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Executives

Martin P. Slark - Vice Chairman, Chief Executive Officer and Member of Executive Committee

Steve Martens -

David D. Johnson - Chief Financial Officer, Executive Vice President and Treasurer

Analysts

Brian J. White - Ticonderoga Securities LLC, Research Division

Anil K. Doradla - William Blair & Company L.L.C., Research Division

Wamsi Mohan - BofA Merrill Lynch, Research Division

Steven J O'Brien - JP Morgan Chase & Co, Research Division

Mike Wood - Macquarie Research

Anthony C. Kure - KeyBanc Capital Markets Inc., Research Division

William Stein - Crédit Suisse AG, Research Division

Amit Daryanani - RBC Capital Markets, LLC, Research Division

Amitabh Passi - UBS Investment Bank, Research Division

Jim Suva - Citigroup Inc, Research Division

Sherri Scribner - Deutsche Bank AG, Research Division

Craig Hettenbach - Goldman Sachs Group Inc., Research Division

Shawn M. Harrison - Longbow Research LLC

Steven B. Fox - Cross Research LLC

Molex (MOLX) Q2 2012 Earnings Call January 25, 2012 9:30 AM ET

Operator

Good day, ladies and gentlemen, and welcome to the Second Quarter Molex Inc. Earnings Conference Call. My name is Anne, and I will be your coordinator for today's call. [Operator Instructions] I would now like to turn the presentation over to Mr. Steve Martens, Vice President of Investor Relations for Molex. Please proceed, sir.

Steve Martens

Thank you, Anne. Good morning, and welcome to our December 2011 conference call. I'm here today with Martin Slark; Dave Johnson; and Liam McCarthy. We want to limit our call today to one hour, and we have quite a few participants. So when we get to the Q&A session, we're going to ask for one question only and one short follow-up per participant. Please refer -- please visit the Investor Relations section of our website to download presentation materials and to access a replay of this call.

Before we turn our attention to the quarterly results, let's review our Safe Harbor statements which are slides 1 and 2 of the presentation materials. During the course of this presentation, we will 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 in understanding of the risks and uncertainties associated with forward-looking information and the reconciliation of non-GAAP measures to GAAP. And now, I'll turn the call over to Martin Slark. Thank you.

Martin P. Slark

Thank you, Steve, and welcome to everybody to our Q2 release call. Let me ask you to turn to Page 3, and I'm going to start my section by giving you a quick summary of the quarter. Q2 for us, frankly, was a challenging quarter primarily from a revenue perspective. But I think if you look at our operating results, we believe that we executed very well in many areas, particularly with our gross margin, our SG&A cost control, and we had very strong cash flow. Looking back over the prior 6 months, and we're all brilliant with the benefit of hindsight, it's now clear that the pre-Christmas production ramp probably peaked in the month of September, and in fact, it was pretty obvious to us it happened around the middle of September and then we saw slowing bookings through October and then into November. Our customers, we believe, were trying to maximize the use of low-cost sea freight to improve margins and were not willing to risk over-building inventory in what are clearly ongoing uncertain economic times. This resulted in very strong revenues in the September quarter, but also weaker than planned December quarter.

As part of the September guidance, we gave our best estimate of the potential impact of the floods in Thailand. The floods actually ended up lasting much longer than were planned or thought at the time and caused much more of a severe disruption to our customers supply chain than we initially expected. Our facility in Thailand was not damaged and has continued in full operation. However, customer shipments from both our facility in Thailand and our regional distribution center in Singapore were reduced. This event was very slow in developing, and we were still in the beginning of the event at the time of our release. At that time we estimated that the impact would be about $5 million per month and probably would last no longer than one month, for a total impact to the quarter of $5 million. Now the quarter is over, we have calculated the impact to revenue to be approximately $15 million. We expect our customers facilities that were severely damage to come back online if they are not already online now progressively during the March quarter and therefore, we do not expect a significant impact to our revenue during this current quarter.

Dave Johnson, our CFO, will provide more color on our financial performance in a few minutes. However, we were pleased with our cost management during the quarter. Our gross margin was strong for this level of revenue. SG&A, despite our annual wage increases around the world, were reduced sequentially. Capital spending was at the low end of our projected range and cash flow was solid. We're working hard to control those aspects of the P&L that we can control, headcount, discretionary spending, et cetera, responding as quickly as possible to changing business conditions, but we are continuing to invest aggressively in R&D and in our new product pipeline.

During the quarter, we closed a small acquisition, Temp-Flex Cable, which we believe will fit well into our high performance cable business, will bring us added exposure to medical as well as other cable-related markets. In addition to bolstering our exposure to these attractive markets, the additional wire and cable capabilities will help us take advantage of increasing opportunities for high-speed cable assemblies across many end market sectors.

Now turning to Page 4, which shows at a high level our revenue and order trends. Revenue was $858 million for the quarter, a sequential decrease of 8.4% and down 4.9% from the September 2010 quarter. While some level of revenue was pulled ahead into the September quarter, the main drivers for the decline were uncertain economic conditions affecting end demand, supply chain disruptions from the flood in Thailand and continued inventory management particularly by our distributors and our end customers.

If you turn now to Page 5, which is a new slide that we have added, which for reasons which I think will become obvious in a second, you can see looking at this slide that our orders were very uneven throughout the quarter. They bottom out in November, which is the longest month in the quarter, and surprisingly for us daily rates then rebounded in December and have been stronger in the early part of January. Based on where we are today, this gives us some momentum going into Chinese New Year, which we assume is going to carry over as we resume after Chinese New Year in February and March, and that daily bookings chart actually goes through Monday of this week.

If you turn now to Page 6, we'll attempt to give you some color on our results by end market. Sequentially, orders were basically down across all sectors with the biggest reduction occurring in the consumer electronics market. As noted on the chart and as noted before, the floods in Thailand impacted our results primarily in the Consumer and Infotech markets. Revenues were also down on a sequential basis with exception of Telecom market where continued success with smartphones and with fiber-optic products, the equipment sector resulted in sequential growth.

Looking at each of the sectors, we think particularly now in these uncertain times, it's important to look at both short-term and long-term trends, so I'm going to endeavor the comment on what we believe happened over the last year, what happened in the quarter and potentially give you some comments to where we think we're going to go from here both in this section and the Q&A. For October, revenues declined 6% sequentially and increased 1% year-over-year in the quarter. The Americas region had a relatively strong quarter and had the strongest results versus the prior year and has been pretty well publicized their increased U.S. car builds during the quarter, primarily from U.S. domestic producers.

The European market was weaker, reflecting the economic issues in Europe and production volumes particularly in France and Southern Europe were down during the fourth quarter. The calendar year '11 global car production was estimated at 77 million units, up 3% versus 2010. Molex's Automotive revenues for the calendar year were up 11%. Looking at 2012, the market projection is that global unit production will increase to 81 million units, reflecting a 6% increase. Increases in the electronic content within those vehicles should drive faster growth for the overall connector market within the automotive industry. And we believe that Molex is well-positioned based on existing design wins, particularly in the comfort and convenience, safety and infotainment sectors.

Looking at the Infotech market. Revenue declined 14% sequentially but increased 3% year-over-year. The notebook and tablet markets were weak largely because of accelerated builds that increased September quarter revenues. The service sector was up sequentially and the data storage sector was flat. Looking back over the last 12 months, we appear to have seen significant inventory build in Infotech sector that peaked in the September quarter. We saw slower orders in October and November, but the resumption in orders at the back end of December and now going into January.

For the calendar year, the Infotech business was up 7%. Based on our design wins for both copper and fiber products, we would expect to see resumption in growth beyond Chinese New Year. Infotech is a very strong market for Molex. We have an extensive product portfolio, preferred supplier status and engineering expertise to support all of the key customers in this segment.

Turning now to Telecom. Revenues, which include both mobile and telecom infrastructure, increased 2% sequentially but decreased 5% from the prior year. Smartphone sector continued to be strong as well as fiber-optic sales into high end telecom equipment. As we move into fiscal year '12, we expect equipment orders to strengthen based on the need to provide high-speed data infrastructure that can support video and high-speed data downloads. The transition from copper to fiber, and in the future to silicon photonics solutions, is creating significant new opportunities that will generate both connector and value-added revenues in the future. We expect equipment revenues to improve in 2012.

In the mobile phone sector, we are expecting unit growth overall to be relatively modest, but the volume of smartphones to increase by a significant percentage. The midrange in the basic sectors of the phone market will come under increasing pressure, as a result, there'll be limited incremental connector revenue opportunities in these subsectors.

For the calendar year, our overall Telecom revenues increased by 11% based on our strong position at the major players in this market sector, and we would expect to see reasonable growth in calendar year '12. It's not surprising that the Consumer electronics market was the hardest hit sector during our second quarter. Revenues declined 14% from the prior quarter and 11% versus the prior year, and orders declined by a similar percentage. All major end markets in this sector declined except for Pachinko gaming, which for those of you aren't familiar with Pachinko is a unique niche that was recovering from the tsunami impacts in Japan earlier this year. Surprisingly, LCD TV market for us was also relatively stable. Digital still camera, plasma displays, car navigation systems, white goods, all of the other major sectors were down on the quarter based on lower production volumes.

The weak economic climate, pre-Christmas builds, effectively finishing in September and the impact of the floods in Thailand all contributed to these declines. The Consumer market for us was relatively strong in calendar year '10 based on the benefits of various stimulus packages around the world and economic recovery that occurred following the financial meltdown. In calendar year '11, if you compare '11 to '10 on a calendar year basis, we have flat relatively flat revenues. We expect Consumer to remain weak through the March quarter with longer-term growth rate only improving as higher wage rates in Asia translate into increased consumer demand in the Asia markets.

Revenue for Industrial decreased 12% on a sequential basis and 14% from December 2010 order with particular weakness in the European industrial markets. Distribution is the primary channel for this market. The distributors have been aggressively working their inventory down and anticipated that demand would accelerate throughout the year and increase their inventory levels to support higher requirements. Over the last 6 months, they have been working inventory down throughout the year, and we don't expect to see stronger order growth in this sector until probably the end of the March quarter going into the final quarter of this fiscal year. The uncertain economic environment, particularly in Europe, is another major factor affecting the industrial markets. Particularly factory automation as end consumers have been delaying projects for capacity addition of new products. Encouragingly though, we have seen automotive customers now start to look at retooling factories particularly in North America and that will positively impact our Industrial business as we move into calendar year '12.

If you turn now to Page 7, I'll talk about our results by channel and by geography. By channel, the OEM saw the biggest declines both sequentially and year-over-year. Distributor orders were down 3% sequentially and down 4% year-over-year. We believe that the excess inventory in this distributor channel has been worked down and, in fact, the data we have from a major distributors indicates that inventory levels in those distributors are now 7% lower than they were at the end of the June quarter. One positive factor here is the order patterns for distribution have improved in December and now again in early January.

By region, orders in the Americas increased both sequentially and year-over-year. Economic conditions seemed to be stable or perhaps improving somewhat in the Americas. Both regions in Asia declined sequentially, and year-over-year, the impact of the Thai floods and the acceleration of pre-Christmas build, which pulled production to September quarter had an impact on both regions. Given the sovereign debt and economic issues in Europe, we expect Europe to continue to decline during the next quarter and clearly that is the region that we are most concerned about. However, as you know, the percent of sales that Molex has in Europe is relatively low compared to some of our competitors in this market. Now, let me turn the call over to Dave Johnson, our CFO, who will give you more details on the financial results.

David D. Johnson

Thanks, Martin, and good morning, everyone. Our revenue results of $858 million were below our record results in the September quarter but included the impact from the Thai floods that Martin explained of approximately $15 million. Despite the low revenue, we are very pleased to report that gross margin and SG&A spending was very well controlled in the quarter with gross margin at 30.7% and SG&A of $163.1 million. SG&A was $6.1 million lower sequentially.

The ongoing legal costs for our Japanese litigation matter was slightly lower sequentially at $2.7 million or $0.01 per share for the quarter. Interest expense was up sequentially for the quarter and other income was also up resulting in very little change on the net other income line. Our effective tax rate for the quarter was 33.7%, including a onetime tax charge of $2.7 million or $0.02 per share, and that is to write down our deferred tax assets in Japan as a result of the Japanese government's announcement in November to reduce the statutory tax rate there. Without this charge, effective tax rate for the quarter would have been 30.9%, just below the midpoint of our guidance range.

Our reported EPS for the quarter then was $0.36 per share but after adding back the $0.02 impact for the tax adjustment and $0.01 for the Japan litigation, our adjusted EPS for the quarter would be $0.39.

Please turn now to Page 9 for our balance sheet and operating metrics. Net cash increased by more than $32 million to just under $300 million for the quarter. Accounts receivable days ticked up to 71 days but remains in good control and at a very stable level. Inventory days increased to a recent high of 91 days as a result of both the traditional reluctance of customers to take on inventory at the December year end, as well as the mathematical impact on days of the significant sequential decrease in revenue. In absolute dollar terms, inventory only increased by $5.1 million sequentially, most of which was due to the Temp-Flex acquisition. Capital expenditures of $52.3 million were 6.1% of revenue. That's at the low-end of our target range of 6% to 7%. And while the SG&A declined sequentially, R&D increased slightly to almost $45 million as we continue to invest in new product development projects with our key customers. Cash flow from operations was $141 million, and free cash flow was $88.7 million, both of which were the second highest levels ever achieved by Molex.

On Page 10, you'll see a return on net assets trend. Though the 20.6% is clearly earning our cost of capital, the RONA percent declined by 70 basis points from the September quarter. The biggest impact on this metric is from the sequential decline in operating income, but putting the operating income levels to the side for a moment, we believe there are still improvements that we can make in managing the asset components of this metric, including inventory, receivables, payables and capital expenditures. Our supply chain initiative will help us to strategically plan our inventory levels, resulting in a permanently reduced investment in inventory.

Our initiative to measure and improve our new product development process is expected to improve the efficiency of our capital spending, enabling us to deliver more new product revenue and margin at a constant capital spending investment level. In our treasury management of receivables and payables, though quite good, can still be improved to generate better RONA returns. But still, our continued focus on improving operating income and margins will have the most significant impact on this metric. We were pleased that for the fourth consecutive quarter, our year-over-year price erosion was below our traditional range of 3% to 5%, validating, once again, the success of our Vendavo pricing initiative.

And finally, on Page 11, we show our outlook for the coming quarter. In providing our guidance, we have factored in the still uncertain global economic environment and the impact of Chinese New Year, offset by the increasing customer order rate that Martin described beginning in December, continuing into January. We are guiding to revenue in the range of $830 million to $860 million, and EPS in the range of $0.32 to $0.36 per share. This assumes an effective tax rate of 32% and $0.01 per share for the costs related to the Japanese litigation. At the midpoint of our revenue range, revenue is down 1.5% sequentially, which is approximately half of the normal seasonal decline usually seen in the March quarter.

In summary, the December quarter was a very strong quarter in terms of gross margin, SG&A spending, CapEx spending and cash flow generation. Revenue was below expectations due to the floods in Thailand, and the lower-than-anticipated orders in November, but at the same time, we are very encouraged by the distinct increase in customer orders that we have seen since November. And now we would like to open up the line for questions.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question comes from the line of Amit Daryanani with RBC.

Amit Daryanani - RBC Capital Markets, LLC, Research Division

Just a question maybe to start up on the OpEx side, pretty good improvement on the sequential basis year-over-year. How should we think about OpEx going from this $163 million run rate because my math sort of OpEx stays flat, looks like margin to get about 11% in the March quarter?

David D. Johnson

Yes. Thanks for the question, Amit. You should probably assume that OpEx, SG&A will be somewhere between the first quarter, which was $163 million and this quarter, which was $169 million, probably in the midpoint of that is where we would be. We believe as we see our growth coming back that we're going to be continuing to invest in R&D and sales over the next couple of quarters, so that would increase our OpEx a little bit.

Amit Daryanani - RBC Capital Markets, LLC, Research Division

That's helpful. And if I could just follow up. Just a question, when I look at the order trends, it looks like orders are down 10% in the quarter. Could you help us understand when orders are down 10%, how we're guiding for down 2% revenues and I fully realize you have some inter-quarter business but that seems that's a fairly material gap, so any clarity there would be helpful.

Martin P. Slark

Yes, Amit, that's a great question and frankly, you can imagine I think if you look over the last couple of quarters, the last quarter and this quarter that we're now in, I think the market has been fairly volatile, and then one of the things we look at when we look at our guidance is the fact that if you look at total bookings of $815 million last quarter, how do you end up with $845 million as a midpoint for the current quarter and frankly, it's based on the fact that if you look at the order trend in the back half of December and now in January and also we get indication orders from our customers in several end markets. So looking at the indication orders were which is like a confirmed forecast from some of the customers, that and the input from our sales force is what we based it on. And we saw, we think, a shutdown in sort of some of the end markets particularly infotech in the middle of September because people thought they had built it for Christmas. Interesting, I personally been involved in number of customers trying to now expedite short-term orders for production in the current quarter. So we just try to balance the conflicting -- the messages we got and kind of take them in the midpoint of it too.

Operator

And our next question comes from the line of Will Stein with Crédit Suisse.

William Stein - Crédit Suisse AG, Research Division

Can you help us understand the impact from Thailand? Is it your factories? I think you said those were okay. Or is it your customers production or is it complementary products that are sitting on the circuit board next to your product that are causing the line down and therefore, reduce demand relative to time?

Martin P. Slark

Yes. Will, it's a good question again. Two things. What it is, is the shipments directly from our own plants where we were told by customers not to ship because their own facilities were impacted by the shutdown and that primarily came out of our Thai facility. And then what happened as the quarter developed was other customers contacted us because they couldn't get other components. They could get our products, they couldn't get the components and pushed back some of their own production. So a result of that particularly start coming out of a distribution center in Singapore across Southeast Asia, those shipments were reduced by customers, because they couldn't get other the components as well. So the combined impact of those and Ray would quantify it pretty accurately was right around between $15 million and $16 million.

William Stein - Crédit Suisse AG, Research Division

Great. And I do have a follow-up, if I can. Temp-Flex, I think, was the acquisition. Can you clue us in to the timing and the size of this deal?

Martin P. Slark

Yes. It closed right at the end of the quarter. So it really had no impact at all on our results this quarter. In our 10-K, the purchase price is quoted in there, at $24 million. On a full year basis, it would add about $20 million of revenue for us, now that full year calendar year '12. So it accelerate as the quarter went on. It's really a niche acquisition that gives us some high-speed cable technology that actually will benefit us over the next 2, 3 years in some of the high-speed cable assembly products that we're trying to build for some of our leading customers and that gives us some captive technology that we can leverage. It's really not a revenue buy, it's a technology buy.

Operator

And our next question comes from the line of Sherri Scribner with Deutsche Bank.

Sherri Scribner - Deutsche Bank AG, Research Division

I wanted to get a sense of your telecom segment. Clearly, you have some different segmentation than some of your competitors, but it doesn't seem like you're seeing as much weakness as maybe some of your competitors or some of your customers are seeing in that market. I was hoping to get a little more detail on why you think you're doing a bit better.

Martin P. Slark

Sherry, I think the explanation I believe is, although obviously this is just based on some market knowledge. I think the explanation is relatively simple and that is that I think some of the competitors you're referring to do a lot of RF business in cellular-base stations, and that's not a sector of the market that Molex participates in a great deal. And I think relatively, Molex has a very strong presence with fiber-optic technology and that part of the market has been relatively strong. So I think if you take weakness in the RF cellular-base station market and then you take our strength in fiber, the combined both things will explain the difference.

Sherri Scribner - Deutsche Bank AG, Research Division

Okay. And then just looking at the commodity cost, it seems like you've been able to do a bit better job on the gross margin. Is that primarily related to commodity cost coming in? And what is your expectation for commodity costs going forward?

Martin P. Slark

Let me take part of that, and then I think Dave can give you some specifics on commodities. As you've probably seen, commodity costs have moderated somewhat and I think if that continues, it would benefit us as we go into calendar year '12. I don't think it had a material impact on our results for last quarter, and in fact, if you take the first half of this fiscal year versus last year, we actually had a headwind of about $20 million associated with commodities in total. So it's a negative impact on the first half. But clearly, our hedges take out some of the volatility. But if you look at our gross margin of why it held up I think better than would have been expected, it's really a combination of number one, I think, this Vendavo pricing initiative that we started. I think we're doing a better job of managing our pricing and that's reflected in our lower than normal price erosion. I think the supply chain initiative we started really went out to drive down our freight and duty cost around the world, and I think good efficiency in our manufacturing plants and also trying to drive more revenue through our Focus Accounts that generally tend to have better margin profiles. So I'd love to tell you the silver bullet there, but it's a combination of a lot of work, a lot of areas, a lot of focus on that and Dave will give you a bit more specifics on the actual commodity impact.

David D. Johnson

Yes. Thanks, Martin. The impact on the quarter itself was a slight positive and as Martin said not a major impact for us but a slight positive, which was mostly because of our hedges, and in fact, that's why we had the positive. When you look at the spot rate today versus the average for the quarter, we're just about both gold and copper are up just slightly. So if you use that as a guide for this quarter, we would expect not a material impact on the third quarter either. But -- and I think Martin did a very good job of explaining our year-over-year impact, so I think that's -- unless there's any other specific questions, that's what I will say.

Operator

And our next question comes from line of Shawn Harrison with Longbow Research.

Shawn M. Harrison - Longbow Research LLC

I wanted to follow-up just on the demand environment. And maybe if you could try to parse out just the demand you're seeing coming back right now, is there any concern that maybe this is just a restocking head fake and then as we get maybe a month or 2 down the road, do you see a little bit of a downturn given what happened in the September quarter? I guess just any visibility and kind of conviction you're seeing in kind of this bounce back in orders?

Martin P. Slark

Yes, good question. I think that's probably the one that everybody is trying to struggle with given the volatility we've seen over the last few months. And obviously, I think one of the other factors you didn't mention is this week, as you know, is Chinese New Year and some customers may well have been placing orders ahead of Chinese New Year. So -- but having looked at that data and looked at previous Chinese New Year impact, our belief is that the slowdown we saw in the October, November period was clearly a reflection of pre-Christmas build being much stronger in our first quarter. And clearly, we talked about the impact of the Thai floods. I think the recovery we're seeing now, some of it is preordering because of Chinese New Year and restocking shelves. But some of it I think also if you look at the customers that are driving that and the end markets they are in, I think there are some clear strengths in some segments. I think the interesting twist today is that even though you see many companies struggling in certain end markets, if you've got good products in certain end market segments, there's still opportunities to grow there. So I think the overall market is -- in '12 for us will grow. I don't think we're going to see anything like the strength for the recovery we saw in calendar year '10, which slowed down in '11, but I do think overall, it'll be positive. And it's going to be very selective on specific customers in certain end segments.

Shawn M. Harrison - Longbow Research LLC

Okay. And then as a follow-up, did you, I guess, reduce any headcount during the December quarter? Will you be -- if so, will you be adding some back in the March quarter and does that in any way affect the incremental gross margin here in the short-term?

Martin P. Slark

Yes. You have to look at 2 factors actually. Our headcount in our plants and then what we do in terms of subcontract work, external manufacturing. We did not reduce any indirect employees, so any SG&A costs and our headcount there actually grew a bit in the R&D area and in the sales area. We reduced during the quarter about 1,500 employees. Our headcount in December was about 1,500 lower than it was in the beginning of the quarter. But that -- some of that primarily is attrition in China, and then the reduction in our external manufacturing is how we manage that direct labor, effectively direct labor costs, but no false redundancies. It was really -- in the Chinese plant in particular was not replacing people that were leaving.

Operator

And our next question comes from the line of Craig Hettenbach with Goldman Sachs.

Craig Hettenbach - Goldman Sachs Group Inc., Research Division

Just a follow-up on a topic of M&A, Martin, just a fair amount of activity across the space in recent months, you did a small tuck-in deal. Can you talk about how you're approaching M&A and type of opportunities and markets you're looking at as we go through the year?

Martin P. Slark

Yes, Craig. A couple of comments, I would say. One is our fundamental strategy really hasn't changed. I think we've been very clear about the fact that Molex is not going to buy companies just to add revenue. And I think our focus is going to continue to be to strengthen our position in the industrial and medical markets. We want to backward integrate more into some of the value-added activities that we're involved in, so that we can improve the margins in that business and we want to strengthen our position in both the RF and high-speed areas. I think what appears to be happening though is that the percentage of the market that is being controlled by the large global players continues to grow. My sense is that you're going to see, particularly with available funding for those companies, acceleration in acquisition activity. We have a very good pipeline of opportunities that we continue to look at. Many of them private deals with family-owned companies we've known, and we'll continue to work on those. What I can't do is predict the timing of them because obviously the decision on the sell date is family-driven versus investment banking-driven.

Craig Hettenbach - Goldman Sachs Group Inc., Research Division

Okay. Now, if I could just follow-up, any update on the Focus Account Program? I know you had expanded it over the last year. Just what you're seeing the type of growth and impact to margins.

Martin P. Slark

Sure. If you look at the December quarter compared to the same quarter last year, the percent of revenue that came from the original Focus Accounts grew from 32% to 35% of our sales. Now, what we have done is we've been so successful with a few of those Focus Accounts is we're actually putting them into a category now what we call strategic customers and feeding in some new target customers at the lower end particularly in the medical industrial market. So we're going to keep that process going on a dynamic basis to make sure that we refocus our sales and marketing resources from customers that we think have faster growth opportunities. The other part of your question is, those smaller faster growing companies do have margin profiles that are slightly better than our larger global accounts. And that's clearly one of the other reasons for going after those companies, and I think that's one of the other factors that's helped hold up our gross margin.

Operator

And our next question comes from the line of Steve O'Brien with JPMorgan.

Steven J O'Brien - JP Morgan Chase & Co, Research Division

Can you remind us of the sort of the mix in the Telecom business between smartphones, feature phones and then the infrastructure side of that? And will you -- feature phones, is that is still sizable enough to actually be a drag on the category?

Martin P. Slark

That's -- it's a very tough question in that. If you look at that market data, what some suppliers described as feature phones other companies call smartphones. And so, if you look today and you look at some of the market data that's published by independent third parties, and you project it out, this year, there were probably something like 1.6 billion cell phones sold around the world. The projection next year as we go to something like 1.75, 1.8 billion phones. As the one piece of data that everybody agrees upon is the fact of the portion of that supplied by smartphones, more integrated devices with greater functionality, is going to grow significantly. The split for us between infrastructure and handsets is right around the 60-40 range favoring the infrastructure portion of that. What we're really excited about there is even though I think there was a slowdown in CapEx this year that made that a tougher market, a lot of the companies we sell to their are trying to work on new pieces of equipment where they're looking at 100 gigabit systems and very sophisticated technology, which is going to give us some opportunities, I think, to grow in that market with some very profitable product lines.

Steven J O'Brien - JP Morgan Chase & Co, Research Division

Got you. And then if I could follow up on the consumer electronics space and seeing a lot of pressure on suppliers, whether it's in TVs or gaming systems, other consumer electronics. Do you believe that -- I guess how is Molex -- is Molex seeing that kind of pressure, and how will Molex manage that kind of pressure? And I guess broadly, is there any signs you see that the demand environment or growth could be better as the year progresses?

Martin P. Slark

There's a lot wrapped in that question but [indiscernible] just looking generally at the consumer market, that's one of the reasons why I tried to quote in our data, because I think one of the things that happens in that market is it's probably the most seasonal of the markets that we service. And the fourth quarter was clearly a very poor quarter in terms of component sales. But if you look at consumer electronics year-over-year, it was basically flat for us. And you're absolutely right, it's a very competitive market but Molex has been in that market for long term, and obviously, we have strong ability to compete in that market and retain our share. When we look forward to next year, we're not relying I think on significant growth in consumer electronics, but we do think there will be some growth driven by 2 factors. First of all, as the wage rates continues to go up in Asia, you're going to end up with more consumers with high disposable incomes and I think that will drive some increased demand. You're, clearly, not going to see higher consumer spending in Europe and I guess the U.S. is a question mark. And then the other thing is if you went to Consumer Electronics Show this year, every year, there's a lot of new consumer devices that are launched, particularly in the gaming industry and things like that, and we have very good designing position on those. So if a few of those companies successful in the games market, for example. And I think the TV market very tough this year and if there's more sophisticated controls in the white goods area, there are pockets of opportunity for growth but clearly a tough market.

Operator

And our next question comes from the line of Jim Suva with Citi.

Jim Suva - Citigroup Inc, Research Division

When we look at your March quarter, sales outlook and EPS outlook and compare it to the December results, your sales outlook at a high end actually is stronger than Q2, but the EPS is lower than the Q2 that you just reported. Can you help us with, what that implies for operating margins going forward, and why is there a step-down in profitability for the March quarter outlook compared to the reported Q2 December report?

David D. Johnson

Thanks, Jim, for the question. Yes, if you take a look at the high end of the range as you just said, it does imply maybe about a $0.02 impact. I think the first thing was the very first question that Amit raised about SG&A that we're expecting SG&A to increase between Q2 and Q3 by roughly $3 million or $4 million. The reason for that is we cut very significantly in the quarter itself. We cut travel. We cut new hires. We kept a very close watch on SG&A. But as we look forward, we think we're going to be needing to invest back in some sales and continue to invest in R&D. The second factor to that is our effective tax rate. We've given guidance at 32%, which was before at a range of between 30% and 32%. So those 2 factors would account for the difference I think that you're talking about.

Jim Suva - Citigroup Inc, Research Division

And then as we progress through the rest of your fiscal year even more importantly, the calendar year, that SG&A level, are we seeing continual increases as of the year progresses or how should we think about that kind of more longer term beyond just the March quarter?

David D. Johnson

I think we would expect to continue to see slight increases. As we said, we do not anticipate increasing our admin costs. In fact, we have launched a Six Sigma effort here in our corporate office. The intention of that is to maintain and to keep admin cost at the same level over quite a period of time. But we will continue to increase our spending in sales and on R&D. So if you took -- if you think about kind of incremental cost, we talked about between 35% and 40% for incremental gross margins, maybe about 30% for incremental operating margins.

Operator

And our next question comes from the line of Mike Wood with Macquarie.

Mike Wood - Macquarie Research

Just a question on the Thailand sales loss. Do you guys expect to recoup them? And if so, would it be in the March quarter?

Martin P. Slark

We would expect to get back about $5 million of it in the March quarter. I think some of it was frankly loss, but I think included in our guidance for the current quarter would assume about $5 million recovery of revenue that was lost.

Mike Wood - Macquarie Research

Okay, great. And then also on the Disti channel, I think you said inventories were 7% lower. Do you expect that level to stay like that? My question being are these guys restocking or is this the demand increase ahead of maybe Chinese New Year?

Martin P. Slark

Honestly, I don't know the answer to that question. I think looking back on the last year, it appears that post the tsunami in Japan, a lot of distributors increased their inventory based on, I think, the fact they thought there were going to be some component shortages and an expectation of the second half for the calendar year was going to be stronger than it was. And then we've seen them since the end of June work down those inventory levels. If you look back on historic levels, and of course, we're just talking about the inventory of our own products in our own major distributors, so I can't comment generally on overall distributor inventories. If you look at the inventory number of days they're carrying today, it is at a relatively low level compared to historic norms. And so we think that provided demand is solid, we should see at least ordering patterns that would support the end demand.

Operator

And our next question comes from the line of Steven Fox with Cross Research.

Steven B. Fox - Cross Research LLC

I just want to make sure I'm clear on what you were just talking about with your order patterns over the last couple of quarters. If you smooth out say September pull-ins and then what you saw in December, are you saying that end demand -- how would you describe end demand where you saw some volatility in those markets? Is it -- are you seeing incremental weakness or strengthening? If you could just speak -- provide more clarity on that. And then secondly, relative to slow consumer electronics growth, which is still growth, what does it mean for your Japanese footprint going forward? If you can sort of give us some color on that.

Martin P. Slark

Steve [indiscernible] can I maybe take the second question first? In terms of our Japanese footprint, as you know, when Molex went through its restructuring operations in Japan, we actually reduced the number of plants we have in Japan from 4 down to 2. We have 2 very highly integrated and highly automated plants in Kagoshima and Shizuoko in Japan. And they're very, very competitive on a global basis. Secondly, of course, a lot of that production was moved to Dalian in China. If you look at the shipments from our plants in Japan, the very high portion of exports as a result of that, because that's the place where we develop a lot of our microminiature technology that is exported around the world. And so I would say over the last 10 years, a lot -- a big portion of what they sell doesn't go into consumer electronics market. It's into the mobile market for us. It's into a lot of other handheld devices and things like that. So I think we're very happy with that footprint. We have -- and, of course, one of the benefits in Japan is very stable, very experienced workforce, so I don't expect to see any structural changes there. That is a real strength of Molex as a company, and we're very proud of it. In terms of trying to look back on last year and look at the end demand and what's happening with the various end segments, I try to do a little bit of that in the commentary, but when I look back on last year, I would make the following comments. And that is I think '11 in total was weaker growth that we saw in '10 where '10 clearly benefited from stimulus packages and recovering from the financial downturn. I think there was a spike in Q3 that was driven by early pre-Christmas builds, and I think what we saw in the December quarter was an exaggerated seasonal downturn caused by the factors we talked about. And as we go into this year, I mean, assuming reasonable economic climate around the world and no meltdown, we're expecting I think clearly a recession in Europe is part of that picture. We're excited about the electronic content in cars continuing to go up and the volume of cars increasing. We're excited about the infotech markets, and we believe there is reasonable growth in sectors of the telecom market. We think industrial is going to be tough, and we think consumer is going to be tough.

Operator

And our next question comes from the line of Anil Doradla with William Blair.

Anil K. Doradla - William Blair & Company L.L.C., Research Division

Couple of questions. One was if you look at the handset industry, we're seeing market shares shift especially getting more and more skewed to maybe the top 2 primarily Apple and Samsung. I think in a scenario of extreme shifts to just a handful of customers, do you guys -- are you guys worried about that exposure or you don't care whoever wins, you guys win? And the second part was, it looks like, Martin, from your commentary, people are a little cautious yet the order patterns are increasing. Is it fair to say that people actually have not increased their inventory largely due to restocking, but it's a reflection of end market demand? Is that a fair statement to say?

Martin P. Slark

Sure. Anil, 2 good questions there. To answer your question, I think about the market and some people getting or some customers ending up with very big chunks of market share and big shifts there, you're absolutely right, and I think obviously as you know, we don't comment on individual customers, but it really relates back to the comment that I made earlier, and that is sometimes, you can see overall sectors grow and you can see particular people within those sectors do very well. And obviously, it's important to be working with them. Sometimes you can actually see a sector be flat or go down but one particular company gain significant market share. So the key is I think to be working with the right end customers. And you're seeing some dramatic shifts in market share and your comment is absolutely right. It's something that we talked about in Molex all the time and that is, frankly, we don't care who wins in the end market as long as they use our parts. And the key is obviously -- went through our engineering and marketing teams to make sure you're working with the industry leaders. But in the electronics market we're in, that's a very dynamic picture. so this year's winner may not be in next year's winner, so you got to make sure you maintain relationships across all the companies but leverage the opportunities when you're there. I think in terms of end demand, I mean, there's been a lot of questions about that during the call. What I would say is this, is that I don't think with the benefit of hindsight, Q3 was as good as it looks. I don't think Q4 is as bad as it looks. And when we look out to calendar year '12, I think we believe there's going to continue to be opportunities for growth but at a moderate rate and the key is going to be what sectors and what customers you focus on.

Operator

And our next question comes from the line of Anthony Kure with KeyBanc.

Anthony C. Kure - KeyBanc Capital Markets Inc., Research Division

Just wanted to touch on a little bit more on the distribution channel again. But outside of the near-term puts and takes and the volatility around building inventory and suppressing inventory, maybe one of the longer-term trend question. Just as you compare your relationship with the distributors and inventory levels at the distributors, is it fair to say, or do you think that on balance, the distribution channel in general is holding much leaner inventory levels than they had maybe 5 years ago? I guess, my question is really trying to gauge whether or not we can expect more potential volatility to the upside and the downside, because of people keeping inventories much less. Just wanted your take on that.

Martin P. Slark

It's a terrific question. And I think you're absolutely right, but it doesn't just apply to distribution. I think one of the changes that has taken place since the tech bubble burst, and increasingly since the financial crisis, is the amount of inventory held across the supply chain generally is much leaner. And that's why you see such increasing volatility, and I think -- when you look back to just September how our order pattern in the middle of September, just dramatically changed like that so it can change very, very fast, and we often talk about the fact that 70% of what we ship in the month is ordered in the same month. So what we are trying to do with our distribution channel, and roughly 25% of our sales go through distribution, is trying to do 2 things. One, of course, respect the fact that they have the right to manage their asset base, but then secondly, also making sure through some policy changes, that distributors don't just factor our products. If all they're doing is buying and reselling it, they're not adding value for us so we're looking at -- we put in place some policies to say they can only order certain product line so many times a month because the role that they should be playing is carrying inventory and providing good service to small- or medium-size customer so that we can have bigger production runs in our plants. Your perspective that industries are tighter or inventories are tighter across the whole supply chain, particularly in distribution, I think, largely because some of the better tools that are available and the paranoia about not carrying too much inventory is absolutely correct.

Operator

And our next question comes from the line of Amitabh Passi with UBS.

Amitabh Passi - UBS Investment Bank, Research Division

A lot of questions have been asked. My main one was just around your Infotech and Industrial markets. If you could just maybe shed a little more color in terms of what dynamic you saw in those end markets particularly with respect to various customers within these 2 end markets?

Martin P. Slark

Yes, I'm happy to do that. I think with those 2 end markets, if you look at the infotech market, the notebook and tablets part of that market were weaker than expected during the current quarter, primarily due to these pre-Christmas builds and also because of the impact of the Thailand floods. Servers were up sequentially and storage was basically flat, both of those were actually better than expected. The other submarkets, when you look at business peripherals, printers, et cetera or HDD, those kind of products, they were basically down during the quarter. And then if you look at the industrial market, really that was one of the weakest sectors largely driven by the fact that there's 2 issues there. First of all, a lot of it goes through distribution that was a weak channel and, of course, the European market in particular was very weak.

Amitabh Passi - UBS Investment Bank, Research Division

And then, Martin, just as a follow-up on a similar vein, orders by channel OEMs were down 15% sequentially, can you just shed some light where most of that weakness came from?

Martin P. Slark

Yes. The OEM weakness for the quarter, I think, was driven a lot by consumer electronics and then the infotech sector on a sequential basis being down.

Operator

And our next question comes from the line of Wamsi Mohan with Bank of America Merrill Lynch.

Wamsi Mohan - BofA Merrill Lynch, Research Division

Dave, could you remind us of where your raw material hedge levels are right now for gold and copper.

David D. Johnson

Sure, I'd be happy to. We -- for the current quarter, that is the third quarter, we are hedged at $3.69 for copper, and that's just above the spot price. And for gold, we're at $1,532, which is a bit below the spot price.

Wamsi Mohan - BofA Merrill Lynch, Research Division

And, Martin, your average daily order trend improvement particularly in December and January was really interesting. Can you give us some sense of how that looked last year when Chinese New Year was in February? Was it a weaker December and a stronger January last year?

Martin P. Slark

Actually, I think one of the challenges when you look back in the last couple of years is I think after the financial crisis, there sort of secular recovery was a result of the economic recovery from those post periods, kind of overrode any kind of seasonality. So I'm not sure the comparison is particularly relevant, but what we have done is we went back over 10-year period and looked at the Chinese New Year trend, and it appears that at least 50% of what we're seeing today is over and above what you'd expect to be for pre-Chinese New Year order. So we were trying to do the same thing ourselves to see, well, it's just the pre-Chinese New Year's peak ahead of the actual holiday period and from what we can tell looking our multiple years rather than just last year, is this appears to be stronger than what we normally see.

Operator

And our next question comes from the line of Brian White with Ticonderoga.

Brian J. White - Ticonderoga Securities LLC, Research Division

I'm wondering if we could talk a little bit about operating margin and the 14% target. It doesn't look like that's in the cards for fiscal '12 or is it? Or is this something we should think about for fiscal '13?

Martin P. Slark

Brian, I think we stated that, that's what we're trying to work towards. We haven't given up on that goal, and I think you've probably seen during this revenue slowdown, we've done a better job of protecting our margins. And I think that bodes well for the fact that as revenues come back again, that we'll see more pull-through there. I think it's unlikely given the current economic climate that you would see that this fiscal year, but I don't want anybody to walk away from the call that we are not 100% focused on getting the margins up to that level. And I think in periods of good growth given our current global model and the work we've been doing to improve our margins, we should be able to get there.

Brian J. White - Ticonderoga Securities LLC, Research Division

And on the networking market, what did you see in the December quarter, and what are you seeing in the March quarter? And I'm not talking telecom equipment, but more of the IP networking, Cisco, Juniper, that type of end market.

Martin P. Slark

Reasonably, flat overall but some market share shifts among some of those players so I think how well you did was a little bit about who your end customers were.

Brian J. White - Ticonderoga Securities LLC, Research Division

And how about the March quarter, Martin?

Martin P. Slark

Hard to tell. The indication orders from that sector that we get the forward forecast are fairly flat with what we saw last quarter.

We've now actually got to the end of the hour that we have, so we'd like to thank everybody for listening to this phone call. We know you had a very busy morning this morning with a lot of other calls, and we appreciate the attention. Steve will be available later today for follow-up questions, and we look forward to talking to you next quarter. Thank you very much.

Operator

Ladies and gentlemen, we thank you for your participation in today's conference. This concludes the presentation. And you may now disconnect. Have a good day.

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