Merix Corporation F1Q09 (Qtr End 08/30/08) Earnings Call Transcript

Merix Corporation (MERX)

F1Q08 Earnings Call

October 8, 2008 9:30 am ET

Executives

Michael D. Burger – President, Chief Executive Officer and Director

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

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

Allen Muhich – Vice President Finance

Analysts

Kevin M. Kessel – Bear, Stearns & Co., Inc.

Analyst for Matthew Sheerin – Thomas Weisel Partners

Shawn M. Harrison – Longbow Research

[Sean Hannon – Sean Hannon]

[Scott Surel – S Squared]

Presentation

Operator

Welcome to the Merix Corporation first quarter 2009 earnings conference call. (Operator Instructions) Comments made during the course of this call that state the company’s or management’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 10K for the year ended May 31, 2008 that is on file with the SEC and those discussed from time-to-time in the company’s and other SEC filings.

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

Michael D. Burger

Joining me on the call today is Kelly Lang, our Chief Financial Officer, Tom Ingham, Executive Vice President of Global Sales & Marketing and Allen Muhich, Vice President of Finance. I’m pleased to report today that we continue to make progress on both our financial and operational objectives. Our first quarter results were within guidance while providing positive cash flow. But, equally as important, we recently achieved two critical milestones that we outlined to you a little over a year ago.

The first is that we’ve completed the HY expansion and technology upgrade. This expansion truly enables us to satisfy our customers and delivering upon our global value proposition. In addition, we’ve successfully completed the implementation of our global ERP system which the Asia go live in August. The global system provides us a foundation to manage our business on one platform as opposed to the three antiquated systems we’ve used before.

These two projects consumed roughly $38 million of capital over the last two years, not to mention the significant human capital investment. With these initiatives accomplished, I believe we have our structural changes behind us which allows us to focus on our customers, markets and ongoing operations.

Moving back to our first quarter financial results, we met the expectations we set at the beginning of the quarter. Revenues of $90.6 million came in at the high end of the range and were modestly better than anticipated. We reported a net loss of $2.1 million that included a $600,000 gain related to the sale of excess assets from our former Hong Kong based factory. Excluding this gain, our net loss of $2.7 million was towards the better end of our expected range.

Consolidated gross margins improved nearly one percentage point to 11.3% and as we anticipated SG&A of $9.7 million or 10.7% of revenue increased from the fourth quarter levels due primarily of the timing of our fiscal yearend financial audit and the accrual for fiscal 2009 bonuses. Despite this increase, we are pleased with the reductions in SG&A. This reduction represents a $2 million year-on-year improvement and we believe that our first quarter levels are sustainable in to the future.

Although we remain below breakeven, our first quarter loss marks the third straight quarter of improving results. Our focus remains on steadily improving our financial performance and delivering outstanding service to our global customer base. Looking forward, we need to ensure that our quality levels in Asia remain at their current levels as we ramp our capacity and technology in HY. Based on the last six month’s production, the quality of our higher technology work has met our expectations and continues to improve.

Within our newly completed building in HY we’ve installed the equipment and today have begun to stabilize the manufacturing processes while ramping our panel output. We should have full capacity running within the third fiscal quarter and from a technology standpoint we now have the capacity of producing approximately 80% of the standard multilayer technology set produced in our higher technology factories in North America. The technology overlap is critical to seamlessly transitioning products between facilities to meet our customers’ differing requirements.

A year ago this was simply a strategy, today it is a reality. As you can imagine we’re extremely excited about this new capability as it differentiates us in the industry and provides new market opportunities upon which our sales force can capitalize. Throughout the ramp, we must maintain our relentless focus on quality. I am confident in our operations and engineering teams and their ability to meet the stated objectives.

Turning to North America, we continue to make good progress towards improving our financial performance. First quarter North American average panel prices increased a further 7% from fourth quarter levels adding to the 5% gains we reported last quarter. The actions we have taken to remix our production through individual part-by-part analysis are having the desired effect. Yields in Oregon continue at record levels as they have increased roughly 2.5 points over the last six months. We are confident these gains are sustainable and will be extended in to the future.

Our North American gross margins improved over four percentage points over the last two quarters driven primarily by the average panel price increases and the quality improvements mentioned above. While profitability remains below our targeted levels, the improvements have demonstrated that our turnaround strategy is working. I believe we continue to make good operational progress in many areas in North America and Asia and are demonstrating the needed discipline of managing our cost structure but, we have much more to do.

We continue to challenge ourselves to become leaner and more efficient. As an example, during the first week of our second quarter we made some modest reductions in our North American overhead structure and are reviewing all of our outsourcing relationships to ensure we are employing the most cost effective product delivery solutions. The estimated impact of these actions resulted in a further half a million to a million reduction in quarterly spending without impacting our capacity.

None of these actions are easy, however we believe they are necessary as we seek to improve the competitiveness of our company. After Kelly makes a few comments regarding the details of Q1 I’ll briefly comment on what we’re seeing in the marketplace and open up the line for questions.

Kelly E. Lang

Before I discuss the details of our first quarter, I want to comment on a couple of changes you’ll note in our results. First, one of our core operating strategies has been to build a strong centralized management team that supports our global factory operations. Over the last few quarters we made good progress in this area, however, as we built the team their costs have been hosted and accounting for within our Oregon cost structure.

Up until this point, the cost remain relatively small and not worth a development of an allocation methodology. However, beginning with this new fiscal year we’ve begun allocating these costs to each of the factories rather than hosting them in simply one. We believe the change more accurately represents the cost structure of each of our operating segments. Secondly, we are reclassifying the majority of our engineering expense in to cost of goods sold.

We believe this classification is reflective of the true efforts of the team and also in line with our peer reporting practices providing greater transparency in our results when compared with others in the industry. The net impact of both these changes resulted in a four and two and a half percentage point reduction in San Jose and Asia gross margins respectively while Oregon gross margins remained relatively unchanged.

There was a minimal favorable impact to the overall profitability due to the capitalization and damage towards a portion of the engineering expenses. All margin comparisons we make during the discussion today will be reflective of these classification changes and for simplicity we have restated prior amounts in today’s press release to ensure consistent comparisons.

As Mike mentioned, our consolidated first quarter revenues of $90.6 million increased 4% when compared with the fourth quarter. In North America first quarter revenue decreased 1% to $44.9 million from the fourth quarter levels. Overall demand in our North America factories did soften in the quarter due to several factors. First, our customers adjusted their order requirements to align with our significant reduction in lead times, thereby reducing their absolute amount of bookings but necessarily their weekly run rates.

Secondly, we experienced some reduction in weekly demand that we attribute to both summer softening that is typical in the PCB market as well as we believe we are seeing a general slowdown in the market due to the challenging macroeconomic environment. The combined impact of these dynamics resulted in a $12.9 million reduction in North American backlog which is about what we would expect given the capacity reductions we made last year and the lead time swings that we saw within the quarter.

At the quarter end North America had a backlog of $20.3 million. The North American book-to-bill normalized for lead time reductions was approximately .96. Asia’s revenue increased 9% in the first quarter to $45.7 million when compared to the fourth quarter. Much of the growth can be contributed to the efforts we made to ensure the continuity of supply with our customers leading up to the Asia factory shutdown in the first week of August for our EPR implementation.

Speaking of our ERP implementation, as of the second week of August we completed the global ERP rollout and are now managing our business using ORACLE in both North America and Asia. The final Asia implementation went as expected. Demand in Asia remained healthy as evidenced by our book-to-bill 1.08 and a $3.6 million increase in backlog to $36.7 million. The adjusted book-to-bill for the first quarter was 1.02. CISCO and Motorola represented greater than 10% of revenue for the first quarter of fiscal 2009.

Put, turn and premium services revenue accounted for 20% of total revenue which is consistent with our normal run rate. Consolidated first quarter gross margins continued their upward trend become in the fourth quarter by improving nearly one percentage point to 11.3% of sales. Gross margins improved in both regions, by 11.5% in North America and in Asia by 11.2%. Each represented nearly one percentage point improvement.

Similar to last quarter these improvements resulted from an average panel price increase enabled by the continued product remixing and cost reduction activities in our North America factories. Operating expenses amounted to $10.3 million or 11.3% of revenue for the first quarter and included a net credit of $600,000 related to the sale of excess factory equipment from the Hong Kong closure.

Excluding this credit, operating expenses increased $1.1 million compared to the fourth quarter and is primarily a result of the previously mentioned timing of yearend audit costs and accruals for fiscal 2009 bonuses. Our cash and investment balance rose modestly during the quarter to $5.9 million. We generated $9.2 million in cash from operations during the first quarter, representing a 48% increase from the fourth quarter. This healthy cash generation [inaudible] we paid for our capital spending in the quarter of $9.4 million.

We are pleased with the improvement in the cash generated from the business during the quarter as it demonstrates good progress in all aspects of the way we’re managing the business. In addition to the operational improvements previously discussed, our global credit and sales teams have come together to enable an accounts receivable decrease of $2.8 million while revenues actually increased.

This improvement translates in to an over five day improvement in our DSO which we believe is not only sustainable but should be improved upon in the coming quarters. Further, we were able to collect approximately $3 million of past due Chinese batch receivables within the quarter. There were no borrowings outstanding on our line of credit. As Mike mentioned earlier, we have substantially completed the HY technology and capacity work as well as the major ERP investment and will significantly reduce capital spending over the balance of the year.

Fiscal 2009 capital expenditures are currently planned at $18 million, of which $9.4 million was spent in the first quarter. We’ll spend about $5 million in this next quarter and roughly $3.5 million over the balance of the year. Additional capital may be approved but will be dependent upon the achievement of financial objectives. As a further source of capital, we continued to actively market our Hong Kong factory and are receiving a good level of interest but today, a transaction is not imminent.

Currently we believe that the proceeds from this sale will be in the range of $10 to $15 million. I want to remind you that during last quarter we indicated that we’d no longer be providing specific forward-looking guidance. We do however plan to continue providing qualitative forward-looking information on market trends and the company’s plans and actions that could affect future performance. In a moment Mike will address the current demand environment in his closing comments.

But, with respect to operating expenses, the underlying spending level is not expected to change in Q2. However, reported operating expenses will not benefit from the Hong Kong equipment sales as they did in Q1. In addition we anticipate an approximate $500,000 charge associated with the small cost reduction Mike mentioned in his opening comments. Other expenses and taxes are not expected to show any significant change from the first quarter.

I’ll now turn the call back over to Mike who will comment on our integration activities as well as provide some qualitative comments on the current trend in the market.

Michael D. Burger

During my first conference call 15 months ago I outlined a strategy for Merix that required significant changes in the underlying asset base as well as fundamental changes in the way we manage the company. I am pleased to report that as of the end of our first quarter, these fundamental changes are essentially complete. As I mentioned earlier, the investment and expansion in our HY factory is virtually finished.

We now have roughly three times the inner layer manufacturing capacity we did a year ago and can manufacture 80% of the standard multilayer technology produced in our higher technology North America factories. We closed our unprofitable Hong Kong manufacturing facility ahead of schedule with minimal interruptions to our customer base. We closed our underutilized Wood Village interlayer manufacturing facility enabling a reduction in our North America fixed cost base as well as reduced the capital outflow required for the HY expansion.

In hindsight, the closure could have been smoother as we did affect some customers. The process however, is complete and was necessary to ensure our future competitiveness. We successfully implemented the global ERP system that enables improved, consistent management practices and gives us a foundation from which to scale our business. The disruption and investment is behind us and we can now focus on maximizing the efficiency gains that a global system enables.

We’ve implemented a global sales force management tool that for the first time in our company’s history enables the management of individual sales team members against a quota on a daily basis. We’ve implemented a global performance management tool that allows us to provide the necessary communications regarding goals, their achievements and the timely feedback on performance to our employees. We also now have a system used to rank and rate our management team assuring that we are retaining and compensating top performing team members and have our eye on the underperforming staff members.

We have made the necessary changes to strengthen and align our management team. The lines of responsibility around the global are now well understood and we’re holding each manager accountable for the results and commitments. Finally, as mentioned we have made meaningful improvements in our cost structure and we believe we have the ability to achieve our targeted 10% SG&A costs by the end of fiscal year 2009. The significant changes and many other minor ones are now complete.

We have the footprint, the management processes and the team to manage this business successfully. The internal focus over the last 15 months is now being turned externally. We must capitalize on market opportunities we have available to finish the transformation of our business. While demand for our Asia factories is steady, we are confident we’ll be able to grow demand to fill the additional capacity we’ve added. The slowing in North America demand, as Kelly outlined earlier, coupled with the uncertainty in the macroeconomic environment is expected to delay our return to profitability.

This softer demand is not contained within one particular market segment but appears to be broad based across all end markets. That being said, in the recent sales [inaudible] our entire team remains extremely confident in the competitive platform that they have available to sell. Our quality, global capacity and technology, on time delivery performance and our recent 31032 military certification provide a compelling and differentiated service offering. However, the current overall demand levels are lower than we’d like.

This is especially frustrating to our team because as I mentioned earlier, delays the timing of our financial recovery. I’d like to provide you a timeline of when we will achieve breakeven however, given the current climate it is difficult to predict with any real certainty. Although the demand environment remains uncertain, we do remain confident that the actions we’ve taken will enable our business to remain cash flow neutral to positive through this difficult market period given the majority of our major capital investments are now behind us.

Further, we have the liquidity necessary to weather the current demand environment. As mentioned earlier, my executive team and I are optimistic about the operational changes we’ve made. We are committed to delivering continuous improving results and believe we have the right strategy and now the foundation for achieving them. As I’ve indicated earlier, I’ve invited Tom Ingham, our Executive Vice President Global Sales & Marketing and Allen Muhich, our Vice President of Finance to help answer any questions. With that, I’ll open the line for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Kevin M. Kessel – Bear, Stearns & Co., Inc.

Kevin M. Kessel – Bear, Stearns & Co., Inc.

I just wanted to get a sense when I think Mike you were mentioning that 80% right now of the business that’s currently done in North America could be done over in the HY facility. Can you give us a sense for I guess what percentage you’re at today in terms of transferring of business over there? And, over what period of time would you expect that balance to change?

Michael D. Burger

The comment was really aimed more at a technology set from a capabilities perspective. We’re routinely doing 24 and greater layers PCB boars in Oregon and we’re shipping out pretty consistently 20 layer boards out of our HY facility. So, from a technology capability perspective that was really my comment. As it relates to the business that’s transferring overseas, Tom do you want to talk about the synergy business?

Thomas R. Ingham

We do transition some of our existing customer base in North America, we actually rotate the business out of our Oregon to our Asia plant. But, the greater amount of synergy business that we call it that we capture really comes from outside our existing customer set that we have in our North America factories today. In general, because as Mike said, we’ve got the ability to do 80% of that business but that 20% of the business that we cannot do over there is largely the business that exists in our North America factories today.

I think I may be inferring that you’re wondering if we’re ready to transfer all of our business out of North America over to Asia and that’s not the case at all. The business that resides here in North America still resides primarily for technology reasons or for reasons that don’t have the same amount of volumes associated with them as well. It’s really been a technology upgrade that allows us to do more business in our HY factory than we were able to do before but I don’t believe it is going to significant affect our existing customer base here.

Michael D. Burger

Maybe to add to it a little bit Tom, I think probably if you look at North America Kevin, it’s really about a higher mix of business relative to our factories in Asia. In fact, it’s one of the things in the last six months or so we’ve been balancing because I think our traditional business here in North America has tend to be, again, a much higher mix business than really what we really targeted the HY expansion at. They were looking for really higher volumes to really maximize the efficiencies and the way the factory is set up.

There’s a lot of automation in that facility and it really has a different mix of business. Albeit there is truly a value proposition we’ve been talking about. It certainly goes quick turn to ramp to production and we move it to Asia and that’s why we bought the Asia assets. But, as Tom highlighted I think it is probably a great portion of it is really new business or business we wouldn’t have otherwise not have competed with going forward.

Kevin M. Kessel – Bear, Stearns & Co., Inc.

I guess what I’m just trying to reconcile then is initially you guys were in the process of at least qualifying and transferring some of your part numbers over from North America to Asia as HY was further building up its capabilities but now its sounding like even though the capabilities or the technologies like Mike pointed out are similar or close to being similar, really HY is still targeting those opportunities that North America isn’t doing whether it be because of mix or other reasons. That certain products that you feel that are North America still need to remain in North America?

Michael D. Burger

That is the case. There are some technologies that are not even really associated with layer count where we’re transferring some of this over. Primarily, what we call our thermal management type work. But, we’ve had just as many opportunities come up with customers that actually had disengaged with us several years ago because we were not able to provide that type of technology in a offshore region. Like I said, some of that has rotated out of here as well.

When dealing with our customers we feel like we have the opportunity to keep the business within Merix rather than transfer it. But, we try to do it when it’s appropriate for the customer in general and not just as a wholesale taking all of our business over here and putting it in Asia.

Thomas R. Ingham

I think also another comment of what’s happening in North America is it seems like certainly for Forrest Grove it’s becoming much more a higher mix lower volume profile. The number of individual part numbers that we’re running through Forrest Grove has probably increased 30% over the last year and that’s just indicative of the fact that our customers are doing higher mix products here and using our facilities in Asia for the higher volume stuff.

Frankly, that higher volume business is business that frankly we were losing as it transfers to Asia so we’re now in a situation where we can capture more of that and I think that it really is indicative to the value proposition. I think the quals we mentioned earlier, the quals weren’t necessary. Our customers still qualify each factory kind of on a one-on-one basis so even though it’s a new factory for many of our customers and we might not be doing business with them in Forrest Grove, they still have to go through the qualification process of HY which is taking some time.

Frankly, we’re actually seeing quite a pipeline, if you will, of business now that these quals are largely behind us.

Kevin M. Kessel – Bear, Stearns & Co., Inc.

Just to finish up on what you were saying earlier, just the overall demand conditions? And, I understand, as you guys said last time you’re not giving specific guidance anymore but, when I look back over the last close to 10 years for Merix, the history has historically been at least on a revenue basis that there’s been some sequential, you could even maybe call it seasonal growth in November versus August. I know it didn’t happen last year but previous to that it was pretty typical to see it. How are you guys thinking about it now?

It sounds like there have been reductions that you guys have started to notice either are they delays or cancellations? I don’t know if there’s a way to flush that out a little bit so we can understand exactly what you’re seeing. I’m just trying to get a sense at a high level how you’re seeing the general trend going in to the end of year.

Kelly E. Lang

I’ll start on kind of the mathematical. I think your observations are right on. I think if we did an empirical analysis of the last six years kind of looking at business cycles I think what you’ve traditionally seen as you’ve exited the summer months going to the fall I think that on average the last six years you’re see a pretty meaningful uptick in the fall months and certainly we’ve seen. If you look at the North America book-to-bill which is really the only independent kind of market analysis out there, we’ve seen three months where it’s actually gone in the other direction.

Your observations are correct with respect to how the market overall is kind of responding and that’s why the comments that we gave you during the call. Tom, I think you could probably answer more specifically to what he’s asking about specific stuff.

Thomas R. Ingham

The good news is we are not experiencing cancellations. What we are not seeing – we’re not seeing upside demand conversely. Certainly, and I think if you take a look at the macro environment everybody is pretty uncertain out there but we have not received any cancellations. We are not getting any types of real push outs either. Demand is not robust out there, certainly everyone knows that and like I say, on the upside we’re not getting that either but we’ve had virtually no cancellations and no push outs.

Michael D. Burger

What seems to be different Kevin and again, not a lot of history in this industry but at least the booking rate on a weekly basis is kind of jumping all over the place. We have a couple of good weeks and then we have a slow week. The patterns are just different than kind of what we have traditionally seen. Then, I guess we all kind of believe what we are reading so we kind of overlay those things and we’re just a little bit nervous about what it’s going to look like at the end of the quarter. That’s kind of our view of the world.

Thomas R. Ingham

Just one more thing to kind of bring your two questions together too Kevin is I think if you look at Asia for us right now because of the HY expansion and this technology overlap we now actually have, it’s not just a strategy it’s a reality today. The demand today, albeit limited visibility kind of over the next 60 to 90 days, it’s actually pretty firm in our factories today relative to I think some of our Asia peers. Certainly in North America we’re not as immune to it because here in North America you don’t have that low cost option that we’ve now got in Asia.

It’s kind of interesting dynamics that we now have regionally and I think it’s great to have that diversification frankly. I think it’s actually showing and playing out quite well for us.

Operator

Our next question comes from Analyst for Matthew Sheerin – Thomas Weisel Partners.

Analyst for Matthew Sheerin – Thomas Weisel Partners

I just had a few quick questions, just real quick how is the visibility right now with your North American networking customers? Any update there?

Thomas R. Ingham

I would just say certainly we’re – last week we were at a supplier day for one of our largest networking customers and I would say that their outlook is just uncertain at this point. They really said to the entire supply base that just the macro conditions right now and I think that’s kind of typical. Everybody’s picking up the paper today, people really don’t know exactly what to look for on a global environment.

Having said that, they’re very optimistic long term. Again, I’ll just reiterate that we haven’t seen any cancellations from any of our networking customers but again, we’re not seeing the upside demand either.

Michael D. Burger

From a backlog perspective we’ve got the traditional visibility that we’ve had. We haven’t seen uncertainty in their placing of orders on us. In fact, we still have pretty much a quarter’s view of what to expect I think. Is that far Tom?

Thomas R. Ingham

Yes, that’s a fair comment.

Analyst for Matthew Sheerin – Thomas Weisel Partners

I guess I wanted to drill down and see have things necessarily gotten worse or maybe better in the quarter to date? We’re in October, how was the month of September?

Thomas R. Ingham

So far quarter to date it looks quite a bit like Q1. If you look at our North America bookings rate across the board, I mean I haven’t looked at it by segment if you want the data but it really has gone sideways since our lead time reduction happened in July. We haven’t really seen a big change in overall order pattern.

Michael D. Burger

I think we’re all hoping it was just kind of a summer slowdown and it doesn’t look like it’s bouncing back as it traditionally has in the late September early October time frame.

Kelly E. Lang

What I will say looking forward a couple of quarters from now, I know we’ll be adding some new customers to Merix in this segment over in our HY factory. How like what I talked about earlier some pretty significant number of people that are either brand new to us or have not engaged with us in several years because of China. We’re going to be able to pick up some share over the next several quarters with some networking guys.

Analyst for Matthew Sheerin – Thomas Weisel Partners

Then just to clarify, the majority of that is not transfer from current North American customers?

Kelly E. Lang

No, none of that would be. I think again to go back to the comments that Mike finished with is the sales conference we had just a couple of weeks ago again, Mike I don’t know if you’ll agree or not but I think it is probably the most pumped up our sales force has been. Then, we have this tool, we’ve talked about this tool for three years but now we’ve truly got a tool that is very complementary to what do we sell, what are the markets we sell in to. It’s really a nice fit.

Again, it’s not 100% overlap so there’s still a very meaningful piece of business for our North America factories as well but right now from – albeit with the market gloom that everybody is kind of reading in the papers, it’s an exciting point that we’re at right now. It’s really kind of an inflection point for us I think.

Analyst for Matthew Sheerin – Thomas Weisel Partners

Just real quick on your automotive exposure, what is your automotive exposure to Asia? It seems like there’s been a weakening demand like many other sectors but there especially. What is your exposure?

Thomas R. Ingham

There has been some weakening demand in the automotive sector. Obviously I think that’s been a sector that was kind of ahead of the macro economy in terms of slowdown. We’re very, very happy though with what our portfolio is. We’re still fully utilized out of the factory that is producing all of the automotive product. We feel like we’re very well positioned strategically with the customers we have today in that segment.

Although we had a bit of a slowdown, we really are I’d say very optimistic going in to the coming calendar year that we’re going to have the right type of balance in that portfolio for the rest of the calendar year. We do calendar negotiations typically with the automotive customers and like I said I feel very good about the portfolio going in to the new year.

Michael D. Burger

We’re still seeing demand holding pretty steady in Asia. We’ve not seen it soften as we’ve seen the North America facility and we do all of our automotive businesses in Asia.

Analyst for Matthew Sheerin – Thomas Weisel Partners

I think you guys mentioned that you expect to hit breakeven by the end of the calendar year. I know earlier you mentioned that you’re not updating that goal but are you actually retracting that goal to hit breakeven by the end of the year given the demand environment?

Michael D. Burger

Again, it’s uncertainty. We’re doing whatever we think we need to, to show improving results quarter-on-quarter and with the uncertainty that we’ve got in this marketplace right now we’d be hard pressed with any certainty to kind of nail that. So, I wouldn’t say we’re retracting it, we’re just saying it’s uncertain because frankly one assumption we made when we went through this whole process was the market would hold. It looks like it is softening in North America so again, I don’t think we don’t know what the market is really going to end up looking like steady state.

Kelly E. Lang

In our prepared comments, I don’t know if you heard or not, Mike did say that we don’t see it happening in the near term but it just all depends on what happens in the market particularly in North America I think.

Analyst for Matthew Sheerin – Thomas Weisel Partners

So if things remain steady as they are today do you think by the end of fiscal 09?

Michael D. Burger

Honestly, we’re not going to peg ourselves to it. I will tell you that focusing on cash flow positive, that’s where we are today and we feel really good about that particularly with the bulk of our capital spend behind us. We can weather this storm both from a liquidity perspective and from a cash flow generation perspective. Again, I’m not going to commit.

Operator

Your next question comes from Shawn M. Harrison – Longbow Research.

Shawn M. Harrison – Longbow Research

A few questions, maybe I missed this, but did you provide a quarter-to-date book-to-bill run rate? It sounds like things were maybe just implying a 1.0 book-to-bill here in North America and something a little bit better than that in Asia.

Kelly E. Lang

We didn’t do a quarter-to-date, we did provide it for Q1 which was 1.02 was our global.

Shawn M. Harrison – Longbow Research

Quarter-to-date I’m guessing it’s tracked down from that given kind of your commentary?

Kelly E. Lang

Again, we don’t provide the comments but it’s probably not a bad inference.

Shawn M. Harrison – Longbow Research

Secondly, if you could just remind me kind of what is the revenue generation capability both in North America and Asia now that the facility expansion, the technology expansions have been pretty much completed?

Michael D. Burger

Are you talking about capacity capabilities?

Shawn M. Harrison – Longbow Research

I guess on a revenue basis holding mix steady?

Michael D. Burger

Well, I think we have the opportunity to do probably on an annualized basis in the $410 million range.

Shawn M. Harrison – Longbow Research

That’s in aggregate?

Michael D. Burger

Yes.

Shawn M. Harrison – Longbow Research

What would it be maybe broken down between Asia and North America?

Kelly E. Lang

Kind of $220 Asia and the balance would be North America. You said keeping mix steady, that’s something that actually you can’t keep mix steady because there is a change in mix occurring in Asia. It’s happening because of the HY ramp so I think it is real key that there is a mix change that might be part of the strategy so I just want to clarify that point.

Shawn M. Harrison – Longbow Research

That goes in to my next question, how much of the price increase that you witnessed quarter-to-quarter was tied to mix versus actual true price increases going to the market?

Kelly E. Lang

Almost all mix. We’ve been very careful, the market certainly doesn’t have the strength to do an overall price increase if you will so we’ve just been a little more selective in the business that we’ve been willing to take. It’s a very competitive market out there both in Asia and North America so it really is mix changes that’s occurring.

Shawn M. Harrison – Longbow Research

Are you seeing normal pricing pressure now be it either on standard lead time or say the quick turn production?

Kelly E. Lang

Not today. As I think anybody in our industry may attest to there’s been pretty consistent price pressure from full lead time standpoint over the last several years so I would say that is still consistent with what we’ve seen. We’ve actually had some of our customers tell us that there’s a recognition that there’s been some core inflation that has affected this market and we’ve actually had a little bit of sensitivity to that from a full lead time basis and some of the expectations actually have been pegged a little bit lower in terms of price.

The quick turn market is a little bit different and you can affect your pricing by mix there pretty handedly, we’re certainly not going to go after every piece of business. There will certainly be some pressures on a part number by part number basis but you can still afford to be fairly selective in what business you bring in the door.

Shawn M. Harrison – Longbow Research

You brought up another point, just the raw material environment, what are you seeing from your suppliers be it on laminate, chemistry, anything else?

Michael D. Burger

We’ve seen some modest increases on chemicals. There have been a lot of noise about the laminate suppliers but we’ve seen just I would consider modest increase in the 1% to 2%, maybe 3% range.

Shawn M. Harrison – Longbow Research

I guess regionally would that be more North America or is that globally?

Michael D. Burger

Globally.

Shawn M. Harrison – Longbow Research

Two final questions, the ERP system has now been completed. I guess when should we expect to see Asia running kind of on an same quarter basis as North America.

Kelly E. Lang

Actually, our plan is to make it happen June of 2009. The reason for it is we’re just – we’re actually going to internally start reporting ourselves without the one month lack actually at the end of this quarter and essentially we’re just trying to make sure that we get steady, that results are consistent to be relied upon. Then externally report those beginning in June is our current plan.

Shawn M. Harrison – Longbow Research

It sounded like from your commentary that there may have been a build of revenues last quarter as you switched over to the new ERP system in Asia meaning that you’d see kind of a corresponding maybe couple day revenue removal this quarter.

Kelly E. Lang

Actually, that’s really a good point, I’m glad you brought that up. We essentially built ahead roughly a week which is $3.5 maybe $4 million to essentially offset the fact that we were down about a little over a week in Asia in our second quarter that will affect revenues in the second quarter in Asia. But again, our factory guys are pushing as hard as they can to try and offset some of that and mitigate that but there is a little bit of lumpiness in that sense that we did ship ahead in Q1 and that’s what you saw a little bit of a bump in revenues in Asia and you’ll see a little bit going down in Q2 but it’s not demand related it’s more how we affected with the ERP system.

Shawn M. Harrison – Longbow Research

My final point, just clarification on the operating expenses, assume on a dollar basis, I just want to make sure this is correct, flat quarter-to-quarter with what you reported during the August quarter?

Kelly E. Lang

So Q4 to Q1?

Shawn M. Harrison – Longbow Research

I guess Q1 to Q2 on a dollar basis assume op ex is steady and kind of hold that number through the remaining portion of the fiscal year?

Kelly E. Lang

I think that’s a good assumption. Again, just taking out that gain on [inaudible] that’s buried itself in operating expenses. You might recall it was $600,000 organic so take that out and then that would be the run rate based on everything we know today.

Shawn M. Harrison – Longbow Research

Kind of $9.7 to $10 million, something of that range?

Kelly E. Lang

We anticipate kind of in the back half of the year some opportunities that we might be able to get a little bit more costs out and that’s how I think we can get to that 10% number again. Assuming revenues hold and build in Asia particularly.

Operator

Our next question comes from [Sean Hannon – Sean Hannon].

[Sean Hannon – Sean Hannon]

You had mentioned a little bit of commentary around lead times, is it possible that you can kind of perhaps elaborate on the lead times per region at least in terms of the progression through the quarter? Then, to follow on that, where you stand with utilization across your facilities today?

Kelly E. Lang

I’ll answer the second part of the question first, today we’re really consistent from a lead time basis. We’re at six to eight weeks globally. We did have, if you recall from our last quarter our lead times in North America were extended outside what the industry average was. We had a production bubble that we worked through so we did have during the quarter an unwinding, or I’ll just call it a normalization of the lead times.

With some of our customers we were out as long as 12 weeks at the beginning of the quarter and about mid quarter we came back to the industry average of six to eight weeks. We’ve been consistently like that since July in North America and we anticipate right now to be globally at six to eight weeks for all of our customers through the balance of this quarter.

Michael D. Burger

From a capacity perspective in Asia we’re busting at the seams, we’re probably 95% plus which is good news. Frankly, our challenge is to keep it at that level as we ramp capacity which is, as we mentioned in the commentary, we’re doing. North America we’re 75% to 80% today.

Operator

Our next question comes from Kevin M. Kessel – Bear, Stearns & Co., Inc.

Kevin M. Kessel – Bear, Stearns & Co., Inc.

I wanted to just find out if there was any update at all on the potential sale of the Hong Kong land?

Michael D. Burger

We are actively marketing it. We have got a lot of interest but we do not have a transaction that is imminent yet. By the way, it’s not just about finding someone that wants it, we’ve got to go through an approval process with the Hong Kong government so that may take a bit of time, part of which we’re not in control over. So, we don’t have anything imminent but there’s a lot of interest.

Kevin M. Kessel – Bear, Stearns & Co., Inc.

At this point is there anything that you guys can outline in terms of what the potential range of value or what you’re marketing it at? Something to give us a sense for what it might be?

Kelly E. Lang

It’s being marketed actually north of $20 million gross before any selling cost and stuff but we’re kind of estimating anywhere between $10 and $15 is kind of our estimate right now just depending on where you sell it at. We’re trying to hedge our bet a bit just because we haven’t sold it and with the macro conditions we’re trying to be a little careful on setting expectations.

Kevin M. Kessel – Bear, Stearns & Co., Inc.

You guys talked about the SG&A and I understand the $600,000 gain that was in SG&A this quarter which going forward you obviously wouldn’t see as a recurring item. But, I think from what I can tell and from what you guys are saying in your press release and in here, I guess there’s a discrepancy in terms of the gross margin I have for you a quarter ago versus the 11% or number you guys have mentioned. I think I was at 12.2% and I don’t know if it has to do with again, another sort of one time item that maybe I have missed.

The way it appears to me is that gross margin actually fell close to 100 basis points on a sequential basis in August. I’m just wondering what I’m missing.

Allen Muhich

In the prepared remarks, I think Kelly did allude to the fact that we had a couple of reclassifications. One, that we actually talked about 12 months ago and that’s a engineering reclass where we moved the majority of the engineering expenses that had previously been in operating expenses, we moved them up in to COS. Then, we also have been developing this global management structure that had previously been hosted in Oregon. Therefore, we moved that around.

That wouldn’t necessarily impact the overall gross margin percentage but it does impact the operating segment margin so you might see some differences within the lines themselves or within the operating segments. In the press release, we actually did include a prior four quarters, all of fiscal 08 by quarter on a restated basis to help you guys reset your models.

Kevin M. Kessel – Bear, Stearns & Co., Inc.

So obviously in the August quarter like you said engineering costs are all showing up in the cost of goods sold number whereas previously clearly they weren’t but you’ve done a reclass so we can see how we get to that 11% number.

Kelly E. Lang

Just to be clear, the reason we did it was just to help comparability and compare us to our peers I think we should be a bit more transparent. Some people asked if that changed our business model and we still believe that gross margins in Asia and North America should be in that 20% range because again, you look at our peers in the same space, there’s no excuse that we can’t be there so that’s where we’re driving our business to.

Kevin M. Kessel – Bear, Stearns & Co., Inc.

I guess that leads to the other question which is that you guys provide that breakdown, the geographic breakdown on a quarterly basis by site but just not for this quarter so I’m wondering can you provide that right now or do we have to wait until the filing to get what the gross margins were by site? I know you do it by region but I’m looking for like Oregon, San Jose breakdown.

Allen Muhich

I think in the press release, on the very last page, page six, the information is actually there. By quarter we provided it for Oregon, San Jose, North America in total, Asia and then obviously the total.

Kevin M. Kessel – Bear, Stearns & Co., Inc.

Allen, I guess I just didn’t see August. I mean I saw September 07 through May 08 and then the fiscal year.

Allen Muhich

The August number is already restated so I think if you went to the income statement that is on our page three it shows the August quarter as stated.

Kevin M. Kessel – Bear, Stearns & Co., Inc.

But it doesn’t have the breakdown. I’m looking for Oregon and San Jose.

Allen Muhich

Oregon was in Q1 of fiscal ’09 Oregon was 10.3% and San Jose was 17.1%. And, that’s obviously on a restated?

Allen Muhich

Yes.

Kevin M. Kessel – Bear, Stearns & Co., Inc.

Then just lastly, I know that you guys talked about cap ex that you’re expecting it to be roughly $18 I think you said on the high end of the earlier range of $16 to $18 for the year. Any sense at all right now where you did $9 million in cash flow from ops in the first quarter where you think that might end of for your fiscal year?

Kelly E. Lang

We really don’t have any guidance to give you on the cash flow from ops. I think you have to build your model from a profitability standpoint but again, the cap ex spend is roughly $9 in Q1, $5ish in Q2 and $3.5 in the back half of the year.

Kevin M. Kessel – Bear, Stearns & Co., Inc.

What about from a working capital perspective? I know you guys said you think you can still improve on a few areas. From an inventory perspective you kind of held it flat, do you see that changing in any material way?

Kelly E. Lang

I think we see inventory probably holding relatively flat. I think there’s some opportunity a little bit on DPO, we really worked that I think the last year. Where I think our real opportunities continue to lay are in DSO. We came up five days this last quarter and we still believe that there’s probably equal to that amount of opportunity kind of over the balance of the year which is kind of $1 million a day is kind of the way to think about it.

Operator

Our next question comes from [Sean Hannon – Sean Hannon].

[Sean Hannon – Sean Hannon]

Just administratively if I could just follow on for your top five customers, don’t know if you had mentioned this in terms of percentage and just the names?

Kelly E. Lang

We don’t provide the names. We did say that CISCO and Motorola were both north of 10%. What else did you want to know?

[Sean Hannon – Sean Hannon]

Just because in the past I think you had just named who two of the top five were. Then separately if I could just get as a percentage how they roll up?

Kelly E. Lang

It’s roughly 40% for the top five which is you kind of look across the last four quarters it’s been between 35% and 43% so we’re up 40% in Q1.

Operator

Our next question comes from the line of [Scott Surel – S Squared].

[Scott Surel – S Squared]

Just a quick question on the gross margins, I apologize if you covered this earlier, but did you give any guidance sequentially as we look out in the current quarter and next quarter where that will be trending? It sounds like the target is still, even though adjusting for R&D moving up above the line, that you’re talking 18% to 20%. But, how do you see that over the next couple of quarters? I know top line is a big component of that but should we still be expecting a sequential increase even if the top line is a little bit challenged in the next quarter or so?

Kelly E. Lang

Scott, we’re not giving the specific quantitative guidance but I can give you some qualitative things to consider and that is what we said is that in Asia we see demand steady and filling the new capacity and we also see that North America we have seen a softening demand. Again, I apologize we’re not giving the specific stuff, we’re trying to follow new guidelines here internally so hopefully that can help you a little bit on that.

I think the bottom line is we did say that albeit the uncertainty we’re seeing in the market right now that we do believe that we will be cash flow positive in the quarter and kind of see how it all plays out. But, right now it’s pretty chopping in North America and steadier and growing in Asia.

[Scott Surel – S Squared]

You mentioned some new customers that you’ve won in Asia as well. It sounds like they’re new customers and not guys you are transitioning from North America. Could you help us understand the magnitude and how quickly some of that might ramp up as we get in to the February and May quarters?

Kelly E. Lang

The magnitude is going to be starting out in probably the $1 to $2 million per quarter. We’re going to see a little bit of that in Q2. I would say by the end of Q4 that the magnitude would be more in the $5 million range per quarter. That’s at two to three customers.

[Scott Surel – S Squared]

In aggregate for $5 million over those two to three customers?

Kelly E. Lang

Per quarter at a run rate by Q4. In the aggregate yes.

Operator

At this time we’re showing no further questions.

Michael D. Burger

Thank you everybody for listening. We appreciate your time and your interest in Merix. We’ll talk to you next quarter.

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