Littelfuse Inc (LFUS) 2007 Q2 法說會逐字稿

Good day, everyone, and welcome to the Littelfuse Inc.

second quarter 2007 conference call.

Today's call is being recorded.

At this time, I will turn the call over to Chairman, President and Chief Executive Officer, Mr.

Gordon Hunter.

Please go ahead, sir.

Thank you.

Good morning and welcome to the Littelfuse second quarter 2007 conference call.

Joining me today is Phil Franklin, our Vice President, Operations Support and CFO.

As you saw in the news release, we achieved our second quarter earnings guidance on sales slightly below the guidance we provided in our mid-quarter update conference call on June 20th.

Our automotive and electrical businesses were on track for the quarter with both businesses achieving increased sales and operating income, however, our electronics business unit was down from the first quarter, and this is our largest business accounting for approximately 65% of total revenues.

The shortfall in the electronics business resulted primarily from weaker demand in key telecom segments, a loss of one major program and effect of the distributor inventory correction.

As we indicated in the press release, we expect Q3 sales to increase 4% to 8% sequentially driven by significant growth in our electronics business and continued strong performance in our automotive and electrical business units.

I'll discuss the second quarter results and our outlook in more detail in a few minutes.

But first, Phil will give the Safe Harbor statement and a brief summary of our press release.

Thanks, Gordon.

Let me remind everyone that comments made during this call include forward-looking statements.

These statements are subject to various risks and uncertainties, and as a result, actual results may differ materially from those expressed in forward-looking statements.

Discussion of these risk factors may be found in the quarterly and annual reports filed with the SEC.

As Gordon said, we met our most recent guidance for the second quarter with sales of $129.1 million and earnings per share of $0.40 excluding restructuring charges.

Sales for the second quarter were down 6% compared to the prior year due to weakness in our electronics business.

Electronic sales declined $12.6 million or 13% compared to the prior year's record quarter.

The major contributors to the year-over-year decline were as follows.

At least half of the sales decline was due to inventory swings in the distributor channel.

In the second quarter of 2006, distributors were building inventory in anticipation of continued demand increases, and in the second quarter of 2007, distributors were reducing inventory.

This was a global phenomenon, although the biggest impacts occurred in North America and China.

The rest of the electronic sales decline was about evenly split between telecom market weakness and lost business, most notably for a major set top box program.

Gordon will provide more color on all these issues in just a moment.

Gross margin for the quarter at 32.2% was also lower than a year ago and lower than where we had hoped to be at this point for the following reasons.

Lower sales always have a negative impact on margins, but in this case, the margin impact was disproportionate for a number of reasons.

First, the sales short fall was largely for telecom and other high margin products.

Second, the telecom short fall creates under-utilization in the Irving wafer fab, which is expensive.

Third, the loss of the set top box customer caused us to write off inventory related to this program.

Costs related to the major product transfers are also depressing margins.

These costs include employee retention costs, accelerated depreciation, equipment move costs and redundant overhead.

We are now estimating these costs at about $1.7 million per quarter which is higher than our earlier estimate and equates to about $0.05 per share per quarter.

Cash flow was a positive for the quarter with $15 million in cash from operating activities compared to only $1 million in the first quarter of 2007.

Working capital continues to be under good control as DSO and inventory turns remain relatively steady despite the challenging sales environment.

Capital expenditures increased as expected from $5.1 million in the first quarter 2007 to $8 million in the second quarter due primarily to higher spending related to plant transfers.

Now let me turn it back to Gordon for some market commentary and more detailed discussion of our business performance.

Thanks, Phil.

Electronic sales for the quarter were $12.6 million or 13% below the second quarter of last year.

Our automotive and electrical businesses continue to perform well with a 7% increase in automotive sales and a 13% increase in electrical sales over the second quarter of last year.

The prior year comparison for electronics is against what was a record second quarter of 2006, and as we called out in the second quarter earnings call last year this record sales level was due in part to inventory building in the channel.

Geographically, sales for the second quarter compared to the prior year were down 12% in the Americas, 5% in Asia, and excluding favorable currency effects, 5% in Europe.

In all regions, electronic product sales decreases outpaced the gains in automotive and electrical products.

I'll begin my comments on the business unit with electronics, and I'll update you on our automotive and electrical businesses, our cost reduction initiatives and new product development programs.

Then finally, I'll turn it back over to Phil to provide guidance.

As I indicated in my opening comments, the short fall in second quarter sales was due to several factors.

The first was weaker than expected demand in the telecom market, specifically telecom DSL, broadband, infrastructure programs at OEMs.

This is due to some program delays at telecom operators including British telecom and AT&T, and also to excess inventory in the supply chain related to those programs.

In addition to these telecom market related factors, the effect of the inventory correction in the overall electronics market in the second quarter were higher than expected with the major impact occurring in North America and China.

As mentioned previously, we lost a major program at a set top box account.

The customer switched to a lower cost chip set for which we were not on the reference design and our new product was not yet ready.

The combination of these factors, telecom market slow down, electronics, market-wide inventory correction and the key program loss drove our overall decline in the electronics business.

Looking ahead to the remainder of the year, quarter to date orders and shipments for our electronics business are approximately 10% higher than the second quarter rate, which supports our view of a stronger Q3.

The decline in distributor inventories was absorbed during the first half of the year, so at this point, we believe inventories in the channel are at appropriate levels.

Also North American distribution POS trends have improved modestly.

We're expecting telecom demand improvement in the second half but sales in the segment will continue to be below our original plan for the year.

With that overview, I'll now move on to our other two business units beginning with automotive, which accounts for about 25% of total Littelfuse sales.

The automotive business continues to deliver solid performance on many dimensions.

Global automotive sales increased 7% in the quarter from a year ago compared to a 1% increase in global passenger car build.

In North America, our automotive sales increased 7% on a 3% decline in car build while in Europe our sales increase of 4% excluding the effects of the strong Euro was in line with the car build increase.

Strength in the Euro contributed to three points of the total second quarter automotive sales increase over the prior year.

Several product lines drove the increase.

In the passenger car segment, sales of our low profile JKs increased 18% over the first quarter as we continue to penetrate high current applications on new programs.

In the off-road truck and bus segment, we continue to penetrate Europe, North America and Asia by adding new sales resources in these regions.

This expansion helped to drive double digit sales increases in our flexible junction block line and low temperature blade fuses.

In summary, the automotive business continues to perform well.

We continue to make inroads into Asia and the off-road truck and bus market to key areas that we've targeted for future growth, and we are working to drive additional growth but by designing in higher value custom products such as master fuse while increasing our focus and resources on faster growing emerging markets including China, India and Eastern Europe.

Moving on to the power guard electrical business.

This business achieve a 13% increase in sales in the second quarter.

This was driven primarily by strong priced realization.

We also continue to make headway in expanding into the service business offering safety consulting services to our customers.

This leverages our expertise in circuit protection and our extensive knowledge of government regulations into increased revenues for Littelfuse while at the same time providing a valuable service for our customers.

We had a major win on this front in the second quarter with a new contract to conduct hazard assessments in several large distribution centers of a Fortune 50 company.

We're building relationships with a number of other large companies in this area as well.

We expect new contracts to begin generating revenues in the second half of this year and into 2008.

As in our other two businesses, commodity pricing remains a concern, especially with the higher copper prices.

We've been able to keep pace by implementing price increases and are evaluating additional price increases.

The outlook for the electrical business continues to be very positive with new products and safety services opportunities providing an added boost to the organic growth for our established product line.

Next I want to update you on two key areas we discussed very briefly in our mid-quarter update call.

A major cost reduction project and our new product development programs.

Three major cost reduction initiatives are underway to move production from Ireland and the U.S.

to Mexico, China and the Philippines.

First is an initiative to move our semiconductor operations to China.

We're on track with moving our Teccor wafer fabrication production out of Irving, Texas, to a new low cost facility we are building in Wuxi, China.

We broke ground for the new facility in the second quarter and expect to begin transferring production in the middle of the next year.

We expect all manufacturing to be transferred by the end of 2009 and will decommission the Irving wafer fab in 2010.

Second, we are moving front end production of our Thin-Film and PulseGuard lines out of our facility in Des Plaines, Illinois and into our lower cost facility in the Philippines.

Expansion of the Philippines building has begun and we continue to add talent into that operation to receive the additional production lines.

We're also moving our automotive production out of Des Plaines to a new facility in Mexico.

We've purchased the land in [Piedres Negres] and construction has begun.

In addition, we are moving our North American distribution facility from Elk Grove Village, Illinois, to Mexico.

As previously communicated, these transfers are on track to be complete by mid-2009, and will enable us to shut down our Des Plaines, Illinois location and relocate our headquarters and engineering functions into a new technology center in the Chicagoland area.

The third major initiative is moving our varistor production from Ireland to Dongguan, China.

We have closed on the acquisition of (inaudible) and continue to work closely with our Dongguan team to complete the production transfer by the end of 2008.

We're working to complete the building expansion and are ramping up Dongguan production through 2007 and into 2008.

These three significant plant moves are expected to save over $10 million in 2008, and approximately $25 million in 2009 before reaching their full annualized savings rate of over $30 million in 2010.

These cost saving initiatives are consistent with our goal to leverage our fixed costs over fewer larger plants located in lower cost countries.

These moves also meet our objectives to locate our people and facilities closer to our customers in the fast growing Asia region.

Turning to new product development, we have major programs underway in all three of our business units.

In electronics, we will launch later this year a series of high power handling thin film fuses for flat screen TV inverter applications.

This will afford us even greater penetration into this growth segment.

We will also be launching an expanded range of our TMOV product which consists of a verista combined with a fuse into one hybrid device.

These offer a fail safe overvoltage and overcurrent capability or transient voltage suppression system applications found in industrial TVSS products as well as higher end PC TVSS applications.

We also plan to launch next generation PulseGuard and PulseGuard array devices for HDTV signal applications.

These PulseGuard devices meet the ESD protection requirements of HDTV equipment manufacturers while presenting very low capacitance to the circuit.

This low capacitance means no degradation of the HDTV signal due to the presence of this protection device.

And our SIDACtor telecom surge protectors will be launching new line extensions that address price sensitive lower power requirement applications and versions that are very low capacitance to operate in a VDSL and higher bandwidth app environment without degrading the broadband signal.

We'll also launch a series of silicon protection array devices to provide ESD suppression in a variety of hand held and telecom voice over IP environments.

They will be suitable also for broadband applications.

Finally, we'll launch in 2007 a new series of power [syrista] devices with higher power handling capability.

These devices will appeal to white goods manufacturers worldwide.

Turning to our automotive business, new product designs are gaining traction with key customers.

A growing number of global OEMs are looking at master fuse and power cable protection products such as our CablePro in designing their new models.

The master fuse is a custom product that protects multiple cables in a vehicle and can be configured to meet each customer's specific platform.

We have design wins with Ford, General Motors, Volkswagen, BMW and Renault and are in active development with a number of others.

We're also starting to see interest for these product lines in the off-road truck and bus segment.

This application will represent a strong part of our growth over the next three to five years.

As part of our expansion into the off-road truck and bus market, we're developing a line of auxiliary junction boxes that are designed specifically for these applications.

The design concept has been completed and we are now producing functional prototypes.

We are currently engaged with multiple customers and expect to gain design wins in the next few months.

In addition to our new product development efforts for industrial OEM customers, the expansion of our PowerGuard business into providing hazard assessments and other consulting services is a strategy that has the potential to generate a solid revenue screen for this business.

Across all three business units, we expect these new product programs to ramp up in 2008 and deliver at least $40 million in incremental revenues in 2009.

On that high note, I'll turn the call back to Phil who will provide additional comments on our guidance for the third quarter, and then we'll open the call for questions.

Thanks, Gordon.

As we said in the press release, sales for the third quarter of 2007 were expected to increase 4% to 8% sequentially.

The sales starting to increase, we're expecting better factory utilization in the third quarter.

While this will result in more favorable overhead absorption, there will be little margin benefit in the third quarter because it will take several months for this lower cost inventory to run through the P&L, therefore, we expect gross margins in the third quarter to be relatively flat with the second quarter.

The tax rate for the year should be about 31%, but the third quarter tax rate is expected to be in the high 20%s.

Earnings per share for the third quarter are expected to be in the range of $0.41 to $0.46.

One of the questions that came up in our mid-quarter update call with 2007 now looking weaker than previously expected is whether we're still targeting 15% operating margin by the end of 2009.

Let me conclude by answering that.

It is true that as a result of the recent electronic sales decline in the head wind of the transfer related cost, we have made less progress on gross margin than previously expected, however, we have a high level of confidence that we can deliver the $30 million of annual cost savings that Gordon just summarized.

At the same time, we are gaining confidence in our new product initiatives as they come closer to fruition.

That said, until we begin closing legacy facilities, we will continue to have some bumps in the road, but looking out to 2009 and beyond, we are still strongly committed to running this business at 15% operating margin.

This concludes our prepared remarks.

Now we'd like to open it up for questions.

Thank you, sir.

(OPERATOR INSTRUCTIONS)

We'll go first to Jeff Rosen with William Blair & Company.

Good morning.

Hi, Jeff.

The first question I'd ask is just a little bit of color on the accelerated bookings that you're seeing.

Do you see that as inventory replenishment?

I assume your lead times are relatively stable.

So any particular pockets of end market demand where you're seeing that kind of reason for that kind of pickup?

I think it's pretty broad based.

I think that clearly we feel that our inventory really now has got down to a level where there's a need for inventory replenishment.

We're seeing modest growth in POS from distribution, and I think that the telecom business is going to start to recover a little bit, although I did say that it's probably going to be more in the fourth quarter into next year, particularly on the major programs that we have with BT and AT&T.

So it's fairly broad based.

I think it's just an indication that we really believe that the second quarter really was the low point particularly from the distribution correction.

So you would say that your sales in the distribution right now are a little bit ahead of sales out?

No, I think that they're fairly parallel.

In fact, I think our POA is pretty parallel to our POS.

Okay, and then in terms of the margin outlook, the expense decline, I think, operating expenses were down nicely this quarter from the March quarter.

Can you talk a little about how you were able to accomplish that and whether that's something that kind of leverage--what kind of leverage you get on that in the third quarter?

Yes, sure, Jeff.

I mean, it's fairly straightforward.

We have been with this year shaping up as a little bit tougher than what we thought going into the year, we've tightened down hard on operating expenses and particularly as it relates to some of the increases that we had planned.

The reduction from the first quarter probably is the biggest piece of that was we took the bonus accrual down for the year.

So that was--and there were some other smaller reductions as well.

As it relates to how much of that is sustainable and what is the rest of the year look like, I would expect the rest of the year, I think, Q3 and Q4 will be up a little bit from Q2 but probably in the range of where Q1 was or possibly even a little bit lower than that.

Okay.

So as we look to the fourth quarter, is it gross margin improvement that would potentially allow you to EPS stay flat or even improve versus Q3?

Revenue's obviously hard to call, but as you look at sort of margin improvement you might get exiting the year, how would you characterize your opportunity?

Yes.

It's a tough question because, the fourth quarter is always--there's always a lot going on in the fourth quarter.

It's usually pretty unpredictable and the holidays add-- make it even less--less easy to predict.

So I think normally we would expect a 5% or so seasonal decline in the top line going into Q4 from Q3 and some commensurate reduction in gross margin due to the operating leverage loss there.

I would say this year because we're kind of coming out of a point where distribution inventories are at pretty low levels, and we're starting to see some recovery in some of these telecom programs that Gordon mentioned.

I would expect somewhat less of a decline on the top line than probably a typical year, and I would expect in part because of the issue we mentioned with factory utilization starting to improve and really not much of that flowing through until we get to the fourth quarter that we would at least be able to probably hold the line on gross margins.

The fourth quarter would be a tough quarter to say we had a big improvement, but as we get into 2008 with some of the cost savings starting to hit.

We should certainly see that margin start to improve, and as we get the benefit of further operating leverage.

So, okay.

That's helpful color and just to finish out this whole idea, then you didn't have anything specific to say about the earnings you gave for the full year today but it sounds like you still feel like at least as a range that that's still within reach?

It's hard to say, I guess.

We were silent on it because the fourth quarter is still a little bit unclear to us but I think we had previously given a range of a $1.65 to $1.75.

I think it will be challenging to be--to be in that range.

I think we have a shot at hitting the low end of it.

but I don't think it would be much better than that.

Okay, great.

Thank you.

Yes.

And we'll go next to John Franzreb with Sidoti & Company.

Good morning, guys.

I guess what I'd like to talk a little about what's going on as far as market shares in light of some of the gross margin pressure you have out there, and the loss of business you referenced in your earlier comments.

Can you talk a little about what the competitive landscape's like and if you're maintaining the shares in all of your businesses?

Well, I think that we called out one specific program where we had a competitive situation in Asia where we are not on a reference design which is a critical thing for--particularly in the telecom market to be on reference designs as it was changed, this particular set top box design was changed over to a different reference design using a different chip set that's yours to use a different circuit protection lower performance and lower costs, and it's a product that we don't yet have.

So there's competition and particularly in the electronics business there's very tough competition on multiple turns of new products particularly in Asia.

I wouldn't say it's changed dramatically, I think we're always facing competition on designs.

Almost all of the products that we have, we have some competitors.

I think one of our advantages is we have the broadest product offering and the broadest range of circuit protection which is clearly an advantage, but on each of those product segments we have competitors in every place, some stronger than others, but I wouldn't say it's changed dramatically.

I think that we're always paranoid about new competition particularly from Asia, particularly companies that are prepared to undercut on price quite a lot, and that's the nature of the business and why we constantly need to be reducing costs.

Okay.

Second question then, the cash.

You've made some tack on acquisitions.

What are your thoughts about uses of cash, Gordon, going forward, relative to acquisitions or repurchasing your own stock?

Sure, John.

I'll take that.

As we've said in the past, and this hasn't changed, we think our first and best use for our cash and the highest return for our shareholders is by doing good, accretive strategic acquisitions, and we continue to look for those.

We had quite a few successes on that front in 2006.

We--we aren't in a position to do that level of--close that level of deals in 2007, but we have quite a number that we're working on right now, and we still think that that is, that is the best opportunity to get good returns on the cash that we're going to continue to generate.

Secondarily we think that there probably is room for stock buyback in parallel with our acquisition program because many of the acquisitions that we're looking at are not all that large and that our balance sheet is as clean as it's ever been and we're still generating significant amounts of cash so we think that we could have a combination of a strong acquisition program complemented by share buyback alongside it, and we expect that that's going to continue.

Okay, and one last question.

You referenced earlier that you've seen some marginal recovery in the telecom business after--I guess we've had delays quite sometime.

Can you kind of quantify how much business is picking up there and what the kind of time line is you're seeing to that business, say, reverting back to normal sales levels?

Yes, I think that we've said that we think we've hit a low point particularly with the two that we called out.

Especially BT that was a major program for us back in 2005 and parts of 2006 that really has been a slowdown, but we know that they have a major program for their rollout of their Century 21 program that we expect to see picking up in the fourth quarter and become significant again next year.

So I think that we've said that next year is probably going to be expected to return to what we call normal levels starting really in the fourth quarter of this year.

Just to add to that, I think as we look forward, John, getting back up to kind of the high levels that we were at and in kind of the '04 time frame, it's going to require us to be successful in some of the--some of new designs and some of the new products that we have coming out in that area and particularly it's going to be more and more on customer premise equipment as opposed to some of the infrastructure stuff that we've done historically, and we're going to have to get those products out and we're going to have to win those designs.

Okay.

Thank you much, Phil and Gordon.

Thanks.

(OPERATOR INSTRUCTIONS)

We go next to Alexander Paris with Barrington Research Asset.

Good morning.

I think that my questions are answered.

Just to finalize this inventory question.

The second quarter was hurt because customers were generally accumulating inventory but at a lesser rate relative to a year ago and then that you're saying that inventory levels have hit bottom both for distributors and OEMs somewhere in the second quarter.

Is that accurate?

I think that that is accurate, Alex, I think that what we really felt, that when we first announced this, which was back in November of last year, it would take a few quarters to flush through, and while we thought that maybe we were getting through this in the first quarter, it continued through the second quarter, but the recent pickup that we're seeing,I think is indicative of the whole channel, the OEMs and the ODMs contract manufacturers as well as the distributors of our product recognizing that that's all flushed through for us, and I think that's one of the reasons for the general pickup that we're seeing this quarter.

So after a year, or a little bit more of an inventory correction it's essentially hit bottom and your customers are as far as you can see are going to be in an inventory accumulation mode which would imply that maybe a little bit higher than in demand the orders from you?

Well, I think a couple of things from sort of past experiences, I think it's a little less, it's probably more like three quarters, we probably started to see this happening really in September, and I think we're now saying in June it's over, and that was what we were really, I think, saying when we were announcing this at the end of the third quarter last year.

So I think that has sort of rang true.

So we're through three quarters, and the industry says this shouldn't happen again.

You go into a relatively flat stable period which is what I think we're entering now and our sales in the distribution and sales by distribution are relatively stable, and I don't think that they are so confident that they're ramping up any inventory right now.

But I think that I'm sure that sometime in the future when there's a lot more optimism around and those days come back that we will see this ramping up phenomenon, I don't think that's what's happening now.

I think there's usually a stable period after the downturn, and that's where I think we are today.

So you're saying essentially pass through.

Their demand is passing through to you?

That's right.

And the telecom, you didn't mention it, but is the shortfall was all in the infrastructure side and not in the mobile phone part of it?

Yes.

I mean that's really what we were calling out, and particularly those products, particularly what were called the Teccor products that we acquired from Teccor, the SIDACtor.

These are products that are used primarily in the infrastructure but also in some of the customer premise equipment so the equipment that goes into offices and homes, FAX machines, set top boxes and those places.

So these are really products that are protected against over voltage lightning protection, different from the products in the mobile phones themselves.

That's really an area that we're really investing in with our new SPA products and developing that as a new product line for the future.

And are the kind of lower end phones mix rising because of more demand from places like China and India and therefore maybe you have less content in those phones?

Is that a trend?

Yes, I don't know if we can categorically say that.

Clearly the mobile phone market overall has been growing dramatically for a few years in China, and I think the fastest growing last few quarters has been India.

So it's clear that the low end phones have been impacting the cell phone manufacturers, and that's been the growth, but they still need protection.

They still need to be reliable.

There's not as much content as the real high end smart phones, but, there's a need for basic levels of protection on all phones.

And then another question.

Looking forward to continuing restructuring your costs, at one point you mentioned $0.01 a quarter for the Ireland to India transition.

Then when you listed the three overall projects, you talked about $0.05 a quarter.

Is that $0.01 included in the $0.05?

Is that what we're looking at about $0.05 a quarter?

Yes, I think what we originally said, we have these three major programs going on along with some other more minor programs that previously we said that we thought the ongoing costs related to these transfers was in the neighborhood of about $0.03 a quarter.

Now we're saying that as we've really--as we've really gotten a full accounting of all those costs and we have the plans more detailed that it's really going to be something more like $0.05 a quarter that as of today and as of the last couple quarters it's been impacting the numbers and will continue to do so until we start winding up some of these programs.

So the savings don't start for a while so that there's no offset to that from the--as the savings gradually accumulate?

The savings up until this point have been very modest, and so that's pretty much an accurate statement, Alex.

As we get into 2008, we will start to see some partial savings on these as I think Gordon mentioned that 2008, we would expect about $10 million of savings, so about a third of the savings will come through by the end of 2008, and then the rest of it will be '09 and then even a little bit additional in 2010.

Just one other quick question.

The cash flow into--from operation went to $15 million from $1 million in the first quarter, I presume mostly because of improving working capital efficiency and that will be hard to repeat at the same level going forward.

So what is the kind of a run rate without substantial working capital efficiency improvements?

Actually, Alex, yes, it was--we had--the Q2 I would look at as being a more normal run rate, Q1 was depressed for a number of reasons, and we had some large payouts for severance costs in the fist quarter.

We also had some significant incentive bonus payouts in the first quarter due to the strong year that we had last year, and those will not repeat.

So I would look at Q1 as being the anomaly, I would expect Q3 and Q4 to look more like Q2.

Good, thank you very much.

Yes, sir.

We'll go next to Greg Halter with Great Lakes Review.

Good morning, gentlemen.

Good morning, Greg.

Question for you regarding the electrical business with the Fortune 50 company that you referenced.

Yes.

Wondered what the--sounds very exciting but wonder what the opportunity is there and if there's a market sized estimate that you may have?

Yes, this is sort of an emerging market that we don't really have our hands around total market.

It's growing a lot as companies are more concerned about electrical safety and quite what the scope that's included in that sort of service of I think we mentioned sometime ago the term ARC-FLASH and really prevention of ARC-FLASH and precautions around that.

So it's an area that we're trying to work on and understand what is that total available market in the scope that we are going after and defining that scope and then how much that's growing.

So that's a good question that we don't have an answer to the exact size of the market, but we're very excited by the reception that we have mainly based on the knowledge that we have of circuit protection and safety from obviously the applications of our products, and so it's still relatively small compared to the total size of the Company, but it could become a significant part of that $50 million PowerGuard business.

And the profitability I would presume there's not a whole lot of cost in there relative to manufacturing and so forth, which is basically none, I would presume.

I would have to guess that the profit opportunity is higher than your core?

Well, it's--I think for a company that's a product company as we are moving into a services segment, we need to understand clearly the profitability of that and the accounting of that and, but exactly, we don't need any factories for that, we're not making any products for that.

There's no asset in that business, it's the knowledge of the employee and some of the partners that we have that we work with that.

So it is a slightly different model, and if it becomes a significant part of the business, I think calling it out separately in the profitability realm, that would be something that would be important.

Okay, and did you state that it was with distribution centers of a Fortune 50 company?

That is correct, and so you could take it from that there's a lot of warehouses and distribution centers, many companies, many different industrial types, and if this is an example of one, it would indicate the market size is quite large.

Right.

Greg, I would just--I would say that you're right in that there certainly there's not a lot of capital investment or anything like that that's required in this business, but our product margins are very high in the electrical area.

I would not expect our service margins to be probably quite as high as what the product margins are, but it would still be an attractive growth segment for us in an area that we can earn a nice return on.

Which could eventually lead into product sales I would presume down the line?

Absolutely.

Okay, and on the electrical side, you did mention that the revenues are up about 13% on the profit side, is that commensurate or is there leveraged operating profit growth from that particular area?

Yes, it's commensurate with that.

We have had--we did some commodity cost increases.

These are larger form factor products, and so we do have a lot of material in those.

We completed the movement of our factory some time ago from Illinois to Mexico and we've been driving cost reductions, but commodity cost increases particularly in copper but also in silver are significant, but the price increases that we've managed to attain in that business have offset that.

So along with all of our cost reduction initiatives in that Mexico plant, I think we're managing to keep profitability with the sales growth in that business pretty well.

Okay, and one last one now with Tyco complete with their spin-off, have you noticed any change in the competitive environment or what they may be doing with some of their units comprised on that new--?

We're observing that very carefully.

We haven't observed anything yet.

I think it's still early days, they're still-- think getting their feet on the ground as an independent public company and deciding really quite what they're going to be focusing on.

So we're eagerly watching that, and it's of great interest to us, but in the marketplace, we haven't seen any changes yet.

Okay.

Great.

Thank you.

Thanks, Greg.

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We'll go next to Reik Read with Robert Baird & Company.

Hey, good morning.

Just to go back to the inventory issue.

Can you guys talk a little bit about with respect to the distributors to the best of your sense, are they kind of--have they been whittling down to what you would call kind of normalized levels and are you in an environment, Gordon, you kind of stated that it was more flattish where maybe they're trying to still pull that down below normal levels?

And also can you talk a little about inventory at the EMS and ODM players as well?

Yes, it's a very good question and we have some data particularly we have very good data in North America.

It's the norm with North American distribution to share that kind of data, and we have certainly seen inventory coming down but I think it's now down at the levels where I would consider it to be stable for the levels of POS that they have.

So we certainly have seen that trend of bringing inventory down, and I think it's now at the appropriate level and I think we feel comfortable with that.

It's much more difficult in the rest of the world where you don't have a tradition of sharing as much of that information in Europe and in Asia, and it's even more difficult to try and really find that out at all of the contract manufacturers and ODMs which are primarily in Taiwan and China.

But the indications that we have in seeing the uptick in the business and anecdotally would seem that they've also flushed through the inventory that we are clearly building all through the channel at this time last year and which really started to peak in September and I think it's taken the three quarters for that to all work its way through, so the anecdotes and the data would both what we have would both confirm to say that that channel inventory is now used up and it's at the appropriate levels.

Okay, okay, great.

Then just going back to the restructuring.

You had given some different numbers which sounds like $10 million in '08, an incremental $15 million in '09 and then an incremental $5 million in 2010.

Is that the correct interpretation of what you were saying?

That is correct.

Is that--it seems to contrast a little bit with you used to say kind of 10, 10, 10, '07, '08 and '09, is there in fact a little bit of a push back there or is that not the correct read, are there some offsets?

I don't think we ever said 10, 10, 10, Reik.

I think what we did say was about 10 million at completion for each one of the programs.

I don't think we ever said it was going to be linear in terms of the savings.

So it was always going to be back end loaded in terms of where the savings showed up, and I don't think we've really moved off our original plan there.

Okay.

So that's on target and then Phil, to that point, you would kind of see a more meaningful change in this fixed variable relationship starting at those facilities going in mid-'08?

Yes, and most of the real fixed cost reduction doesn't occur until 2009 and even kind of a final slug in 2010, but we will certainly get--start to get some meaningful benefit as we get out into '08.

Okay, and then you talked about the 15% operating margin.

Do you have a sense for how much revenue you will need to get to that level?

It's a good question.

I think it is going to require certainly some growth to get there.

We believe although if you just do the math of $30 million of savings on our current numbers, it puts us up above that number obviously by the time we get there, there's going to be price erosion, there are going to be other things that will change.

I think we're going to need some growth, but I don't think it's going to be exceptional growth, I think that the growth, kind of the historical market growth plus a little bit of extra from some of the new product programs should, I think, easily get us to a level where we can achieve that kind of a number.

Okay, and then also on just cost reduction initiatives, you guys have talked in the past about being able to achieve some purchasing savings, which I think you've talked about as being something along the lines of $7 million annually.

Is that part of the $30 million that we're talking about here or is that incremental to that?

The $7 million is--I mean that's been $6 million to $7 million has kind of been a typical, annual number that we've been able to achieve without any benefit of some of the big--big bangs here for these programs.

I think in the $30 million, there might be a little bit of purchasing savings in some of those, but I don't--I would--we would clearly expect to achieve significant additional purchasing savings over and above the $30 million that we're talking about there.

Of course some of these savings that we're doing every year we need to continue to do just to stay even with price erosion, so we're aggressively doing things in the factories and things in purchasing and things in logistics that aren't included in the $30 million that we just need to do to just stay whole on our base margin.

Okay, and then just one final question on the free cash flow.

I think historically, you guys have said think about doing $30 million to $40 million in the next couple of years.

Is that still a fair statement for 2008 and with 2007 with some of the weakness you're seeing, do you start come at the low end or maybe a little below that number?

Yes, I think that 2007, 2008 are going to be a little bit more difficult from a free cash standpoint, A., because we're spending cash not only fund capital programs related to these transfers, where we're building brick and mortar in a number of different places Wuxi, China, Mexico, Philippines.

We're also--we also have to fund severance costs for example where we've accrued it, it's already been booked through the P&L, but the cash hasn't gone out in many cases yet, and we'll have to fund that.

So there's going to be more cash going out for those kinds of things related to the transfer over the next couple of years than we would certainly expect going forward.

So I think free cash will probably be a little bit towards the low end of that range for the next couple of years, but I think our long-term cash generating capability hasn't changed, we still think something like 7% of revenues and free cash is a very realistic target that we can achieve on the average going forward.

Okay.

Great.

Thank you very much for the comments.

At this time, we have no further questions.

I'd like to turn the call back over to Mr.

Gordon Hunter for any additional or closing comments.

Well, thank you for joining us on our call this morning.

We appreciate your interest and we look forward to talking with you again next quarter.

That does conclude today's call.

Again, thank you for your participation.

Have a good day.