Littelfuse, Inc. (NASDAQ:LFUS) Q2 2024 Earnings Call Transcript

Littelfuse, Inc. (NASDAQ:LFUS) Q2 2024 Earnings Call Transcript July 31, 2024

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 Kelley. Please proceed. .

David Kelley: Good morning, and welcome to the Littelfuse second quarter 2024 earnings conference call. With me today are Dave Heinzmann, President and CEO; and Meenal Sethna, Executive Vice President and CFO. Yesterday, we reported results for our second quarter, and a copy of our earnings release and slide presentation is available on 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. 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 Form 10-K 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. 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 to Dave.

Dave Heinzmann: Thank you, David. Good morning, and thanks for joining us today. Let’s start with highlights on Slide 4. Our second quarter results exceeded our expectations, reflecting our resilient business model, diverse and balanced technology offering and broad customer reach. Our seasoned global teams navigated through a continued dynamic environment and delivered solid results, while we saw a 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&A while maintaining our commitment of returning capital to shareholders.

Our second 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. I want to thank our global team for their hard work, dedication and meaningful achievements through the first half of 2024. 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 Littelfuse 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 on 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. We strive to deliver internal progress and external enhancements for the betterment of our communities, employees, customers and investors. 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 passive electronics channel destocking that negatively impacted 2023 and the first half of 2024 results is largely behind us. Our passive electronic book-to-bill remains above one as passive electronics channel inventory levels have normalized. We expect to return to more normalized order rates as typical following a destocking period.

However, thus far into 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’re also seeing moderating inventory reductions across our protection 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.

Second 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 second quarter. 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. 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’s business for a customer in Asia and for liquid cooling application in North America. We also secured business for a data center customer in Asia that will utilize 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. 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 which support local OEMs that continue to experience robust growth. Second 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.

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-in 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 second quarter. Looking forward, we see continued soft demand led by Europe and China regions, extending into the second half of the year. Long term, we remain well positioned to deliver electronification and electrification innovations across our broad commercial vehicle exposures, including material handling, agriculture, construction equipment and heavy-duty truck and bus markets.

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 the 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. 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 second quarter. And 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 innovations. In the second quarter, 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 doing 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. 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. I will now turn the call over to Meenal to provide additional color on our financial performance and outlook.

Meenal Sethna: Thanks, Dave. Good morning, everyone, and thank you for joining us today. Please turn to Slide 11 to start with details on our second quarter results. Revenue in the quarter was $558 million, 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. GAAP operating margins were 11.7% and adjusted operating margin of 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. Second quarter GAAP diluted earnings per share was $1.82 and adjusted diluted EPS was $1.97.

Our second 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 shifts across jurisdictions. 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 million, and we generated $50 million in free cash flow. Year-to-date, we generated $92 million 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. 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 million 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 buybacks. In the quarter, we returned $41 million of capital to shareholders, including $25 million via share repurchases and $16 million via a cash dividend. Through the first half of 2024, we’ve returned $73 million of capital to shareholders. Our Board of Directors approved an 8% increase in our quarterly cash dividend, equating to $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 Products segment. 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%. The 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%. Margins improved 210 basis points and 180 basis points sequentially reflecting our portfolio diversification efforts and strong execution.

We’re proud of the margin resiliency of our Electronics Products segment through this extended destocking cycle and are confident in the team’s ability to drive continued expansion. Moving to our Transportation Products 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. 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. 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 basis points and 410 basis points sequentially, reflecting strong execution following our capacity additions and footprint actions noted in the first quarter.

Please turn to Slide 16 for the forecast. 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 third quarter sales in the range of $540 million to $570 million. 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 second quarter. We’re projecting third 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. At current rates, we expect those to be a headwind of 1% to sales and about $0.40 to EPS for the year. We 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 undercurrent, we expect company operating margins to finish in the range of 12% to 14% for the full year. 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 million in amortization expense and $39 million in interest expense, about two-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 shifts across jurisdictions, and we expect to invest about $100 million in capital expenditures.

We continue to execute well through a dynamic environment and remained 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 a global customer base and ongoing profitability improvements. We will continue our path forward and best-in-class profitability and cash generation, driving value creation for our stakeholders. Thank you to our Littelfuse colleagues worldwide in their unwavering commitment in steering our company forward every day. And with that, I’ll turn it back to Dave for some final comments.

Dave Heinzmann: 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 second 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 in 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. 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 2024. And with that, I will now turn the call back to the operator for Q&A.

Q&A Session

Operator: [Operator Instructions] And your first question comes from the line of Luke Junk with Baird. Your line is open. Mr. Junk, please check your mute button.

Luke Junk: Dave, maybe if 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.

Dave Heinzmann: And so we’ve talked about overall electronics book-to-bill at being over 1.0. So it’s slightly above one, we’re seeing there. And there is a little bit of a delineation between the semiconductor portion of it in the passives. We’ve also talked about kind of cautiousness in order patterns. So if you look at our passives business, we were above one last quarter. We continue to be slightly above one this quarter. And our — so the book-to-bill are reasonably stable, but we’re not seeing as much of a pickup as we would typically see. And I think that’s really cautiousness driven by the OEM customers in placing orders. So it remains healthy and sell-through remains healthy. However, we’re just not seeing that pick up yet.

On the semiconductor side, as we’ve talked about, because we’ve intentionally in the semiconductor, particular power semiconductor side kind of invested into the industrial space as we think it creates a better balance for our business over time. Industrial is soft. So book-to-bill have been below one 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. So they’re approaching one again, even in the power semi side. But just to 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 that’s really going to be 4, 5 months out before we see sales starting to pick up there. So that’s why we talk about, really, kind of expecting to see that kind of going into next year.

AI data centers in general is the second part of your question. 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 and 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 second quarter and then into the third quarter.

Q – Luke Junk: 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 end customers as well, just given what you’re seeing there? Could we see one or both of those inflect maybe late in the 3Q range or maybe more likely in the fourth quarter, Dave?

Dave Heinzmann: Yes. I think our protection semiconductor business behaves a little more like our passive business, if you will. It has a 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 passives 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 to the other direction in passives, the protection portion of our semiconductor tends to follow a quarter or two behind that. So it’s difficult to say exactly when we see that turning back up in the protection side, but it’s probably a quarter or two behind our passive business.

Luke Junk: And then if I could sneak one final question in Meenal, this is a margin-related question. And just looking at the full year guidance for 12% to 14% operating margins that’s applying 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, I assume that would be mostly electronics related and ultimately, what could drive that sort of incremental exiting the year? I guess I’m really trying to reconcile that with what seems like some more conservatism in the third quarter guide from a margin standpoint where at the midpoint, maybe you’re even picking up pretty flat EBIT if we strip out [Indiscernible] comp stepping down sequentially.

Meenal Sethna: 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 look the floor, which it has done for 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. And so based on the general view that we’ve given on, starting to see recovery in various places, little bit of 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 margins.

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

Matt Sheerin: 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? 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&P auto numbers got cut recently?

Dave Heinzmann: Sure, Matt. I’ll take that one and Meenal feel free to jump in. So if we look at kind of the return to growth in the fourth quarter, which is our current view of when we expect to begin to see things turn, absolutely, if you look at normal calendarization. In a normal environment, we would see electronics sequentially down in the fourth quarter. However, we are seeing the inventory position. Weeks of inventory for our passive products are back to pre-COVID levels. So they are 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, we’ll 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.

Meenal Sethna: Sure. And I’ll add 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 incrementals. 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 third going into the fourth quarter as the sales start to improve.

Matt Sheerin: 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? And how should we think about pricing in channel?

Meenal Sethna: 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. What I would also say is, the other dynamic going on is we’re working even with the metals pricing, et cetera, we’re working on pricing independently. We’ve been doing that. So beyond in metals and the metals cost increases, we’ve been both on the automotive side as well as in 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.

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

Christopher Glynn: I had a couple on industrial. Had a really strong sequential lift there. And just curious, what got better. I think the revenues were pretty significant proportion above expectations.

Dave Heinzmann: 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. 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 a 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 first quarter, where we’re in the midst of moving into a new factory that we were building out.

So always, when you’re in transition, between that, 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.

Christopher Glynn : And then on the initial signs of HVAC recovery, could you put a little bit more color on that? Are the OEMs, anyone, actually kind of building inventory there? And how much is kind of market for new designs because you put some emphasis on new designs.

Dave Heinzmann : Yes, we did. And so in our exposure to HVAC, particularly in North America, we have a heavier tie to residentially 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 rate 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. 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.

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

Grant Smith: This is Grant Smith on for Saree. You talked a lot about the cautious order patterns in passives. But I was 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 and increasing orders?

Dave Heinzmann: 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 cost of inventory are pretty high these days. 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 is there that kind of general cautiousness. 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.

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

Dave Heinzmann: And clearly, we work our funnel very aggressively over time, and we have a very active funnel that we continue to work. What I would say is we look at M&A using our M&A capabilities and our 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&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 create a good balance across the industries that we see attractive. We look for margin profiles and 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, those are the criteria 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. 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&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. 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.

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

Josh Buchalter: Maybe I want to start with a bigger picture one. So if I look at where second quarter came in versus your guidance, it was above the high end, I believe, and clearly surprised you to the upside within the quarter, but then the commentary on the third quarter sounds a bit more cautious. If I think about it and step back, was this a function of you got inventory cleared. Now it’s just — you’re shipping closer to end demand, but end demand is tepid. I’d just be curious to hear big picture how you’re seeing the business environment given your breadth and scale.

Dave Heinzmann: Yes. So we had a little more positivity in the second quarter than we anticipated and our ability to execute to that. I talked a little bit about order patterns in the electronics 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. So we saw some upside in the electronics 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 third quarter 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 electronics side of things on our products, particularly the power semiconductor 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’ve seen stabilization in the electronics. But on the industrial kind of centric power semiconductor business, we’ve actually seen order pushouts a bit and delays from our customers there as their end markets have been a bit soft. So that’s where the cautiousness, maybe a little bit in the third quarter is coming from.

Meenal Sethna: Maybe I would add one more, David, on the transportation side, especially on the automotive side, right? 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 in some of the Western area, a little bit more in North America, Europe, et cetera.

Josh Buchalter: Dave, I appreciate all the color there. Maybe one for Meenal. If I look at the shape of your CapEx, they hit the $100 million, 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. 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 a valuation or strategic perspective in M&A?

Meenal Sethna: Sure. So on your first question as it relates to CapEx, we monitor that closely. 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, and we want to make sure we’re building the capacity and focusing on the organic growth. At the same time, our businesses watch the markets 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 us as we approach the end of the year, we may not quite get to that $100 million, if that’s what we’re seeing in there, but it’s not a — we’re not trying to manage the CapEx for our cash number, but more trying to be prudent and 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 fab from Elmos 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 million includes some investments that we’re making for capacity that we’re building out in advance. 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 in 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. As 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. And we feel like the market is not recognizing our growth strategy and really incorporated that into the share prices. That’s when we look at buying back shares. That was really the view that we took in the first half of the year on that. 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&A. And we make those determinations of holding back in some cases or looking at share buybacks.

So we’re not a continuous one of share buyback, and we’re a little bit more periodic about it.

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

David Williams: I guess, first, I 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 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?

Dave Heinzmann: Yes. From a data center perspective, we get involved kind of in two aspects of it. One 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 of 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. 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 back plane 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. For us, it’s more really the volume creation that drives by the data center build-out that drives our business up there.

David Williams: 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 demand or even a design-in perspective that’s changed over the last maybe 60 to 90 days over the last, maybe, even half year. Just kind of curious, if the design activities are staying fairly stable geographically.

Dave Heinzmann: Yes. I think in general, from a revenue perspective, what I would say and 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. 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, first 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. 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 noticed.

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

William Kerwin: 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?

Davie Heinzmann: 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, actually, for us, our exposure and on-road heavy truck has been a bit more resilient than we anticipated, and that’s been positive for us. ConAg, certainly, has been challenged, and we see, certainly, Europe and China specifically where it’s the softest. So we don’t see that shifting 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 designing for our technologies into our customer base in the commercial vehicle side. 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.

William Kerwin: And then maybe that’s a good tie-in with a longer one here or longer-term one. 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?

Dave Heinzmann: 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, we have good — great design-in activity in the EV space. We’ve seen that. 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. The good news is, we have a good balance of our technologies that serve regardless of the powertrain. We have good content opportunity there. But it’s 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, talked about that for the last 1.5 years or so. So that continues to be challenging there. Competition-wise, on the rest of the world on EV, 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 the Western world, if you will, on the EV competition. On commercial vehicle, electrification it’s all over the map. Each customer has a very different view and where there’s a lot of energy around kind of last mile sort of vehicles there that continues to be good. On the construction and agriculture, there’s progress, but volumes really aren’t taking off yet in electrification. So it’s a bit of a mixed bag.

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

David Silver: The question I wanted to ask was really about the status of the wafer fab purchase in Germany. And Meenal, certainly, touched on it a little bit. But I was just wondering, a couple of things. I think with the original announcement, there was a time line 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.

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.

Dave Heinzmann: Sure. Very 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, LMOS uses that fab and its supporting automotive applications and things like that, that’s key part of their business. The reason we acquired this fab and the manner we did, this is a long-term play for us. But candidly for us, it’s more oriented towards industrial, not automotive. But there’s a multiyear, 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 could take years to do that.

We support them during that as they begin to ramp down and will begin to ramp up our industrial products in that fab over that same time frame. 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.

Operator: Thanks, David. And we will take a follow-up question from Matt Sheerin with Stifel. Your line is open.

Matt Sheerin: 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?

Meenal Sethna: Yes. I would say you can look at it the continued trends that we’ve had. I think I talked about the fact that in the second quarter the long-term incentive was about $0.30. Think of it as, let’s call it, $10 million or so rounded, et cetera. So from there, you can expect sort of back to a normalized run rate or so. I would put it into, what I’d say, is for something like an SG&A, think about it in the mid-80 range and for R&D think about it in the upper 20s million dollars.

Operator: We will take a follow-up question from David Williams with Benchmark. Your line is open.

David Williams: As follow-up real quick. Just wanted to ask David or Meenal, 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 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?

Meenal Sethna: 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 look like it’s dilutive, but that’s fully the arrangement. 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.

David Kelley: Yes. Thank you, Abbie. 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.