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Molex Inc’s earnings for the fourth quarter of fiscal 2012 beat the Zacks Consensus by 4 cents, or 10.8%. Revenues were again weaker-than-expected, but the earnings beat raised share prices 3.09%, making up for the 3.00% loss during the day.

Revenue

Molex reported revenue of $858.5 million, which was up 2.6% sequentially and down 6.0% year over year, missing management expectations of $870-900 million (up 4-7% sequentially). Revenue was also short of the consensus expectation of around $880.5 million, which management attributed to weakness in the consumer electronics market (particularly in Japan), in the mid-range handset market and in the industrial market in Europe.

Revenue by End Market

The Data or Infotech market (26% revenue share) remained the largest contributor to revenue, growing 6.7% and 6.2% from the previous and year-ago quarters. Molex stated that tablets were the major driver of revenue, with high-end computing, server and storage, and peripheral equipment remaining stable. However, the notebook segment continued to disappoint, being cannibalized by tablets from Apple (AAPL - Analyst Report) and Samsung among others.

Longer-term drivers in this market continue to be the migration to SAAS 2.0 and 16GB fiber channel networks in the storage market, as well as the popularity of tablets and other MIDs. The transition from copper to fiber-optic platforms will also drive results, as Molex remains well-positioned with solutions for this market.

Telecommunications stayed in the second place, increasing 2.6% sequentially and declining 17.3% year over year to 22% of total revenue. Both the mobile and infrastructure sides of the business were stable sequentially and weak in comparison with the year-ago quarter.

Management appears optimistic about improving trends in the infrastructure segment. The dynamics in the mobile segment are both positive and negative for Molex at this point. As smartphone penetration increases, Molex should benefit from its position at leading manufacturers. At the same time, feature phones (midrange devices) will continue to decline, which will be a negative for Molex.

The long-term drivers for mobile phones are the growing adoption of smartphones and the continued cramming of features into increasingly smaller devices. Secular drivers of the infrastructure business include increased Internet usage, increased volumes of mobile devices of various kinds, more video being watched and transmitted, as well as the adoption of cloud computing.

The automotive market brought in 18% of total revenue, up 2.6% sequentially and 12.8% from the year-ago quarter. Molex is seeing normal seasonal trends in this business, as well as increased design activity and project wins. The growing adoption of standard devices in Asia is a positive in terms of profitability.

The increasing electronic content for safety systems, powertrain, infotainment and telematics in automobiles is a long-term positive because it expands the market for Molex’s connector technology. This and Molex’s exposure to China (where a large amount of auto manufacturing has shifted) are secular drivers of demand in this market.

Consumer Electronics grew 2.6% sequentially while declining 15.9% year over year to 17% of revenue. The sequential increase was helped by increasing orders toward the end of the quarter, which appears to be the beginning of a pre-Christmas build. The decline from last year was because of cautious consumer spending, as well as weakness at a leading Japanese customer.

Molex should do well longer-term, as its customers introduce new products targeting the BRIC countries, as well as Vietnam and Thailand, where growth is expected to be stronger than in other parts of the world. Higher disposable income and increased consumerism in developing countries are secular drivers of demand in this market.

Industrial generated 14% of revenue, up 2.6% sequentially and down 12.3% from last year, similar to the trend in the March quarter. This seems to indicate improving markets, which management stated was the case in the Americas and Asia. However, Europe remained weak, as macro concerns remained. Around 65% of the company’s industrial revenue comes through distributors that continued to maintain lean inventories. The business typically reflects global GDP growth rates.

The remaining 3% of Molex’s revenue came from medical/military markets, which were down 23.1% sequentially and 6.0% year over year. Molex is currently seeing greater opportunities in medical.

Orders

Total orders were up 3.2% sequentially and down 0.6% in the June quarter. However, backlog strengthened, growing 10.9% sequentially and 2.3% from last year. The book to bill increased to 1.05, positive for the second straight quarter.

Approximately 26% of Molex’s total orders were from the data/ infotech market, 24% from telecom market, 17% from auto, 17% from consumer, 13% from industrial and 3% from medical/military. All except industrial and auto grew on a sequential basis, while all except infotech and auto declined from the year-ago quarter.

Molex decided not to give region-wise specifics as it has done in the past, merely stating that orders weakened in Europe, stabilized in the Americas and grew in Asia. The Asia/Pacific North region (Japan and Korea) was hit by weakness in Japan. Therefore, Asia/Pacific South fared better.

Molex also did not provide any insight into the breakup by OEM/distribution/EMS.

Margins

Molex reported a gross margin of 30.0%, down 48 basis points (bps) sequentially and 79 bps year over year. The margin was impacted by a higher percentage of lower-margin business, as well as commodity cost and currency headwinds.

Operating expenses of $161.6 million were up 1.4% from the previous quarter’s $163.1 million, with the operating margin expanding 28 bps sequentially, while shrinking 123 bps year over year to 11.2%.

Net Income

Molex’s pro forma net income was $75.0 million or 8.7% of revenue compared to $67.4 million or 8.1% of revenue in the March 2012 quarter and $80.6 million or 8.8% of revenue in the June quarter of 2011. Our pro forma estimate for the last quarter excludes losses related to unauthorized operations in Japan.

Including the special item, Molex reported a GAAP net income of $72.0 million ($0.40 per share) compared to an income of $64.9 million ($0.36 per share) in the previous quarter and income of $77.3 million ($0.44 per share) in the year-ago quarter.

Balance Sheet

Inventories were down 2.8%, with inventory turns increasing from 4.3X to 4.5X. DSOs went from 79 to around 80.

Molex ended with a cash and short term investments balance of $652.2 million, up $29.8 million during the quarter. Cash generated from operations was $143.3 million, up from $138.9 million in the fiscal third quarter. Capital expenses were $77.7 million, or 9.1% of revenue, up from 6.5% of revenue in the previous quarter.

The significantly higher capex is related to new products that the company will be introducing in the next quarter. Molex also paid $20.0 million for acquisitions, $96 million for repayment of long-term loans and $35.3 million for cash dividends in the last quarter.

Guidance

Molex expects revenue of $900-940 million in the next quarter, up 5-10% sequentially. The pro forma EPS (excluding a cent for unauthorized activities in Japan) is expected to be 38 to 42 cents a share, assuming a tax rate of 30-32%. The Zacks Consensus estimate for the first quarter of fiscal 2013 was 43 cents, better than the guided range.

Conclusion

Molex is a leading player in the fast-growing connector market, with several secular growth drivers. However, the company appears to be seeing more growth in lower-margin segments, which is impacting its profitability.

Additionally, macro conditions in Europe are impacting results, and the negative effect may be expected to continue in the next few quarters. The Zacks Rank for Molex shares is therefore #4, indicating a Sell recommendation in the short term (1-3 months).

A few other factors need to be considered for the long term. For instance, the nature of the business necessarily leads to some commoditization, which in turn results in price erosion. New product launches by customers and the evolving nature of the served markets are offsetting positives that Molex should be able to take advantage of given its market position. Therefore, our long-term (3-6 month) recommendation on the shares is Neutral.

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