Littelfuse Q2 2024 Earnings Call Transcript

Quartr
Provided by Quartr
July 31, 2024

There are 11 speakers on the call.

Operator

Good day, everyone, and welcome to the Littelfuse Second Quarter 2024 Earnings Conference Call. Today's call is being recorded. And at this time, I would like to turn the call over to the Head of Investor Relations, David Kelly. Please proceed.

Speaker 1

Good morning, and welcome to the Littelfuse Q2 2024 Earnings Conference Call. With me today are Dave Heinsmann, President and CEO and Meenal Sethna, Executive Vice President and CFO. Yesterday, we reported results for our Q2, and a copy of our earnings release and slide presentation is available in the Investor Relations section of our website. A webcast of today's conference call will also be available on our website. Please advance to Slide 2 for our disclaimers.

Speaker 1

Our discussions today will include forward looking statements. These forward looking statements may involve significant risks and uncertainties. Please review yesterday's press release and our Forms 10 ks and 10 Q for more detail about important risks that could cause actual results to differ materially from our expectations. We assume no obligation to update any of this forward looking information. Also, our remarks today refer to non GAAP financial measures.

Speaker 1

A reconciliation of these non GAAP financial measures to the most comparable GAAP measure is provided in our earnings release available in the Investor Relations section of our website. I will now turn the call over

Speaker 2

to Dave. Thank you, David. Good morning and thanks for joining us today. Let's start with highlights on Slide 4. Our 2nd quarter results exceeded our expectations reflecting our resilient business model, diverse and balanced technology offering and broad customer reach.

Speaker 2

Our seasoned global teams navigated through a continued dynamic environment and delivered solid results while we saw solid design in activity and secured significant new business across sustainability, connectivity and safety megatrends. We again delivered strong free cash flow, a testament to our proven operating model, while our balance sheet and significant financial capacity positions us to enhance our long term growth strategy. We will continue to prioritize capital allocation towards thoughtful M and A, while maintaining our commitment of returning capital to shareholders. Our 2nd quarter results exceeded the high end of both our sales and earnings guidance ranges. Meenal will provide additional color on our financial performance and outlook.

Speaker 2

I want to thank our global team for their hard work, dedication and meaningful achievements through the first half of twenty twenty four. Turning to Slide 5, we highlight several of our key accomplishments from our recently published 2023 Sustainability Report, which is available on our website. Sustainability is core to Littlefuse as our history is deeply rooted in providing solutions to our broad customer base and across our diverse set of end markets that ultimately drive an increasingly sustainable world. Whether advancing electrification and transportation, providing robust solutions for renewable energy or enabling safety critical medical technology, sustainability is incorporated into our daily actions across our businesses. I am proud of the efforts of our global teams who strive to deliver internal progress and external enhancements for the betterment of our communities, employees, customers and investors.

Speaker 2

Ultimately, we view sustainability as an integral part of our long term growth strategy highlighted on Slide 6. Before diving into our end markets and design activity, I wanted to highlight a few key market channel and OEM inventory trends. We believe the path of electronics channel destocking that negatively impacted 2023 and the first half of twenty twenty four results is largely behind us. Our passive electronic book to bill remains above 1 as passive electronics channel inventory levels have normalized. We expect to return to more normalized order rates as typical following a destocking period.

Speaker 2

However, thus far in Q3, we are seeing some ongoing signs of cautiousness from customers and hesitancy to restock passive electronics inventory following what ultimately has been a historic and elongated destocking cycle. We are also seeing moderating inventory reductions across our protected semiconductor product lines and we expect more stable order trends in the second half of the year. Finally, we observed further industrial OEM destocking in the quarter, which had a more pronounced impact on our power semiconductor exposure. As we see continued soft industrial demand, which I will provide more detail on shortly, we expect these conditions will impact us through the second half of the year. Now let's turn to our end markets and design activity, starting with the electronics on Slide 7.

Speaker 2

2nd quarter electronics markets remained soft, although we are seeing initial signs of demand recovery. Consumer products, appliances and building technologies demand was again soft in the quarter, although customers are increasingly optimistic in a nearing recovery led by AI applications. Demand for data center and especially AI driven data center applications was robust in the Q2. Taking a step back, we believe customers are increasingly upbeat in subset of regions such as Taiwan. While design in activity continues to be healthy and encouraging across our global exposures.

Speaker 2

Regardless of our near term trends, we remain well positioned to enable ongoing innovation and drive long term through cycle growth across our diverse electronic market exposures. We believe this is evidenced by our strong design win cadence in the quarter. We delivered numerous wins ranging from innovative data center solutions to safety critical medical applications. Specifically in the quarter, we secured several data center wins, including fuse business for customer in Asia and for a liquid cooling application in North America. We also secured business for

Speaker 3

a data center

Speaker 4

customer in Asia that will utilize

Speaker 2

our switch technology. We delivered multi technology and safety critical wins for medical customers in Europe and South Korea for defibrillator applications as well as medical switch technology for a customer in North America. Finally, we secured appliance business with customers in Europe and multiple regions in Asia that will utilize our diverse set of technologies including our sensor and circuit protection capabilities. Moving on to transportation end markets and design wins on Slide 8. Our passenger vehicle exposure again benefited from our balanced product capabilities, broad technology leadership and global customer reach.

Speaker 2

We continue to see strong interest in our core products as customers delay EV launches and pivot to internal combustion and hybrid vehicles in North America and Europe markets. In China, we again delivered strong results in low voltage applications. We support local OEMs that continue to experience robust growth. 2nd quarter global passenger vehicle production was modestly lower versus the prior year and we expect a modest decline in the full year 2024. We remain well positioned to deliver on long term passenger vehicle growth drivers as we continue to enable electronification as well as next generation electrification advancements across hybrid and electric vehicle architectures for a diverse and global customer base.

Speaker 2

Regarding our commercial vehicle exposure, our ongoing profitability initiatives led by our pruning and pricing actions continue to bear fruit, while we remain encouraged by design and activity and traction with our broad customer base. We are seeing continued soft market conditions driven by our ag construction exposures. However, on road truck and bus demand was more resilient than expected in the Q2. Looking forward, we see continued soft demand led by Europe and China regions ending into the second half of the year. Long term, we remain well positioned to deliver electronification and electrification innovation across our broad commercial vehicle exposures, including material handling, agriculture, construction equipment and heavy duty truck and bus markets.

Speaker 2

In the quarter, we secured meaningful new transportation business across both passenger and commercial vehicle end markets. In passenger vehicles, we secured a high voltage fuse opportunity with a customer in South Korea. We also delivered multiple low voltage fuse wins across our global customer base, including for customers in the Americas, Europe and in China. We also secured a win within a battery management system for a customer in South Korea as well as for a key customer in China. Finally, we continue to gain traction with our broad switch portfolio as we secured meaningful business in North America during the quarter.

Speaker 2

In commercial vehicles, we secured several wins highlighted by construction equipment business for customers in North America, Japan and South Korea. We also delivered on road truck win for a customer in Brazil and a bus win in Mexico. Turning to Slide 9, industrial markets and design activity. In the quarter, we saw ongoing demand weakness led by industrial equipment and factory automation, construction and charging infrastructure applications. Demand remains mixed for renewable applications with energy storage robust, while the solar market was again soft in the Q2.

Speaker 2

That industrial safety applications continue to show further signs of growth and we are benefiting from residential HVAC volume recovery, although at a modest pace to date. Broadly, power semiconductor customers continue to work down inventories and push out orders. Looking forward, we believe soft end demand conditions will persist through year end with a more pronounced impact where we have semiconductor exposure. Taking a step back, long term industrial growth trends remain attractive, supported by ongoing infrastructure spend, increasing electrical efficiency requirements, advancements in automation and global commitments to decarbonization. Industrial design activity remains strong across our exposures as customers seek to drive ongoing innovation.

Speaker 2

In the Q2, we had success in the North America HVAC market where we won business with multiple customers across a variety of product categories. We continued our recent industrial safety momentum, touring meaningful business with a North America customer. In renewables, we secured business for residential solar application and for a wind turbine application in Asia. We also delivered multiple EV charging wins in the quarter across several regions. Finally, we secured business within an industrial smart meter application in North America customer.

Speaker 2

Across our businesses, we continue to deliver innovative solutions to our broad customer base for our diverse end market exposures. We remain well positioned to deliver on our long term double digit annual revenue growth target as evidenced by our continued design win momentum supporting sustainability, connectivity and safety megatrends. Will now turn the call over to Meenal to provide additional color on our financial performance and outlook.

Speaker 5

Thanks, Dave. Good morning, everyone, and thank you for joining us today. Please turn to Slide 11 to start with details on our 2nd quarter results. Revenue in the quarter was $558,000,000 down 9% versus last year and down 8% organically. The product line pruning actions we discussed reduced sales 2% in line with our expectations in the prior quarter.

Speaker 5

GAAP operating margins were 11.7% and adjusted operating margins 12.7%. Adjusted EBITDA margins finished at 18.6%. Foreign exchange and commodities had an 80 basis point unfavorable impact to margins, largely due to commodity inflation and primarily driven by copper and silver exposure. 2nd quarter GAAP diluted earnings per share was $1.82 and adjusted diluted EPS was 1.97 dollars Our 2nd quarter GAAP effective tax rate was 26% and adjusted effective tax rate was 25%. Our adjusted effective tax rate was slightly higher than expected due to income shift across jurisdictions.

Speaker 5

Please turn to slide 12 for updates on capital allocation. We continue to deliver strong cash generation year to date. Operating cash flow in the quarter was $69,000,000 and we generated $50,000,000 in free cash flow. Year to date, we generated $92,000,000 in free cash flow yielding a 98% conversion rate. We've continued to reduce both inventory days and dollars this year, contributing to our solid cash flow performance.

Speaker 5

We expect to deliver on our targeted 100% free cash flow conversion for the full year aligned with our long term goals. We ended the quarter with $562,000,000 of cash on hand and net debt to EBITDA leverage of 1.6 times. Given the strength of our balance sheet, we'll continue to prioritize our free cash flow for thoughtful acquisitions. And we will continue to return capital to our shareholders through our dividend and periodic share buyback. In the quarter, we returned $41,000,000 of capital to shareholders, including $25,000,000 via share repurchases and $16,000,000 via a cash dividend.

Speaker 5

Through the first half of twenty twenty four, we've returned $73,000,000 of capital to shareholders. Our Board of Directors approved an 8% increase in our quarterly cash dividend equating to a $2.80 annual rate. We've grown our dividend 12% on a compounded annual basis since inception, a testament to our long term earnings and cash generation power. We'll remain disciplined in our capital allocation strategy as we strive to maximize long term shareholder value. Please turn to slide 13 for our product segment highlights, starting with the Electronics product segment.

Speaker 5

Sales were down 13% versus last year and 12% organically. Sales across passive products were down 4% versus last year, while semiconductor products declined 19%. Passive products were impacted by ongoing, but moderating inventory declines and we're starting to see similar trends across our protection semiconductor products. The continued weakness we saw in industrial markets particularly impacted our power semiconductor product sales in the quarter. Operating margins in the quarter were 15.1%, while EBITDA margins finished at 21.6%.

Speaker 5

Margins improved 210 and 180 basis points sequentially, reflecting our portfolio diversification efforts and strong execution. We're proud of the margin resiliency of our Electronics product segment through this extended destocking cycle and are confident in the team's ability to drive continued expansion. Moving to our Transportation product segment on slide 14, segment sales were down 2% and down 1% organically. Sales were negatively impacted 4% versus last year from pruning actions we've been undertaking largely within our commercial vehicle business. Across our passenger vehicle business, sales grew 2% organically.

Speaker 5

We saw continued strength in China and weaker trends across Europe with some partial offsets due to ongoing sensor product line pruning. Within commercial vehicles, sales for the quarter were down 3% organically as pruning actions and ongoing end market softness were in part offset by continued favorable pricing momentum. For the segment, operating margins were 9% and EBITDA margins finished at 14.4% in the quarter. We believe our pricing and pruning initiatives as well as structural cost actions are bearing fruit as margins were in line with our expectations. On slide 15, Industrial Products segment sales were down 7% and 6% organically.

Speaker 5

We continue to see soft industrial end market conditions across our broad and diverse exposures as well as a continuation of inventory reductions at some OEMs. However, we again benefited from solid industrial safety growth while we also observed early signs of residential HVAC volume recovery in the quarter. Operating margins finished at 11.4% and EBITDA margins were 16%. These represented positive improvements of 490 and 410 basis points sequentially, reflecting strong execution following our capacity additions and footprint actions noted in the Q1. Please turn to slide 16 for the forecast.

Speaker 5

Summarizing Dave's earlier comments, while we believe the passive electronics inventory destocking is largely behind us, we are seeing some ongoing cautious order patterns from customers. We also expect continued weakness across our semiconductor products due to ongoing market softness and inventory destocking. And we expect some persistent commodity headwinds. With these assumptions, we expect 3rd quarter sales in the range of 540 $1,000,000 to $570,000,000 This includes about a 3% headwind from FX and expected product pruning versus last year. Across our segments, we expect sales to be largely flat relative to the 2nd quarter.

Speaker 5

We're projecting 3rd quarter EPS to be in the range of $1.95 to $2.15 and includes a tax rate of 26%. This incorporates about $0.25 in headwinds from FX and commodity rates as well as a higher tax rate versus the prior year. Please turn to slide 17 for our full year 2024 expectations. For the full year, we expect our product line pruning actions to reduce total sales about 2% and reduce transportation sales growth about 6% versus last year. We are seeing mitigating currency movements, but increasing commodity costs.

Speaker 5

At current rates, we expect those to be a headwind of 1% to sales and about $0.40 to EPS for the year. We've demonstrated the resiliency of our Electronics segment margins through cycles. We've also delivered solid transportation and industrial segment margin traction, reflecting operational execution and structural initiatives. However, we do expect a more gradual margin ramp, reflecting continued subdued end market demand and cautious order patterns across our customers and channels. With these market undercurrents, we expect company operating margins to finish in the range of 12% to 14% for the full year.

Speaker 5

Across our segments, we expect electronics operating margins to average in the mid teens and industrial operating margins in the low teens. We continue to expect transportation to exit the year with high single digit operating margins. On other modeling items, we're assuming $63,000,000 in amortization expense and $39,000,000 in interest expense, about 2 thirds of which we expect to offset through interest income from our cash investment strategies. We are estimating a full year tax rate of about 23%, slightly higher than our prior estimate due to income shift across jurisdictions. And we expect to invest about $100,000,000 in capital expenditures.

Speaker 5

We continue to execute well through a dynamic environment and remain well positioned to support our broad customer base and diverse market exposures. We are confident in our positioning, reflecting our diverse technology offering, strong relationships across the global customer base and ongoing profitability improvements. We will continue our path forward in best in class profitability and cash generation driving value creation for our stakeholders. Thank you to our Littelfuse colleagues worldwide and their unwavering commitment in steering our company forward every day. And with that, I'll turn it back to Dave for some final comments.

Speaker 2

Thanks, Meenal. Our solid second quarter results reflect our strong execution through an ongoing dynamic environment. We also believe our portfolio diversification efforts and relentless focus on providing innovative solutions to our customers bolstered our 2nd quarter performance. Our strong balance sheet and first half cash generation provide us with considerable flexibility as we continue to prioritize thoughtful but disciplined acquisitions and attractive end markets. We remain confident we are on the path to continued double digit annual revenue growth through cycles and leveraged earnings expansion, which we believe will translate to top tier value creation for our stakeholders.

Speaker 2

I want to again thank our global Littlefuse team for their persistent hard work and commitment to our customers and supplier partners through the first half of twenty twenty four. And with that, I will now turn the call back to the operator for Q and

Speaker 5

A. Thank you.

Operator

We will now begin the question and answer session. And your first question comes from the line of Luke Junk with Baird. Your line is open. Mr. Junk, please check your mute button.

Speaker 6

Sorry about that. I was on mute. Thanks for taking the question and good morning. Dave,

Speaker 7

maybe if

Speaker 6

we could start with delineating electronics book to bill between passive and on the semi side, maybe just how much above 1.0 on the passive side and are you seeing any sequential progress in semis? And within all of that, you mentioned AI is a driver in the quarter as well. Just curious how that might be impacting orders? Thank you.

Speaker 2

Sure. Thanks, Luke. And so we've talked about overall electronics book to bill at being over 1.0, so it's slightly above 1, we're seeing there. And there is a little bit of a delineation between the semiconductor portion of it and the passives. We've also talked about kind of cautiousness in order patterns.

Speaker 2

So if you look at our passives business, we were above 1 last quarter. We continue to be slightly above 1 this quarter. And our so the book to bill is a reasonably stable, but we're not seeing as much of a pickup as we would typically see. And I think that's really cautious, the cautiousness driven by the OEM customers in placing orders. So it remains healthy and sell through remains healthy.

Speaker 2

However, we're just not seeing that pickup yet. On the semiconductor side, as we've talked about, because we've intentionally in the semiconductor, particularly power semiconductor side kind of invested into the industrials space as we think it creates better balance for our business over time. Industrials are soft. So book to bills have been below 1 in the industrial or in the power semi portion of the business. However, we've seen through July actually those order rates begin to stabilize.

Speaker 2

So they're approaching 1 again even in the power semi side. But just keep in mind that if you think about lead times in the Power Semi are longer. So even if we reach book to bills that are above 1, that's really going to be 4 or 5 months out before we see sales starting to pick up there. So that's why we talk about really expecting to see that kind of going into next year. AI, data centers in general is the second part of your question.

Speaker 2

We broadly participate across several different technologies into the data center space. And while we don't get a specific uptick related to AI from a technology shift, the build out of the data centers and the more power consumption in data centers that we see, we get a linear pickup in our business there. And data centers have been pretty robust and we've seen orders be pretty strong in that space during the Q2 and into the Q3.

Speaker 6

Got it. Thank you for that. Also hoping to touch on something that you mentioned in the prepared remarks in terms of channel dynamics beyond passive distribution. I'm thinking of the kind of protective portion of the semiconductor business that's distributed and inventory and customers as well, just given what you're seeing there, could we see 1 or both of those inflect maybe late in the 3Q Q range or maybe more likely in the Q4, Dave?

Speaker 2

Yes. I think our protection semiconductor business kind of behaves a little more like our passives business, if you will. It has slightly higher index to automotive electronics, as a higher portion of that business. So what we saw is actually the protection semiconductor business went into correction mode later than our passes did by a couple of quarters. And what we've typically seen is when we begin to see an inflection point and a correction coming the other direction in passives, the protection portion of our semiconductor tends to follow a quarter or 2 behind that.

Speaker 2

So difficult to say exactly when we see that turning back up in the protection side, but it's probably a quarter or 2 behind our passes business.

Speaker 8

Got it. And then if

Speaker 6

I could sneak one final question in. Minal, this is a margin related question. And just looking at the full year guidance for 12% to 14% operating margins, that's applying a step up in the back half at the midpoint, but at the high end, it would be pushing above the mid teens in the second half versus 12 in the first. Can you just unpack that upside risk, if you will, assume that would be mostly electronics related and ultimately what could drive that sort of incremental exiting the year? I guess really trying to reconcile that with what seems like some more conservatism in the Q3 guide from a margin standpoint, where at the midpoint, maybe you're even picking up pretty flat EBIT if we strip out the incentive comp stepping down sequentially?

Speaker 6

Thank you.

Speaker 5

Sure. I would say in general, just stepping back on margins overall, we've done a lot of work in the past several years around, we talked about portfolio diversification, execution, really improving that foundation and have expected that that's going to continue to lift the floor, which it has done for us, the margin floor. With the cycle that we're in, we're really trying to look and predict out on where things are going. And you heard some of Dave's commentary on sales. For us, given all the foundational work we've done, now it's really the volumes coming back.

Speaker 5

And so based on the general view that we've given on starting to see recovery in various places, a little bit improvement across the transportation segment, which is more on the operational side. That's really where we ended up with the 12% to 14% guide range as we think about the full year for full year margin.

Speaker 8

Okay. I'll leave it there for now. Thank you.

Speaker 1

Thanks for your questions, Luke.

Operator

And your next question comes from the line of Matt Sheerin with Stifel. Your line is open.

Speaker 4

Yes. Thank you. Good morning. Another question regarding the guidance for the year and expectations for a year over year growth net of that product pruning. Typically, your electronics business is down sequentially and given, as you say, a very cautious order patterns from customers, should we expect that again?

Speaker 4

And are you expecting year over year growth in electronics despite that? And then thoughts around the auto business sequentially in the next couple of quarters given that we've seen the S and P auto numbers get cut recently? Thanks.

Speaker 2

Sure, Matt. I'll take that one and Meenal, feel free to jump in. So if we look at kind of return to growth in the Q4, which is our current view of when we expect to begin to see things turn. Absolutely, if you look at normal calendarization and in a normal environment, we would see electronics sequentially down in the Q4. However, we are seeing the inventory position, weeks of inventory for our passive products are back to pre COVID levels.

Speaker 2

So they're very normalized sorts of weeks of inventory in the channel. And as we do begin to see that impact the fact that POS is reasonably stable, that lack of inventory burn in the back end of the year will begin to show some growth. So we think that growth offsets kind of the normal calendarization that perhaps we see there. And on the automotive side, while car build will likely be down in the back half of the year compared to the previous year, we still have outgrowth that creates opportunities for us to drive growth in that area. So with those kind of pieces, we do feel confident that we're going to begin to turn the corner and see a return to growth in the back end of the year.

Speaker 5

Sure. And I'll add to that on your question on margins related to that, right? Going back to the first question I answered for us, given all the work that we've done, it's really now volumes coming back that we feel will really drive the margins. And historically, as we have seen growth coming out of cycles, that growth coming back tends to come back at very, very strong incremental. So with this maybe atypical pattern on sales that we're seeing with as the market recovers, I think that would also be a little bit of an atypical margin and margin recovery 3rd going into the 4th quarter as the sales start to improve.

Speaker 4

Okay. That's helpful. And just related to your margin commentary, you did talk about some headwinds for input costs like copper and silver. And I know typically in the past when we've seen significant increases in those costs, you've been able to at some point pass them along. But given the tough demand environment, is that more difficult?

Speaker 4

And how should we think about pricing in general?

Speaker 5

Yes. So in general, when we talk about metals and metal pricing, I think I've mentioned in the past that that's much heavier weighted towards our transportation segment. So yes, we are seeing some higher input costs there. Yes, not all, but many of our contracts do include clauses where we do have a copper pass back. The timing may not exactly be aligned quarter to quarter, but yes, there is a pass back included there.

Speaker 5

What I would also say is the other dynamic going on is we're working even with the metals pricing, etcetera, we're working on pricing independently. We've been doing that. So beyond the metals, and the metals cost increases, we've been both on the automotive side as well as on the commercial vehicle side working on pricing. So that's part of the I'll say the balance in our margin progression as we think about the transportation segment.

Speaker 4

Okay. All right. Thanks a lot.

Speaker 1

Thanks for your questions, Matt.

Operator

And your next question comes from the line of Christopher Glynn with Oppenheimer. Your line is open.

Speaker 9

Thanks. Good morning, folks. Had a couple on Industrial. You had a really strong sequential lift there. And just curious what got better there?

Speaker 9

I think the revenues were

Speaker 2

pretty significant proportion above expectations. Yes. I think generally the industrial markets are soft for sure. And we kind of have a mix of different markets that we're serving. And you're looking specifically at the industrial reporting segment, where we saw softness there is in pockets that are kind of broad based.

Speaker 2

So EV charging as an example continues to be soft. Within renewables, it's a bit of a mix between the solar types of installation, which has been really strong driver for us in history. That is soft, but energy storage has been quite strong. So we've got kind of moving pieces in both directions there. Keeping in mind also from a financial performance there, we talked about in the Q1, we're in the midst of moving into a new factory that we were building out.

Speaker 2

So always when you're in transition, between that and we also transitioned some operations from China to Mexico. That creates a fair amount of noise and costs associated with that. We've got the bulk of that behind us as we went into the second quarter and certainly almost all of it behind us going into the third quarter. So that kind of helped to uplift the bottom line performance of the Industrial business. Okay.

Speaker 9

And then on the initial signs of HVAC recovery, Could you put a little bit more color on that? Are the OEMs, is anyone actually kind of building inventory there? And how much is kind of market versus new designs because you

Speaker 2

put some emphasis on new designs? Yes, we did. And so in our exposure to HVAC, particularly in North America, we have a heavier tie to residential HVAC and that, of course, well documented, including in your reports, has been an area where there's been over inventory from our customers' perspective as they're pushing into the field. We've seen our customers take rates from us improving as they've kind of pushed through some of that inventory in their channels. So their takes from us are starting kind of early signs of uptick there, as their inventories have begun to stabilize.

Speaker 2

From a design in perspective, we had really good robust activity there across many customers, many of our product technologies, particularly with a lot of focus on industrial HVAC areas where we need to improve our position there. So we saw a lot of design in activity there and the teams are very active. So we think long term that will play out well for us in the industrial exposure to HVAC.

Speaker 7

Great. Thank you, Dave.

Speaker 1

Thanks, Chris. Thanks for your questions, Chris.

Operator

And your next question comes from the line of Saree Boroditsky with Jefferies. Your line is open.

Speaker 8

Hey, good morning. This is Grant Smith on for Saree. Thanks for taking our questions. You talked a lot about the cautious order patterns in passives. But just hoping you could elaborate a bit on what these customers are kind of telling you and what would increase their confidence to maybe start more of the restocking increasing orders?

Speaker 2

Yes. Our visibility to the end customers are a bit more challenging than they are distribution partners. And what we're seeing is in our discussions with our distribution partners, they're seeing order patterns from end customers be a bit muted considering where we're at in the cycle. And I think some of that comes from the fact that OEMs, EMS certainly carried a lot of excess inventory over the last couple of years and they've been working to burn that down. They've made meaningful progress in burning down their excess inventories, carrying costs of inventory are pretty high these days.

Speaker 2

And so I think as lead times have shrunk, they'll look at that and our sense is they're saying, hey, lead times are pretty short, capacities are not being pushed. So if I hold off a little bit and drop orders in a little later, the odds I'm going to get support for that are pretty high. So I think they're just kind of playing it pretty cautious on their order patterns to place them. These are the situations that drive capacity constraints in the future, which is a kind of a typical pattern in electronics. But that's our sense in general, there's that kind of general cautiousness.

Speaker 2

And we don't sense there's some massive problem in the end market. It's more just being very cautious on coming off of excessive inventories that they've been carrying.

Speaker 8

Got it. Makes sense. And you mentioned thoughtful M and A in attractive end markets. Can you just expand a little bit on those end markets and maybe on the M and A focus going forward? And kind of what does the environment look like out there as far as the pipeline and valuations?

Speaker 8

Thank you.

Speaker 2

Sure. And clearly, we work our funnel very aggressively over time and we have a very capital that we can deploy in that capital that we can deploy in that way to thoughtfully continue to diversify the markets that we serve. So you've seen that over the last 3 or 4 years where our M and A has increased our exposure as an example to the industrial market. That's been intentional. So, we look at things that will help to offset the balance in our businesses and can create a good balance across the industries that we see attractive.

Speaker 2

We look for margin profiles in long term that are going to be attractive and supportive of where we are as a company. And ultimately, it plays into the megatrends that we define our business around. So what are these trends that are going to drive growth over the long term? And with those things that those are the criteria as we look to kind of create our search in those areas. So certainly things that are going to continue to build out our industrial markets, that's an area of attractiveness for us.

Speaker 2

While we're still doing some work to turn around the profitability of our commercial vehicle business, we still think that over time is going to be an attractive place to be. We always look at potential kind of bolt on consolidation opportunities that come along occasionally. At the end of the day, we want to do M and A into an area that will enable us to continue to support an outsized organic growth model into attractive spaces. As far as what multiples look like and how that's coming along, I would say as much as we would expect and hope that multiples start dropping off, we haven't seen that so much. The multiples continue to be pretty solid out there, pretty strong.

Speaker 2

So that's an area we've got to be thoughtful about and make sure that the second order screen for us is, are we going to get the return profile we want out of the acquisition? And it may meet some of the other criteria, but if we're pushing too far on the return profile, we'll step back from it.

Speaker 8

Got it. Thanks for taking the questions.

Speaker 3

Sure. Thanks

Speaker 1

for your questions, Grant.

Operator

And your next question comes from the line of Josh Buchalter with TD Cowen. Your line is open.

Speaker 7

Guys. Good morning. Thanks for taking my questions. Maybe I want to start with a bigger picture one. So if we look at where Q2 came in versus your guidance, it was above the high end, I believe, and clearly stopped surprised you to the upside within the quarter.

Speaker 7

But then the commentary on the Q3 sounds a bit more cautious. If I think about it and step back, was this a function of you got inventory cleared and now it's just you're shipping closer to end demand, but end demand is tepid? I would just be curious to hear big picture, how you're seeing the business environment given your breadth of scale? Thank you.

Speaker 2

Sure. Thanks, Josh. Yes, so we had a little more positivity in the Q2 than we anticipated and our ability to execute to that. I talked a little bit about order patterns in the electronic side and the cautiousness in ordering often leads to people dropping orders in very late. And sometimes that reduces our visibility and our chance to kind of see that.

Speaker 2

So we saw some upside in the electronic side where orders kind of dropped in late. And that's been a positive and on the industrial side as well. However, the offset to that and a bit of our cautiousness in the Q3 is particularly light industrial and the broader industrial markets while we're seeing our inventories have come down to where they ought to be in the passives and electronic side of things on our products, particularly the power semi products that are selling into kind of light industrial types of applications, those markets are softer. And so therefore, we are seeing on that portion of the business some OEM and channel destocking as they're bringing down their inventories to match up to these softer markets. So I think that offset of we're seeing stabilization in the electronics, but on the industrial kind of centric power semiconductor business, we've actually seen order push outs a bit and delays from our customers there as their end markets have been a bit soft.

Speaker 2

So that's where the cautiousness maybe a little bit in the Q3 is coming from.

Speaker 5

Maybe I would add one more Dave is on the transportation side, especially on the automotive side, right? It's starting to see a little bit of a down guide through IHS and car builds coming down also. So there's a little bit of caution also on the automotive side, especially some of the Western areas, a little bit more North America, Europe, etcetera.

Speaker 7

Thank you, Dave and Meenal. I appreciate all the color there. Maybe one for Meenal. If I look at the shape of your CapEx, to hit the $100,000,000 you got to step up spending pretty meaningfully in the back half of the year. Maybe you could walk through some of the priorities there.

Speaker 7

And then also, it's been good to see the repurchase the last couple of quarters. Should we expect that to step down correspondingly in the back half of the year? Or do you think you can maintain the current level of repurchases until you get something you're more excited about from evaluation or strategic perspective in M and A? Thank you both.

Speaker 5

Sure. So on your first question as it relates to CapEx, we monitor that closely and we the great news for us is that we generate the cash that we want to reinvest back in the business. And Dave talked a lot about organic growth We want to make sure we're building the capacity and focusing on the organic growth. At the same time, our businesses watch the market closely and if they find that as they look out a few quarters things are maybe not picking up at the same way, we'll delay capacity investments. And you may see as we approach the end of the year, we may not quite get to that $100,000,000 if that's what we're seeing in there.

Speaker 5

But it's not a we're not trying to manage the CapEx for our cash number, but more trying to be prudent in when and how we're spending our capital. The other thing I would say is, as you recall, we had signed an agreement last year to acquire a fab from L MOS Semiconductor. We call it the Dortmund fab as it's located in Germany. And we are doing some spending in advance of taking over that fab in the beginning of 2025. So that $100,000,000 includes some investments that we're making for capacity that we're building out in advance.

Speaker 5

That's the first part. The second part in terms of your questions around share buyback in general. What I would say is, our philosophy has always been as we think about capital allocation, first, it's around prioritizing organic growth, as I just talked about and investing, making the right investments for organic growth. Dave spent a lot of time talking about thoughtful acquisitions, what that means for us and how we consider the acquisition space. Then we've got a dividend, that we've had since 2010, double digit growth there on the dividend.

Speaker 5

If you look over the years, we just increased that again this past quarter. And for us, share buyback tends to be a more periodic event. When we feel like the market is not recognizing our growth strategy and is not really incorporated that into the incorporated that into the share prices. That's when we'll look at buying back shares. That was really the view that we took in the first half of the year on that.

Speaker 5

And at the same time, we balance that with what's in the horizon, what's pretty close in the funnel when it comes to M and A. And we make those determinations of holding back in some cases or looking at share buyback. So we're not a continuous run of share buyback and we're a little bit more periodic about it.

Speaker 9

Thank you, Meenal.

Speaker 5

Sure.

Speaker 1

Thanks for your questions, Josh.

Operator

And your next question comes from the line of David Williams with Benchmark. Your line is open.

Speaker 9

Hey, good morning and thanks for taking my question. I guess first wanted to ask just kind of around the data center applications and AI that you talked about. I understand that's around a lot of the build out that's ongoing. But just kind of curious if you could help understand or help us understand maybe where what type of applications you talked about cooling, liquid cooling earlier, but where else are you seeing that? And is there a way to think about maybe the magnitude of that contribution overall when you think about data centers and just how many are being built out today?

Speaker 2

Yes. From a data center perspective, we get involved kind of in 2 aspects of it. 1 is the infrastructure for the data center building and power system itself. So within that, you've got power backup systems and power distribution within the building, that creates opportunities for us that typically show up in our industrial segment, types of products and technologies that sell into that. And then you get and every data center owner has a slightly different architecture and approach to these things.

Speaker 2

But at the rack level, then you start getting more of our electronic components that are being sold into the rack level. And it can be primarily circuit protection, but we'll see some semiconductor business in those spaces. We'll even see, now that we've kind of moved into switches, some switches that are used in that application. And then even in the servers themselves, we'll have content that shows up there. So whereas I know there's some others in our space where on the semiconductor side or on the backplane side, there's a technology shift that's pretty big with latency concerns and things like that, that drives both kind of the volume of data center increase, but the technology shift.

Speaker 2

For us, it's more really the volume creation that drives by the data center build out that drives our business up there.

Speaker 9

Okay. Thanks so much. Certainly some great color there. And then secondly, just from a geographic perspective, you talked about a lot of design wins across all your regions. But are you seeing anything from maybe a demand or even a design in perspective that's changed over the last maybe 60 to 90 days or over the last maybe even half year.

Speaker 9

Just kind of curious if the design activities are staying fairly stable geographically? Thanks.

Speaker 2

Yes. I think in general, from a revenue perspective, what I would say in order patterns and things, I think we're seeing kind of modest improvements in Asia, which has been kind of a tough space for us over the last several quarters and we're beginning to see that improve a bit. Europe, if anything, Europe from an order pattern is down meaningfully. So that's probably the bigger shift is Europe being softer. North America has continued to be our most stable and our most solid business and that continues to be the case.

Speaker 2

So if you think about regionally, that's more orders and revenue related. From a design perspective, design from a regional perspective sometimes does not line up, 1st of all, with where we actually ship to and the regions where it's bought. It's really where the design activity is. I'm not sure we're seeing a heavy shift there. We're seeing pretty solid consistent design activity across the board.

Speaker 2

It varies by automotive versus electronics and things like that. But we haven't seen any kind of meaningful shift in that. That's been noticeable.

Speaker 9

Thanks so much.

Speaker 1

Thanks for your questions, David.

Operator

And your next question comes from the line of William Irwin with Morningstar. Your line is open.

Speaker 10

Hi, everyone. Thanks for letting me get on here at the end. Maybe to start, I was hoping if you could elaborate on some of the weakness that you're seeing in commercial transportation. It sounds like there's some softness in Europe and also China, but maybe some positive offsetting there from the agriculture. Just wondering if you could unpack kind of that softness geographically by end product and then how you are thinking about a rebound eventually for that part of the business?

Speaker 2

Thanks, William. Yes, a bit of a correction there. Actually, construction and agriculture is probably the weakest spot for us that we're seeing from a market perspective, where we've seen positive for us. But ConAg certainly has been positive for us. But ConAg certainly has been challenged and we see certainly Europe and China specifically where it's the softest.

Speaker 1

So we don't see that shifting

Speaker 2

too much in the foreseeable future. We kind of see that pattern now. We continue to look for it. The good news is for us, as we've worked to kind of rebalance our portfolio there and we've done some pruning in the commercial vehicle space, which has kind of pulled back our organic growth, if you will. But we think there's still meaningful opportunity for us in content improvement and design in of our technologies into our customer base in the commercial vehicle side.

Speaker 2

So while we think the markets are going to continue to be a bit challenging, we think there's meaningful opportunity for us to go after design wins and activities there.

Speaker 10

Okay, terrific. And then maybe that's a good time with a longer one here or longer term one. I'm curious if you could talk through how you're seeing the competitive landscape evolve with electric vehicles both across pass car and commercial transportation and just rising competition as that high voltage market rises and how you feel about defending your position there?

Speaker 2

Sure. So certainly the EV space is a pretty dynamic space these days. And with our particularly the Western pass car OEMs as we've seen. They have good great design and activity in the EV space. We've seen that.

Speaker 2

We continue to see that. However, a lot of programs are getting pushed out as they're shifting focus to hybrids, plug in hybrids, those types of things.

Speaker 1

The good news is we have

Speaker 2

a good balance of our technologies that serve regardless of the powertrain. We have good content opportunity there. But it is shifting a little bit in the West on where we're seeing launches and volumes and things there that's pulled back a little bit. From a competitive landscape, what I would say is, in China specifically, the competitive landscape on the high voltage side is tough. That has been kind of we've seen that and talked about that for the last year and a half or so.

Speaker 2

So that continues to be challenging there. Competition wise on the rest of the world on EB, we have not seen that get tougher. In fact, we've seen a few players maybe pull back a little bit from that space. So we've seen that to be pretty stable on the Western world, if you will, on the EV competition. On commercial vehicle electrification, it's all over the map.

Speaker 2

Each customer has a very different view and where there's a lot of energy around kind of last mile sorts of vehicles there It continues to be good. On the construction and agriculture, there's progress, but volumes really aren't taking off yet electrification. So it's a bit of a mixed bag there.

Speaker 10

Okay, terrific. Thank you for the detail and thanks again.

Speaker 1

Sure. Thanks, William. Thanks for your questions, William.

Operator

And your next question comes from the line of David Silver with CLK. Your line is open.

Speaker 3

Yes. Hi. Thank you. The question I wanted to ask was really about the status of the wafer fab purchase in Germany. And me and Al certainly touched on it a little bit.

Speaker 3

But I was just wondering a couple of things. I think with the original announcement, there was a timeline where regulatory approvals and then final closing were supposed to be targeted for the end of this year. And so first thing is I'm wondering if that's still on track. And then maybe more to the point, I mean, with all of the turmoil in the transportation or I shouldn't say turmoil, uncertainty in the transportation sector right now. My understanding was that, that facility, the legacy owner was using the wafers there for transportation oriented end markets.

Speaker 3

And it's been about a year since the deal was announced. I'm just wondering from your perspective, is there any change in your thinking about how you would use your capacity allocation in the early years? And then maybe longer term, you're thinking about the highest and best use of that asset?

Speaker 2

Sure. Happy to give some color on that. First of all, everything is on track. We do expect to close at the kind of end of this year, beginning of next year on that where we'll take ownership of the fab. But the nature of the contract and you're correct, El Mas uses that fab and is supporting automotive applications and things like that.

Speaker 2

That's a key part of their business. The reason we acquired this fab in the manner we did, this is a long term play for us. The candidly for us is more oriented towards industrial, not automotive. But there's a multi year like a 4, 5 year contract agreement with the seller where we will continue to produce product for them out of this fab as they begin to export out of this fab into different fabs, which takes time, it takes years to do that. We support them during that as they begin to ramp down and we'll begin to ramp up our industrial products in that fab over that same timeframe.

Speaker 2

So the goal is to try to keep the fab fairly well loaded through the transition. And it's really a long term play for us for our power semiconductor products with a heavy focus on the industrial application side.

Speaker 3

Very good. Thanks for all that color. That's all I had. I appreciate it.

Speaker 1

Thanks, David.

Operator

And we will take follow-up questions from Matt Sheerin with Stifel. Your line is open.

Speaker 4

Yes, thank you. I just had a quick modeling question, Meenal, regarding OpEx. I know that was up sequentially because of the stock comp, which is seasonal. So how should we think about OpEx in Q3, in Q4?

Speaker 5

Yes. I would say you could look at it, the continued trends that we've had. I think I talked about the fact that in the Q2, the long term incentive was about $0.30 Think of it as, let's call it $10,000,000 or so rounded, etcetera. So from there, you can expect sort of back to a normalized run rate or so. I would put it in the what I'd say is for something like an SG and A, think about it in the mid-eighty range and for R and D, think about it in the upper 20s $1,000,000

Speaker 4

Got it. Okay. Okay. Yes, that's it. All right.

Speaker 4

Thanks so much.

Operator

We will take a follow-up question from David Williams with Benchmark.

Speaker 9

Hey, thanks for letting me ask this follow-up real quick. Just wanted to ask David or Menel maybe on the thinking about the fab and that transition over 4 to 5 years as you load your industrial products, but you're still manufacturing the automotive products, there's typically is quite a large margin differential there as you're making for others. How should we think about the margin impact from either a gross or operating margin as you load that fab over time? Thank you.

Speaker 5

Sure. Great question. So, with the arrangement that Dave mentioned that we've worked out, we will have a modest margin that to your point will be lower than our typical margin as we're really performing a service almost like a foundry partner is really what we are. So really the goal was, as Dave mentioned, to really level load the fab and not that's been the main point. So we will have a margin that will be that will look like it's dilutive, but that's where the arrangement.

Speaker 5

So as we get into talking about 2025, we'll provide some further details on that and what that does to the overall segment margin.

Operator

And that concludes our question and answer session. I will now turn the conference back over to Mr. David Kelly for closing remarks.

Speaker 1

Yes. Thank you, Abby. We look forward to speaking with everyone at the August 28 Evercore ISI Semiconductor IT Hardware and Networking Conference in Chicago, as well as the September 5 Jefferies Industrials Conference in New York. We hope everyone has a great rest of their day. Thanks again.

Operator

Ladies and gentlemen, this concludes today's call and we thank you for your participation. You may now disconnect.

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Earnings Conference Call
Littelfuse Q2 2024
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