Molex Incorporated F4Q10 (Qtr End 06/30/10) Earnings Call Transcript

| About: Molex Incorporated (MOLX)

Molex Incorporated (NASDAQ:MOLX)

F4Q10 (Qtr End 06/30/10) Earnings Call

August 3, 2010 5:00 PM EST

Executives

Steve Martens – VP, IR

Martin Slark – CEO

Dave Johnson – CFO

Analysts

Craig Hettenbach – Goldman Sachs

Jim Suva – Citi

Anil Doradla – William Blair

Steven Fox – CLFA

Amitabh Passi – UBS

Matt Sheerin – Stifel Nicolaus

William Stein – Credit Suisse

Ryan Jones – RBC

Steve O'Brien – JPMorgan

Shawn Harrison – Longbow Research

Operator

Good day, ladies and gentlemen, and welcome to the fourth quarter 2010 Molex Inc. earnings conference call. My name is Jasmine and I will be your operator for today. At this time, all participants are in a listen-only mode. (Operator Instructions).

As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the conference over to your host for today, Mr. Steve Martens, Vice President of Investor Relations, please proceed.

Steve Martens

Thank you, Jasmine. Good afternoon, everyone, and thank you for joining us today.

I’m joined on the call by Martin Slark, our Chief Executive Officer; Dave Johnson, our Chief Financial Officer; Liam McCarthy, our Chief Operating Officer; and Lisa Baittie, our Director of Investor Relations.

Please note that this call is being recorded and will be available for replay by accessing the Investor Relations section of our website. Presentation materials are also available on the website.

As usual, we’d like to limit this call to one hour. When we get to Q&A, we ask for one question per participant and one follow-up question. Thanks.

Before we turn our attention to the quarterly results, let's review our Safe Harbor statements.

During the course of this presentation, we’ll be providing forward-looking information and referring to non-GAAP measures. Please read carefully the Forward-Looking Statements section of our press release and Form 10-K for an understanding of the risks and uncertainties associated with forward-looking information and the reconciliation of non-GAAP measures to GAAP.

And now, I will turn the call over to Martin.

Martin Slark

Thank you, Steve, and good afternoon, everyone. Before I talk about our Q4 results, I’d like give all of you a brief update on our Japanese fraud issue.

As previously reported, in April 2010, we launched an investigation when we learned that individual working in Molex Japan’s Finance Group had obtained unauthorized loans from third-party lenders that we used to cover losses from unauthorized trading.

That investigation is substantially complete, and is confirmed that this individual forged documentation in arranging and concealing the transactions, and the total amount of the potential loss has not changed significantly from the prior quarter.

Based on the results of the investigation to date, we have decided for accounting purposes to treat this amount as a loss in the historic financial statements to the company and record a liability for the outstanding unauthorized loans in the amount of $166 million as of June 30th.

We have recorded this liability by restating our financial statements with very little profit and loss impact in the prior three years, and most of the impact being and adjustment to beginning retained earnings.

Dave Johnson will speak more about this accounting treatment during this section of the call.

The accounting treatment that we have adopted does not in anyway change our view of this matter and we intend to vigorously contest any attempt by the holder of the unauthorized loans to seek payment.

Due to the sensitive nature of this ongoing legal issue, we will not be able to answer questions relating to the fraud on this call.

So now let me take you on to talking about our operating results for the quarter. And, if you’d like to turn to page three, and look at the slide that shows our order trend, I’ll talk about that trend.

Bookings for the quarter were an all-time record of $910 million, which is 9% higher than the March 2010 quarter and 58% above the June 2009 quarter. While we generally see an improvement in order rates in the June quarter, a 9% sequential increase is significantly above our normal average and indicates that our key markets continue to improve.

The order rate accelerated throughout the quarter and is continued to be strong in July. This we believe gives us the solid momentum going into the September quarter.

For the full year, our bookings were $3.23 billion, up 34% year-over-year. It’s worth noting that in APS, Asia Pacific South, our bookings were up 50%, and we now have bookings in that region almost equal to the combined bookings that we see in the Americas and Europe.

Our book-to-bill ratio was 1.07-to-1. This is still quite strong. However, we expect that this will moderate in the coming quarters, a sequential order increases assume more normal seasonal patterns as additional capacity comes on line.

Now, turn to page four, and I’ll talk a little bit about the order trend by industry. Automotive bookings decreased 1% sequentially, but increased 43% year-over-year. As automotive production tends to decrease in the September quarter with summer shutdowns and model changes, a slight sequential decline in bookings is not surprising.

Bookings in Europe decreased the most sequentially as incentive programs in these regions are winding down. June car sales in Europe were down 6% year-over-year. The US market has been recovering and is stabilizing in the range of 11 million to 12 million units per year. Dealer inventories remain low and it appears as domestic brands are taking some share back after a very poor period.

As a result, we saw a sequential increase in US bookings, which was offset by decreases in Europe. It’s interesting to note that China will most likely extend its lead over the US, selling an estimated 15.6 million vehicles versus a projected 11.8 million vehicles in North America. So the importance of the China market and the increasing electronic content in vehicles in those markets becomes even more important.

Bookings in the data market increased 12% sequentially and 54% year-over-year. We continued to see evidence of increased enterprise spending in networking, service and storage. Demand for our socket products continues to increase and new product introductions have generally been well received in this market.

Our large customers that we’ve talked to over the large couple of months seemed to be very optimistic that the second half of this year will continue to be strong in these segments.

Telecom bookings increased 12% sequentially and 60% year-over-year. The telecom infrastructure market without this market this quarter, but the real driver of market performance was mobile phones, specifically smartphones. We are very well positioned with the major smartphone manufacturers. We saw a significant increase in orders in the June quarter as compared to the proceeding quarter. We expect this trend to continue as consumers accelerate their migration to smartphone segment and as new devices with increased functionality are introduced in the Christmas season.

Consumer electronics bookings increased 11% sequentially and 43% year-over-year. The digital still camera, flat-panel TV, and games sectors, all remain strong, based primarily on strong demand within Asia.

Backlight and 3D TV production is expected to accelerate in the July to December period and this will further strengthen bookings over that time period.

The car navigation market will probably slow in North America and Europe, but is beginning to accelerate in China.

Industrial bookings increased 8% sequentially and a very 96% year-over-year. Our industrial business continues to improve due to the recovery of the factory automation segment and very strong orders in the alternative energy markets.

In addition, we continued to see good synergy from our Woodhead acquisition and significantly increased bookings from our focus accounts in the industrial space. We expect this market to continue to expand as global GDP improves.

Our fastest year-over-year growth rates are shown in the military and medical markets. Two years ago, we had virtually no sales in these markets, were based on our bookings trends we could see up to 5% of our revenue coming from these markets in the year ahead. This is terrific progress based on focus on specific accounts with specific new technologies.

If you turn now to page five, I’ll talk briefly about what we’ve seen by channel and by geography. On the channel basis, we continued to see the strongest sequential increases in the distribution at EMS channels. Distributors seemed to be tightly managing their inventory and we have not seen significant increases in the inventories of our products during the quarter.

It should also be noted that the vendor managed inventory days increased by only 1.7 days sequentially from 24.7 days to 26.4 days, but were down from the 27.2 days a year-ago and still below our 30% target days. EMS customers continue to benefit from continued outsourcing as well as new product introductions, particularly in the consumer smartphone and notebook sectors.

On the geographic basis, we saw a nominal sequential improvement in the US and European markets. However, APS and APN both logged significant sequential improvements in bookings. The improvement in Asia is driven by data, telecom and consumer electronics market as much of the production for these global markets is in Asia. We have also noted that there is surging demand for these products in emerging countries within Asia and as a percentage of the products produced in Asia and then consumed in Asia continues to grow. This we believe will provide a strong growth going forward.

Please note that the percentage of our bookings coming from Asia is now at 61% and the percentage of our bookings outside the Americas is now at 76%.

Now, turn to page six. We’ve shown on this chart our revenue trend for the past two years. Revenue for the quarter was $847 million, which is 12% above the proceeding quarter and 48% above June 2009 quarter. All of this is organic growth.

Revenue is now 67% higher than our locally registered in Q3 of FY09 and 3% below our high point of $872 million. The month of June was our first ever month with more than $300 million sales. We’ve improved for five consecutive quarters and we expect this trend to continue.

Turning now to page seven, I’ll talk very briefly about the revenue trend by industry, which largely follows the same trend that we’ve seen with our bookings. All of the markets were up sequentially and year-over-year. And we saw a stronger sequential growth rates push our revenue above the high end of our guidance for the quarter. The ongoing economic recovery has been more important than normal seasonal patterns over the last few quarters, but we think that normal seasonal patterns will start to resume during the second half of this calendar year.

There continues to be uncertainty as to how sustainable the global recovery is. Looking forward at our major markets, we expect automotive to moderately decline sequentially, while data, telecom, consumer electronics and the industrial markets will continue to grow. Our view is that much of the economic commentary that we read today is too US-centric and understates the strength of ongoing economic recovery particularly in Asia.

Trying to balance all of these factors, we are giving revenue guidance of $850 million to $880 million for our next quarter. This would represent a 2% sequential revenue increase at the midpoint. At the upper end of the range, it would represent a 30% year-over-year increase in revenue and it’ll also represent record revenues for the company.

On that note, let me turn the call over to Dave Johnson, our CFO, who will take you through the financial statements. Thank you very much.

Dave Johnson

Thank you, Martin, and good afternoon, everyone. We have come to another yearend and it was a monumental year for Molex in so many ways. We are certainly very pleased with the financial results that we have achieved in fiscal year 2010.

So let’s start with the high level review of our fourth quarter P&L which is shown on page eight. Since we’ve already talked quite a bit about the strong revenue in bookings for the quarter, I’ll skip that and I’ll start with the gross margin of 29.9%. Though, this isn’t over 500 basis points from the prior year, it is down sequentially, which I’ll explain in detail in just a few minutes.

SG&A increased sequentially by just over 1% due to a modest increase in R&D for new product introductions and in selling costs due to the positive demand situation. Restructuring costs of $26.5 million closed out our restructuring program and I’ll discuss this in more detail also on a later slide.

The loss on unauthorized activities in Japan was $4.8 million for the quarter, representing primarily the cost of our investigation. By looking at this line, you’ll get a much better sense of the impact of our restatement. We had previously taken a charge of $31 million in Q3, as you might recall, which has now been reduced to $8 million, and the $2.7 million announced in Q4 of last year is the entire charge taken for that year.

As Martin said, the P&L impact in the recent three years is not significant, and most of the impact has been reflected in retained earnings. In fact, when you look at EPS, there is no impact in 2009, no impact in 2008 for the restatement. And, in 2007, we actually improved EPS by $0.02. And, in 2006, we reduced EPS by $0.04. So as we say, really very little impact on the P&L.

Even though we had recognized this matter as a contingent liability at the end of the third quarter, at the end of the year and based on the substantially completed investigation, we recorded for accounting purposes, an accrued liability of a $165.8 million for the outstanding unauthorized loans pending the resolution of these matters. What this means going forward is that if there is an ultimate resolution at any amount less than the liability, the difference will be reflected as a gain for Molex.

Please see the footnotes in our earnings release and the relevant disclosure in our 10-K, which we filed today for a full explanation of this restatement. I’m required to tell you that previously filed financial statements should not be relied on, but as I just said, we filed our 10-K, just about 30 minutes ago, which, of course, you can rely upon those financial statements.

Moving on, other expense returned to a more normal level of $1.8 million in the quarter and after an effective tax of 35% GAAP EPS came in at $0.23 per share.

Now to translate that to a non-GAAP basis, please see page nine. Beginning with the $0.23 from the prior page, we add back the restructuring charge of $0.14, and I’d like to emphasize that this will be our last quarter of calling out restructuring charges and reporting a non-GAAP EPS number.

The effective tax rate on the restructuring charge this month is unusually low due to the tax jurisdictions where the restructuring actions took place due to net operating losses in certain impacted locations and due to restructuring related tax charges, all of which increased the after-tax amount.

Finally, we add back $0.02 for the loss of an unauthorized activities in Japan and the resulting non-GAAP EPS therefore is $0.39 for the quarter, which was a sequential increase of 34% from the March quarter. And as the lower box indicates the effective tax rate on a non-GAAP basis for the fourth quarter was 27%, for the full year, the effective tax rate on a non-GAAP basis was 30.4%. So for the first quarter of fiscal 2011, we believe the effective tax rate should be somewhere in the range of these two points, that is between 27% and 30%, and we have used 30% in our guidance outlook.

The chart on page 10 shows our full-year results. Revenue reached the $3 billion level, up 16.5% from the prior year. We experienced revenue growth in all end markets for the full year, but have the highest growth in automotive, consumer, and data markets. Geographically, our growth was strongest in the Asia-Pacific region, led by our strong presence in China.

For the year, gross margin improved 430 basis points to 29.7%. SG&A increased 4% from $587 million to $611 million. But remember that we had numerous one-time action such as salary and benefit reductions which reduced costs in 2009. As a percent of sales, SG&A improved by 240 basis points to just over 20% for the year.

And, on the next line, recall that restructuring and impairments included a goodwill impairment in 2009 of $264 million, due to the economic downturn. The next line is the loss in unauthorized activities, which we have already talked about it in length.

Next, other income and expense moved from an other income of $27.3 million to a expense of $6.3 million the most recent year. And this is due to higher interest expense in 2010 and some significant foreign exchange gains in 2009.

The effective tax rates and EPS numbers are not very comparable due to the 2009 goodwill impairment. However, on a non-GAAP basis, the results can be much more easily compared.

So if you turn the page to page 11, we show that excluding restructuring, unauthorized activities in Japan, excluding tax corrections and goodwill, EPS for 2010 was $1.10 per share compared with $0.32 in 2009. This represents a 244% increase in non-GAAP EPS for the full year.

Page 12, sets forth some of our key balance sheet metrics. Net cash decreased sequentially but remains still above the $100 million. The reduction in cash is related to both the working capital and capital expenditures required to support our rapidly increasing business as well as the payment of cash severance for previous restructuring actions.

Both receivables and inventory are trending well and are in good control. AR days sales outstanding are increasing slightly as more business ships to Asia where payment terms are generally longer than in the US. Inventory days are dropping gradually, but still remains higher than optimal due to the inventory banks that have been built up for our final production transfers related to the restructuring actions.

Capital expenditures increased to just under $80 million for the quarter, due to spending on tooling and assembly equipment for new product releases and also for generic capacity in which we have strategically invested to meet our critical delivery needs of our customers.

Page 13 is a key chart that shows our progression toward our operating income goal of 14%. The number that stands out is a sequential reduction in gross margin in the recent quarter to 29.9%, which I mentioned before that we would take about. We have carefully analyzed this lower-than-expected gross margin and concluded that the impact is not due to mix or to other business model issues, but rather due almost entirely to issues that we face in the quarter and delivering product to our customers, during what turned out to be the peak of our ramp up in demand, coupled with peaks of our production transfer activity.

We made the conscious decision to deal head-on with the customer delivery issues and to ensure that we would not disappoint our key customers in this critical time of our recovery. We incurred about $12 million to $14 million of unusual supply chain related costs, including overtimes, special warehousing costs, premium freight, and facility ramp-up costs. The good news is that these costs began to subside in June and has further come down in July.

Based on this progress, our guidance for the September quarter assumes that about half of these higher than usual supply chain costs will be eliminated by the coming quarter and we will revert back to a gross margin level in line with the third quarter, and the third quarter was 31.2%.

SG&A at 18.7% of revenue continues to move in a positive direction, dropping below 19% for the first time in our history. We continued to tightly manage the administrative costs, while allowing appropriate increases in R&D and selling expense to accommodate market demand. Overall, we are still in track for our 14% gross margin target and expect to achieve this milestone sometime in the upcoming fiscal year.

Now moving to restructuring on page 14, the upper left box summarizes our total programs, $315 million of costs and annual savings of $205 million. The total costs are $15 million higher than we had been forecasting. As we closed out the program, we added over $15 million of noncash asset and building impairments upon our final evaluation of the projects. The main portion of these impairments relates to buildings that had been written down earlier in the process, which needed to be further impaired due to the declining real estate market.

The top right box highlights our savings for the quarter, including $1 million of sequential savings, which is right on our prior forecast. The lower box shows a sequential savings that carry over into 2011. We expect $2 million of sequential savings in Q1 and a final $3 million of sequential savings in Q2. These savings related to the final closure and actions taken in the fourth quarter, the most important of which was the closure of our largest European facility located in Slovakia, which was finally closed in June.

We are done and we are pleased with the results. And our job now is to keep the cost savings, to simulate the production in the new locations, and to focus additional attention now to strategically build our new business.

Page 15 depicts our return on assets trend, which we refer to as RONA. Please look at the upward trend there, we have surpassed our target of 15% for the year. We achieved 15.8% and we are now sitting on our sites on the range of 20% to 25% in fiscal 2011.

And, on page 16, we show a similar trend of non-GAAP EPS, growing steadily from a negative $0.09 one year ago, to the current level of $0.39 for the June quarter, and most importantly, we expect the growth in earnings to continue which takes us to our last slide.

Slide 17 is our outlook for the first quarter of fiscal 2011. We have decided not to provide a full-year outlook since the economic environment is still difficult to predict. However, with the record order level going into the quarter and solid orders so far through July, we believe that we have good visibility into our near-term situation. And as a result, we are expecting to revenue in the range of $850 million to $880 million.

At this level of revenue, considering the improvements to our gross margin that I mentioned a few minutes ago and forecasting no increase in SG&A for the quarter, we expect earnings per share in the range of $0.42 to $0.46. At the midpoint of this range, EPS would grow sequentially by 13% and on a year-over-year basis by a 144%, and would represent operating income in absolute dollars for the company at record levels.

This guidance includes an estimate for the professional service costs in Q1, related to the Japan fraud, which we do not expect to be significant since the investigation is substantially complete.

This concludes our comments, and we will now take your questions. But I must remind you again that we will not be able to answer any questions related to the fraud in Japan.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from the line of Craig Hettenbach with Goldman Sachs. Please proceed.

Craig Hettenbach – Goldman Sachs

Then, you mentioned that half of the transition costs will be eliminated in the September quarter. Can you give any guidance into – as you look into the December quarter of this year?

Martin Slark

Hi, Craig, this is – first – Steve Martin. The first part of your question was cut off, but I believe what you asked was, we talked about the elimination of some of these transition and logistics costs of 50% over the next quarter, what the impact would be in the second quarter moving forward, is that what you asked?

Craig Hettenbach – Goldman Sachs

Yes, more so, just going out into the December quarter, by that time, you’ll capture all that or will it take into the March quarter, any visibility there?

Martin Slark

I’d expect that we would see further reduction in the December quarter, based on a couple of factors. First of all, we were [inaudible] down the production in all of the new locations, including some of the new warehousing locations.

Also, as you probably appreciate, I think the December quarter tends to be slower towards the backend of it, so a little bit less pressure from a shipment perspective too. So, it would certainly come down. And, I mean, frankly, our goal is to eliminate them as soon as possible, so I think we’ve given update on that at the end of the Q1. But you’re going to see a significant reduction this quarter and certainly further reductions in Q2.

Craig Hettenbach – Goldman Sachs

And then, just sticking with the manufacturing, I know it varies by product type and geography, but any proxy for kind of where utilization is today?

Martin Slark

It’s funny, we can ask that question a lot. And, as you know, we look at utilization at three levels, at a factory level, at a generic equipment level, and at product-specific level. I think given the massive rent costs that we’ve seen on over the last year, we are adding some additional factory space in selected countries in Asia. There’s further expansion taking place in Singapore, China, Japan, and Vietnam, based on supporting both global and regional demand out there.

We’ve also – as part of our CapEx this quarter has been an additional generic equipment of molding and planting machine, just to cut the sheer volume we’re shipping now is at record levels. And I think you have to look at our CapEx spending in the context of our bookings, not just our billings, because, obviously, we’re adding capital now to support future order trends which seem to be continuing to grow. And then, I think you’ve to look at our product-specific level.

And I would say there, there’s a mixed bag. We have some products to some capacity, we have some products literally on allocation, and we have others where we are adding it based on the projections of future demand. But, the overall – your question is, I think the crack to utilization is obviously picked up a lot in the last six months across the board.

Craig Hettenbach – Goldman Sachs

Okay. And if I can follow-up, can you talk about the performance of the focus accounts within the quarter? And then also just new design win activity there, any particularly end markets particularly within the focus accounts that you’re excited about?

Martin Slark

Yes, I’m glad you asked that question, because I would tell you that when we look at the $910 million in bookings for the quarter, we are very excited about the focus accounts, because of two reasons.

First of all, on the bookings coming from the focus accounts is now approaching 30% of our business and continues to grow, and bear in mind, over a three-period period, that’s up from 13%. And, what we’ve done is, we’ve now taken the original list of accounts and added some others to it for the coming year.

And, what we’ve realized, I think when we focus our new global sales team and our product division on specific accounts, we are very difficult to beat and that’s what really what helped us grow significantly in some of those end markets.

And, if you look at the margins on those accounts, purely from a perspective of looking at raw materials and labor costs and depreciation, so take the logistics out here for a second, the margins are better on those accounts. So I think we’re excited that that process seems to working and we will be expanding on it in the year ahead.

Craig Hettenbach – Goldman Sachs

Great, thank you.

Martin Slark

You’re welcome.

Operator

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

Jim Suva – Citi

Thank you, and congratulations to you and your team. I had a question a little bit diving into the details of while revenues were significantly better than expected, the gross margins came in weaker than expected. And, to be clear, I would think if sales came in better than expected, and you were FedExing product around due to greater sales that you would pass that cost off to the customer, unless your team has not been able to manage the operations or the restructuring successfully. So can you help me through of really who’s to point the finger of blame here? I just think that higher sales should be able to pass through the customers if they’re changing their order on a rapid basis.

Martin Slark

Yes, thanks Jim. That’s a fair question. And I think if you look at the last quarter, I think when we look at the whole year, I think we are pleased with the progress that we have made. And I think if you look at our operating income, it doubled from Q1 to Q4. But when we look at Q4 and we look at those results, I would say the disappointing number for us was the gross margins. And, as we said, it’s not due to mix or material or labor cost, it was due to logistics costs. And, I would say, it’s a combination number of things.

Number one, we were in the final phases of the restructuring that we were doing, and closing down 14 plants and having the number of logistic centers we have around the world. No disrespect to anybody in the analyst community, but I think you – it’s hard to imagine how challenging that is. It’s an enormous task. And by all means if you want to point a finger at our organization for saying that could have been executed more efficiently, certainly go ahead and do that.

But, I also think you have to look at the fact that if you look at the top 100 connector companies around the world, the only one based on Bishop data that’s ranked in the top 10 consistently for customer service is Molex and we are very proud of that. We’ve been in the top 10 for the last 10 years. And we felt that it was appropriate to take extraordinary means to protect our customers during that period.

And a lot of those costs were caused, because we were moving production around the world, when our bookings were ramping up. So absolutely it’s something we’re accountable for. But I would rather take one quarter of higher costs, protect our customers, so that we can continue to grow our business ahead, I think that’s a prudent business decision. And our vision here is how we grow share in the market and how we continue to service our customer as well. It’s not about just one quarter’s results.

And I would tell you in the middle of all that, as you know, we’re certainly not going to blame this, we had the volcano in Europe, but we certainly had a tremendous number of shipments that were impacted by that, and that had a considerable impact on the overall numbers as well.

Jim Suva – Citi

And then as a follow-up on a different topic, on M&A, previously you suggested that as much as 30% of your growth could come from M&A. And can you help us understand as M&A is still on the horizon or are you focused more on internal organic growth or how should we think about that as it doesn’t seem like Molex really has taken advantage of the evaluation multiples during this recession?

Martin Slark

We continue to look at the increased arm acquisitions. As I said to you before, as Molex did very few acquisitions in its history, we did falloff calendar year. I would say that in the last period, certainly while we’ve resolved or work to resolve our issue in Japan, we have not looked at specific targets. But I can tell you we have a very strong pipeline of potential opportunities there. And I think evaluations are where they are.

And, frankly, if you look at some of the deals that have been done in the last few months, I wouldn’t say those evaluations were particularly attractive. And I would tell you the pipeline we have opportunities in Asia are strategically focused on the business areas we’re interested in. And I think you would see going forward that a portion of our growth will come from that. But we’ve always stated that our growth will be more organically driven and through acquisitions.

And, certainly, I think both our organic growth and the new bench of startups that we’ve had and don’t lose sight of the fact that a chunk of our growth this quarter came from our SNX and SSL initiatives, and both of those are entirely funded venture capital startups and they’re doing very well. So I think you’ll see our growth comes from a mixture of all three things. Organic growth will be dominant, internally funded startups will be there, and we would certainly do our fair share of deals going forward.

Jim Suva – Citi

Thank you, and congratulations to you and your team.

Martin Slark

Thanks.

Dave Johnson

Thank you, Jim.

Operator

Your next question comes from the line of Anil Doradla with William Blair. Please proceed.

Anil Doradla – William Blair

Hi, guys. Thanks for taking the question. Two questions. The first one was overall supply and demand; there’s been some concern about little excess supply in certain components, would love to hear your thoughts on that. And, also Martin, you talked about smartphones and in particular you – that stood out as being an area of strength. Can you give a little bit more color around it? I mean, you’re chasing certain key customers out there, but a color around that would be great. And also, within that, I mean are you seeing any softness and weakness in the PC, because there has been commentary about the PC weakness in general.

Martin Slark

Sure. We’ve got three questions. Actually, I laughed, because we asked people to limit themselves to one question.

Anil Doradla – William Blair

Okay.

Martin Slark

I'll give you a question, but that's okay, don’t worry about it. In terms of the demand environment, I would say that I have never seen such a big disconnect between what I read in the paper everyday about the economy and what we’re seeing in terms of our incoming order rate.

And, as you saw during the commentary, I think a lot of the economic commentary you read in the press is very US centric. And we stretched I think during this call the percentage of our businesses outside of the US, and we genuinely believe there are a lot more other growth in Asia is self sustaining.

And so, all I can tell you is the best predict that we have in future business I think is what’s happening to our bookings rate. It accelerated throughout the quarter, May was stronger than April, June was stronger than May, and July has continued that path. And we’ve got – a couple of days of August have been good too. So we haven’t seen it yet.

Now, having said that, I would point out a couple of things. First of all, some portion of the recovery we’ve seen is clearly been driven by stimulus and restocking. Some of that obviously has to go away. I think some of what’s being built is being built for the Christmas season. And the question is will that be sold? And I don’t know the answer to that. But I think we’ll have a clearer picture on that at the end of the next quarter.

We certainly aren’t seeing a build up with our products from an inventory prospective in distribution or in a vendor managed location. So, so far, I’d say demand has been strong. But, obviously, you’re not going to see the same sequential growth rates, because we’re now up at very high levels and it more than surpassed where we were over a year-ago.

In terms of your other questions, smartphones, I think the industry leaders there are well known, and there some key companies that have taken a lot of share. We have very good content in those phones based on our micro-mini chip products coming out of Japan and a number of other products from other divisions. And so, we’re really excited about that transition, because those phones transition around the world from particularly in Asia to operated devices, I think that’s just a great opportunity for the connector industry in general and we think we’re in a great, great position.

The comment I would make about the PC market is, the one area there where I have seen some concern is in the notebook sector. And I would say that scenario where there were some buildup of inventory of notebooks. And what we talked in the notebook suppliers, what they didn’t know was, was that, A, a slowdown in end demand and they were disappointed with kind of the back-to-school season coming up or why there wasn’t bulk there, or have the launches of things like the Apple iPad taken away some of the demand that they would have had, and has that impacted the end demand of notebooks. But if you look across the computer sector for us generally, overall demand is very good. But I say the inventory issue has been with ODMs in the notebook sector.

Anil Doradla – William Blair

Okay. Thank you very much.

Martin Slark

You’re welcome.

Operator

Your next question comes from the line of Steven Fox [ph] with CLFA. Please proceed.

Steven Fox – CLFA

Hi, good afternoon. Martin, not to beat a dead horse, but just in terms of the performance in the quarter around the gross margins, you mentioned that part of the problem was that you had a pretty steep ramp going on in terms of customer pull it sounded like. Can you talk just functionally what has changed, because I would imagine you're going to have a pretty steep ramp at times in the second half of this year and so how are you better equipped to address that this time, so that we don't see margins maybe come back in into fourth quarter or something like that?

Martin Slark

Steve, I'm glad you asked that question. I think the reason you won’t see it again was that what we won’t see happen in the next six months is you won’t see very high ramping demand, enough moving both manufacturing capacity and warehousing locations at the same time.

We have significantly reduced the number of customer service centers we have around the world and we’ve put in place regional hubs to support each region from an inventory perspective. And we have as you heard closed the largest plant in European in the last quarter. So all those things combined while volume was ramping was a real challenge.

What I can tell you is the 90% of those costs were in the April-May time period. I mean, the impact was really at the beginning of the quarter. As we got those actions completed and we now have the new locations in place and manufacturing operating effectively in the new locations we see those costs going away.

And what I see is I think honestly if I was objective about the quarter, we got to our EPS goals to a stronger growth than we anticipated, but with weaker margins. But the margins impact for one time and in fact I think it gives us the cushion as we go into the first half of next fiscal year, because we think the demand will remain strong and we’re going to be able to improve the margins based on eliminating those factors. And the factors are largely within our factors.

Steven Fox – CLFA

That makes sense. And then that just brings me to my follow-up which is on one hand, you did say that you expect demand to remain strong, but on the other hand you're not willing to step out on a full year guidance, which obviously you aren't the only company doing that. But I guess where do you feel the most confidence, which end market of scale do you think you have the best look into where the builds make sense relative to the pulls that you've been seeing recently?

Martin Slark

Okay. You’re absolutely right. I think there are very few people who would have predicted a year-ago that many electronics companies would have recovered as well as they have. And I think going out another year is just really hard to do given the current environment. When I look at where do we get our confidence in terms of growth, let me quote the following: first of all, I think this whole info tech refresh around the world and the spending that companies are spending on their infrastructure to support that is ongoing. And, certainly our major customers seem to feel confident about that continuing.

Secondly, I think there’s consumer spending in Asia. And the Asian demand for consumer devices that are very prevalent in North America and Europe is certainly ongoing. I've been fascinated by going to stores in China and watching how bare the stores are there and how they can’t keep flat panel TVs on the shelves, et cetera.

And, lastly, I think we have a unique situation at Molex in the – our focus account program and our ability to grow our business in industrial and medical and military markets is supplementing what would be good growth and what a core markets for us computer and consumer. And so, that’s why I think barring a double-dip recession, I think we feel pretty confident about our ability to grow in the year ahead.

Steven Fox – CLFA

That's helpful perspective. Thank you.

Operator

Your next question comes from the line of Amitabh Passi with UBS. Please proceed.

Amitabh Passi – UBS

Hi, thank you. Martin, I was hoping you could help clarify some of the order trends. Frankly, the patterns are a little disturbing and I'd love to get your commentary here. North America and Europe we saw massive deceleration in orders in June, Asia Pacific remains strong, so just wanted to see how you sort of reconcile that with the really positive outlook on demand. And then tied to that even if I look at the channel order trends, distribution in EMS continue to remain strong, whereas the last couple quarters OEMs is simply growing about 4% to 5%, so I can't help but wonder whether we're still seeing restocking phenomenon that's still propelling orders and distribution into EMS, and whether in fact we are seeing some deceleration in order trends.

Martin Slark

Yes, I think when you look at the sequential growth in Europe and the Americas, I think that would be seasonally normal given the fact that you’ve got holiday periods in July, August, coming up. And so I think – and, of course, don’t forget when you look at Asia Pacific, in the prior quarter, you had Chinese New Year.

So if you look back on the historic data, I would say it’s not unusual in this quarter to see Asia have much faster growth sequentially in North America and Europe. And other thing too is is that 1% to 2% sequential growth offers a very high revenue level would normally be considered pretty healthy quarter-to-quarter. And I think people have got used to in this recovery mode of seeing very large and sequential jumps. And – but one of the things I tried to highlight in the call is that, I think the fact that Molex now derives now over 60% of its business from Asia, I think if I had confidence in anything, it’s of ongoing economic growth in Asia.

So if you combine that, I think ongoing moderate sequential growth in Europe and the Americas is still positive and stronger growth in Asia in my mind is what you should expect given the difference in the economic prospects of those areas. I absolutely agree with you in terms of the higher rates of growth in distribution certainly is based on restocking. But the good news is, through our SAP system, we have very good tracking of both the POS and the POP data. And so we can see what’s being sold through. So there isn’t a build up that we can see of our specific products.

Now if end demand slows, obviously you would see that. So if you look at all that picture, I think what we’re going to see in our view is a fairly good quarter going into September. And I think then instead of seeing economic recovery driving the growth, we would then go back to normal seasonal trends. So you would expect to see sequential slower growth in the December and Chinese New Year quarter and then picking up again after that. So I think we’re getting back to more normal seasonal trends. I don’t think that means we’re going backwards. Next.

Steve Martens

Next question.

Operator

Your next question comes from the line of Matt Sheerin with Stifel Nicolaus. Please proceed.

Matt Sheerin – Stifel Nicolaus

Yes, thank you. Martin, I just want to ask about the ASP trends. Given that the lead types have stretched a little bit, are you starting to increase prices selectively? And, if so, are you starting to see customers trying to book orders ahead of price increases and does that have anything to do with the backlog that you're seeing?

Martin Slark

Matt, it’s a good question. What we are seeing is that the rate of price erosion has slowed down, was slower this year, this fiscal year than it was last year. We are putting through selective price increases on certain product lines and are looking at a more general price increase that would take place later in the quarter.

Matt Sheerin – Stifel Nicolaus

Okay. So any idea of whether customers are trying to lock in orders at a lower rate?

Martin Slark

No, if you look, we track the percentage of our orders that go out beyond three months, and that if you remember the last call, I talked about the fact that that percentage has actually gone up a little bit has actually come down in the last quarter, it’s right around this 10% level, so there’s no evidence of more forward orders being placed. I think the real in terms of this whole demand cycle is as we hit the September-October periods, what it’s exactly in terms of end demand of the products that are being built.

I mean, do we run into a horizon where more stuff is being built than people are ultimately going to buy and that drives a slowdown as we get close to Christmas. Our view is that if we maintain business at the current level, if you just multiplied our fourth quarter by four, for us, we would end up with still a very healthy growth rate for the – to the whole year. So I think it’s inevitable that the sequential quarters are going to show slower growth. Our overall pictures taking to customers and looking at our geographic mix is that, you’ll continue to see growth, but at a probably slower rate.

Matt Sheerin – Stifel Nicolaus

Okay, that's helpful. And just my follow-up has to do with the expense line, which obviously you've had some very good leverage there. As you look to the next quarter, where should we think about expenses? Do you have any one-time expenses that go up because of the change in the fiscal year or any incremental expenses that may go up?

Martin Slark

Let me let Dave Johnson answer that question, because he’s got some specific data, will help you.

Dave Johnson

The – I think the biggest thing is we put through our salary increases in September, so that would be one month in this quarter and in the balance of the next quarter, so not significant in this first quarter.

That’s the only thing that would – I think would be impacted. We’re looking at it – as we’ve said in the past, our philosophy is to bring down the administrative costs and do that overtime, while we allow R&D and selling cost to go up modestly to offset that, but that would continue into the next quarter I think.

Matt Sheerin – Stifel Nicolaus

Dave, what's the quarterly run rate on that? Is that $1 million or $2 million or so?

Martin Slark

It’s yes.

Dave Johnson

Yes.

Matt Sheerin – Stifel Nicolaus

Okay, thanks a lot.

Operator

Your next question comes from the line of William Stein of Credit Suisse. Please proceed.

William Stein – Credit Suisse

Thanks. I'm wondering if we can talk a bit about the 14% operating margin goal. Can you remind us what the revenue required to get there is? And once we're past that, what we can think about in terms of drop through both on the gross and operating line?

Dave Johnson

Okay. That sounds like a question for me. The revenue that we set for that target last year was $840 million, which, of course, we’ve exceeded that in this quarter. What we have said to is, we need to wait until we get through the full restructuring and we’ve got still restructuring savings coming in in Q1 and Q2.

The fall through that we’re using – looking at this entire year, we’re still overall in the range of between 40% and 50% gross margin fall through. So I think that as the year goes on, we should see that probably trending down to closer to 40%. I think at some point in time, we’ll be done at about that level. But, I think for modeling purposes to use it in the next couple of quarters, say, 45% is probably reasonable.

William Stein – Credit Suisse

Okay. And then another question on CapEx. The transition that the company made, as I recall, this whole thing was designed around transitioning from a geographic focused company to an end markets focused company, started several years ago or at least thinking about it and presented quite some time ago. Remember, one of the key focal points was to reduce the company's CapEx and we saw a pretty big step up there this quarter. Can you help us reconcile those?

Martin Slark

Yes. And, first of all, when we started this process don’t forget that Molex’s CapEx was up around the 14% range. And so, we said, we would significantly reduce that. And I think if you look at that CapEx, it’s significantly down.

If you look at the CapEx in the current quarter, over and above the new product spending that was in there, there was CapEx added to add factory space and generic equipment in particularly in Asia, and that were to replace some of the capacity that we have eliminated in North America and Asia, so some of that is obviously one time. We still think that the CapEx in that 6% to 7% range is where we would be on an ongoing basis which is the half of what it was in our old structure.

Dave Johnson

In the quarter – this is Dave. In the quarter itself we spent between 40% and 45% of our capital for new products. And that is, we’ve launched 221 new products in this year versus 194 last year and a lot of that came in at toward the end of the year, so a lot of the capital spending is for that. But still that leaves 55% or so for generic capacity, and a lot of that capacity was put in place, because of our need to satisfy our customers’ requirements. And as Martin said, put in place facilities in certain locations.

Now, plating is one area in particular that we have been investing in. We see good margin improvement by investing in plating. It was hard for us get plating on the outside that was – we do a lot in the outside, but was hard to expand that and it’s an area of a skill set for ours that we’d like to have in-house, so we’ve invested maybe about $10 million with the capital in this quarter, just in plating in three different locations.

And, Martin, you’re right in terms of our targets, we – we’ll see higher capital spending probably also in this first quarter. We have a long-term target still to be at 6.5%. It may be higher closing to 7% for this year, however, because of the spending we’re seeing in this first quarter.

William Stein – Credit Suisse

Great. Thank you.

Dave Johnson

Sure, welcome.

Operator

Your next question comes from the line of Ryan Jones with RBC. Please proceed.

Ryan Jones – RBC

Hi guys, and congratulations on the quarter. It looks like growth by geography was heavily skewed toward Asia this quarter. I think we have talked about that several times in the call already. Are you able to parse out how much of that revenue was marked for export back into Europe and North America? I’m just trying to get a sense of whether or not there's inventory restocking going on into Asia and whether or not that could pick up any time if North America and Europe would fall back into a recession?

Martin Slark

It’s a great question that we get asked a lot. And, in fact, I think it’s a question that gets asked more generally about the dependence of Asian economies on the export markets. And, as you know, I lived in Asia for 10 years, and during those periods, that customers were largely dependent upon export markets. We have some records that talk about the fact that about three years ago, more than 50% of the electronics that was made in Asia, now stays in Asia, and that percentage has obviously grown.

And, I think if you look at the economic growth rates of the Asia economies – and I think one of the positive byproducts of the wage increases you’ve seen in China is that is going to put more Chinese across the tipping point what I can afford to buy consumer durable goods. So the downside of those wage rates is higher labor costs in China. The upside I think is increasing domestic market opportunity there.

So our view is that more of it stays in Asia now than comes back. I think it’s very hard to get accurate data for that. And, certainly, we don’t have the ability go to every one of our customers and ask that question, because very often, we could be selling to a distributor or a CM who is telling to an end customer, so it’s very difficult to get a clear end picture.

Ryan Jones – RBC

All right, that was very helpful. And then just as my follow-up, I was curious if higher wage rates in China had any impact on the gross margin this quarter?

Martin Slark

No, our wage rates in China go through or increases go through at the same time as they do for other employees in September. And we – our wage rates are more than competitive in China and I think it’s also important to point out that we don’t provide dormitories for our employees except in one location.

So we don’t have any of the working environment or leading environment issue that you’ve read about in the press. And if you look at the wage increases that will make the impact is probably about $2 million to $3 million over a year. So, even though you talk about big percentages, the absolute dollars are not huge in terms of the standard increase that we go through.

Ryan Jones – RBC

All right, thanks again, and congratulations on the quarter.

Martin Slark

Thanks.

Dave Johnson

Thanks.

Operator

Your next question comes from the line of Steve O'Brien with JPMorgan. Please proceed.

Steve O'Brien – JPMorgan

Hi, thanks for taking my question. When we look at the product mix trending over the next couple quarters, can you comment if there's any impact to the gross margins when we see mobile devices, consumer devices contributing more to the mix and less automotive?

Martin Slark

Actually, I would say that our automotive business generally has lower margins than our consumer and telecom business, so lower automotive business certainly wouldn’t be negative. And one of the big reasons for the restructuring we did, as you know, was to focus on manufacturing for automotive in really two major plants, one if North America and one in China. So automotive margins are getting better, but I would say they’re below our average, so lower automotive is not a big impact for us.

Steve O'Brien – JPMorgan

Got you. And then on the raw material side, I think last quarter your expectation was maybe $1 million in fiscal Q1, $1.5 million in the fiscal Q2 for higher raw materials costs. If we could just get an update on how you're seeing raw material prices and the impact on the margins over the next couple quarters?

Dave Johnson

Yes. The – those numbers are still roughly the same, that hasn’t changed it. That is really basically the impact of coming off of the hedges and that I would still use that in your numbers. When you look at the difference in the last quarter, copper was actually down 2 percentage points or 3 percentage points on average from Q3 to Q4, and gold was up 7 percentage points or 8 percentage points from Q3 to Q4. So that is – the impact not has not been too significant as of yet. Compared to the – that point in time, now, the spot price for gold is down just a hair and copper is about what it was, but still not much of a change even through today.

Just for the information if I may. We’ve put our hedges in place and we put our hedge in place for copper at $3.26 and we put our hedge in place for gold at $1,251 per Troy ounce, so those are – the copper hedges ever so slightly in the money and we’re well below that for gold today. So, just a little bit more information for you.

Steve O'Brien – JPMorgan

And one point of clarity if I could. The effective tax rate looking out through all of fiscal 2011, did that sort of 27% to 30% apply?

Dave Johnson

Yes, I would suggest to use the 30%, because we have gone through a lot of activity in the last year. I mentioned on one previous call that we had, our new VP of Tax has gone through a lot of change, we have put in place a major process for our tax basis, balance sheet, that has been completed.

We also changed our internal transfer pricing, midyear this year. My best guess is in that range, I think the best number to use to model is still probably 30%. And we will update you as the quarters go on as we get more clarity around the tax rate.

Steve O'Brien – JPMorgan

And is there a long-term goal of maybe getting closer to some of peers more advantaged tax rates?

Dave Johnson

Absolutely. To start there and move it down, we’d like to be down in that lower rate – the lower range of that 27 would be a good target. But, as I said, until we see – we stop some of the moving parts and there was so many special transactions that took place this year, I’d suggest 30%, but absolutely, Steve, I think our goal would be to bring down below that as the time goes on.

Steve O'Brien – JPMorgan

Thanks.

Operator

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

Shawn Harrison – Longbow Research

Hi. Try to make these brief. In terms of the hedges, Dave, is it still 25% of the copper and 50% of the gold that you've hedged?

Dave Johnson

No, it’s about 35% or about a third of each this time. And what our plan is, as we put those in place, and as the quarters go on, and we’re going to be hedging further out in the future. And as I think I mentioned last time, we’re going to therefore put in place a process whereby we don’t have any clip where the hedges come off. We’re going to all those be hedged, but our first startup process is at 33%.

Shawn Harrison – Longbow Research

And that's a 12 month hedge?

Dave Johnson

These are 12 months hedges, yes.

Shawn Harrison – Longbow Research

Okay, the second would be just the incremental restructuring savings, the mix between COGS and SG&A in terms of the benefit for the next two quarters?

Dave Johnson

Still about 30% for SG&A and about 70% for COGS.

Shawn Harrison – Longbow Research

Okay. And then finally, I know that questions on Molex Japan you can't really answer, but in terms of an expectation of a timeline is there anything that you can say in terms of when to expect updates or is it just as part of the quarterly earnings release expect some news?

Martin Slark

We do expect to get quarterly updates or if there’s a major shift in the situation we would certainly make an update on that front.

Shawn Harrison – Longbow Research

Okay. I mean is there any timeline of expect something before the end of the calendar year or is it just too difficult to speculate?

Martin Slark

It’s too difficult to speculate. I think it’s going to be an ongoing case in Japan. I think we’ve obviously now reflected it in our financial statements that we are shifting gears now and attempt to get it resolved.

Shawn Harrison – Longbow Research

Okay, thank you very much.

Dave Johnson

Thanks Shawn. I think that is time.

Martin Slark

I think that’s the last question we’ll take this afternoon. It’s well over the hour. So I want to thank everybody for listening into the call. And certainly Steve Martens will be available for follow-ups later today or tomorrow. And we appreciate talking to you. Thank you very much.

Operator

Ladies and gentlemen, that concludes today’s conference. Thank you for your participation. You may now disconnect. Have a great day.

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