Merix 10-Q 2008
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
For the quarterly period ended August 30, 2008
For the transition period from to
Commission File No. 1-33752
(Exact name of registrant as specified in its charter)
Registrants telephone number, including area code: 503-716-3700
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of accelerated filer, large accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
The number of shares of common stock outstanding as of October 6, 2008 was 21,237,502 shares.
INDEX TO FORM 10-Q
CONSOLIDATED BALANCE SHEETS
See accompanying Notes to Consolidated Financial Statements.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
See accompanying Notes to Consolidated Financial Statements.
CONSOLIDATED STATEMENTS OF CASH FLOWS
See accompanying Notes to Consolidated Financial Statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. NATURE OF BUSINESS
Merix Corporation, an Oregon corporation, was formed in March 1994. Merix is a leading global manufacturing service provider for technologically advanced printed circuit boards (PCBs) for original equipment manufacturer (OEM) customers and their electronic manufacturing service (EMS) providers. The Companys principal products are complex multi-layer rigid PCBs, which are the platforms used to interconnect microprocessors, integrated circuits and other components that are essential to the operation of electronic products and systems. The market segments the Company serves are primarily in commercial equipment for the communications and networking, computing and peripherals, industrial and medical, defense and aerospace and automotive markets. The Companys markets are generally characterized by rapid technological change, high levels of complexity and short product life cycles, as new and technologically superior electronic equipment is continually being developed.
NOTE 2. BASIS OF PRESENTATION
The accompanying consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and note disclosures normally included in the Annual Report on Form 10-K prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to those rules or regulations. The interim consolidated financial statements are unaudited, however, they reflect all normal recurring adjustments and non-recurring adjustments that are, in the opinion of management, necessary for a fair presentation. The interim consolidated financial statements should be read in conjunction with the consolidated financial statements and the notes thereto included in our 2008 Annual Report on Form 10-K. Results of operations for the interim periods presented are not necessarily indicative of the results to be expected for the full year.
The Companys fiscal year consists of a 52 or 53 week period that ends on the last Saturday in May. Fiscal 2009 is a 52 week fiscal year ending on May 30, 2009. The first quarter of fiscal 2009 ended August 30, 2008 and the first quarter of fiscal 2008 ended September 1, 2007 and included thirteen and fourteen weeks, respectively.
NOTE 3. BASIS OF CONSOLIDATION
The consolidated financial statements include the accounts of Merix Corporation and its wholly-owned and majority-owned subsidiaries. Except for activity related to Merix Asia, for which certain intercompany amounts cannot be eliminated as discussed below, all intercompany accounts, transactions and profits have been eliminated in consolidation.
The functional currency for all subsidiaries is the U.S. dollar. Foreign exchange losses for the fiscal quarters ended August 30, 2008 and September 1, 2007 totaled $0.3 million and $0.3 million, respectively, and are included in net other expense in the consolidated statements of operations.
The Companys financial reporting systems at Merix Asia are predominantly manual in nature, and accordingly, significant time is required to process and review the transactions in order to assure the financial information is properly stated. Additionally, Merix Asia performs a complex financial consolidation of its subsidiaries prior to the Companys final consolidation. The time required to complete Merix Asias consolidation, record intercompany transactions and properly report any adjustments, intervening and/or subsequent events requires the use of a one-month lag in consolidating the financial statements for Merix Asia with Merix Corporation. Intercompany transactions which occurred during these periods have been eliminated in consolidation. Intercompany balances resulting from transactions with Merix Asia during the one-month lag period have been netted and presented as a current asset on the consolidated balance sheet. The net intercompany receivable, which was included as a component of other current assets, totaled $0.3 million as of August 30, 2008 and $0.2 million as of May 31, 2008. Due to the one-month reporting lag, Merix Asia borrowings totaling $1.7 million on the revolving line of credit during August 2008 are not reflected on the consolidated balance sheet as of August 30, 2008.
The Company selected a new enterprise resource planning (ERP) system to support its transition to a global business and completed implementation for its North America operations during fiscal 2008. The Company completed the process of implementing the new ERP system for its Asia operations during August 2008 and this system will be used to report results of Asia operations beginning in the second quarter of fiscal 2009. The new system will allow for the streamlining of business processes and may eventually eliminate the need for the one-month reporting lag for Merix Asia.
NOTE 4. RECLASSIFICATIONS
Certain immaterial reclassifications were made to the prior period financial statements to conform to the current period presentation, including a reclassification of certain engineering costs which are directly related to the production of goods for sale which are included in cost of sales in the consolidated statements of operations. These costs were previously included as a component of operating expenses. The impact of the reclassification on inventory balances is not material. The results of operations for the first quarter of fiscal 2008 have been revised as shown below:
NOTE 5. INVENTORIES
Inventories are valued at the lower of cost or market and include materials, labor and manufacturing overhead. Inventory cost is determined by standard cost, which approximates the first-in, first-out (FIFO) basis.
The Company includes a provision for inventories to cover excess inventories to their estimated net realizable values, as necessary. A change in customer demand for inventory is the primary indicator for reductions in inventory carrying values. The Company records provisions for excess inventories based on historical experiences with customers, the ability to utilize inventory in other programs, the ability to redistribute inventory back to the suppliers and current and forecasted demand for the inventory. The increase (decrease) to inventory valuation reserve was ($0.8 million) and $0.3 million, respectively, during the first quarters of fiscal 2009 and 2008. As of August 30, 2008 and May 31, 2008, our inventory reserves totaled $2.9 million and $3.7 million, respectively.
The Company maintains inventories on a consignment basis in the United States and in Asia. Consignment inventory is recorded as inventory until the product is pulled from the consignment inventories by the customer and all risks and rewards of ownership of the consignment inventory have been transferred to the customer.
Inventories, net of related reserves, consisted of the following (in thousands):
NOTE 6. ASSETS HELD FOR SALE
Assets held for sale included the following:
These assets are recorded at the lower of their carrying amount or fair value, less cost to sell and are no longer being depreciated.
During fiscal 2008, the Company ceased manufacturing operations at its Hong Kong facility. The net book values of the building and related land use rights were reduced to $0 by an impairment charge recorded in fiscal 2007. These assets are classified as assets held for sale at August 30, 2008 and May 31, 2008.
NOTE 7. PREPAID AND OTHER CURRENT ASSETS
Prepaid expenses and other current assets consisted of the following at August 30, 2008 and May 31, 2008 (in thousands):
NOTE 8. DEFINITE-LIVED INTANGIBLE ASSETS
At August 30, 2008 and May 31, 2008, the Companys definite-lived intangible assets included customer relationships and a manufacturing sales representative network. The gross amount of the Companys definite-lived intangible assets and the related accumulated amortization were as follows (in thousands):
Amortization expense was as follows (in thousands):
Amortization is as follows over the next five fiscal years and thereafter (in thousands):
NOTE 9. OTHER ASSETS
Other assets consisted of the following at August 30, 2008 and May 31, 2008 (in thousands):
NOTE 10. ACCRUED LIABILITIES
Accrued liabilities consisted of the following at August 30, 2008 and May 31, 2008 (in thousands):
During the first quarter of fiscal 2009, the Company incurred $0.8 million in costs related to the restoration of leased Wood Village facilities which were charged to the asset retirement obligation.
NOTE 11. ACCRUED WARRANTY
The Company generally warrants its products for a period of up to twelve months from the point of sale. However, in selected circumstances, Merix Asia grants longer warranty periods to certain customers of up to three years. The Company records a liability for the estimated cost of the warranty upon transfer of ownership of the products to the customer. Using historical data, the Company estimates warranty costs and records the provision for such charges as an element of cost of goods sold upon recognition of the related revenue. The Company also accrues warranty liability for certain specifically identified items that are not covered by its assessment of historical experience.
Warranty activity was as follows (in thousands):
NOTE 12. ADOPTION OF FAS 157 AND FAS 159
In September 2006, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 157, Fair Value Measurements. SFAS No. 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosure related to the use of fair value measures in financial statements. The provisions of SFAS No. 157 were to be effective for fiscal years beginning after November 15, 2007. On February 6, 2008, the FASB agreed to defer the effective date of SFAS No. 157 for one year for certain nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). Effective June 1, 2008, the Company adopted SFAS No. 157 except as it applies to those nonfinancial assets and nonfinancial liabilities. The adoption of SFAS No. 157 did not have any material impact on the Companys results of operations or financial position.
Effective January 1, 2008, the Company adopted SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities including an amendment of FASB Statement No. 115. SFAS No. 159 allows an entity the irrevocable option to elect fair value for the initial and subsequent measurement of certain financial assets and liabilities under an instrument-by-instrument election. Subsequent measurements for the financial assets and liabilities an entity elects to fair value will be recognized in the results of operations. SFAS No. 159 also establishes additional disclosure requirements. The Company did not elect the fair value option under SFAS No. 159 for any of its financial assets or liabilities upon adoption. The adoption of SFAS No. 159 did not have a material impact on the Companys results of operations or financial position.
NOTE 13. COMPREHENSIVE LOSS, EARNINGS PER SHARE AND SHARE ACTIVITY
Comprehensive income (loss) includes the change in our cumulative translation adjustment. The following table sets forth the calculation of comprehensive income (loss) for the periods indicated (in thousands):
Basic earnings per share (EPS) and diluted EPS are computed using the methods prescribed by SFAS No. 128, Earnings per Share. For the fiscal quarters ended August 30, 2008 and September 1, 2007, the following potentially dilutive shares were excluded from the calculation of diluted EPS because their effect would have been dilutive.
Potential common shares excluded from diluted EPS since their effect would be antidilutive:
During the first quarter of fiscal 2009, approximately 139,000 shares were issued related to share-based compensation transactions, primarily due to the semi-annual share purchase under the employee stock purchase plan.
NOTE 14. SEGMENT INFORMATION
The Company has three reportable business segments defined by geographic location in accordance with SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information: (1) Merix Oregon, (2) Merix San Jose and (3) Merix Asia. Operating segments are defined as components of an enterprise for which separate financial information is available and regularly reviewed by senior management. The Companys operating segments are evidence of the internal structure of its organization. Each segment operates in the same industry with production facilities that produce similar customized products for its customers. The production facilities, sales management and chief decision-makers for all processes are managed by the same executive team. The Companys chief operating decision maker is its Chief Executive Officer. Segment disclosures are presented to the gross profit level as this is the primary performance measure for which the segment managers are responsible. No other operating results information is provided to the chief operating decision maker for review at the segment level. The following tables reconcile certain financial information by segment.
Net sales by segment were as follows (in thousands):
Gross profit by segment was as follows (in thousands):
Beginning in fiscal 2009, the Company recorded an allocation of certain costs attributable to costs of sales in all segments that were previously charged to the Merix Oregon segment and included certain engineering costs in costs of sales that were previously presented as a component of operating expenses. Gross profit by segment for the first quarter of fiscal 2008 has been revised to present comparable results. The impact of these revisions on gross margin by segment is presented in the table below.
Total assets by segment were as follows (in thousands):
NOTE 15. SIGNIFICANT CUSTOMERS
Two customers accounted for 15% and 10% of the Companys net sales in the first quarter of fiscal 2009. One customer accounted for 12% of net sales in the first quarter of fiscal 2008. No other customer comprised more than 10% of net sales in the first quarters of fiscal 2009 and fiscal 2008.
At August 30, 2008, five entities represented approximately 46% of the Companys net accounts receivable balance, individually ranging from approximately 5% to approximately 17%.
NOTE 16. COMMITMENTS AND CONTINGENCIES
The Company is, from time to time, made subject to various legal claims, actions and complaints in the ordinary course of its business. Except as disclosed below, management believes that the outcome of litigation should not have a material adverse effect on its consolidated results of operations, financial condition or liquidity.
Securities Class Action
Four purported class action complaints were filed against the Company and certain of its executive officers and directors in the first quarter of fiscal 2005. The complaints were consolidated in a single action entitled In re Merix Corporation Securities Litigation, Lead Case No. CV 04-826-MO, in the U.S. District Court for the District of Oregon. After the court granted the Companys motion to dismiss without prejudice, the plaintiffs filed a second amended complaint. That complaint alleged that the defendants violated the federal securities laws by making certain inaccurate and misleading statements in the prospectus used in connection with the January 2004 public offering of approximately $103.4 million of the Companys common stock. In September 2006, the Court dismissed that complaint with prejudice. The plaintiffs appealed to the Ninth Circuit Court of Appeals. In April 2008, the Ninth Circuit reversed the dismissal of the second amended complaint. The Company sought rehearing which was denied and rehearing en banc was also denied. The Company obtained a stay of the mandate from the Ninth Circuit and filed a certiorari petition with the United States Supreme Court on September 22, 2008. The plaintiffs seek unspecified damages. A potential loss or range of loss that could arise from these cases is not estimable or probable at this time.
Breach of Contract
In June 2008, a complaint was filed against Merix Caymans Trading Company Ltd. by Clark Sales, LLC, Case No. 2:08-CV-12551-MOR-VMM, in the United States District Court, Eastern District of Michigan. The complaint alleges breach of contract in relation to payment of post-termination commissions. The plaintiffs seek damages in excess of $4 million. The Company believes that the court has no jurisdiction to hear the claim and that the claims have no merit and as such, has not recorded a liability for potential loss. The plaintiff has agreed to arbitrate the claim. The arbitration is scheduled to begin on December 4, 2008.
As of August 30, 2008, the Company had capital commitments of approximately $4.8 million, primarily relating to the purchase of machinery and equipment.
NOTE 17. RELATED PARTY TRANSACTIONS
The Company recorded the following amounts for transactions with Huizhou Desay Holdings Co. Ltd., a minority shareholder in two Merix Asia manufacturing facilities, during the periods indicated (in thousands):
NOTE 18. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In December 2007, the FASB issued SFAS No. 141(R), Business Combinations, and SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements. SFAS Nos. 141(R) and 160 require most identifiable assets, liabilities, noncontrolling interests and goodwill acquired in a business combination to be recorded at full fair value and require noncontrolling interests (previously referred to as minority interests) to be reported as a component of equity, which changes the accounting for transactions with noncontrolling interest holders. Both statements are effective for periods beginning on or after December 15, 2008 and earlier adoption is prohibited. SFAS No. 141(R) will be applied to business combinations occurring after the effective date and SFAS No. 160 will be applied prospectively to all noncontrolling interests, including any that arose before the effective date. The Company is currently analyzing the effects of adopting SFAS Nos. 141(R) and 160.
In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities, which requires certain disclosures related to derivative instruments. SFAS No. 161 is effective prospectively for interim periods and fiscal years beginning after November 15, 2008. The Company is currently evaluating the effects, if any, that the adoption of SFAS No. 161 will have on its financial position and results of operations. The Company currently has no derivative instruments and does not currently engage in hedging activity and as such, the adoption of SFA No. 161 is not expected to have a significant impact on its financial position and results of operations.
NOTE 19. SEVERANCE AND RESTRUCTURING CHARGES
Total severance and restructuring charges were as follows (in thousands):
In the first quarter of fiscal 2008, the Company committed to phasing out operations at its Hong Kong facility, closing the facility and relocating production to other manufacturing facilities. Full closure of the facility was completed in the fourth quarter of fiscal 2008. This closure was a part of the Companys actions to consolidate its Asian operations at its lower-cost facilities in China. The Company is also expanding the facilities at its Huiyang plant to increase its manufacturing capacity in China. The Company recorded approximately $40,000 and $0.2 million, respectively, in severance and related costs in the first quarters of fiscal 2009 and 2008 in connection with the closure of the Hong Kong facility. In the first quarter of fiscal 2009, the Company recorded a gain of $0.6 million related to the sale of equipment previously used at the Hong Kong facility.
A roll-forward of the Companys severance accrual for the first quarter of fiscal 2009 was as follows (in thousands):
Forward Looking Statements
This Quarterly Report contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. All statements, other than statements of historical fact, including statements regarding industry prospects and future results of operations or financial position, made in this Quarterly Report are forward-looking. We use words such as anticipates, believes, expects, future should and intends and other similar expressions to identify forward-looking statements. Forward-looking statements reflect managements current expectations, plans or projections and are inherently uncertain. Actual results could differ materially from managements expectations, plans or projections. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this report. Certain risks and uncertainties that could cause our actual results to differ significantly from managements expectations, plans and projections are described in Part II, Item 1A, Risk Factors under the subheading Risk Factors Affecting Business and Results of Operations. This section, along with other sections of this Quarterly Report, describes some, but not all, of the factors that could cause actual results to differ significantly from managements expectations, plans and projections. We do not intend to publicly release any revisions to these forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. Readers are urged, however, to review the factors set forth in reports that we file from time to time with the Securities and Exchange Commission, including our most recent Annual Report on Form 10-K for the fiscal year ended May 31, 2008.
We are a leading global manufacturing service provider of technologically advanced printed circuit boards (PCBs) for original equipment manufacturer (OEM) customers and their electronic manufacturing service (EMS) providers. Our principal products are complex multi-layer rigid PCBs, which are the platforms used to interconnect microprocessors, integrated circuits and other components that are essential to the operation of electronic products and systems. The market segments we serve are primarily in commercial equipment for the communications and networking, computing and peripherals, test, industrial and medical, defense and aerospace and automotive markets. Our markets are generally characterized by rapid technological change, high levels of complexity and short product life cycles, as new and technologically superior electronic equipment is continually being developed.
Our business has three operating segments: (1) Merix Oregon, (2) Merix San Jose and (3) Merix Asia. Operating segments are defined as components of an enterprise for which separate financial information is available and regularly reviewed by senior management. Each operating segment operates predominately in the same industry with production facilities that produce similar customized products for our global customers. The chief decision-maker for all of our operating segments is our Chief Executive Officer.
Markets and Customers
The following table presents the percentage of net sales, by segment, for significant customers comprising greater than 10% of total net sales:
Approximately 55% and 54%, respectively, of our OEM sales in the first quarter of fiscal 2009 and 2008 were made to EMS providers. Although our contractual relationship is with the EMS provider, most of our shipments to EMS providers are directed by OEMs that negotiate product pricing and volumes directly with us. In addition, we are on the approved vendor list of several EMS providers and are awarded incremental discretionary orders directly from some of them. We expect these discretionary orders to increase in the future as we strengthen our direct relationships with these EMS providers.
Backlog comprises purchase orders received and, in some instances, forecast requirements released for production under customer contracts. Backlog shippable within the next 90 days totaled $57.0 million and $66.3 million at August 30, 2008 and May 31, 2008, respectively. The decrease in backlog is due in part to the reduction in lead times achieved during the current quarter. Backlog was abnormally high at the end of fiscal 2008 due to extended customer lead times resulting from the fourth quarter closure of our Wood Village facility requiring customers to place orders over a longer-than-normal period of time. As the production lead times were shortened during the first quarter of fiscal 2009, customers did not need to place orders as far in advance, leading to a reduction in orders placed in the current quarter that is shippable in future quarters.
Customers may cancel or postpone all scheduled orders, in most cases without penalty. Therefore, backlog may not be a meaningful indicator of future financial results.
Summary of Sequential Quarterly Results and Outlook for Second Quarter of Fiscal 2009
Net sales of $90.6 million in the current quarter increased $3.1 million or 4% compared to net sales in the fourth quarter of fiscal 2008, due primarily to a 9% increase in net sales in our Asia segment. This increase was primarily due to early shipments of product to customers intended to ensure a continuity of supply in preparation for a planned one-week shutdown of our Asia factories in August 2008 to enable a successful enterprise resource planning (ERP) system implementation in that region as well as a one-week shutdown of our Asia factories for Chinese New Year in the fourth quarter of fiscal 2008. Increases in Asia were offset by a minor $0.6 (1%) million decrease in net sales in our North American segments. Gross margin increased to 11.3% in the current quarter compared to 10.7% in the fourth quarter of fiscal 2008 due primarily to pricing increases in North American segments, and cost savings as a result of the closure of our Hong Kong facility as well as improved fixed cost absorption on higher production volumes in our Asia segment. Operating expenses of $10.3 million increased $0.6 million compared to the prior quarter due primarily to variable compensation expense and the timing of costs related to the annual audit of our fiscal 2008 financial statements which was completed in the first quarter of fiscal 2009, offset by a $0.6 million gain recorded on sales of equipment from our former Hong Kong facility. Net non-operating expense of $1.1 million decreased by $0.5 million due primarily to the write-off of deferred financing costs related to the replacement of our former revolving line of credit facility in the fourth quarter of fiscal 2008. Net loss for the quarter totaled $2.1 million or $0.10 per diluted share, compared to $3.5 million or $0.17 per diluted share in the fourth quarter of fiscal 2008.
In the first quarter of fiscal 2009, we experienced a softening of demand in our North American segments due to several factors including:
This softer demand is not contained within any one particular market segment but appears to be broad-based across all of our end markets. In the second quarter, we expect orders for our Asian factories to remain steady, however, North American demand is anticipated to reflect the softness in our current order booking rate resulting in reduced revenue levels in the second quarter of fiscal 2009.
The decrease in orders for our North American factories, coupled with uncertainty in the macro economic environment, will likely delay the timing of our financial recovery and provides limited visibility for a timeframe of returning to profitability. As a result of ongoing cost containment efforts, we do not expect underlying spending levels to change in the second quarter, however, reported operating expenses will increase as first quarter expenses benefited from a $0.5 million gain on Hong Kong equipment sales. No significant changes are expected for other non-operating expenses and the income tax provision compared to first quarter levels.
Results of Operations Compared to Prior Year
The following table sets forth our statement of operations data, both in absolute dollars and as a percentage of net sales (dollars in thousands).
Net sales decreased by $8.8 million, or 9%, to $90.6 million, in the first quarter of fiscal 2009 compared to $99.4 million in the first quarter of fiscal 2008. This decrease is primarily due to an $11.3 million or 20% decrease in North American segments offset by a $2.5 million or 6% increase in our Asia segment, as further discussed below.
Net sales by segment were as follows (in thousands):
Per Unit Information
We define unit as the number of panels. Percentage increases (decreases) in unit volume and pricing for the first quarter of fiscal 2009 compared to the first quarter of fiscal 2008 were as follows:
Consolidated unit sales volume decreased 5%, driven primarily by decreases in our North American segments as further discussed below. Consolidated average unit pricing decreased by 4%, despite increases in average unit pricing reflected for each of our segments as discussed below. Our Asia segment comprised 50% of net sales in the first quarter of fiscal 2009 compared to 44% in the first quarter of fiscal 2008. Further, our Asia segments average price per unit is significantly lower than both the Oregon and San Jose segments. This overall shift in product mix from higher-technology, higher-priced PCBs produced by our North American facilities to lower-technology, lower-priced PCBs produced by our facilities in Asia results in a lower consolidated average unit price.
Merix Oregon net sales of $37.2 million decreased by $10.1 million or 21% compared to the first quarter of fiscal 2008. The decrease in net sales at Merix Oregon in the first quarter of fiscal 2009 compared to the first quarter of fiscal 2008 was primarily due to a 23% decrease in unit volume resulting from:
The volume decrease was partially offset by a 3% increase in average unit pricing, which resulted primarily from our efforts to be more selective on orders and to utilize plant capacity for more profitable parts.
Merix San Jose
Net sales for Merix San Jose decreased by $1.2 million or 13% the first quarter of fiscal 2009 compared to the first quarter of fiscal 2008. Approximately half of that decrease is attributed to the 13-week first quarter in fiscal 2009 compared to the 14-week first quarter in fiscal 2008 (see Note 2 of Notes to Consolidated Financial Statements). Panel unit volumes decreased by 27% compared to the first quarter of the prior fiscal year due to the efficiency impact of difficulties experienced with a major piece of production equipment as well as soft demand for quick-turn services, but net sales in the current quarter were comprised of higher-layer, higher-technology products which carry a higher price premium and resulted in a 19% increase in average unit pricing.
Merix Asia net sales of $45.7 million in the first quarter of fiscal 2009 increased by $2.5 million or 6% compared to the first quarter of fiscal 2008. Panel unit volumes decreased by 3% compared to the same quarter in the prior year, but efforts to improve our product mix through enhanced technology offerings from our Asia manufacturing operations over the past year resulted in a 9% increase in average unit pricing.
Net Sales by End Market
The following table shows, for the periods indicated, the amount of net sales to each of our principal end-user markets and the percentage of the end-user markets sales to our consolidated net sales (dollars in thousands):
The $1.5 million or 25% increase in defense & aerospace was due to strategic efforts to penetrate this market to diversify our customer base and provide a steady and profitable North American revenue stream.
The $0.8 million or 4% decrease in automotive net sales is relatively minor and is due primarily to macroeconomic factors impacting the ultimate demand for our customers products.
The decreases in net sales of $3.9 million (9%) in communications & networking, $1.4 million (18%) in computing & peripherals, $1.1 million (9%) in test, industrial & medical and $3.1 million (27%) in other end markets were due primarily to the strategic rationalization of our production to focus on more profitable parts as well as the impact to ongoing customer relationships of the closure of our Wood Village facility in the fourth quarter of fiscal 2008. We believe that our key competitive advantages include our reputation for product quality and our unique value proposition, which enables a seamless interface from quick-turn production at the beginning of product life cycles to lower-cost volume production in mature product life cycles. Operating our restructured North American facilities and upgraded Asian facilities to leverage those competitive advantages should enable us to restore and grow our customer base in the future.
Net Sales by Geographic Region
Net sales to customers outside the United States totaled 62% and 67% of net sales in the first quarters of fiscal 2009 and fiscal 2008, respectively.
Cost of Sales and Gross Margin
Cost of sales includes manufacturing costs, such as materials, labor (both direct and indirect) and factory overhead.
A number of costs, including those for labor, utilities and manufacturing supplies, incurred by our plants in the Peoples Republic of China (PRC) are denominated in Chinese renminbi. Strengthening or weakening of the Chinese renminbi relative to the U.S. dollar affects our cost of sales and profitability. Recent increases in the value of the Chinese renminbi relative to the U.S. dollar have caused the costs of our operations in Asia to increase as stated in U.S. dollars.
Cost of sales decreased $8.0 million, or 9%, to $80.4 million (88.7% of net sales) in the first quarter of fiscal 2009 compared to $88.4 million (88.9% of net sales) in the first quarter of fiscal 2008.
Beginning in fiscal 2009, we recorded an allocation of certain costs attributable to costs of sales in all segments that were previously charged to the Merix Oregon segment. Gross margin by segment for the first quarter of fiscal 2008 has been revised to present comparable results using the same allocation methodology. Our gross profit by segment was as follows (in thousands):
Our gross margin as a percentage of net sales by segment was as follows:
Our gross margin at Merix Oregon decreased to 10.3% of net sales in the current quarter from 13.4% in the first quarter of fiscal 2008 primarily due to decreased fixed cost absorption on lower production volumes. Although, the closure of the Wood Village facility at the end of fiscal 2008 resulted in a reduction of costs of approximately $1.7 million in the current quarter when compared to the first quarter of fiscal 2008, reduced demand for quick-turn services as discussed above led to significant decreases in production volumes. Factory margins are heavily influenced by factory utilization rates because the cost structure needed to produce printed circuit boards is heavily weighted to fixed or step-variable costs. Thus, lower production volumes resulted in lower utilization rates and a decrease in gross margin as a percentage of net sales.
Merix San Jose
Our gross margin at Merix San Jose increased to 17.1% in the current quarter from 14.3% in the first quarter of fiscal 2008 primarily due to a shift in product mix to higher-technology products which command a higher price and are more profitable.
Our gross margin at Merix Asia increased to 11.2% in the current quarter compared to 8.0% in the first quarter of fiscal 2008 primarily as a result of a product mix improvement to more profitable higher-technology orders and cost efficiencies gained from the closing of our Hong Kong facility in fiscal 2008.
Engineering costs include indirect labor, materials and overhead to support the development of new manufacturing processes required to meet our customers evolving technology requirements.
Engineering costs increased $0.1 million, or 21%, to $0.6 million in the first quarter of fiscal 2009 compared to $0.5 million in the first quarter of fiscal 2008. The increase is primarily due to compensation expense on headcount increases compared to the staffing levels in the prior year.
Selling, General and Administrative Costs
Selling, general and administrative (SG&A) costs include indirect labor, travel, outside services and overhead incurred in our sales, marketing, management and administrative support functions.
SG&A costs decreased $1.9 million to $9.7 million in the first quarter of fiscal 2009 as compared to the first quarter of fiscal 2008 due primarily to a reduction in bad debt expense as a result of improved collection programs recently implemented and reduced external sales representative commissions which were renegotiated at lower rates during fiscal 2008 combined with lower revenue levels.
Amortization of Identifiable Intangible Assets
Amortization of identifiable intangible assets was $0.5 million in the first quarter of fiscal 2009 and the first quarter of fiscal 2008, respectively. Our identifiable intangible assets balance at August 30, 2008 was $8.3 million and current amortization is approximately $0.5 million per quarter.
Severance and Restructuring Charges
Severance and restructuring charges of ($0.5 million) and $0.2 million in the first quarters of fiscal 2009 and fiscal 2008, respectively, primarily included costs related to the closing of our Hong Kong facility
Total severance and restructuring charges were as follows (in thousands):
In the first quarter of fiscal 2008, we committed to phasing out operations at our Hong Kong facility, closing the facility and relocating production to other manufacturing facilities. Full closure of the facility was completed in the fourth quarter of fiscal 2008. This closure was a part of our actions to consolidate our Asian operations at our lower-cost facilities in China. We are also expanding the facilities at our Huiyang plant to increase our manufacturing capacity in China. We recorded approximately $40,000 and $0.2 million, respectively, in severance and related costs in the first quarters of fiscal 2009 and 2008 in connection with the closure of the Hong Kong facility. In the first quarter of fiscal 2009, we recorded a gain of $0.6 million related to the sale of equipment previously used at the Hong Kong facility.
Interest expense decreased to $0.9 million in the first quarter of fiscal 2009 compared to $1.1 million in the first quarter of fiscal 2008. In the third quarter of fiscal 2008, we repaid $2.5 million on the subordinated promissory note in connection with the reduction in the purchase price of Merix Asia and the remaining $5.1 million of outstanding principal of debt was eliminated in exchange for us settling all past and any future claims against the note holder in relation to our Merix Asia acquisition.
Income Tax Expense
On a quarterly basis, we estimate our provision for income taxes based on our projected results of operations for the full year. Income tax is provided for entities expected to generate profits that are not offset by losses generated by entities in other tax jurisdictions. As a result, our effective income tax rate was negative 62.1% in the first quarter of fiscal 2009 and negative 13.7% in the first quarter of fiscal 2008.
Our effective income tax rate differs from tax computed at the federal statutory rate primarily as a result of our mix of earnings in various tax jurisdictions, the diversity in income tax rates, and our continuous assessment of the realization of our uncertain tax positions and deferred tax assets. The effective tax rate reflects current taxes expected to be paid in profitable jurisdictions, interest accrued on uncertain tax positions and maintenance of valuation allowances in jurisdictions with cumulative losses or profitability risks.
Liquidity and Capital Resources
Our sources of liquidity and capital resources as of August 30, 2008 consisted of $5.9 million of cash and cash equivalents and $50.5 million unused availability under our revolving bank credit agreement, described below. We expect our capital resources to be sufficient to fund our operations and known capital requirements for at least one year from August 30, 2008, although we may seek additional sources of funds.
We have a Loan and Security Agreement with Bank of America, N.A. (the Credit Agreement) which provides a revolving line of credit of up to $55.0 million on a borrowing based calculated with respect to the value of accounts receivable, equipment and real property. The Credit Agreement expires in February 2013. The obligations under the Credit Agreement are secured by substantially all of our U.S. assets. The borrowings bear interest based, at the Companys election, on either the prime rate announced by Bank of America or LIBOR plus an applicable margin. As of August 30, 2008, the unused borrowing base was $50.5 million, with an outstanding balance of $1.7 million borrowed during August 2008 by our Asia subsidiary which is not reflected in the consolidated balance sheet due to the one-month reporting lag. The Credit Agreement contains usual and customary covenants for credit facilities of this type, all of which we were in compliance with as of August 30, 2008.
In the first quarter of fiscal 2009, cash and cash equivalents increased $0.2 million to $5.9 million as of August 30, 2008 from $5.7 million as of May 31, 2008 primarily as a result of $9.2 million provided by operations (as described in more detail below) and $0.6 million in cash proceeds on sales of assets, offset by the use of $9.4 million for the purchase of property, plant and equipment.
Cash flows from operating activities totaled $9.2 million. Cash totaling $3.6 million was provided by net loss of $2.1 million, adjusted for $5.7 million in non-cash charges, primarily $5.5 million for depreciation and amortization. As discussed in more detail below, other significant changes in working capital generating $5.6 million in cash from operations in the first quarter of fiscal 2009 include $2.8 million from reductions in accounts receivable and $3.2 million from decreases in other assets, primarily related to a VAT refund received from the Chinese tax authorities. Note that changes in working capital balances vary from cash flows from operations due to the impact of non-cash transactions on amounts reported in the consolidated balance sheets.
Accounts receivable, net of allowances for bad debts, decreased $2.8 million to $70.3 million at August 30, 2008 from $73.2 million as of May 31, 2008. Our days sales outstanding, calculated on a quarterly basis, was 71 days at August 30, 2008 and 76 days at May 31, 2008 as a result of improved collection programs recently implemented.
Prepaid and other current assets decreased $2.9 million to $10.0 million as of August 30, 2008 compared to $13.0 million as of May 30, 2008, primarily due to a VAT refund received during the first quarter of fiscal 2009. Other non-current assets decreased by $0.5 million to $5.4 million as of August 30, 2008 due to amortization of deferred financing costs and minor reductions in various other assets.
Expenditures for property, plant and equipment of $9.4 million in the first quarter of fiscal 2009 primarily consisted of expenditures for the expansion and improvement of the process technology at our China-based Huiyang facility, improvement of the process technology and increasing the process speed of our North American facility and the continuing implementation of a company-wide ERP system. Most of the capital expenditure associated with the recent expansion of our Huiyang, China facility and ERP implementation is complete at the end of August 2008. Remaining capital expenditures in fiscal 2009 are currently estimated at $8.5 million. Additional capital expenditures may be approved in fiscal 2009, but are dependent upon achievement of financial objectives.
We are currently marketing for sale the facility formerly housing our Hong Kong manufacturing operation. Although a transaction is not imminent, we estimate proceeds on sale in the range of $10 million to $15 million.
Recently Issued Accounting Pronouncements
In December 2007, the FASB issued SFAS No. 141(R), Business Combinations, and SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements. SFAS Nos. 141(R) and 160 require most identifiable assets, liabilities, noncontrolling interests and goodwill acquired in a business combination to be recorded at full fair value and require noncontrolling interests (previously referred to as minority interests) to be reported as a component of equity, which changes the accounting for transactions with noncontrolling interest holders. Both statements are effective for periods beginning on or after December 15, 2008 and earlier adoption is prohibited. SFAS No. 141(R) will be applied to business combinations occurring after the effective date and SFAS No. 160 will be applied prospectively to all noncontrolling interests, including any that arose before the effective date. We are currently analyzing the effects of adopting SFAS Nos. 141(R) and 160.
In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities, which requires certain disclosures related to derivative instruments. SFAS No. 161 is effective prospectively for interim periods and fiscal years beginning after November 15, 2008. We are currently evaluating the effects, if any, that the adoption of SFAS No. 161 will have on our financial position and results of operations. We currently have no derivative instruments and do not currently engage in hedging activity and as such, the adoption of SFA No. 161 is not expected to have a significant impact on our financial position and results of operations.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements that have or are reasonably likely to have a material current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.
Critical Accounting Policies and Use of Estimates
We reaffirm the information included under the heading Critical Accounting Policies and Use of Estimates appearing at page 45 of our Annual Report on Form 10-K for the year ended May 31, 2008, which was filed with the Securities and Exchange Commission on August 7, 2008.
There have been no material changes in our reported market risks and risk management policies since the filing of our Annual Report on Form 10-K for the year ended May 31, 2008, which was filed with the Securities and Exchange Commission on August 7, 2008.
Attached to this quarterly report as exhibits 31.1 and 31.2 are the certifications of our Chief Executive Officer (CEO) and Chief Financial Officer (CFO) required by section 302 of the Sarbanes-Oxley Act of 2002 (the Section 302 Certifications). This portion of our quarterly report on Form 10-Q is our disclosure of the conclusions of our management regarding the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report based on managements evaluation of those disclosure controls and procedures. This disclosure should be read in conjunction with the Section 302 Certifications for a complete understanding of the topics presented.
Evaluation of Disclosure Controls and Procedures
Our management evaluated, with the participation and under the supervision of our CEO and CFO, the effectiveness of our disclosure controls and procedures as of the end of the period covered by this Quarterly Report on Form 10-Q.
In connection with managements assessment of our internal control over financial reporting as of August 30, 2008, we determined that the material weakness in our internal control continued to exist as a result of the control deficiency previously identified with respect to our Merix Asia operations.
Merix Asia was acquired in September 2005. Upon acquisition, Merix Asia had weak internal controls over financial reporting and needed to develop processes to strengthen its accounting systems and control environment management. We have devoted significant time and resources to improving the internal controls over financial reporting since the acquisition. However, Merix management did not maintain sufficient controls to adequately monitor the accounting and financial reporting of our Merix Asia operations. This control deficiency could result in a material misstatement to the interim or annual consolidated financial statements that would not be prevented or detected in a timely manner. Accordingly, management has determined that this control deficiency constitutes a material weakness.
Remediation Steps to Address Material Weakness
Because of the material weakness identified in our evaluation of internal control over financial reporting, we performed and plan to perform additional steps to enhance internal control over financial reporting. Our procedures include, but were not limited to, the following:
Despite the significant improvement of internal controls over financial reporting related to our Merix Asia operations, management believes that it cannot be determined that the material weakness is sufficiently remediated until the successful implementation of the global ERP system for our Asia operations can be evaluated later in fiscal 2009. The ERP system in Asia was implemented at the beginning of our Asia subsidiarys second fiscal quarter in August 2008 and we are currently assessing the impact of the new ERP system on our internal controls at our Asia subsidiary.
Based on managements evaluation of the effectiveness of our disclosure controls and procedures, our CEO and CFO concluded that as of the end of the period covered by the Form 10-Q, due to the need to evaluate the implementation of the global ERP system for our Asia operations, our disclosure controls and procedures were not effective in providing reasonable assurance that information we are required to disclose in reports that we file or submit under the Securities Exchange Act of 1934 is accumulated and communicated to our management, including our CEO and our CFO, as appropriate to allow timely decisions regarding required disclosure and that such information is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms.
Changes in Internal Control Over Financial Reporting
There has been no change in our internal control over financial reporting that occurred during our last fiscal quarter that has materially affected or is reasonably likely to materially affect our internal control over financial reporting. Due to the one-month lag in reporting results of operations for our Asia operations, the implementation of our ERP system in Asia at the beginning of August 2008 did not impact internal control over financial reporting for the first quarter of fiscal 2009.
PART II OTHER INFORMATION
We are, from time to time, made subject to various legal claims, actions and complaints in the ordinary course of business. Except as disclosed below, we believe that the outcome of litigation should not have a material adverse effect on our consolidated results of operations, financial condition or liquidity.
Securities Class Action
Four purported class action complaints were filed against Merix and certain of our executive officers and directors in the first quarter of fiscal 2005. The complaints were consolidated in a single action entitled In re Merix Corporation Securities Litigation, Lead Case No. CV 04-826-MO, in the U.S. District Court for the District of Oregon. After the court granted our motion to dismiss without prejudice, the plaintiffs filed a second amended complaint. That complaint alleged that the defendants violated the federal securities laws by making certain inaccurate and misleading statements in the prospectus used in connection with the January 2004 public offering of approximately $103.4 million of the our common stock. In September 2006, the Court dismissed that complaint with prejudice. The plaintiffs appealed to the Ninth Circuit Court of Appeals. In April 2008, the Ninth Circuit reversed the dismissal of the second amended complaint. We sought rehearing which was denied and rehearing en banc was also denied. We obtained a stay of the mandate from the Ninth Circuit and filed a certiorari petition with the United States Supreme Court on September 22, 2008. The plaintiffs seek unspecified damages. A potential loss or range of loss that could arise from these cases is not estimable or probable at this time.
Breach of Contract
In June 2008, a complaint was filed against Merix Caymans Trading Company Ltd. by Clark Sales, LLC, Case No. 2:08-CV-12551-MOR-VMM, in the United States District Court, Eastern District of Michigan. The complaint alleges breach of contract in relation to payment of post-termination commissions. The plaintiffs seek damages in excess of $4 million. We believe that the court has no jurisdiction to hear the claim and that the claims have no merit and as such, we have not recorded a liability for potential loss. The plaintiff has agreed to arbitrate the claim. The arbitration is scheduled to begin on December 4, 2008.
RISK FACTORS AFFECTING BUSINESS AND RESULTS OF OPERATIONS
Investing in our securities involves a high degree of risk. If any of the following risks impact our business, the market price of our shares of common stock and other securities could decline and investors could lose all or part of their investment. In addition, the following risk factors and uncertainties could cause our actual results to differ materially from those projected in our forward-looking statements, whether made in this Quarterly Report on Form 10-Q or the other documents we file with t31he SEC, or in our annual or quarterly reports to shareholders, future press releases, or orally, whether in presentations, responses to questions or otherwise.
We are dependent upon the electronics industry, which is highly cyclical and suffers significant downturns in demand resulting in excess manufacturing capacity and increased price competition.
The electronics industry, on which a substantial portion of our business depends, is cyclical and subject to significant downturns characterized by diminished product demand, rapid declines in average selling prices and over-capacity. This industry has experienced periods characterized by relatively low demand and price depression and is likely to experience recessionary periods in the future. Economic conditions affecting the electronics industry in general, or specific customers in particular, have adversely affected our operating results in the past and may do so in the future. Currently, the global economy has been greatly impacted by the credit crisis in the home mortgage sector, volatile high-cost fuel, increasing food prices and a changing political and economic landscape. These factors have contributed to historically low consumer confidence levels which could result in a significantly intensified downturn in the demand for products incorporating PCBs.
The electronics industry is characterized by intense competition, rapid technological change, relatively short product life cycles and pricing and profitability pressures. These factors adversely affect our customers and we suffer similar effects. Our customers are primarily high-technology equipment manufacturers in the communications and networking, computing and peripherals, test, industrial and medical, defense and aerospace and automotive markets of the electronics industry. Due to the uncertainty in the markets served by most of our customers, we cannot accurately predict our future financial results or accurately anticipate future orders. At any time, our customers can discontinue or modify products containing components manufactured by us, adjust the timing of orders and shipments or affect our mix of consolidated net sales generated from quick-turn and premium services revenues versus standard lead time production, any of which could have a material adverse effect on our results of operations.
Competition in the printed circuit board market is intense and we could lose sales if we are unable to compete effectively.
The market for PCBs is intensely competitive, highly fragmented and rapidly changing. We expect competition to persist, which could result in continued reductions in pricing and profitability and loss of market share. We believe our major competitors are U.S., Asian and other international independent manufacturers of multi-layer printed circuit boards, backplanes and other electronic assemblies. Those competitors include Daeduck Electronics Co., DDi Corp., Elec and Eltek., Meadville Holdings, Ltd., LG Electronics, Multek Corporation (a division of Flextronics International Ltd.), Sanmina-SCI Corporation, TTM Technologies, Inc., WUS Printed Circuits Company Ltd., ViaSystems, Inc and Ibiden Co., Ltd.
Some of our competitors and potential competitors may have a number of advantages over us, including:
In addition, these competitors may have the ability to respond more quickly to new or emerging technologies, be more successful in entering or adapting to existing or new end markets, adapt more quickly to changes in customer requirements and devote greater resources to the development, promotion and sale of their products than we can. Consolidation in the PCB industry, which we expect to continue, could result in an increasing number of larger PCB companies with greater market power and resources. Such consolidation could in turn increase price competition and result in other competitive pressures for us. We must continually develop improved manufacturing processes to meet our customers needs for complex, high-technology products, and our basic interconnect technology is generally not subject to significant proprietary protection. We may not be able to maintain or expand our sales if competition increases and we are unable to respond effectively.
Other considerations that affect our ability to compete include providing manufacturing services that are competitively priced, providing continually evolving technical capabilities, having competitive lead times and meeting specified delivery dates. Currently, most of our North American operations have lead times that extend beyond what is generally competitive in the market. Also, during the latter half of fiscal 2008 our on-time delivery was adversely affected by the Wood Village facility closure. During this period, our lead times at our Forest Grove facility increased to between 10 to 14 weeks and were believed to be uncompetitive in the North American market. This is likely to have resulted in lost orders or lower customer demand in future quarters. Our lead times have improved and are more competitive today, which should improve our fulfillment of customer expectations. It is uncertain how quickly we will be able to restore the full confidence of our customer base and what long-term affects these actions have had on future demand for our products.
During recessionary periods in the electronics industry, our competitive advantages in providing an integrated manufacturing solution and responsive customer service may be less important to our customers than they are in more favorable economic climates.
If competitive production capabilities increase in Asia, where production costs are lower, we may lose market share in both North America and Asia and our profitability may be materially adversely affected by increased pricing pressure.
PCB manufacturers in Asia and other geographies often have significantly lower production costs than our North American operations and may even have cost advantages over Merix Asia. Production capability improvements by foreign and domestic competitors may play an increasing role in the PCB markets in which we compete, which may adversely affect our revenues and profitability. While PCB manufacturers in these locations have historically competed primarily in markets for less technologically advanced products, they are expanding their manufacturing capabilities to produce higher layer count, higher technology PCBs and could compete more directly with our North American operations.
If we are unable to respond to rapid technological change and process development, we may not be able to compete effectively.
The market for our products is characterized by rapidly changing technology and continual implementation of new production processes. The success of our business depends in large part upon our ability to maintain and enhance our technological capabilities, to manufacture products that meet changing customer needs, and to successfully anticipate or respond to technological changes on a cost-effective and timely basis. In addition, the PCB industry could encounter competition from new or revised manufacturing and production technologies that render existing manufacturing and production technology less competitive or obsolete. We may not be able to respond effectively to the technological requirements of the changing market. If we need new technologies and equipment to remain competitive, the development, acquisition and implementation of those technologies and equipment may require us to make significant capital investments. We may not be able to raise the necessary additional funds at all or as rapidly as necessary to respond to technological changes as quickly as our competitors.
During periods of excess global PCB manufacturing capacity, our profitability may decrease and/or we may have to incur additional restructuring charges if we choose to reduce the capacity of or close any of our facilities.
A significant portion of our factory costs of sales and operating expenses are relatively fixed in nature, and planned expenditures are based in part on anticipated orders. When we experience excess capacity, our sales revenues may not fully cover our fixed overhead expenses, and our gross margins will fall. In addition, we generally schedule our quick-turn production facilities at less than full capacity to retain our ability to respond to unexpected additional quick-turn orders. However, if these orders are not received, we may forego some production and could experience continued excess capacity.
If we conclude we have significant, long-term excess capacity, we may decide to permanently close one or more of our facilities, and lay off some of our employees. Closures or lay-offs could result in our recording restructuring charges such as severance, other exit costs, and asset impairments.
Damage to our manufacturing facilities or information systems due to fire, natural disaster, or other events could harm our financial results.
We have U.S. manufacturing and assembly facilities in Oregon, California and China. The destruction or closure of any of our facilities for a significant period of time as a result of fire, explosion, act of war or terrorism, or blizzard, flood, tornado, earthquake, lightning, or other natural disaster could harm us financially, increasing our costs of doing business and limiting our ability to deliver our manufacturing services on a timely basis. Additionally, we rely heavily upon information technology systems and high-technology equipment in our manufacturing processes and the management of our business. We have developed disaster recovery plans; however, disruption of these technologies as a result of natural disaster or other events could harm our business and have a material adverse effect on our results of operations.
A small number of customers account for a substantial portion of our consolidated net sales and our consolidated net sales could decline significantly if we lose a major customer or if a major customer orders fewer of our products or cancels or delays orders.
Historically, we have derived a significant portion of our consolidated net sales from a limited number of customers. Our five largest OEM customers, which vary from period to period, comprised 40% of our consolidated net sales during the first quarter of fiscal 2009. Net sales to two customers individually represented 15% and 10% of consolidated net sales during the first quarter of fiscal 2009. We expect to continue to depend upon a small number of customers for a significant portion of our consolidated net sales for the foreseeable future. The loss of, or decline in, orders or backlog from one or more major customers could reduce our consolidated net sales and have a material adverse effect on our results of operations and financial condition. Further, as part of our plan to improve the profitability of our North American operations we aim to reduce our reliance on certain customers and certain products that have historically generated significant revenues for Merix. We anticipate retaining a meaningful portion of this business, but there can be no assurance we will be successful. An unplanned loss of a large portion of this revenue could adversely affect our financial results.
Some of our customers are relatively small companies, and our future business with them may be significantly affected by their ability to continue to obtain financing. If they are unable to obtain adequate financing, they will not be able to purchase products, which, in the aggregate, would adversely affect our consolidated net sales.
We are exposed to the credit risk of some of our customers and also as a result of a concentration of our customer base.
Most of our sales are on an open credit basis, with standard industry payment terms. We monitor individual customer payment capability in granting open credit arrangements, seek to limit open credit to amounts we believe the customers can pay, and maintain reserves we believe are adequate to cover exposure for doubtful accounts. During periods of economic downturn in the global economy and the electronics and automotive industries, our exposure to credit risks from our customers increases. Although we have programs in place to monitor and mitigate the associated risk, those programs may not be effective in reducing our credit risks.
In total, five entities represented approximately 46% of the consolidated net trade accounts receivable balance at August 30, 2008, individually ranging from approximately 5% to approximately 17%. Our OEM customers direct our sales to a relatively limited number of electronic manufacturing service providers. Our contractual relationship is typically with the electronic manufacturing service providers, who are obligated to pay us for our products. Because we expect our OEM customers to continue to direct our sales to electronic manufacturing service providers, we expect to continue to be subject to the credit risk of a limited number of customers. This concentration of customers exposes us to increased credit risks. If one or more of our significant customers were to become insolvent or were otherwise unable to pay us, our financial condition and results of operations would be adversely affected.
Because we do not generally have long-term contracts with our customers, we are subject to uncertainties and variability in demand by our customers, which could decrease consolidated net sales and negatively affect our operating results.
We generally do not have long-term purchase commitments from our customers, and, consequently, our consolidated net sales are subject to short-term variability in demand by our customers. Customers generally have no obligation to order from us and may cancel, reduce or delay orders for a variety of reasons. The level and timing of orders placed by our customers vary due to:
We have experienced terminations, reductions and delays in our customers orders. Future terminations, reductions or delays in our customers orders could lower our production asset utilization, which would lower our gross profits, decrease our consolidated net sales and negatively affect our business and results of operations.
The increasing prominence of EMS providers in the PCB industry could reduce our gross margins, potential sales, and customers.
Sales to EMS providers represented approximately 55% of our net sales in the first quarter of fiscal 2009. Sales to EMS providers include sales directed by OEMs as well as orders placed with us at the EMS providers discretion. EMS providers source on a global basis to a greater extent than OEMs. The growth and concentration of EMS providers increases the purchasing power of such providers and could result in increased price competition or the loss of existing OEM customers. In addition, some EMS providers, including some of our customers, have the ability to directly manufacture PCBs within their own businesses. If a significant number of our other EMS customers were to acquire these abilities, our customer base might shrink, and our sales might decline substantially. Moreover, if any of our OEM customers outsource the production of PCBs to these EMS providers, our business, results of operations and financial condition may be harmed.
Automotive customers have higher quality requirements and long qualification times and, if we do not meet these requirements, our business could be materially adversely affected.
For safety reasons, our automotive customers have strict quality standards that generally exceed the quality requirements of our other customers. Because a significant portion of Merix Asias products are sold to customers in the automotive industry, if our manufacturing facilities in Asia do not meet these quality standards, our results of operations may be materially and adversely affected. These automotive customers may require long periods of time to evaluate whether our manufacturing processes and facilities meet their quality standards. If we were to lose automotive customers due to quality control issues, we might not be able to regain those customers, or gain new automotive customers, for long periods of time, which could significantly decrease our consolidated net sales and profitability.
The cyclical nature of automotive production and sales could adversely affect Merix business.
A significant portion of Merix Asias products are sold to customers in the automotive industry. As a result, Merix Asias results of operations may be materially and adversely affected by market conditions in the automotive industry. Automotive production and sales are cyclical and depend on general economic conditions and other factors, including consumer spending and preferences. In addition, automotive production and sales can be affected by labor relations issues, regulatory requirements, trade agreements and other factors. Any significant economic decline that results in a reduction in automotive production and sales by Merix Asias customers could have a material adverse effect on Merix business, results of operations and financial condition.
Products we manufacture may contain manufacturing defects, which could result in reduced demand for our products and liability claims against us.
We manufacture highly complex products to our customers specifications. These products may contain manufacturing errors or failures despite our quality control and quality assurance efforts. Further, our technology expansion efforts including the major expansion in our Huiyang factory increase the risk related to unanticipated yield issues, as well as to uncertainties related to future warranty claims. Defects in the products we manufacture, whether caused by a design, manufacturing or materials failure or error, may result in delayed shipments, increased warranty costs, customer dissatisfaction, or a reduction in or cancellation of purchase orders. If these defects occur either in large quantities or too frequently, our business reputation may be impaired. Since our products are used in products that are integral to our customers businesses, errors, defects or other performance problems could result in financial or other damages to our customers beyond the cost of the PCB, for which we may be liable in some cases. Although we generally attempt to sell our products on terms designed to limit our exposure to warranty, product liability and related claims, in certain cases, the terms of our agreements allocate to Merix substantial exposure for product defects. In addition, even if we can contractually limit our exposure, existing or future laws or unfavorable judicial decisions could negate these limitation of liability provisions. Product liability litigation against us, even if it were unsuccessful, would be time consuming and costly to defend. Although we maintain a warranty reserve, this reserve may not be sufficient to cover our warranty or other expenses that could arise as a result of defects in our products.
We may incur material losses and costs as a result of product liability and warranty claims that may be brought against us.
We face an inherent business risk of exposure to warranty and product liability claims in the event that our products, particularly those supplied by Merix Asia to the automotive industry, fail to perform as expected or such failure results, or is alleged to result, in bodily injury and/or property damage. In addition, if any of our products are or are alleged to be defective, we may be required to participate in a recall of such products. As suppliers become more integral to the vehicle design process and assume more of the vehicle assembly functions, vehicle manufacturers are increasingly looking to their suppliers for contributions when faced with product liability claims or recalls. In addition, vehicle manufacturers, who have traditionally borne the cost associated with warranty programs offered on their vehicles, are increasingly requiring suppliers to guarantee or warrant their products and may seek to hold us responsible for some or all of the costs related to the repair and replacement of parts supplied by us to the vehicle manufacturer. A successful warranty or product liability claim against us in excess of our available insurance coverage or established warranty and legal reserves or a requirement that we participate in a product recall may have a material adverse effect on our business, financial condition and results of operations.
We rely on suppliers for the timely delivery of materials used in manufacturing our PCBs, and an increase in industry demand, a shortage of supply or an increase in the price of raw materials may increase the cost of the raw materials we use and may limit our ability to manufacture certain products and adversely impact our profitability.
To manufacture our PCBs, we use materials such as laminated layers of fiberglass, copper foil and chemical solutions which we order from our suppliers. Suppliers of laminates and other raw materials that we use may from time to time extend lead times, limit supplies or increase prices due to capacity constraints or other factors, which could adversely affect our profitability and our ability to deliver our products on a timely basis. We have experienced in the past, and may experience in the future, significant increases in the cost of laminate materials, copper products and petroleum-based raw materials. These cost increases have had an adverse impact on our profitability and the impact has been particularly significant on our Asian operations which have fixed price arrangements with a number of large automotive customers. Some of our products use types of laminates that are only available from a single supplier that holds a patent on the material. Although other manufacturers of advanced PCBs also must use the single supplier and our OEM customers generally determine the type of laminates used, a failure to obtain the material from the single supplier for any reason may cause a disruption, and possible cancellation, of orders for PCBs using that type of laminate, which in turn would cause a decrease in our consolidated net sales.
If we lose key management, operations, engineering or sales and marketing personnel, we could experience reduced sales, delayed product development and diversion of management resources.
Our success depends largely on the continued contributions of our key management, administration, operations, engineering and sales and marketing personnel, many of whom would be difficult to replace. We generally do not have employment or non-compete agreements with our key personnel. If one or more members of our senior management or key professionals were to resign, the loss of personnel could result in loss of sales, delays in new product development and diversion of management resources, which would have a negative effect on our business. We do not maintain key man insurance policies on any of our personnel.
Successful execution of our day-to-day business operations, including our manufacturing process, depends on the collective experience of our employees and we have experienced periods of high employee turnover. If high employee turnover persists, our business may suffer and we may not be able to compete effectively.
We rely on the collective experience of our employees, particularly in the manufacturing process, to ensure we continuously evaluate and adopt new technologies and remain competitive. Although we are not generally dependent on any one employee or a small number of employees involved in our manufacturing process, we have experienced periods of high employee turnover generally and continue to experience significantly high employee turnover at our Asian facilities. If we are not able to replace these people with new employees with comparable capabilities, our operations could suffer as we may be unable to keep up with innovations in the industry or the demands of our customers. As a result, we may not be able to continue to compete effectively.
We export products from the United States to other countries. If we fail to comply with export laws, we could be subject to additional taxes, duties, fines and other punitive actions.
Exports from the United States are regulated by the U.S. Department of Commerce. Failure to comply with these regulations can result in significant fines and penalties. Additionally, violations of these laws can result in punitive penalties, which would restrict or prohibit us from exporting certain products, resulting in significant harm to our business.
Because we have significant foreign sales and presence, we are subject to political, economic and other risks we do not face in the domestic market.
As a result of increased Asian operations, we expect sales in, and product shipments to, non-U.S. markets to represent an increasingly significant portion of our total sales in future periods. Our exposure to the business risks presented by foreign economies includes:
We must comply with the Foreign Corrupt Practices Act.
We are required to comply with the United States Foreign Corrupt Practices Act, which prohibits United States companies from engaging in bribery or other prohibited payments to foreign officials for the purpose of obtaining or retaining business. Foreign companies, including some of our competitors, are not subject to these prohibitions. Corruption, extortion, bribery, pay-offs, theft and other fraudulent practices occur from time-to-time in many jurisdictions, including mainland China. If our competitors engage in these practices they may receive preferential treatment from personnel of some companies, giving our competitors an advantage in securing business or from government officials who might give them priority in obtaining new licenses, which would put us at a disadvantage. Although we inform our personnel that such practices are illegal, we cannot assure that our employees or other agents will not engage in such conduct for which we might be held responsible. If our employees or other agents are found to have engaged in such practices, we could suffer severe penalties.
We are subject to risks associated with currency fluctuations, which could have a material adverse effect on our results of operations and financial condition.
A significant portion of our costs is denominated in foreign currencies, including the Hong Kong dollar and the Chinese renminbi. Substantially all of our consolidated net sales are denominated in U.S. dollars. As a result, changes in the exchange rates of these foreign currencies to the U.S. dollar will affect our cost of sales and operating margins and could result in exchange losses. The exchange rate of the Chinese renminbi to the U.S. dollar is closely monitored by the Chinese government. Recent increases in the value of the renminbi relative to the U.S. dollar have caused the costs of our Chinese operations to increase relative to related dollar-denominated sales. The impact of future exchange rate fluctuations on our results of operations cannot be accurately predicted. We may enter into exchange rate hedging programs from time to time in an effort to mitigate the impact of exchange rate fluctuations. However, hedging transactions may not be effective and may result in foreign exchange hedging losses.
Our operations in the Peoples Republic of China subject us to risks and uncertainties relating to the laws and regulations of the PRC.
Under its current leadership, the Chinese government has been pursuing economic reform policies, including the encouragement of foreign trade and investment and greater economic decentralization. However, the government of the PRC may not continue to pursue such policies. Despite progress in developing its legal system, the PRC does not have a comprehensive and highly developed system of laws, particularly with respect to foreign investment activities and foreign trade. Enforcement of existing and future laws and
contracts is uncertain, and implementation and interpretation thereof may be inconsistent. As the Chinese legal system develops, the promulgation of new laws, changes to existing laws and the preemption of local regulations by national laws may adversely affect foreign investors. For example, the PRC recently passed a unified enterprise income tax law, which changes and increases the income tax on foreign-owned facilities. The PRC also recently enacted new labor laws that became effective January 1, 2008 that make it more difficult and expensive for companies to make changes in their workforce. In addition, some government policies and rules are not published or communicated in local districts in a timely manner, if they are published at all. As a result, we may operate our business in violation of new rules and policies without having any knowledge of their existence. These uncertainties could limit the legal protections available to us. Any litigation in the PRC may be protracted and result in substantial costs and diversion of resources and management attention.
Our Chinese manufacturing operations subject us to a number of risks we have not faced in the past.
A substantial portion of our current manufacturing operations is located in the PRC. The geographical distances between these facilities and our U.S. headquarters create a number of logistical and communications challenges. We are also subject to a highly competitive market for labor in the PRC, which may require us to increase employee wages and benefits to attract and retain employees and spend significant resources to train new employees due to high employee turnover, either of which could cause our labor costs to exceed our expectations.
In addition, because of the location of these facilities, we could be affected by economic and political instability in the PRC, including:
Moreover, inadequate development or maintenance of infrastructure in the PRC, including inadequate power and water supplies, transportation or raw materials availability, communications infrastructure or the deterioration in the general political, economic or social environment, could make it difficult and more expensive, and possibly prohibitive, to continue to operate our manufacturing facilities in the PRC.
New labor laws in the PRC may adversely affect our results of operations.
Approximately two-thirds of our workforce is located in the PRC. Effective on January 1, 2008, the PRC government enacted a new labor law that significantly impacts the cost of a companys decision to reduce its workforce. Further, the law requires certain terminations to be based upon seniority and not merit. In the event we decide to significantly change or decrease our workforce in the PRC, the new labor law could adversely affect our ability to enact such changes in a manner that is most advantageous to our circumstances or that is timely and cost effective. Additionally, in response to inflationary concerns, wages in certain provinces in China have recently increased and may continue to do so in the future. Significant increases in wages paid to employees in our Merix Asia facilities could reduce our profitability.
Success in Asia may adversely affect our U.S. operations.
To the extent Asian PCB manufacturers, including Merix Asia, are able to compete effectively with products historically manufactured in the United States, our facilities in the United States may not be able to compete as effectively and parts of our North American operations may not remain viable.
If we do not effectively manage the expansion of our operations, our business may be harmed, and the increased costs associated with the expansion may not be offset by increased consolidated net sales.
In fiscal 2008, we commenced efforts to significantly expand the Huiyang, China-based facility and any other future capacity expansion with respect to our facilities will expose us to significant start-up risks including:
Our forward-looking statements depend upon a number of assumptions and include our ability to execute tactical changes that may adversely impact both short-term and long-term financial performance. The success of our expansion efforts will depend upon our ability to expand, train, retain and manage our employee base in both Asia and North America. In connection with our expansion efforts in Asia, we expect to require additional employees throughout the company. If we are unable to attract, train and retain new workers, or manage our employee base effectively, our ability to fully utilize our Asian assets will likely be impaired. If we are unable to effectively expand, train and manage our employee base, our business and results of operations could be adversely affected.
In addition, if our consolidated net sales do not increase sufficiently to offset the additional fixed operating expenses associated with our Asian operations, our consolidated results of operations may be adversely affected. If demand for our products does not meet anticipated levels, the value of the expanded operations could be significantly impaired, which would adversely affect our results of operations and financial condition.
Electrical power shortages in certain areas of southern China have caused the government to impose a power rationing program and additional or extended power rationings could adversely affect our China operations.
In the winter months of fiscal 2008, certain areas of Southern China faced electrical power constraints which resulted from extreme winter weather in the area. In order to deal with the power constraints, the Southern China Province Government initiated a power rationing plan. This rationing program affected our Huizhou and Huiyang facilities. In order to minimize the effect on our operations, we realigned our routine equipment maintenance program to coincide with the power rationing schedule. The power rationing program was terminated in May 2008. In the future, there may be further restrictions regarding power and other key services that may impair our ability to compete effectively as well as adversely affect revenues and production costs. Any additional or extended power supply rationing could adversely affect our China operations.
Failure to maintain good relations with minority investors in our China manufacturing facilities could materially adversely affect our ability to manage our Asian operations.
Currently, we have two PCB manufacturing plants in the PRC that are each partially owned by a separate Chinese company. While we are the majority interest holder in both of these companies, there is a minority interest holder in each subsidiary, owning a 5% and 15% share, respectively. These minority holders are local investors with close ties to local economic development and other government agencies. The investors are the leaseholders for the land on which the plants owned by our Chinese operating companies are located. In connection with the negotiation of their investments, the local investors secured certain rights to be consulted and consent to certain operating and investment matters concerning the plants and to board representation. Failure to maintain good relations with the investors in either China joint venture could materially adversely affect our ability to manage the operations of one or more of the plants and our ability to realize the anticipated benefits of the Asian acquisition.
We do not currently have options to renew our leased manufacturing facility in the PRC and failure to renew such lease could adversely affect our ability to realize the anticipated benefits of the Asian acquisition.
Our Huizhou manufacturing facility is leased from a Chinese company under an operating lease that expires in 2010 and does not contain a lease renewal option. Although the landlord also has a minority interest in our subsidiary that operates the facility, this minority interest holder may choose to not renew our lease. Failure to maintain good relations with this investor could materially adversely affect our ability to negotiate the renewal of our operating lease or to continue to operate the plant. Although we have renewed this lease in the past, failure to successfully renew such lease in the future could materially adversely affect our ability to realize the anticipated benefits of the Asian acquisition. In addition, the lease renewal allows early termination by either party, so failure to maintain good relations with this investor could materially impact our continued leasehold of the facility. Further, zoning and changes in laws in China could impair the ability of the landlord to extend or renew the lease.
Our bank credit covenant that limits our incremental investment in Merix Asia may restrict our ability to adequately fund our Asian operations and our growth plans in Asia.
Merix has a bank credit agreement covenant that limits the incremental investment into Merix Asia to $40 million and provides that our investments cannot be made if a default exists under the credit agreement or the Excess Availability (defined in the credit agreement as a function of outstanding borrowings and available cash) is less than $20 million. As of August 30, 2008, we had advanced Merix Asia approximately $21 million against the incremental investment limit. If our Asian operations at any time require an amount of cash greater than our available capital resources, or than is permitted to be advanced under applicable credit agreements, there is risk that we will not be able to fund our Asian operations or achieve our growth plans in Asia.
Acquisitions may be costly and difficult to integrate, may divert and dilute management resources and may dilute shareholder value.
As part of our business strategy, we have made and may continue to make acquisitions of, or investments in, companies, products or technologies that complement our current products, augment our market coverage, enhance our technical capabilities or production capacity or that may otherwise offer growth opportunities. In any future acquisitions or investments, we could potentially experience:
In addition, in connection with any future acquisitions or investments, we could:
Any of these factors could prevent us from realizing anticipated benefits of an acquisition or investment, including operational synergies, economies of scale and increased profit margins and revenue. Acquisitions are inherently risky, and any acquisition may not be successful. Failure to manage and successfully integrate acquisitions could harm our business and operating results in a material way. Even when an acquired company has already developed and marketed products, product enhancements may not be made in a timely fashion. In addition, unforeseen issues might arise with respect to such products after the acquisition.
We face a risk that capital needed for our business and to repay our debt obligations will not be available when we need it. Additionally, our leverage and our debt service obligations may adversely affect our cash flow.
As of August 30, 2008, we had total indebtedness of approximately $70 million, which represented approximately 38% of our total capitalization. We also have $50.5 million unused availability under a secured bank revolving line of credit that would increase our leverage if utilized.
Our indebtedness could have significant negative consequences, including:
Recent turmoil in global financial markets has limited access to capital for many companies. We are not currently experiencing any limitation of access to our revolving line of credit and management is not aware of any issues currently impacting our lenders ability to honor its commitment to extend credit. However, if we were unable to borrow on our revolving line of credit in the future due to the global credit crisis, our business and results of operations could be adversely affected.
Additionally, we are exposed to interest rate risk relating to our revolving credit facility which bears interest based, at our election, on either the prime rate or LIBOR plus an additional margin based on our use of the credit facility. At August 30, 2008, there was $1.7 million outstanding under the revolving line of credit that was borrowed during August by our Asia subsidiary which is not reflected in the consolidated balance sheet due to the one-month reporting lag. If we need to utilize our revolving credit facility to meet our capital requirements, we are subject to market interest rate risk that could increase our interest expense beyond expected levels and decrease our profitability.
Our capacity build-out and technological changes will require significant capital investment and could adversely affect our liquidity.
We are currently undergoing a major expansion at our Huiyang, China based facility and are improving our technological capabilities through the addition of new capital in both our North American and China based facilities. This expansion, and other capital requirements, will require approximately $18 million of capital expenditures in fiscal 2009, with additional spending required to complete the projects in fiscal 2010. We anticipate funding this expansion from operations, existing cash and cash equivalents and bank credit facilities. Currently, we are not profitable and, if financial performance deteriorates further, we may have to significantly reduce capital spending that could impair our ability to successfully restructure our business and compete effectively. Further, our bank credit facilities provide credit based upon a number of covenants, with which we are currently in compliance. However, business conditions or our execution on a number of critical initiatives to support the capacity and technology expansion efforts could impair our ability to access these facilities.
Restructuring efforts have required both restructuring and impairment charges and we may be required to record asset impairment charges in the future, which would adversely affect our results of operations and financial condition.
We recorded impairment charges against certain assets in fiscal 2007 and we recorded restructuring and impairment charges in the fiscal 2008 for the closure of our Wood Village, Oregon manufacturing facility and other restructuring actions. As our strategy evolves and due to the cyclicality of our business, rapid technological change and the migration of business to Asia, we might conclude in the future that some of our manufacturing facilities are surplus to our needs or will not generate sufficient future cash flows to cover the net book value and, thus, we may be required to record an impairment charge. Such an impairment charge would adversely affect our results of operations and financial condition.
As of August 30, 2008, our consolidated balance sheet reflected $40.1 million of goodwill and intangible assets. We periodically evaluate whether events and circumstances have occurred that indicate the remaining balance of goodwill and intangible assets may not be recoverable. If factors indicate that assets are impaired, we would be required to reduce the carrying value of our goodwill and intangible assets, which could harm our results during the periods in which such a reduction is recognized. Our goodwill and intangible assets may increase in future periods if we consummate other acquisitions. Amortization or impairment of these additional intangibles would, in turn, harm our earnings.
As we continue our work to implement a global enterprise resource planning (ERP) system, unexpected problems and delays could occur and could cause disruption to the management of our business and significantly increase costs.
During fiscal 2008, we completed the implementation for our world-wide ERP system at our North American operations. The new ERP system is integral to our ability to accurately and efficiently maintain our books and records, record our transactions, provide critical information to our management and prepare our financial statements. Our work to plan, develop and implement this new ERP system continues as an active project, as we implemented the ERP system at our Asian operations in August and we need to evaluate the success of that implementation as we begin using the system to report the results of operations for our Asia subsidiary in the second quarter of fiscal 2009. These systems are new to us and we have not had extensive experience with them. The new ERP system could eventually become more costly, difficult and time-consuming to purchase and implement than we currently anticipate. Implementation of the new ERP system has required us to change certain internal business practices and training may be inadequate. We may encounter unexpected difficulties, delays, internal control issues, costs, unanticipated adverse effects or other challenges, any of which may disrupt our business. Corrections and improvements may be required as we continue to refine the implementation of our new system, procedures and controls, and could cause us to incur additional costs and require additional management attention, placing burdens on our internal resources. Any disruption in the transition to our new or enhanced systems, procedures or controls, could harm our ability to accurately forecast sales demand, manage our supply chain, achieve accuracy in the conversion of electronic data and records, compete effectively and report financial and management information on a timely and accurate basis. Failure to properly or adequately address these issues could result in the diversion of managements attention and resources and impact our ability to manage our business and our results of operations.
We have reported material weaknesses in our internal control over financial reporting and if additional material weaknesses are discovered in the future, our stock price and investor confidence in us may be adversely affected.
A material weakness is a control deficiency, or combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim consolidated financial statements will not be prevented or detected. In connection with managements assessments of our internal control over financial reporting over the prior fiscal year, we identified material weaknesses in our internal control over financial reporting.
We have previously identified a material weakness in controls over financial reporting for our Merix Asia operations and have determined that this material weakness still exists at August 30, 2008. At the time of the acquisition in September 2005, Merix Asia had weak internal controls over financial reporting and needed to develop processes to strengthen its accounting systems and control environment management. We have devoted significant time and resources to improving the internal controls over financial reporting since the acquisition; however, as of August 30, 2008, we have determined that we did not maintain sufficient controls to adequately monitor the accounting and financial reporting related to our Merix Asia operations. See Item 9A. Controls and procedures.
We may, in the future, identify additional internal control deficiencies that could rise to the level of a material weakness or uncover errors in financial reporting. Material weaknesses in our internal control over financial reporting may cause investors to lose confidence in us, which could have an adverse effect on our business and stock price.
Our failure to comply with environmental laws could adversely affect our business.
Our operations are regulated under a number of federal, state and municipal environmental and safety laws and regulations including laws in the U.S. and the PRC that govern, among other things, the discharge of hazardous and other materials into the air and water, as well as the handling, storage, labeling, and disposal of such materials. When violations of environmental laws occur, we can be held liable for damages, penalties and costs of investigation and remedial actions. Violations of environmental laws and regulations may occur as a result of our failure to have necessary permits, human error, equipment failure or other causes. Moreover, in connection with our acquisitions in San Jose, California and in Asia, we may be liable for any violations of environmental and safety laws at those facilities by prior owners. If we violate environmental laws, we may be held liable for damages and the costs of investigations and remedial actions and may be subject to fines and penalties, and revocation of permits necessary to conduct our business. Any permit revocations could require us to cease or limit production at one or more of our facilities, and harm our business, results of operations and financial condition. Even if we ultimately prevail, environmental lawsuits against us would be time consuming and costly to defend. Our failure to comply with applicable environmental laws and regulations could limit our ability to expand facilities or could require us to acquire costly equipment or to incur other significant expenses to comply with these laws and regulations. In the future, environmental laws may become more stringent, imposing greater compliance costs and increasing risks and penalties associated with violations. We operate in environmentally sensitive locations and we are subject to potentially conflicting and changing regulatory agendas of political, business and environmental groups. Changes or restrictions on discharge limits, emissions levels, permitting requirements and material storage, handling or disposal might require a high level of unplanned capital investment, operating expenses or, depending on the severity of the impact of the foregoing factors, costly plant relocation. It is possible that environmental compliance costs and penalties from new or existing regulations may harm our business, results of operations and financial condition.
We are potentially liable for contamination at our current and former facilities as well as at sites where we have arranged for the disposal of hazardous wastes, if such sites become contaminated. These liabilities could include investigation and remediation activities. It is possible that remediation of these sites could adversely affect our business and operating results in the future.
Pending or future litigation could have a material adverse effect on our operating results and financial condition.
We are involved, from time to time, in litigation incidental to our business including complaints filed by investors. This litigation could result in substantial costs and could divert managements attention and resources which could harm our business. Risks associated with legal liability are often difficult to assess or quantify, and their existence and magnitude can remain unknown for significant periods of time. In cases where we record a liability, the amount of our estimates could be wrong. In addition to the direct costs of litigation, pending or future litigation could divert managements attention and resources from the operation of our business. While we maintain director and officer insurance, the amount of insurance coverage may not be sufficient to cover a claim and the continued availability of this insurance cannot be assured. As a result, there can be no assurance that the actual outcome of pending or future litigation will not have a material adverse effect on our results of operations or financial condition.
We may be subject to claims of intellectual property infringement.
Several of our competitors hold patents covering a variety of technologies, applications and methods of use similar to some of those used in our products. From time to time, we and our customers have received correspondence from our competitors claiming that some of our products, as used by our customers, may be infringing one or more of these patents. Competitors or others have in the past and may in the future assert infringement claims against our customers or us with respect to current or future products or uses, and these assertions may result in costly litigation or require us to obtain a license to use intellectual property rights of others. If claims of infringement are asserted against our customers, those customers may seek indemnification from us for damages or expenses they incur.
If we become subject to infringement claims, we will evaluate our position and consider the available alternatives, which may include seeking licenses to use the technology in question or defending our position. These licenses, however, may not be available on satisfactory terms or at all. If we are not able to negotiate the necessary licenses on commercially reasonable terms or successfully defend our position, our financial condition and results of operations could be materially and adversely affected.
We may have exposure to income tax rate fluctuations as well as to additional tax liabilities, which would impact our financial position.
As a corporation with operations both in the United States and abroad, we are subject to taxes in the United States and various foreign jurisdictions. Our effective tax rate is subject to fluctuation as the income tax rates for each year are a function of the following factors, among others:
Changes in the mix of these items and other items may cause our effective tax rate to fluctuate between periods, which could have a material adverse effect on our financial position.
We are also subject to non-income taxes, such as payroll, sales, use, value-added, net worth, property and goods and services taxes, in both the United States and various foreign jurisdictions.
Significant judgment is required in determining our provision for income taxes and other tax liabilities. Although we believe that our tax estimates are reasonable, we cannot provide assurance that the final determination of tax audits or tax disputes will not be different from what is reflected in our historical income tax provisions and accruals.
RISKS RELATED TO OUR CORPORATE STRUCTURE AND STOCK
Our stock price has fluctuated significantly, and we expect the trading price of our common stock to remain highly volatile.
The closing trading price of our common stock has fluctuated from a low of less than $2.00 per share to a high of more than $70.00 per share over the past 14 years.
The market price of our common stock may fluctuate as a result of a number of factors including:
We expect volatility to continue in the future. In recent years, the stock market in general has experienced extreme price and volume fluctuations that have affected the PCB industry and that may be unrelated to the operating performance of the companies within these industries. These broad market fluctuations may adversely affect the market price of our common stock and limit our ability to raise capital or finance transactions using equity instruments.
A large number of our outstanding shares and shares to be issued upon exercise of our outstanding options may be sold into the market in the future, which could cause the market price of our common stock to drop significantly, even if our business is doing well.
We may, in the future, sell additional shares of our common stock, or securities convertible into or exercisable for shares of our common stock, to raise capital. We may also issue additional shares of our common stock, or securities convertible into or exercisable for shares of our common stock, to finance future acquisitions. Further, a substantial number of shares of our common stock are reserved for issuance pursuant to stock options and our employee stock purchase plan. As of May 31, 2008, we had approximately 3.3 million outstanding options, each to purchase one share of our common stock, issued to employees, officers and directors under our equity incentive plans. The options have exercise prices ranging from $1.86 per share to $67.06 per share. These outstanding options could have a significant adverse effect on the trading price of our common stock, especially if a significant volume of the options was exercised and the stock issued was immediately sold into the public market. Further, the exercise of these options could have a dilutive impact on other shareholders by decreasing their ownership percentage of our outstanding common stock. If we attempt to raise additional capital through the issuance of equity or convertible debt securities, the terms upon which we will be able to obtain additional equity capital, if at all, may be negatively affected since the holders of outstanding options can be expected to exercise them, to the extent they are able, at a time when we would, in all likelihood, be able to obtain any needed capital on terms more favorable than those provided in such options.
Some provisions contained in our Articles of Incorporation, Bylaws and Shareholders Rights Agreement, as well as provisions of Oregon law, could inhibit an attempt by a third party to acquire or merge with Merix Corporation.
Some of the provisions of our Articles of Incorporation, Bylaws, Shareholders Rights Agreement and Oregons anti-takeover laws could delay or prevent a merger or acquisition between us and a third party, or make a merger or acquisition with us less desirable to a potential acquirer, even in circumstances in which our shareholders may consider the merger or acquisition favorable. Our Articles of Incorporation authorize our Board of Directors to issue series of preferred stock and determine the rights and preferences of each series of preferred stock to be issued. Our Shareholder Rights Agreement is designed to enhance the Boards ability to protect shareholders against unsolicited attempts to acquire control of us that do not offer an adequate price to all shareholders or are otherwise not in the Companys best interests and the best interests of our shareholders. The rights issued under the rights agreement will cause substantial dilution to any person or group who attempts to acquire a significant amount of common stock without approval of our Board of Directors. Any of these provisions that have the effect of delaying or deterring a merger or acquisition between us and a third party could limit the opportunity for our shareholders to receive a premium for their shares of our common stock, and could also affect the price that some investors are willing to pay for our common stock.
We repurchased the following shares of our common stock during the first quarter of fiscal 2009:
Purchases during the first quarter of fiscal 2009 represented shares purchased by the Company from employees from which the proceeds are remitted to pay the employees withholding taxes due at the time the employees restricted stock awards vest under our equity-based compensation plans.
The following exhibits are filed herewith and this list is intended to constitute the exhibit index:
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.