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Item 1.
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Legal Proceedings
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See Note 15 of Notes to Consolidated Financial Statements.
RISK FACTORS AFFECTING BUSINESS AND RESULTS OF OPERATIONS
Investing in our securities involves a high degree of risk. If any of the following risks occur, 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 the 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.
The electronics industry is characterized by intense competition, rapid technological change, relatively short product life-cycles and pricing and
margin pressures. These factors adversely affect our customers and we suffer similar effects. Our customers are primarily high-technology equipment manufacturers in the communications, automotive, high-end computing and storage, test and
measurement, and aerospace and defense end 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 services and premium revenues
versus standard lead time production, any of which could have a material adverse effect on our results of operations.
Lower sales may cause gross
profits and operating results to decrease because many of our operating costs are fixed.
A significant portion of our operating expenses are
relatively fixed in nature, and planned expenditures are based in part on anticipated orders. If we do not receive orders as anticipated or if revenue is reduced by reductions in the proportion of our quick-turn services and premium business, our
operating results will be adversely affected. Revenue shortfalls have historically resulted in an underutilization of our installed capacity and, together with adverse pricing, have decreased our gross profits. Future decreases in demand or pricing
will likely decrease our gross profits and have a material adverse impact 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 printed circuit boards is intensely competitive,
highly fragmented and rapidly changing. We expect competition to persist, which could result in continued reductions in pricing and gross profits and loss of market share. We believe our major competitors are United States, Asian and other
international independent manufacturers of multi-layer printed circuit boards, backplanes and other electronic assemblies, and companies that offer quick-turn services. 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. and ViaSystems, Inc.
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Some of our competitors and potential competitors may have a number of advantages over us, including:
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significantly greater financial, technical, marketing and manufacturing resources;
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preferred vendor status with some of our existing and potential customers;
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more focused production facilities that may allow them to produce and sell products at lower price points;
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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 printed circuit board industry, which we expect to continue, could result in an increasing number of larger printed circuit board 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.
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 when 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 gross profits may be materially adversely affected by increased pricing pressure.
Printed circuit board 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 printed circuit board markets in which we compete, which may adversely affect our revenues and profitability. While printed circuit board 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 printed circuit boards.
Success in Asia may adversely affect our U.S. operations.
To the extent Asian printed circuit board
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.
The cyclical nature of automotive production and sales could adversely affect Merix’ business.
A significant portion of Merix Asia’s products are sold to customers in the automotive industry. As a result, Merix Asia’s 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 Asia’s customers could have a material adverse effect on Merix’ business, results of operations and financial condition.
We rely on suppliers for the timely delivery of materials used in manufacturing our printed circuit boards, 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 gross profits.
To manufacture our
printed circuit boards, 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 gross profits and our ability to deliver our products on a timely basis. We have recently experienced, and expect that we will
continue to experience, significant
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increases in the cost of laminate materials, copper products and oil-based or oil-derivative raw materials. These cost increases have had an adverse impact
on our gross profits 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 printed circuit boards 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 printed circuit boards using that type of laminate, which in turn would cause a decrease in our consolidated net sales.
Acquisitions may be costly and difficult to integrate, may divert and dilute management resources and may dilute shareholder value. Recently, we announced our
intention to accelerate the expansion of both production capability and capacity at our China-based factories. This expansion, coupled with the phased closure of our Hong Kong-based facility scheduled to be completed by July 2008, will further
increase the risk of integration of Merix Asia. There is no guarantee that the expansion and closure will be completed as planned.
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 connection with our San Jose and Asian acquisitions, we have experienced, and in any future acquisitions or investments, we could experience:
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problems integrating the purchased operations, technologies or products;
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failure to achieve potential sales, materials costs and other synergies;
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unanticipated expenses and working capital requirements;
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diversion of management’s attention and loss of key employees;
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further charges and asset impairments related to the acquisitions; and
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problems completing anticipated technology transfers to our Asian operations.
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In addition, in connection with any future acquisitions or investments, we could:
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issue stock that would dilute our current shareholders’ percentage ownership;
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incur debt and assume liabilities that could impair our liquidity;
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incur amortization expenses related to intangible assets;
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uncover previous unknown liabilities; or
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incur large and immediate write-offs that would reduce net income.
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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.
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.
We recently announced our intentions 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:
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delays in receiving and installing required manufacturing equipment;
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inability to retain management personnel and skilled employees, or labor shortages in general;
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difficulties scaling up production at our expanded facilities;
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challenges in coordinating management of operations and order fulfillment between our U.S. and Asian facilities;
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a need to improve and expand our management information systems and financial controls to accommodate our expanded operations;
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additional unanticipated costs;
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shortfalls in production volumes as a result of unanticipated start-up or expansion delays that could prevent us from meeting our customers’ delivery schedules
or production needs; and
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our Forwarding 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.
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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.
Our restructuring efforts, capacity build out and technological changes will require significant capital
investment.
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 $25 million to $30 million of capital expenditures in fiscal 2008 and additional spending in
2009. 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.
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 printed circuit board 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.
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
are 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.
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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 $25 million. As of December 1, 2007, we had advanced Merix Asia approximately $11.5 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, or otherwise, there is risk that we will not be able to fund our Asian operations and the growth plans in Asia.
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 printed circuit board 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 are minority interest holders in each of them. The aggregate minority interest in these companies ranges from 5% to 15%. These minority holders are local investors
with close ties to local economic development and other government agencies. The investors lease to our Chinese operating companies the land on which the plants 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. The joint venture relating to our Huizhou facility is scheduled to terminate in November
2008, unless it is extended. Failure to extend the Huizhou joint venture or 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 materially 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 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 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, 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.
New labor laws in the PRC may adversely affect our results of operations.
As of January 1, 2008, we had approximately 2,260
employees in the PRC. In July, 2007 the PRC government enacted a new labor law that becomes effective on January 1, 2008 that significantly impacts the cost of a company’s 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 in a timely and cost effective manner.
We may detect additional material weaknesses or significant deficiencies
or may not be able to remediate the material weaknesses in our internal control over financial reporting, which may adversely affect investor confidence in us and our stock price.
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 management’s assessment of our internal control over financial reporting, we identified the following material weakness in our internal control over financial reporting:
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After considering the errors that resulted in the restatement of our first quarter of fiscal 2008 financial results, management has concluded that a material
weakness existed in our internal control over financial reporting. Specifically, we did not maintain adequate controls over the processing and recording of transactions related to customer returns of products for warranty rework or credit.
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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, as of May 26, 2007, Merix
management did not maintain sufficient controls to adequately monitor the accounting and financial reporting of our Merix Asia operations. This material weakness resulted in adjustments to our 2007 annual consolidated financial statements that were
identified by management and the external auditors. Additionally, 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.
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We continue to integrate
our businesses that include developing and installing a new global ERP system. While the integration process continues and new systems and processes are initiated, we may uncover 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.
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 Asia’s 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.
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 32% and 37% of our consolidated net sales during the first two quarters of fiscal 2008 and in all of fiscal
2007, respectively. Net sales to one customer represented 11% of consolidated net sales during the first two quarters of fiscal 2008. Net sales to two customers individually represented 15% and 11% of consolidated net sales during fiscal 2007. 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 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.
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.
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In total, five entities represented approximately 31% of the consolidated net trade accounts receivable balance at
December 1, 2007, individually ranging from approximately 3% to approximately 11%. 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:
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fluctuation in demand for our customers’ products;
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changes in customers’ manufacturing strategies, such as a decision by a customer to either diversify or consolidate the number of printed circuit board
manufacturers used;
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customers’ inventory management; and
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changes in new product introductions.
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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.
Our operations in the People’s Republic of China subject
us to risks and uncertainties relating to the laws and regulations of the People’s Republic of China.
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 are 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 timely published or communicated in local districts, 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 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 Hong Kong 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
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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.
Our Chinese and Hong Kong 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 and Hong Kong. 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 and Hong Kong, 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 or Hong Kong, including:
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lack of developed infrastructure;
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overlapping taxes and multiple taxation issues;
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employment and severance taxes;
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the burdens of cost, compliance and interpretation of a variety of foreign laws;
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difficulty in attracting and training workers in foreign markets and problems caused by labor unrest; and
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less protection of our proprietary processes and know-how.
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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.
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.
With the acquisition of our 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:
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logistical, communications and other operational difficulties in managing a global enterprise;
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potentially adverse tax consequences;
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restrictions on the transfer of funds into or out of a country;
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longer sales and collection cycles;
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potential adverse changes in laws and regulatory practices, including export license requirements, trade barriers, tariffs and tax laws;
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protectionist and trade laws and business practices that favor local companies;
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restrictive governmental actions;
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burdens and costs of compliance with a variety of foreign laws;
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political and economic instability, including terrorist activities;
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natural disaster or outbreaks of infectious diseases affecting the regions in which we operate or sell products; and
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difficulties in collecting accounts receivable.
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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. 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 printed circuit board, 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 limitations 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.
As we commence our work to implement a new 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.
We are
currently using multiple ERP and other information systems. We began the initial design and implementation for a single world-wide ERP system during fiscal 2007. We expect the new ERP system will become 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 in fiscal 2008 as an
active project. 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 may require us to change certain internal business practices and training may be inadequate. We may encounter unexpected difficulties, delays, internal control issues, costs or other challenges, any of which may
disrupt our business. Corrections and improvements may be required as we continue 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
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resources. Any delay in the implementation of, or 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 and to 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 management’s attention and resources and impact our ability to manage our business and our results of operations.
If we lose key management, operations, engineering and 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.
Pending or future litigation could have a material adverse effect on our operating results and financial condition.
We are currently subject to legal proceedings and claims, including a securities class action lawsuit as follows:
Four purported class action complaints were filed against us 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,
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 our common stock. In September 2006, the Court dismissed that complaint with prejudice. The plaintiffs appealed to the Ninth Circuit Court of Appeals. The parties have submitted briefs to the Court of
Appeals. We expect that oral argument in the appeal will occur in 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. We have recorded charges for estimated probable costs associated with defending these claims, as it is our policy to accrue legal fees when it is probable that we will have to
defend against known claims or allegations and we can reasonably estimate the amount of anticipated expense.
Where we can make a reasonable estimate of
any probable liability relating to pending litigation, we record a liability. Although we have created a reserve for some of the potential legal fees associated with litigation currently pending against us, we have not created any reserve for
potential liability for settlements or judgments because the potential liability is neither probable nor estimable. Even when we record a liability, the amount of our estimates of costs or liabilities could be wrong. In addition to the direct costs
of litigation, pending or future litigation could divert management’s attention and resources from the operation of our business. Accordingly, our operating results and financial condition could be adversely affected.
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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 anticipate recording restructuring and impairment charges in the third quarter of 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.
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 both 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:
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the effects of a mix of profits or losses earned by us and our subsidiaries in numerous tax jurisdictions with a broad range of income tax rates;
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our ability to utilize net operating losses;
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changes in contingencies related to taxes, interest or penalties resulting from tax audits; and
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changes in tax laws or the interpretation of such laws.
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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 assure you 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 13 years.
The market
price of our common stock may fluctuate as a result of a number of factors including:
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actual and anticipated variations in our operating results;
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general economic and market conditions, including changes in demand in the printed circuit board industry and the end markets which we serve;
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geopolitical conditions throughout the world;
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perceptions of the strengths and weaknesses of the printed circuit board industry and the end markets which it serves;
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our ability to pay principal and interest on our debt when due;
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developments in our relationships with our lenders, customers, and/or suppliers;
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announcements of alliances, mergers or other relationships by or between our competitors and/or our suppliers and customers;
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announcements of plant closings, layoffs, restructurings or bankruptcies by our competitors; and
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developments related to regulations, including environmental and wastewater regulations.
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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 printed circuit board 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. As of December 1, 2007, we had 2,989,972 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 $2.04 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 rights agreement, as well as provisions of Oregon law, could inhibit a takeover attempt.
Some of the provisions of our articles of incorporation, bylaws, rights agreement and Oregon’s 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 rights agreement is designed to enhance the Board’s 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 our 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.
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