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Molex Inc. (NASDAQ:MOLX)

Q4 2006 Earnings Conference Call

August 02, 2006 5:00 pm ET

Executives

Neil Lefort - Vice President, Investor Relations

Martin P. Slark - Vice Chairman, Chief Executive Officer

David Johnson – Chief Financial Officer

Analysts

Michael Walker - Credit Suisse First Boston

Jim Suva - Citigroup

Alexander Paris - Barrington Research Associates

Matt Sheerin - Thomas Weisel Partners

Jay Sikorski - JPMorgan

Shawn Harrison - Longbow Research

Steven Fox - Merrill Lynch

Carter Shoop - Deutsche Bank

Yuri Krapivin - Lehman Brothers

Robert Maynard - Chicago Tribune

Jeff Rosenberg - William Blair Company

Operator

Good day, ladies and gentlemen, and welcome to the Fourth Quarter 2006 Molex Inc. Earnings Conference Call. My name is Sheryl and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of this conference. [Operator Instructions] I would now like to turn the presentation over to your host for today's call, Mr. Neil Lefort, Senior Vice President. Please proceed, sir.

Neil Lefort - Vice President, Investor Relations

Thank you, Sheryl. And thank you for all the participants for joining us today. With me on the call are Martin Slark, our CEO, Dave Johnson, our CFO and Liam McCarthy, our President and COO. As Sheryl said, this call is being recorded, it is available in telephone replay by dialing the number supplied in the press release. The call is also available live and in replay by accessing our website. Please note that we have added slides to our presentation and those wishing to view the slides can do so on the website under the investor section.

At the beginning I would just like to say we would like to hold the call to one hour and have everybody start with one question. Tomorrow we have just in Chicago our analyst meeting. If you want details on the analyst meeting, it starts at 10:00 Central Time, you can find them in the press release. If you can't attend, we are webcasting part of it on an audio basis only and that is also available on our website.

Now I'd like to begin with our condensed reading of our Safe Harbor statement. Again, the full Safe Harbor statement is in the slides on page 2 on the website. It's also in the press release. Statements in this release that are not historic are forward-looking and are subject to various risks and uncertainties that could cause actual results to vary materially from those stated. Forward-looking statements are based on currently available information and include, among other, the discussions under transition to product focus global organization, acquisition of Woodhead Industries, 2007 fiscal year outlook and 2007 first fiscal quarter outlook as well as statements regarding future growth expectations. These risks and uncertainties are set forth in Molex’s documents filed with the Securities and Exchange Commission, including Molex’s Form 10-K for the year ending June 30, 2006. Molex disclaims any obligation to revise these forward-looking statements or to provide any updates regarding information contained in this release resulting from new information, future events, or otherwise.

In addition, because we mention our pending tender offer for Woodhead Industries, I need to remind you that the solicitation and offer to purchase Woodhead common stock is being made only pursuant to an offer to purchase and related materials at Molex and its acquisition subsidiary filed with the SEC on July 10th. Stockholders should carefully read the offer to purchase and related materials as amended because they contain important information. These materials may be obtained for no charge upon request to Georgeson Inc., the information agent for the tender offer. In addition, these materials are available on the SEC's website at www.sec.gov.

Disclosures in this conference call regarding earnings per share, excluding restructuring charges, this is slide 3, that I'm on, which is a non-GAAP financial measure are available in the investor section of the company's website at www.molex.com and in addition are included in the slides used during this call.

Now I'd like to get to the business. And quickly review the highlights. This is slide 4 of the quarter that we just finished, the June quarter. Revenue was 783.8 million, up 21.8% from the prior year and up 8.8% sequentially. New orders were 785.2 million, up 20.5% from the prior year and 2.1% sequentially. Earnings per share excluding restructuring charges were $0.42. That's a year-over-year increase of 55.6%.

Now on slide 5, I'd like to review the financial summary all under GAAP. The sales were 783.8 million. The currency translation was a negative 5.8 million. Therefore, the local increase in sales was 22.7%. The gross profit margin was 35%. The SG&A as a percent of sales was 21.7%. The restructuring charge in the quarter was 10.7 million. We had a positive $1 million gain in equity income. Interest income was a gain of 2.3 million. We had another loss of 1.3 million. The pre-tax return on sales was 12.3%, the effective tax rate was 26.8%. The net income was 70.3 million. That's 9% return on sales under GAAP. The EPS were $0.38 and the average shares outstanding were 186,274,000.

Now, I’d just like to make some initial comments on those numbers before Dave goes through his financial review. Sales were above our previous guidance with all major markets and geographies showing strong growth. Again, the currency translation impact to sales was negative while sales in dollars increased 22%, sales in local or constant currencies grew 23%. Gross profit margin declined sequentially by 60 basis points to 35% but is improved by 60 basis points during fiscal ‘06.

SG&A was 21.7% of sales, our lowest rate this fiscal. The quarter also included 3.8 million due to the adoption of FASB No. 123(NYSE:R) regarding stock option costs. This cost was included in our expectation for the quarter but should be considered when comparing to prior-year SG&A levels. Please note that these SG&A amounts do not include the 10.7 million restructuring charge for the quarter that is recorded separately in the income statement. Both interest income and equity income were fairly consistent with recent historic levels. The effective tax rate of 26.8% was lower than prior quarters as we adjusted the full fiscal rate to 28%. Including all of the items I mentioned above, GAAP EPS was $0.38 per share.

On page 6, there's a reconciliation to GAAP earnings as I just said was $0.38, the restructuring charge in the quarter was $0.04, the non-GAAP earnings per share, $0.42. And the $0.42, as I said previously, would have been up 55.6% from the prior year quarter. Looking at the backlog, the backlog at the end of June ‘06, the current quarter was 370 million. That compares with the prior-year backlog June 2005 of 259.5 million, therefore the backlog in dollars is up year-over-year 42.6%. If we were to translate the local currency backlog at the end of June at the prior year rate, June 2005 rate, the current backlog would have been 363.2%, therefore the local currency increase in the backlog would have been 40%. Just to remind you, the backlog at the end of March, the sequential prior backlog was 354.3 million. The company maintains strong momentum with ending backlog above the prior year by 42.6% and improved sequentially by 4.4%.

Looking briefly at the stock buyback. During the quarter, we repurchased 200,000 shares of MOLX, 735,000 shares of MOLXA. We spent $30.3 million to do that. Just to reminder that the current authorization through December 31, 2006 was for 250 million, meaning that we still have 50.1 million remaining on that authorization. And now I am going to turn it over to Martin.

Martin P. Slark - Vice Chairman, Chief Executive Officer

Thank you, Neil, and good afternoon everybody. In this first section I am going to give you a quick overview of our revenue trends, both by industry and by geography. But firstly looking at slide 9 and looking at our overall revenue trends. As Neil has already told you, we had revenues of 784 million in the fourth quarter. That’s our fourth consecutive record revenue quarter and a 22% increase from the prior Q4 level of 644 million. The increase in revenue is very broad based and reflects increases in all our major markets and regions and if you turn to slide 10, I’ll talk to you a little bit about how we're growing by geography.

As you can see on slide 10, we had good growth in every region. It really was an exceptional quarter in terms of our global growth rate. While the Far East regions continue to lead, we were very pleased to see broad-based strength both in Europe and the Americas. And while quarterly growth rates for the overall connector market are difficult to obtain, we are very confident that we are taking significant market share with an increase of 22% over the prior year no matter whose data you look at, that is clearly several times the growth rate of the market. We believe are taking full advantage of our long-term and strong presence in the Far East. It's important to remember that we've been in Japan since ‘69 and in China since 1982.

Overall, in U.S. dollar terms we had a 32% growth in the Far East South region, 14% growth in Japan or Far East North, and remember that is based on the third-party sales from their actual export value of those sales is higher. We had 13% growth in the Americas. And I think particularly encouraging was the 18% growth we had in Europe, which has been a region that has struggled but now is showing some good momentum.

If you look at slide 11, and our growth rate by market sector, the consumer market has remained strong because increasing sales of digital consumer products especially the flat panel TVs, and even though the sales relative to the World Cup period were somewhat disappointing, the leading players in that market are encouraged about the potential for increased sales as we move towards Christmas. Particularly because the price of those flat panel displays have now got to the point where they are about twice that the old CRT tubes and as a result of that they are becoming increasingly attractive to the consumer and so there is a great sense amongst those manufacturers that the volumes there will continue to increase.

The mobile phone market continued to grow with the market split at this point approximately 50-50 between low-end new subscriber phones, primarily in the developing world, and higher end replacement phones. But the sense among the major manufacturers is the percentage of sales coming from those replacement phones is going to increase. We think that is particularly encouraging because those replacement phones tend to have increased functionality and higher content for Molex. The market sector that struggled the most after the Tech Bubble Burst in the telecom infrastructure market and that's continuing to recover and we had a 15% year-over-year growth in that sector. Networking and 3G infrastructure applications at Cisco, Tellabs, Ericsson, Wireway and (indiscernible) drove this growth.

Revenue growth in the data market which have been slower for us later in the year, earlier in the year when we were doing some product pruning continued to improve. Especially in the notebook and data storage areas and this is really driven by new products that were introducing in those markets. Automotive growth which is really continuing with good growth was based primarily on increased electronic content in new car models and new product wins. We are seeing good progress also in the industrial markets, particularly in test equipment and the robotics sectors. And some of the recent reports from Bishop, et cetera, showing that the industrial market is going to grow significantly faster in the future because of increased electronic content in industrial applications is really further increased our enthusiasm for the Woodhead application.

Focus markets such as medical and military also grew at a strong rate in the last quarter and we believe our pipeline of new opportunities is also equally strong going forward. Overall, we had a 32% growth rate in the consumer markets, 23% in telecom, 14% in data, 12% in automotive, 31% in industrial, and 23% for medical. So, good strong growth in every single end market. Finally, looking at our bookings, the bookings for the quarter increased 20.5% over the prior year and we are up 2.1% sequentially. Bookings dipped modestly in the April month but then were extremely strong in May and June with June being the highest month in the quarter. So we entered the -- exited the year with good momentum and strong bookings. I will now turn the call over to Dave Johnson, who’s going to give you some further detail on our financial results.

David Johnson – Chief Financial Officer

Thank you, Martin. Let's start with the EBITDA reconciliation on page 13. Starting at the top with our net income of $70.3 million, subtracting that interest income, adding back income taxes, adding back depreciation and amortization, we get to an EBITDA level of just under $150 million for the quarter or just under 19% of revenue. Then adding back restructuring expenses, which were $10.7 million for the quarter, we get to an adjusted EBITDA of $158.6 million, just over 20% of revenue. You'll note that the restructuring expenses of $10.7 million are higher than we had previously estimated. This is because of a number of early retirements that went into place both in Europe and in the Americas that cause that to be a bit higher. Also please note that the numbers on this page are all GAAP EBITDA numbers.

If you turn to the next page, page 14, we'll go through some of the balance sheet metrics. Cash was $485.5 million cash and cash equivalents at the end of the quarter, which is up over $80 million from the previous quarter. This is a result of very good working capital generation as well as clearly the results of our cash flow from operations. Both accounts receivable and inventory picked up slightly in the quarter and you can see down below the days came down, clearly receivables inventory are both growing at rates slower than the growth of revenue and we'll go into some more detail on the days for inventory and receivables in a few minutes.

Our capital expenditures for the quarter were $82.9 million. That is higher than the previous quarter and a bit higher than our estimate based mainly to closing out of projects at year-end, but also we put in place much-needed capacity for the recent surge of demand in orders. Depreciation for the quarter was $53.7 million, and our R&D expense was $35.7 million, fairly consistent with expectations in the previous quarter.

Our gross margins are shown on page 15. Gross margin for the current quarter was 35%. This is well above the 33.4% last year, but down slightly sequentially from 35.6% in the third quarter. If you go quarter-by-quarter for this year, starting at the fourth quarter last year, as I say we were 33.4% Q1 this year, 34.3% Q2, and December of 34.7%, Q3, 35.6 and now 35%. The current quarter margin is down slightly because -- primarily because of inventory adjustments and higher material costs. At the year-end we had roughly $5 million of adjustments to inventory, 3 million of that was related to ROHAS, which is the restriction on use of hazardous substances we've talked about in previous calls we felt that in coming into compliance with that for the July 1st kickoff date in Europe, we needed to provide roughly $3 million. In addition we've got about $2 million of write-offs related to scrap recovery estimate changes. We've got cycle count adjustments and some residual inventory write-off for a few of our plant closures as I said about $2 million for that in the quarter as well.

In addition, we again suffered significant increases in gold and copper prices. That resulted in roughly a material cost increase of 4 to $5 million in the quarter. We would expect to have continued pressure on material costs as we go into 2007 and our guidance assumes that the margins in the first quarter of 2007 will recover slightly and roughly be at the same level as the third quarter level for 2006.

Our SG&A trend is shown on page 16. This is shown as a percent of revenue. And, you will see the trend has come down quite significantly throughout the year. The overall trend is very positive and I’d say it is mostly driven by the increase in leverage that comes from the increased revenue, that was also had some very good impact on the restructuring activities in Europe and in Americas and other specific cost containment actions that we’ve taken most notably in Europe that has brought down our SG&A percent. If I go back and go through the trend at the end of the last year Q4 ’05, it was 24.1%, Q1 24.5%, Q2 came down at 22.9%, Q3 23.7% and now down to 21.7% in Q4 of 2006. We will continue to focus on SG&A, we made some good improvement this year, this year we expected to be some continued improvements as a percent of revenue as we go into 2006.

The trend of return on invested capital is shown on page 17, again a very, very good trend upward we achieved our goal of 10% for the year and in fact reached 10.3% for the full-year. On a quarterly basis we began at the end of last year at 6.9% and as you can see March steps steadily throughout the year to get to the 10.3%.

I want to remind you this is done on GAAP numbers only we do not adjust for restructuring for this, this is purely a GAAP calculation. We now are looking forward to our goal for 2007, we expect to be, our long-term goal that we’ve identified is close to be in excess of 12%. We expect, that we could in fact reach 12% in 2007 on the trend that we are on today.

If you turn to page 18, going through our receivable days outstanding, we have reduced our days from this quarter last year of 75 days, now to 70 days and the (indiscernible) between at 72 days as you can see from the chart. We’ve made some very good progress, the only point of interest for the full-year was the issue that we had with the (indiscernible) receivable because we heard bankruptcy that affected Q1 and Q2 but overall receivables is in very big control and you’re seeing some nice improvements as you see from the chart throughout the year.

On page 19, seeing the picture now there are inventory days outstanding reducing from a height in Q1 of last year of 72 days down to 69 days at the end of this year, its kind of very good improvement, its important to note that our vendor managed inventory or VMI days continue to be about 30 days and we believe this reports or comments in the past that this was a well managed inventory and outstanding strategy for the company and we can’t keep inventory days down with that strategy.

I mentioned before that we had some adjustments for foreign exchange reserves because of the ROHAS initiative that I would say was quite -- most significant item in packaging inventory for the year which I work on ROHAS

I would like to update you now on an accounting reclassification that will be making as of the first of July 2006. In the past, we’ve reported paid out to customers and customer shipments and warehousing cost in SG&A. Though not absolutely required the best accounting practices suggest that these cost should really be included in cost of sales, and we’re making that change for fiscal year 2007.

The chart on page 20, shows a simple illustration of this reclassification roughly we will be reclassifying if you were to do this in 2006, it would be $56 million roughly reclassifying that from SG&A to cost of sales. That would have done for last year has reduced our gross margin from 34.9% to 33% and also reduced our SG&A from 23.1% to 21.2%. Now, clearly there is no change in net income or any other metrics is simply a reclassification between those two accounts.

On page 21, for use in modeling we provide to you, the impact on each of the quarters in 2005 and 2006, so that you can change your model. This presentation will be available on our website as well, so you can refer back to these numbers as you need to update your models.

Now, that I had explained the reclassification, what I’d like to do is to show what our long-term profitability model looks like with these new gross margin and SG&A percentages. If you look at the chart, it shows the actual results for 2005 and 2006 adjusted for the reclassification. It’s also been adjusted to remove the restructuring and impairment cost because we do not see those going forward in the future and sure not affect our long-term model.

Our long-term model is that gross margins in the range of 33% to 35%, SG&A in the range of 19% to 21% and the resulting net income, that was approximately 10%.

I would like to now turn the call back over to Martin to go through some other items in our guidance.

Martin P. Slark - Vice Chairman, Chief Executive Officer

Thanks Dave, what I would like to do finally in our prepared remarks is to cover three issues that we mentioned in the press release and give you a little bit more detail relative to each of those. First of all, I’d like to talk about our transition into market focus organization away from the traditional geographic focus that we have had. We intend to maintain our geographic regions but within place the global market focus division. The fully implementation of this transition will be complete by July 3, 2007 and our plan is to create five global divisions, an automotive division, a consumer division, a commercial division, the industrial division and one focused on our integrated product.

In addition to those divisions there will also be one worldwide sales and marketing organization. When fully implemented we expect the new structure to enable us to work more effectively as a global team, as well as the better leverage at the growing expertise and low cost product centers around the world. The new worldwide sales and marketing organization will enhance our ability to sell any product to any customer anywhere in the world. And in fact we are taking what is already a very strong company and making it stronger by implementing changes designed to enable continued long-term performance improvement. And all of this is designed around really servicing our customers more effectively than we’ve done in the past. We don’t expect the transition process to generate significant implementation cost during fiscal 2007 and we have considered any non-cost in the 2007 fiscal year outlook.

On June 30, 2006 we announced also our plan to acquire Woodhead and that is an all cash transaction valued approximately 256 million. Woodhead, develops, manufactures and market network and electrical infrastructure product, engineered for performance in cost demanding and hazardous environmental end market. There is less than a 1% overlap between Woodhead product line and our own, so we believe that Woodhead acquisition is an excellent use of that cash and it significantly enhanced a portion of our sale that go into the fast growing industrial market to about 17% of our total revenue as compared to about 9% today.

Now I would like to briefly talk about the review that we did about stock-option practices. As we announced in the press release, we recently completed a review of our stock-option grants procedures. As described in the release, a special committee of our independent directors on the [inaudible] to-date through some options and restricted stock grants get rid in a number of instances from the dice (ph) of the grants that were approved by the appropriate board committee. The amounts involved were not material to Molex and no change will be made to previously issued financial statement that issued under generally accepted accounting principle. We planned to file our annual report on Form 10-K with the SEC tomorrow and that will include our audited financial statements for 2006 with the results as we described into you today. As described in this release, no executive officer that currently employed by Molex will realize any benefit due to the misdating of these options. And third that the company has revised its current stock-option practice procedures, so the option misdating will not occur in the future.

[Inaudible] is the final part of these prepared results, just give you our guidance for the coming year. We believe that we are in a strong overall competitive position and we are well positioned in many of the fast growing industry segments and we are extremely well positioned in the fast growing geography. We therefore think that we can continue to grow fast in the overall connective market. We’ve entered the new fiscal year with excellent business momentum and a very strong financial position, while the global economic outlook is uncertain which makes forecasting difficult. We believe that’s useful to provide investors with some initial estimates of fiscal year 2007 consistent without prior practices.

Based on the current outlook, we estimate that net revenue for fiscal year ending June 30, 2007 will be in the range of 3 billion to 3.3 billion. This represents a mid range increase of about 10.1% compared to fiscal 2006. During fiscal 2007 we will make a change in our Brazilian operation, and we will exit the lower margin value-added assembly operation and we’ll concentrate solely on the connective business in that geography. This will eliminate approximately 40 million of low margin sales during fiscal 2007. Without this change, our estimated mid-range sales growth would be about 11.5%. We estimate that our earnings per share for the full fiscal year will be in the range of $1.60 to $1.70. This represents a mid range increase of 31% compared to 2006. These comments and the outlook for the 2007, third fiscal quarter do not include the impact, the potential impact of Woodhead. We expect the revenue for the third fiscal quarter ended September 30, 2006 will be in the range of 760 million to 780 million representing a mid range increase of 16.7% compared with the last year’s third fiscal quarter. We expect that the earnings per share will be in the range of $0.37 to $0.41 representing a mid range increase of 56% compared with the same quarter last year. Please note that all of the mid range increases are compared to prior year GAAP results.

We estimate the capital expenditure for the fiscal year ended June 30, 2007 will be in the range of 280 to 320 million, these capital expenditures will be primarily focused on expanding product capacity either the new products or additions in capacity constrained areas as well as general capacity increases to support high volume. Capital increases expenditures were about 276.8 million for fiscal year ended June 30, 2006. That concludes our prepared remarks which were obviously longer today than they normally are, given all the various areas we are trying to cover. We would now like to open the call up for questions.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions]. Your first question comes from the line of Michael Walker from Credit Suisse. Please proceed.

Michael Walker - Credit Suisse First Boston

Thanks, good evening. My first question is just on the revenues, you are seeing a sequential increase was mostly we’ve had all year long, and we’ve heard you talk generally about demand, but it seems like, it seems to be pretty bit more in this quarter which seasonally would be little surprising. So I’m wondering if you could give any kind of further detail as to whether you think this is a macro economic demand environment or if you feel that, if the connector sort of specific aspects for the market share, certainly market extravagant?

Martin P. Slark

Yes, thanks Mike, let me try and give you some initial comments on that one certainly and may have some additional one. There is a lot of uncertainty I think as you write in the press today about the economic environment. We have frankly so far not seen that in the demand for our products, we think that the strength in our revenues and bookings particularly over the last 6 months is a function of a lot of the new products we’ve released into many of the market that we covered, but then also an increasing part of the market demand is clearly coming from the Asian economy. And I think Molex is particularly strong there and I think there is increasing demand in Asia with products being made and sold in Asia we are even better positioned than we have been in the past. So I think it’s the combination of getting the pay back on the investment we have made in R&D and new product and being very well positioned geographically in the gulf market.

David Johnson

Yeah I would just add to that, we have over the last 2 or 3 quarters seeing less price erosion than we normally see in the business and that is a function of demand I think being strong but its also a function of getting some reward from the customers for the higher raw materials that we’ve seen. So I think some of the stronger growth is really coming that the pricing environment has turned a little more profitable.

Michael Walker - Credit Suisse First Boston

Okay and if I could ask a follow-up its on your margin targets you are already there at the gross margin level, its got a little bit of upsides at the SG&A and the operating margin and you already there at the net margin. So I guess, I am wondering why you claim in targets may be is there no upsides from here or is this just new trend?

Martin P. Slark

Let me ask, it’s a good question, let me ask Dave Johnson to address that for you.

Dave Johnson

Sure we, you are correct, we are at the edge on both the gross margin and SG&A we’re at the edge of the margin of the target which means we have basically 2 percentage points that we could move within each of those. Our target still is to be at 10% we can provide you a bit better than that if we hit the higher ends from both SG&A and gross margins but, I think we are hitting, we are doing well and we are making some good improvements and I think that we are proud of the direction we are going in.

Michael Walker - Credit Suisse First Boston

Okay, thanks a lot.

Martin P. Slark

I would like to mention again to the – we would like to limit the callers to the questions to one question, because we are trying to finish by 1 hour time frame and then I think we took a little longer than we normally do.

Operator

Your next question comes from the line of Jim Suva from Citigroup. Please proceed.

Jim Suva - Citigroup

Thank you and congratulations. Can you comment a little bit about what you’re seeing out there on the terms of inventory bills, specifically your inventories went up this quarter while your sales and outlook looks like its going to be down a little bit or just flat. And especially in the handset area where over a year ago we saw inventory bill. Thank you.

David Johnson

Thanks for the question Jim. If you look in absolute dollars as we announced, our inventories were high up but as Dave covered in terms of our own inventories, the number of days of inventory actually went down. And then if you look at the channels we spell into, we think the OEM inventories that we work with are in shape and we have pretty good visibility on that based on the vendor managed inventory that we manage for a lot of our major customers. Our distribution inventory for connectors which we have good visibility for seems to be in good shape as well. But the one sector where there seems to be more of an inventory billed in dollar terms is the CM area and the contract manufactures that we work with have said that they are a built back which is consistent with what’ve done in prior years in preparation for the ramp that they normally see leading in the Christmas, particularly for the cell phone industry and other related markets. We frankly have not seen any areas where we’ll be concerned about the build in inventory by our own products and certainly we are seeing very good flow through in terms of the incoming orders and outgoing shipments in the same month.

Jim Suva - Citigroup

Great thank you and as a quick housekeeping item, tax rate was lower than expected, what should we expect going forward?

David Johnson

We are going to use roughly the 28.5% rate for fiscal 2007.

Jim Suva - Citigroup

Great, thank you and congratulations.

David Johnson

Thank you.

Operator

Your next question comes from the line of Alexander Paris from Barrington Research Associates. Please proceed.

Alexander Paris - Barrington Research Associates

Good afternoon, great quarter.

Martin P. Slark

Thank you.

Alexander Paris - Barrington Research Associates

I just have a question on Woodhead, I think they have a good strong focus on factory for communications. Is that a new area, does that give you a good base, is that a sizeable area for which Woodhead would provide a good base and if so who is you main competitor be in that kind of business?

Martin P. Slark

Alex thanks, that’s a great question. We are actually very excited about Woodhead on two fronts, they give us a number of products that we don’t have today that we could sell into our existing customers. And also they sell to a number of customers and through a number of channels on a number of new distributions that we are now dealing with today. So we think that could be substantial synergy on both side there and particularly you highlighted that whole factory automation market where they are a big player, provide a lot of the cable assemblies and the rugged eye connectors for that. But the electronic control to go with that, Molex could certainly provide the connectors for that as well. So we think that it’s a very good match for us in the final acquisition that strengthens us in the market where we’ve been historically been stronger, that only a 1% product overlap is we think is a good point. There are number of other strong competitive net market. But it’s a very fragmented market with no dominant player, there is certainly no one that we would be concerned about competing against in that sector.

Alexander Paris - Barrington Research Associates

Okay. Thank you.

Operator

Your next question comes from the line of Matt Sheerin from Thomas Weisel Partners. Please proceed.

Matthew Sheerin - Thomas Weisel Partners

Yes, thank you. I would like to ask question regarding handset market which is been a real area of strength for you. You spoke Martin, about the market being sort of divided into two segments, kind of low end and high end. I believe that you’re more skewed to the high end, but could you give us some more specifics about that and also customer exposure, do you have -- I know you’ve got two very big customers there, but could you talk about the exposure there. And as you look forward do you expect to see some growing or slowing growth rates there and how are you generally positioned across the other big players?

Martin P. Slark

I think, let me answer the last part of that question first. You know that the cell phone market has seen years of, 30% plus growth rate. It’s not out due that the cell phone industry in total is going to continue to grow at 30% plus rate. So I think the total growth rate there will slow, but I think it’s going to slow to probably more of a 25% growth rate, it’s still going to be very healthy. You are right that we are a major player supplier to Motorola, Nokia, Sony Ericsson, all of the major players in that market. And the interesting thing that happened is that there were some past two years ago that those leading global players would lose out at the low end of the market to low cost manufacturers in China and the developed world, but the interesting amongst the Chinese in particular very brand conscious and all of those players would have their own low end phones to compete in that market but you look to the cell phone market in total last year, the only players that gained market share were those leading company, we do to our Chinese operation supplied bad and the Chinese manufacture but they are mainly voice only phones that have limited connected content. So the opportunity and for both revenue and obviously the growth is much stronger at the higher end of the market.

Matthew Sheerin - Thomas Weisel Partners

Okay, and you are pretty well positioned there then?

Martin P. Slark

We think that if you look at those phones that carry functionality the cameras, MP3 players have 3G capability, the more and more compound within those, the stronger and stronger Molex position becomes.

Matthew Sheerin - Thomas Weisel Partners

Okay, thanks very much.

Operator

Your next question comes from the line of Jay Sikorski (ph) from JPMorgan. Please proceed.

Jay Sikorski - JPMorgan

Good afternoon guys, just a quick question on the gross margins, I’ve been into the impression the year gross margins for some of your consumer products perhaps a bit more robust in the rest of the enterprise and with the strength that you saw there this quarter I would have expected a little bit more margin expansion on gross margins. So I was just wondering if the assumption is correct that gross margins are little bit more robust for the consumer products and then secondly, if they was in a bit more system build this quarter then you would have seen in past quarters that may have explained the lack of expansions so to speak in gross margins?

Martin P. Slark

Let me ask Neil to address that and then couple of others will have comment for this.

Neil Lefort

Yeah, I will address the first part in terms of, I think we said at the beginning this quarter was not a quarter where our growth was driven by consumer or the mobile side, it was certainly that contributed in a broad way but we have fairly broad growth to all the different segments, I think we had good growth numbers in automotive and in the other segment. So it’s not a quarter where I think the gross profit margin was driven or dominated so much by our percentage sales in the consumer amount of products.

David Johnson

I think, we also get comments about another relative margin levels in the end market we are selling to, and I would tell you that it vary tremendously by customer and by product line and by end application. The one general rule of thumb I would say though is that to the extent that the end products we’re selling to is a commodity and the ultimate extreme with that is desktop PC. The margins there under much greater pressure, we are going to the spectrum where your winning designs based on technology and I would say telecom switching equipment is the example there, the margins are much stronger. The consumer I would say is some what in the middle depending on the application, so I think now there are higher tech end markets that we’re selling through our stronger margin.

Jay Sikorski - JPMorgan

Okay, great, thanks guys.

Operator

Your next question comes from the line of Shawn Harrison from Longbow Research. Please proceed.

Shawn Harrison - Longbow Research

I just had a quick house keeping question, firstly you mention the sales was due to the elimination of the Brazilian business, I was just wondering if you could mention the earnings impact?

Martin P. Slark

Let me, I would say we -- with the sales, a bit more about the Brazilian situation if you have a general sense. It is, part of it is a restructuring activity, we have decided not to account for this in the restructuring line from taken -- because it wasn’t announced previously its quite small in ’06, probably less than $2 million in terms of a charge we took in ’06 will be a charge in ’07 as well but it will be within operations because its not material, we’ll reserve and have the restructuring activity for really material items and we don’t expect to have in ’07. The profitability of that business was fairly low which is the reason why we’re moving, moving it from the current business into the – by recent activity, so margin contribution was quite small for last year.

Shawn Harrison - Longbow Research

Okay and my question just has to do with, operating expenses and margins heading into the September quarter, I think it was mentioned that gross margin would be similar to kind of the March quarter and if my math is right, that looks like there is going to be a significant at least 5 plus million dollar, maybe step up in operating expenses kind of get you to where you need to be in terms of your earnings guidance. Just wondering if you could provide some commentary?

Martin P. Slark

Yeah the increase in material cost this quarter, I’ll give you a bit of more color on that as well, I said it was we had about $4 million sequential increase due to copper and gold and plastics in Q4. Because of the significant increase in material cost in that quarter we actually, that number is a net number, net of an increase that we had that was quite a bit higher. We actually have capitalized the end of the year, our negative purchase price variant roughly $7 million. So the real increase in those commodities in the quarter for us is about $11 million. And that continues, that will continue until next, until the next quarter as well, we’ll see that that increase.

David Johnson

I think that when you look at the overall model for Q1 which may be what you are targeting at we would see the gross margin being slightly stronger than Q4 but turning back towards the Q3 level we talked about. As we go in to the new year, we have got salary increases around the world, another things like that which is why the SG&A in absolute dollars kicks off for that, that’s what reflected, so you are doing your modeling there, and that’s what reflected in that model.

Shawn Harrison - Longbow Research

Al right, thanks a lot, nice quarter.

Operator

Your next question comes from the line of Steven Fox from Merrill Lynch. Please proceed.

Steven Fox - Merrill Lynch

Hi, good afternoon. Could you talk a little bit about the wireless business or sales to handset market a little more specifically, what percentage of sales did you want to bring in the quarter, what type of growth rate was it and what are your assumptions for the current quarter in terms of trends there?

David Johnson

Yes, as you know we don’t break out mobile specifically, as part of the telecom sectors. But generally speaking if you said that roughly 28% of our sales are in the telecom sector overall, roughly 18% of that 28% today is in the mobile market, we think that the fourth quarter growth rate for the mobile sector, if you broke that out to telecom with somewhere in the range of 25%.

Steven Fox - Merrill Lynch

And then going forward what type of summary are you expecting here, Martin?

Martin Slark

I think, we think that the mobile sector based on projections from our leading customers typically the two quarters going in to Christmas are strong. So we are anticipating that this quarter with unusually strong compared to prior years and normally start the ramp up from here till Christmas and certainly the major customers are forecasting that and that’s what we are assuming.

Steven Fox - Merrill Lynch

Okay. And then just a house keeping question, option expense going forward, Dave?

David Johnson

Will be roughly at the same level, this year was about 13 million, say 13 to 15 million kind of range for next year.

Steven Fox - Merrill Lynch

Thank you.

Operator

Your next question comes from the line of Carter Shoop from Deutsche Bank. Please proceed.

Carter Shoop - Deutsche Bank

Yeah great. We talked a lot about how Molex as a global company and today we are talking about how we are moving from more of a regional to a global structure. And I was wondering if you could kind of dig down a little bit and walk us through what sort of steps you are taking to become a more global company, what sort of benefits do you expect to realize and also what are some of the operational risk that sure should be cautious of, as you make the transition?

Martin P. Slark

That’s a great question we wish we had couple of hours to answer because as you can imagine Molex had geographic structures, 60 plus years and this is a significant transition. What motivated this, which I am sure you can appreciate is that pre-tech bubble only about 30% of our sales required us to use resources in more than one region. The predominant part of revenue was driven by designing, working with the customer geography, designing it there, making it there and selling it there. Since the tech bubble burst in so many of our customers and new production around the world well over 70% of our revenue did I required to do something in more than one region. So the previous structure that we had where we were measuring and rewarding people based on it on the geographic results didn’t motivate global behavior and we weren’t able to often leverage the resources we had around the world. So, for example, if a customer in the U.S. one is micro miniature technology out of Japan it was hard to make that happen. So, by putting a global structure in place where we had divisions that own their own phones in each area of the world as well as engineering resources that are focused on specific technologies. We can leverage the global resources that Molex had, we can avoid we think duplicating capacity around the world as we done it before when we had the geographic structure and we think we can use our organization more effectively and have a sales and marketing organization, that in before used at primarily focus more on the product vision there on geography, sell everything we make to any customer anywhere in the world and they will be measured and rewarded for doing that. So we think we can do a better job of leveraging the global resources, we’ve always had a great global presence, which we think will make us a more effective global customer company.

Carter Shoop - Deutsche Bank

Based on what it sounds like you guys are doing in automotive vision or you already have been in automotive division regarding creating a global entity, it sounds like there is going to be a lot of product transitions across the globe. Can you talk a little bit about that and any operational risk there might be in regards to servicing your customers?

Martin P. Slark

Obviously whenever you move production there is some risk, but we have over the last two years as you know done some significant restructuring, so we are down in the developed countries to very large integrated facilities. And to the extent that we need to move product to support customers we would do that but we don’t will see as a result of which realignment of our organization, massive movement of production. What we do see is as we tool new products we will put those in the appropriate location and not be guided by geography.

Carter Shoop - Deutsche Bank

What’s really changing here? Is it more on the kind of IT side and sales competition side?

Martin P. Slark

It’s where we are changing the structure of the organization and the way we measure and reward everybody in the organization to think and act globally in what is a global market. And I think you will see the benefit for that as we move forward.

Operator

Your next question comes from the line of Yuri Krapivin with Lehman Brothers. Please proceed.

Yuri Krapivin - Lehman Brothers

Good afternoon everybody. Can you quantify the savings from your restructuring program that you are able to realize in fiscal ‘06 and what could be incremental in fiscal ’07?

Martin P. Slark

Yeah we can do that, and Dave has exact numbers for that, that he is going to give you.

Dave Johnson

Okay, giving the overview for ’06, the cost as you see on our income statement was about $26 million. The benefits were roughly in the range of $13 million for the year. So the net impact on a GAAP basis for the year was negative $13 million. But as I said the benefits that we saw in the year was 13. To go into 2007 we believe that you will have roughly $32 million of benefit in 2007, so subtracting the 32 from the 13 it’s about $19 million incremental benefit in fiscal 2007. And we believe that will break down roughly 60% for SG&A and about 40% for cost of sales.

Yuri Krapivin - Lehman Brothers

Great. And what are expectations for the R&D expense in fiscal ‘07?

David Johnson

R&D expenses was about 4.9%, about 5% of revenue in fiscal ‘07.

Yuri Krapivin - Lehman Brothers

Thanks.

Operator

Your next question comes from the line of Robert Maynard from Chicago Tribune. Please proceed

Robert Maynard - Chicago Tribune

Yes, actually I would like to talk with someone privately regarding the options, pursue the name and number of an executive I can speak to after this conference call is complete.

Martin P. Slark

Yeah, if you would like to call me Martin Slark and my direct line number is 630-527-4464.

Robert Maynard - Chicago Tribune

630-527?

Martin P. Slark

4464

Robert Maynard - Chicago Tribune

4464, I will be calling you shortly after the call. 630-527-4464? Correct?

Martin P. Slark

Thank you.

Operator

Your next question comes from the line of Jeff Rosenberg from William Blair Company. Please proceed.

Jeff Rosenberg - William Blair Company

I was looking at your CapEx spending and your expectations for this year and it’s coming in around 10% of sales and obviously we are in a growth note now that’s above the long term trend. Can you talk about whether or not, we should think about our lower CapEx as a percentage of sales longer term than the 12% or 14% that you’ve targeted historically?

Martin P. Slark

I think so, yes Jeff as you know as we put more of an investment in Asia, we tend to get, using the American especially more buying for the bucks and the dollars there. Once we go into next year we part of that total there is the build out of our new facility in Chengdu in the east of China. And for the investments we are making some new areas build some flat like circuitry et cetera. But we do think we can start to bring that down but obviously we also want to make sure we have adequate capacity in place to support the demand we are seeing.

Jeff Rosenberg - William Blair Company

Okay, thank you.

Operator

Your final question comes as a follow-up from the line of Michael Walker from Credit Sussie. Please proceed.

Michael Walker - Credit Sussie First Boston

Hey, just one question, I was wondering if could provide us the sequential change by end market, sequential growth?

Martin P. Slark

Yeah I can do that, well actually not sequential what I could give you is the full year growth on, and I can give you the full quarter year over year. If you like what we will do is that we can get that sequential number and give it to you later we certainly have that data.

Michael Walker - Credit Sussie First Boston

Okay that would be great. Thanks.

Operator

I would now like to turn the call over to your host for any closing remarks.

Neil Lefort - Vice President, Investor Relations

Okay. Well thank you very much for the time you spent with us. Again I remind everybody about our analyst meeting tomorrow, we’ll adjourn for today now and if you have any more questions we will have our full management team to answer them tomorrow. Thank you, good night.

Operator

Thank you for your attendance in today’s conference this concludes the presentation. You may now disconnect, have a wonderful day.

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Source: Molex Q4 2006 Earnings Conference Call Transcript (MOLX)

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