They’ve migrated. Does that make sense?
Bill Dezellem: I believe it does make sense. Let me try to play that back to make sure that I’m hearing it correctly. Which is customers that are willing to pay or who demand a higher level of service are willing to pay the extra price for the U.S. The customers who want the lowest price, they’re going to Vietnam, which you had built Mexico on a higher service model, higher service, lower cost, but not the lowest cost, and that really has left Mexico in a no man’s land and therefore now you’re needing to make an adjustment and it sounds like, if I’m hearing correctly, you are taking the extra cost that went along with the higher level of service out of the Mexican cost structure and will allow you to run the big programs and less changeovers taking place because those changeovers will probably be in the U.S. or the super low cost in Vietnam. Am I hearing that somewhat close?
Craig Gates: Yes.
Bill Dezellem: I guess that leads to two additional questions and my apologies for dominating here so long. First of all, does that put Mexico in a strange place for now given that it’s two-thirds of your revenue and yet a little bit of no man’s land and then secondarily, how quickly do you foresee Vietnam filling up and I guess thirdly coming back to Mexico, would you anticipate that the changes that you are making with this restructuring will then accelerate growth in Mexico so that you otherwise wouldn’t have been able to win because you just weren’t positioned correctly?
Craig Gates: The third question is the most important and that is exactly what we expect. We have already seen that as we’ve been pricing as if we had the new model completely put in place, which we will by the time these programs actually hit. That’s the main impetus for doing this is that we have to have Juarez able to compete on a commodity basis. That doesn’t mean that they won’t be able to provide the extra services that some customers will want, but that will be on an optional pay by the time you use it rather than baked into the basic cost structure of Juarez. It’s a switch from we’re standing there ready and we’ll do it for free to we can do it if it’s important enough that you want to pay for it. That comes down to a split in the customers of people who make the decision and people who have to live with it.
Typically the guy that makes the decision is mainly focused on price only and the folks that have to live with the decision are focused on the service level that they can get. As the makeup of the customers coming back from China has changed over the years, or as I should say, the makeup of the people that are interested in Mexico has changed over the years, the person making the decision that’s interested only in price has got the louder voice, whereas in the past it was more of a shared decision. Because the people that are coming out of China have a sticker shock when they’re ordered to move and they have to come to Mexico and our price and anybody else’s price is more than China. They don’t like it. Trying to sell a baked in service level that’s better than China to the person who’s only evaluated on price is an uphill battle.
It didn’t used to be as much as it is now. That’s why we’re making the change. I don’t think it’s going to drive any change in the attractiveness of Vietnam or the United States. I don’t think the two are that much interconnected because they pretty much stand on their own right.
Bill Dezellem: Craig, does this put you in the enviable position where the upfront decision maker, you can win them because you have a lower price and then when the operator is basically being told you need to get something done and your job’s on the line if you’re not able to accomplish it, they can come to you and you’ll have the ability and they say I don’t care what it costs, loosely speaking, and you’re able to charge for that. You win on both sides.
Craig Gates: That’s certainly the intent.
Bill Dezellem: One additional question and I’ll step back in queue. Do you see a place for an additional facility or an additional geography within Mexico or somewhere else near and I’m thinking inland where the and when I say inland I mean non-border where the labor costs are lower and yet you can still have the relative nearness of Mexico or do you believe what you’re doing here accomplishes all that you need from a geographic dispersion?
Craig Gates: Well, any time over the last 20 years we’ve kept an eye out on opportunities deeper within Mexico and we continue to see after much analysis and hand wringing that the delta in direct labor wages that you receive by going deeper inland as you say to Mexico is mainly offset by the increase in salaries you have to pay to get people who want to work in salaried positions deeper into Mexico and then you have the further offsetting disadvantage of shipping time and the further offsetting disadvantage of getting engineers across the border and eight hours into Mexico. So as of right now we are staying pat on our ORES hand but that could change at any time as various factors that we don’t control change. So we’re prepared to change our decision but right now after looking at it pretty hard it appears that ORES is the right answer for us.
Bill Dezellem: Understood. I told you that would be my last question. I am going to renege on that and say relative to the restructuring that you’re doing is this primarily the labor that you’re laying off hourly labor or primarily salaried labor?
Craig Gates: Well, here’s a quiz. Which do you think it is?
Bill Dezellem: I would guess it would be more salaried labor is just how I’m thinking about what I thought I heard you say.
Craig Gates: Perfect. That’s exactly right. We are communicating.
Bill Dezellem: So if you are laying off that salaried workforce, essentially the fixed cost or some portion of the fixed cost there, when a customer who historically been able to say to you, gosh, I really need this quickly, how do you respond since it was in part because of those salaried people, I suspect some of them that will no longer be with you were making that happen?
Craig Gates: So we’re not laying them all off. We’re laying quite a few of them off and we’ve already seen that the customers who need that and who are willing to pay for it create much less of a workload than what we were giving away as part of the total business proposition a year ago. So we still have the capability to do it, just on a smaller scale. And that scale is smaller because customers now have to pay for it in many cases versus getting it for free previously.
Bill Dezellem: Well, congratulations on the learnings. And it sounds like this is a little bit like the difference between going to an a la carte restaurant and a buffet that we probably do all of us tend to eat a little bit more at the buffet simply because we can.
Craig Gates: That’s a true statement. Part of it is learning, but part of it is what has changed in the marketplace as people have come out of China who were there before. So it’s not so much learning as it is analysis of the change and reacting to it.
Bill Dezellem: Great. Thank you. I’ll step back in queue and queue back in again.
Operator: Thank you. [Operator Instructions] The question comes from the line of George Melas with MKH Management.
George Melas: Good afternoon, guys. That was a very interesting discussion earlier with Bill. So thank you for that. Thank you, Bill. I have some questions that are much more numbers oriented. The $8.1 million in inventory sales, was that at no gross margin?
Brett Larsen: There was no gross margin on it, but we were able to charge a few fees for the transportation and recycling of that. So there wasn’t that much dilution in the actual gross margin when you offset those two.
George Melas: Okay. Because I was trying to see that if you had no profit on those sales, your gross margin really was $8.6 instead of $8.1. So if you exclude those inventory sales, what would have been the gross margin?
Brett Larsen: Roughly about 8.3%-8.4%. Okay. So it’s a little bit more than that.
George Melas: Okay, great. Looking at the off-ex, I think USG&A expected to be sort of flattish, but it was up. Your product development is at the lowest level it’s been in three years, at 1.8. Is there some chargers? Can you help explain those numbers?
Brett Larsen: We’ve taken a real serious look at of course salaried positions. The other is that there have been some changes in payroll benefits that we’ve been able to reduce some costs there as well. I would anticipate prospectively that we will see a slight increase to our op-ex, but nothing substantial. We really have taken a sharp pencil to our operating expenses.
George Melas: Okay. So essentially you see USG&A being relatively flat and maybe product development coming up just a little bit.
Brett Larsen: Correct.
George Melas: Now I want to try to understand the guidance including the chargers. If I look at the guidance of 0 cents to 15 cents that implies a net income of 0 to let’s say 1.6. And if I add back the chargers of 1 to 2.5, I think in the midpoint I get to roughly $2.5 million in what I would call adjusted net income. And to get to $2.5 million and if you have interest expense of $3 million and the tax rate of 20%, that implies an EBIT of roughly $6 million. And then if we add back the op-ex of $8 million, that implies a gross profit of $14 million, which implies a gross margin of 10. So I’m just trying to see if I got the numbers right or maybe where I’m off.
