cost functions, variances in supplies, material etcetera in which myself and my team sit down with the operations team on a weekly basis and go through.

So it’s a much more attention to detail. Asia has been running that way for sometime, and I think it is fair to say that the management’s team focus was primarily on Asia and we blew it in North America.

Thomas R. Ingham

As far as in the communication segment, you hit on a few of the points and you really I think were right on with some of your assessment but I’ll give you my assessment of it as well.

We do not believe there was any major losses of share. We had some puts and takes at a couple different customers specifically in that segment. We did have one customer have a programs go end of life, which has actually come back in our Q4 demand, so that was kind of a one-time blip. But really a good amount of it is because it is a high concentration portion of our business, a lot of that business has been transferred over to our Asia facilities at a lower price point in some specific programs and some new customers. I think that attributed to some of the decline overall on a quarter-over-quarter basis.

I would also say too we also had some pricing pressures within North America too that probably attributed to some of the erosion in that space too. In talking to our largest customers, I really don’t think we had any significant share loss.

Michael D. Burger

We talked to a lot of you guys in November and John and I made a tour of New York and talked to a bunch of you guys and the reality is that at that point we were basically operating off of APO 4, or our fourth period, and frankly the data wasn’t strong but it was solid, and frankly the first period of each quarter is kind of ragged anyway, so we felt really very, very confident at that time that we were on track.

When we got back, actually a week after we got back, we were hit with our fifth period results which were well below. Frankly by that time, by the time the data was looked at, we were basically a three-week plus in the quarter and we didn’t react quick enough. So we have basically were running on auto pilot in North America and shame on us, it won’t happen again.

Matthew Sherrin – Thomas Weisel Partners

With the restructuring and the closing of the Woods Village facility, what would that put your capacity utilization rate in North America at, at a current revenue run rate?

Kelly E. Lang

I think that right now I would estimate once Wood Village is closed we are going to be running in the 90% plus. I mean, one of the things Mike has really challenged us to do is to really look at the market in and of itself here in North America and I can decide the factories that we can fill the factory with good work that really fits the technologies and the services that we are really going after.

One of the things in hindsight that you always doing when you go through one of these challenges, Matt, is you look at your book of business. What’s interesting is unlike the Asia issue that we had last year, where we had frankly a lot of unprofitable parts, we didn’t have any unprofitable parts, if you will. But what we found is that our sales force is doing exactly what we told them to do. As they were transitioning products to Asia, because our customers wanted to go there, which again, that is why Asia is turning around as we had anticipated. But we also told them to keep filling the factories in North America and again, they did what we asked them to do.

Tom and his team did a great job, but what we didn’t do is give them the right metric, if you will, and what’s acceptable work with respect to technology. The bottom line is, again, we are resizing the factories set to what we think we can fill and keep at a high utilization rate and be profitable.

Matthew Sherrin – Thomas Weisel Partners

You talked about the mix being unfavorable; are you walking away from certain customers or end markets? Should we expect revenue as a result to decline somewhat over the next couple of quarters in North America as you look to take more profitable business on?

Kelly E. Lang

I’ll answer the last part and I’ll let Tom talk about the mix and steps he is doing on that. I think in general from a revenue standpoint, I think you are probably going to see a very modest low single-digit, probably a single-digit decline in revenue in North America be offset all, if not more than offset, by growth in Asia. I think there will be some reductions, but it’s going to be, again, I think some of the smaller businesses that we’ve taken to refill North America versus I think strategic accounts. Tom, do you want to add to that?

Thomas R. Ingham

Kelly, that hit it on a nutshell. Certainly your question about are there any market statements we are walking away from? Not at all, and in fact some of that business we brought in in Q2 was really wasn’t a concentrated amount of business in any customer or any end market segment. We are not taking any specific actions with large pieces of business whatsoever.

Michael D. Burger

By the way, Matt, as it relates to Wood Village, Wood Village utilization was sub-optimized and has run that way for some period of time. I think we were, as a company, waiting for a cycle to turn and I just think that is not prudent. So overall capacity is not going to be affected dramatically. We are just utilizing the assets better.

Operator

Your next question comes from Brian White - Jefferies.

Brian White - Jefferies

Within the communication to market, where are you seeing the softness? Is it more in the wireline or in the wireless area?

Kelly E. Lang

I don’t even have the granularity to tell you with any specific answer about whether it is wireless or wireline at this point. I didn’t take a look at that as we kind looked at what happen and as I mentioned earlier to Matt, I had really attributed a lot of it not so much as softening in demand from our customers, but more so from to having a larger amount of business over in our Asia factories at a lower pricepoint.

I couldn’t answer accurately whether it was on the wireline or the wireless side of the business. If I were to estimate, I would say it would probably be on a couple of programs on the wireless side. That’s just because of some of our concentration in the wireless side.

Brian White - Jefferies

What percent of the softness was end market versus some of the other issues that you discussed in the comp market?

Kelly E. Lang

I would attribute the majority of it just to mix issues related to where we are producing it. We had some puts and takes within some customers that kind of balanced each other out a lot, but most of the puts were over in our Asia factories rather than in our North American factory.

Thomas R. Ingham

As you know, we spent some time with you in November and I think again as Mike mentioned, we came back from our trip and we got our second months results, the surprise wasn’t necessary I think on the top line. It was more just the effectiveness of our North America ops team and the management team and how they reacted. I mean it’s as Mike said, I think the best way to describe it is there was complacency that culturally I think has been acceptable; and again, under Mike’s short tenure here that is not something that is acceptable. That’s why we are changing some leadership here and doing some of the things we are describing today.

Brian White - Jefferies

You missed the top line and comp was down 10% sequentially. So that’s pretty significant, actually.

Thomas R. Ingham

Yes, but again I think that part of it would be again just some of the output that came from the factory. I think you would have otherwise seen within our range of revenue some of the outputs would have been there.

Brian White - Jefferies

Top five customers, do you have the top five?

Thomas R. Ingham

Yes. Cisco, TRW, Motorola, Bosch and Tellabs.

Brian White - Jefferies

When you look at book to bill for total company, what is the number?

Thomas R. Ingham

Book to bill for the second quarter was 1.06. Again, it was very strong in Asia and I think this goes to the execution that we’ve talked about in Asia. Again, just the customers wanting to go there, so that is a real positive sign for us.

Brian White - Jefferies

Lead times, what are we thinking North America versus Asia lead times?

Michael D. Burger

We are still running around on average six weeks.

Brian White - Jefferies

With Asia being a little higher?

Thomas R. Ingham

Not six weeks overall, if you average it all out it’s really six weeks between North America and Asia.

Kelly E. Lang

What’s helped us in Asia, we added that capacity right towards the end of our quarter in Asia and it is coming on on the technology side, that’s surely gives Tom some relief to actually sell a little bit more and not have to affect lead times.

Brian White - Jefferies

If we look out into the February quarter, what markets do you think will actually rise sequentially, what will decline?

Kelly E. Lang

I actually don’t have that granularity at that point here, Brian, I wouldn’t want to speculate at this point. I would say just based on what we have seen from a demand standpoint, we are going to look relatively the same going into the February quarter.

Brian White - Jefferies

So nothing looks meaningfully soft for the February quarter in terms of markets?

Kelly E. Lang

Not at this point.

Michael D. Burger

No, actually it doesn’t.

Operator

Your next question comes from Kevin Kessel - Bear Stearns.

Kevin Kessel - Bear Stearns

In terms of what you have referenced and you just mentioned it as well, it wasn’t so much weakening demand as I guess it was changing demand, so maybe you can just give us a little bit more color on when you guys are referring to the changing mix, what I’m interpreting it as some of the business you’re transferring over to Asia from North America, where you were getting higher gross margins on it. It is going into Asia at a lower price point. It is still accretive to Asia’s overall model in terms of where it stands, so that’s a positive in terms of improving Asia.

But then you’re seeing the drop off because the mix in North America is declining because you are bringing in business to back fill that at a lower margin then what left. Is that the right way to interpret what you’re saying by change in demand environment?

Michael D. Burger

That is actually perfect, you should have done the press release.

Kevin Kessel - Bear Stearns

Okay.

Kelly E. Lang

That’s why we stated this resizing and again I think the view from management has always been to just to continue to keep capacity where it was at, but a lot of it if you look at some of the Prismarc data, as you know the North America market is basically supposed to be flat or growing 2% between now and the end of the year. I mean, we like that optimism, but I think if you looked at just the ITC data, we’ve seen about a 9% to 10% decline in the last year.

I think that you guys have the rose colored glasses on and believe it’s going to grow a whole lot and there will be some cyclical changes, we’re certainly not at a cyclical peak by any stretch. But again, I think what we believe that if we are going to be profitable and successful, we’ve got to make sure we have the right capacity and also not just the old capacity that used to be the jack of all trades and ran the same way we always did in Oregon; it’s got to be very focused on cycle times because that’s the way we can win and be competitive in North America.

We have got to be very focused on the technologies because again, if you look at what we asked our Oregon factories to do was basically to do everything from relatively low layer counts to a very high technical HDI work. It’s pretty tough to be the do-all versus more of a specialist, so that’s where we are really driving to right now.

Michael D. Burger

We also believe that the long-term view of the America’s mix of business, not so much from a market segment but from a service perspective, is not migrating obviously to more and more quick turn and obviously the military business will stay here. So going forward, when we are looking at what the long-term view of the American footprint, we’re taking those things in mind.

One of the things we are proud of is the fact that we did grow our quick turn revenue pretty substantially; I think it was 8% quarter on quarter. That cost us some revenue per panel, but the reality is that it’s the right thing to do from our perspective, because that is the future state of the Americas.

We just need to effectively focus the Americas operation on being able to compete in those markets, as well as continue to support our key customers and be able to move when they want to move their business to Asia. I think we are doing that very, very well.

Roughly a third of our business in Asia is from our North American customer base and that’s very exciting.

Kevin Kessel - Bear Stearns

In terms of quick turn, I think the former DCS acquisition, how much capacity do they still have available for expansion? Where are they running?

Thomas R. Ingham

During the last quarter, San Jose was roughly 75% to 80% from a utilization standpoint, but I think Mike touched on what we are really trying to do there.

Michael D. Burger

I think we do quick turn both in San Jose as well as in Oregon. We are expanding the San Jose operation. We are in a process of actually relaying that facility out, and we think that has some upside. We are also remixing.

What’s happened over a period of time is that we kind of morphed San Jose into a little Oregon, which is a scary thing, which means that they are doing some full lead time business as well as quick-turn. We are remixing that, if you will, and basically moving all of the premium and full lead time business back into Oregon where our customers will let us, and that frees up opportunity for more quick-turn revenue out of San Jose. Of course, we still have ample capacity in Oregon for quick-turn.

The issue with quick-turn is you don’t get much visibility into it, it’s a cubical warfare and it’s day by day. So the onus is really on Tom and his team to see if we can generate it but certainly we want to give him the opportunity, once we book it, to basically be able to execute it. By freeing up San Jose’s capacity that gives us that opportunity.

Kevin Kessel - Bear Stearns

You gave the book-to-bill I think of 1.06. Is there a split between North America and Asia?

Thomas R. Ingham

Asia was 1.17, which I think is the highest we have ever had since we owned the business and then North America is just below parity at 0.98.

Michael D. Burger

I think that’s the future.

Kevin Kessel - Bear Stearns

Is Asia temporarily boosted just by the transfer activity that’s happening?

Michael D. Burger

Now we don’t believe so. I think the transfer activity is not a program we are driving. It is basically, we are there to react with what our customers want. Tom is not actively trying to push customers to Asia. Our customers, in large part, know exactly where they want to put the business and we are now in a position to support them on both sides of the pond.

Kevin Kessel - Bear Stearns

Just remind us what backlog was last quarter?

Kelly E. Lang

I know it grew $7.5 million. I am just trying to get the number here. 57.4 was what it was last quarter and it grew 7.5 this quarter.

Kevin Kessel - Bear Stearns

That business in terms of the increased backlog, is there a way to say was it of a different type?

Kelly E. Lang

I don’t have the details, but it just kind of an estimate here on it would be that is it improving technology, because most of the backlog growth happened in Asia, and again the layer count is rising because of the expansion activity in technology that is going on over there.

It is a higher price mix that is reflected by the fact that prices are up roughly 20% this year over last year in Asia. From a North American standpoint I think Tom alluded to that the mix is probably very similar to what we have seen in the past, so getting good demand out of the COMS business, very steady, consistent with what we saw last quarter. So it is a really big mix change, would you agree Tom?

Thomas R. Ingham

That’s correct.

Kevin Kessel - Bear Stearns

On taxes, you said it is going to be a similar tax amount this quarter?

Kelly E. Lang

I would say that the total tax dollar, the tax rate is going to be kind of a funky thing to try to figure out. I think tax dollars would be the estimate that I would use and it would be that expense that we recorded this quarter. I think over time it will rise as China continues to improve its profitability. So maybe 100,000 or so, a little bit higher this quarter, but about the same overall.

Kevin Kessel - Bear Stearns

Is there a percentage to think about?

Kelly E. Lang

The reason why it is difficult from a percentage standpoint is because you have got North America right now which is unprofitable and generates losses that can’t offset profitability in China, so that is why you get kind of a weird tax rate. Often times you if you have losses you have a tax benefit; that is not the case for us.

Operator

Your next question comes from Amit Daryanani - RBC Capital Markets.

Amit Daryanani - RBC Capital Markets

I think I heard you guys say you expect to hit breakeven by August quarter. If that is correct, could you talk about the revenue run rate you need at this point to hit that breakeven level?

Thomas R. Ingham

Yes, we do anticipate breaking even if everything holds with the markets, without anything significantly changing in the market, who knows on that, but I think just in general we do anticipate the August quarter. We are probably looking at $100 million to $105 million in revenue. If the Asian expansion continues to do well, which right now it looks as though it is possible, we could actually have our Hong Kong facility closed in the spring. If that occurs it could be a little bit north of that $105 million number.

Amit Daryanani - RBC Capital Markets

In terms of the $18 million in savings we expect out of all the restructuring we are doing in North America, how much in severance and other charges would you have to flow through your P&L to get to that?

Thomas R. Ingham

The actual cash cost if you want to look at it, of the $15 million in kind of mean cost, about $2 million is actual cash; most of it is severance. Also there is some, I will call it transportation costs, associated with moving some of the equipment to Asia. There is roughly $2 million over the next six months in cash costs. The balance is for the most part, non-cash.

There are some expenses related to the lease of the Wood Village facility that goes through 2010; if we don’t sublet it or the lessor finds a tenant, we have to continue to pay, but it is roughly $2 million in cash over the next six months.

Amit Daryanani - RBC Capital Markets

Got it. So $2 million cash, $20 million in non-cash is what the split would look like. We get $18 million in savings in this North America restructuring and if I recall from the Asian restructuring we should get about a $4 million to $6 million annual run rate, right?

Thomas R. Ingham

Yes.

Amit Daryanani - RBC Capital Markets

So that gives us about $22 million. That should boost your margins by about 600 basis points roughly. That just puts you back to where you guys were three or four quarters ago for the most part.

Thomas R. Ingham

Well, again I think part of it is we are not really giving a whole lot of guidance with respect to the future market. There is a triage plan in North America which is going to get us back to the low double-digits here in North America over the next six months, but I think overall we continue to believe that we can get North America back to the high teens to low 20s to being even in the mid 20s depending on where we are in the cycle.

It depends where you are from a cyclical standpoint. Right now we are looking at markets, we are still at the lower end of the cycle.

Amit Daryanani - RBC Capital Markets

What I’m trying to do is just look at your gross margin of 11.6%. If I add 600 basis points, I get somewhere around 17% with that on aggregate. Is that where you see the business being, probably at the low end of the cycle?

Thomas R. Ingham

What’s your question again? Sorry.

Amit Daryanani - RBC Capital Markets

I see about 600 basis points of margin expansion from these restructuring initiatives, right? That will put your gross margin level around 17%. Is that where you see the measure of the business to be around when you are at the low end of the cycle?

Thomas R. Ingham

No, I think you are going to see an improvement overall beyond that. I mean just look at Asia as an example, we’re roughly in the low 40s today; the expansion that should be completed again here by the early summer at the latest we guess would be, that’s going to continue to rise.

We are going to be low to mid-teens this quarter in Asia, we anticipate when Hong Kong is closed and that mix of business continues to evolve, we should be in the high teens to low 20s in Asia. That piece of business is growing and also the margin from that is going to grow.

North America, our San Jose business, you can look at the margins, they are already in the 20s. That we believe there is still opportunities to continue to improve margins there. It’s really restructuring this Oregon piece, which again today we still view that Oregon should still be at the low-end of the market in the high teens.

When you put all those pieces, this is a company that should have gross margins in the 20% range at the low end.

Amit Daryanani - RBC Capital Markets

Finally, could you just talk a little bit on raw materials? Copper prices have come down a bit of late. Is that hopefully going to be a positive tailwind at some point or do you not see that happening?

Thomas R. Ingham

Well, copper has been up and down and that is harder to predict than what is going on in the PCB market. Right now our view on copper laminate costs are going sideways. We don’t see any immediate relief. Our vendors have not given it in the past when it has declined. Really no change, I think is our view.

Operator

Your next question comes from Shawn Harrison - Longbow Research.

Joe Wittine – Longbow Research

I want to go back to the restructuring. There were a couple of numbers -- the press release noted the cost savings for the 180 people to be in the $11million range. I think from what I’m hearing now it is going to be closer to $18 million. Is that $18 million the whole North America piece or just these 180 people?

Thomas R. Ingham

Yes. There is the people side and then there is also just the non-head count related stuff. There are a number of costs associated with Wood Village depreciation leasehold costs. All that type of stuff. Overall, if you add it all up it is roughly $18 million on an annual basis.

Joe Wittine – Longbow Research

On the timing of that $18 million, you provided that Wood Village was projected to be closed by March 1st. Is it too soon to predict the quarterly run rate of those savings, which would start immediately thereafter you start to see it come on in the fourth quarter?

Kelly E. Lang

We think we will get a meaningful piece here in the third quarter and we think by the fourth quarter we’ll have all of it. We should have all this shutdown. Right now we are slated to actually have Wood Village closed by roughly March 1st. The equipment and the capacity, is for the most part already in Forest Grove, there is some equipment change there.

Again we believe it should be fairly quick as far as trying to get that done and there will of course be some disruptions in the next few weeks as people try to figure out what’s happening and as you know, with any stuff like this it always takes some time to get the workforce realigned, if you will.

By the fourth quarter we feel pretty confident that should happen.

Joe Wittine – Longbow Research

Additionally, any commentary you could provide on ASPs going forward? I think you quoted your number on 20% increases in ASPs in Asia over the last six months. Can you provide that going forward? Thank you.

Thomas R. Ingham

I would say that we are still seeing pricing pressure in North America. I think that we are modeling in that ASPs may still show some slight decline going forward. In Asia I think we’re going to level out from where we have been, as Kelly mentioned earlier and Mike.

We have transferred a lot of our North American customers over there and it has actually improved the base business over there, but I would say we are going to be relatively flat to where we are going forward in Asia.

Further out as we have more headroom from a technology standpoints just with higher panel prices from higher technology we will continue to see ASPs rise there. But I’d say in this next quarter we’re going to look pretty much like I’d say we looked in Q2.

Operator

Your next question comes from Jeff Walkenhorst - Banc of America.

Jeff Walkenhorst - Banc of America

Can you provide us with the revenue and gross margin split for North America between Oregon and Tennessee?

Thomas R. Ingham

Let’s get to it in a moment.

Jeff Walkenhorst - Banc of America

As you look for that, my concern is that you talk about being at the lower end of the cycle in North America and I actually thought that we had stabilize based on my checks and EMS is a little bit better and I really thought that the North American market had stabilized.

Do you think that there is potential that we can have a recovery in what should be, 2008 in our view should be a strong IT spending environment, which I think would present some risk. But as you try to fill the Asian factories and you have plans to bring capacity up to about $60 million per quarter revenue run rate I think by early summer, which potentially could take more revenue away from North America. Can you give us a little more color and your thoughts there?

Michael D. Burger

I think you are absolutely right. We are not implying that we believe we are at the low end. Our assessment is that the reason we are taking this action today is we don’t believe that it is going to recover next quarter or the following quarter -- by recovering meaning a 1.1 kind of book to bill. So we do believe that if the market turned negative, our customers are going to push us faster to Asia which will create a bigger hole in North America.

In our modeling of what North America eventually is going to look like, we are taking that into consideration. So we are not counting on this business turning around to 1.1 book to bill in North America, even though we are gaining share in the quick turn.

Thomas R. Ingham

Jeff, from the revenue split out, North America we did just round numbers, $53 million in North America from revenue for the quarter. We did $44 million in Asia. Gross margin dollars we did $ 6.5 million in North America and $4.8 million in Asia.

Jeff Walkenhorst - Banc of America

The split between Oregon and San Jose, do we wait for the Q for that?

Thomas R. Ingham

No, I will give you that, that’s no problem. Oregon is 4.6 and San Jose was 1.9.

Jeff Walkenhorst - Banc of America

And on the revenue side?

Thomas R. Ingham

Revenue is 44.6 for Oregon and 8.3 for San Jose.

Jeff Walkenhorst - Banc of America

So you think that if you do have a slight recovery and you’re not expecting to get to this 1.1 book-to-bill ratio for North America, but if you did, what would the margin potential be for the Oregon facility? In the 20s?

Thomas R. Ingham

I think that Jeff we’re going to get through this and return to this triage. The first thing we did is we looked at it and said, we’ve got to fix things. But as we looked at what are the tenants of our view on the North American market and where it’s going to be? I think we believe they are still in place. We think this Oregon factory combined with San Jose still should be in that 20% to 25% range depending on where we are at in the market.

Again, the bottom line is what’s happened in Oregon is -- I’ll say it again – we have marked that facility and again, this hasn’t happened over the last year, this is something that has been happening for the last five or six years as we continue to ask them to do more and more technologies. The spectrum of technologies continues to broaden and we’ve asked them to be as efficient. They’ve never been able to really step up to it, I think it’s probably been an unfair expectation.

What we’re trying to do is really narrow their focus and also really accelerate, if you will, the cycle timings. We have cut the cycle times in the last three or four years in roughly half, but there are still 12 or 13 days here in Oregon and we think that we need to cut those in half again.

We think that we’ve done some preliminary estimates, we think we can get there. So then it becomes this whole pricing game that we have got to mess around with. Basically you produce everything in almost a quick-turn fashion.

Michael D. Burger

I think also this company has, as the cycles have gone, so has our profitability and one of the tenants of this restructuring is that we need to be profitable even at the bottom of the trough and that’s our goal.

Jeff Walkenhorst - Banc of America

But getting back to the bigger picture question, do you think that there is trough? Do you think that there is a potential up cycle in North America? Or with this ongoing shift to Asia, lead to flat to down revenue for the foreseeable future?

Michael D. Burger

I think that we have been bouncing along, I mean when you have got a book-to-bill of close to one, that doesn’t feel like it’s the bottom to me. I remember when the cycle busted several years ago, you had a book-to-bill of 0.8, so that to me would be the bottom.

Our view is that we are, as you said, we are stabilized, we are probably midway through in terms of the worst case, we are probably not as bad as we think it could be. We are going to plan for it to get worse and if it doesn’t that is upside for us. But we are not going to wait for the cycle to save us. We are going to take control over that ourselves to drive the costs and the efficiencies out and if the market did turn up, we would certainly get gearing associated with that and that would be an upside for us.

But if does turn down, it is not acceptable for us to blame the market, we need to basically take control.

Jeff Walkenhorst - Banc of America

One last question, the quick-turns business, I know you have a plan to double that business going forward. Do you still think that’s an attainable goal? Do you think you have the skillsets and controls necessary to make that happen?

Michael D. Burger

We definitely have the skillsets, we definitely have the tools. I think we have the skills, I think it’s going to be a transition in philosophy, particularly in Oregon, to get there. As I said, we grew 7% or 8% quarter on quarter. I do feel that we have the reputation in the salesforce, so the answer to your question to transition it is primarily a philosophy transition.

In Oregon, we do quite a bit of quick-turn in Oregon and yet Oregon I think sees itself as pretty much a full lead time factory and that transition is not an easy one and we are in the midst of it as we speak.

Operator

Your next question comes from Sean Hannan - Needham.

Sean Hannan - Needham

What was the quick turn percentage in the quarter?

Thomas R. Ingham

As a percent of mix?

Sean Hannan - Needham

Yes.

Thomas R. Ingham

It’s 14%.

Sean Hannan - Needham

14% and then combined with premium services?

Thomas R. Ingham

Roughly 24%.

Operator

Your next question comes from Brian White - Jefferies.

Brian White - Jefferies

I’m just wondering if you could talk a little bit about what you think the future for volume production in North America is? As we look out over the next couple of years, what markets do you think will still be here?

Michael D. Burger

For sure the military business will be here, right? We think that some of the extremely high-end technical business is driven primarily today for us by some of the communication guys where IP is an issue. We think that will stay here.

We do believe there’s going to be the second-tier guys who don’t have manufacturing capabilities in Asia and that business will stay here, although I think it will be tough to count on because it will be cyclic based.

Then of course the quick-turn. I think that our view of the mix if you were to say two years from now it is quick-turn, military and some of the high-layer account, high aspect ratio, HDI business. Frankly, the latter is typically not super high volumes. It’s very equipment-based or very technology-specific.

I think that’s our view of what it looks like and therefore we are basically putting those capabilities and sizing America to that end.

Brian White - Jefferies

If we look out two years, what percent of your revenue will be based out of Asia and what percent in North America?

Kelly E. Lang

I think that our view would probably be if you looked back about a year ago, we were about 65% North America and 35% Asia. My guess is it’s probably going to be a flip-flop of that right now.

What keeps driving it, Brian, is the customers want to go to Asia and again that is a base tenant that has not changed and this whole thing has gone on, they are pushing us to go. That’s why I say, I think if you are a North America backed PCB factory and you don’t have an Asia shop, I think it’s going to be a tough road to hold unless you are military based only.

Michael D. Burger

I have to believe if the market turns, that is going to accelerate.

Operator

At this time there appear to be no further questions. I’ll turn the floor back over to Michael Burger for any closing remarks.

Michael D. Burger

Well other than our embarrassment for the quarter and the embarrassment of the recording we still remain very excited about our situation here. Our customer-base believes in Merix, believes in our quality, in our technology. They are frankly beating us up to go faster into Asia in terms of capabilities, and that’s what we’re doing.

We are really excited about the future, but we do have some work to do. So the restructuring albeit painful, is necessary. We appreciate your attention on the call and your interest in Merix. Thank you.

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