Littelfuse Inc (LFUS) 2014 Q2 法說會逐字稿

Good day, everyone, and welcome to the Littelfuse Incorporated second-quarter 2014 conference call. Today's call is being recorded. At this time, I would like to turn the call over to Chairman, President and Chief Executive Officer, Mr. Gordon Hunter. Please go ahead sir.

Thank you and good morning, and welcome to the Littelfuse second-quarter 2014 conference call. As always, joining me today is Phil Franklin, our Senior Vice President and Chief Financial Officer.

As you saw in the news release, we (technical difficulty) quarter. Both our electronics and automotive businesses had record sales for the quarter, helping to offset the impact of the continued weakness in the mining sector and lower sales of electrical fuse products. Excluding a number of special items, earnings for the second quarter came in at the lower end of our guidance.

I'll discuss the second-quarter performance in more detail in a few minutes, but first I'll turn the call over to Phil, who will give the Safe Harbor statement and a brief summary of the news release.

Thanks, Gordon, and good morning. Before we proceed, let me remind everyone that comments made during this call include forward-looking statements based on the environment as we currently see it, and as such do include various risks and uncertainties. Please refer to our press release and SEC filings for more information on the specific risk factors that may cause actual results to differ materially from those expressed in forward-looking statements.

Sales for the second quarter of 2014 were $221 million, which was up 18% year-over-year and consistent with our guidance. GAAP earnings for the second quarter of 2014 were $1.08 per diluted share. This included purchase accounting adjustments related to the SymCom acquisition, restructuring charges, and non-cash foreign exchange losses. Without these special items, earnings were $1.26 per diluted share, which was at the lower end of our guidance.

Earnings for the quarter were negatively impacted by higher scrap and inventory obsolescence charges and a large increase in stock compensation expense. The scrap and obsolescence problems were primarily from two sources -- first, quality and performance issues at one of our Mexico plants, and secondly, the downturn in our mining industry which caused us to take a reserve for certain slow-moving inventory. We believe both of these issues are largely behind us at this point.

The increase in stock compensation expense relates to a technical accounting issue which causes us to recognize over 40% of our stock compensation expense for the year in the second quarter. Stock comp expense will be approximately $1.8 million lower in both Q3 and Q4.

The Company continues to generate strong cash flow as cash from operating activities in the second quarter was $31 million compared to $23 million for the same quarter last year. As usual, we expect cash flow to increase as we progress through the year.

For the first time in over two years, we repurchased shares during the quarter, as we took advantage of the mid-quarter pull-back in the stock price.

Now I will turn it back to Gordon for more color on business performance and market trends.

Thanks Phil. I'll begin the segment reports with the electronics business which accounts for about half of total Littelfuse sales. Electronics had a record second quarter with sales of $110 million. This was a 20% increase over the prior-year quarter. We had strong growth across all product lines, especially semiconductors. Fuse and ceramic products also performed well and we continue to benefit from the Hamlin acquisition. Excluding acquisitions, second-quarter electronics sales were up 13%.

Electronics channels inventories increased about 10% from the end of the first quarter to the end of the second quarter. At the same time, end market customer sales were up about 7%. We are comfortable that our channel inventories are at appropriate levels based on current market conditions. And consistent with normal seasonality, we expect inventories to work their way down through the end of the third quarter and into the fourth quarter.

Typically, the third quarter is slightly stronger than the second. However, given our record second quarter sales, we anticipate this year's third quarter will be approximately flat sequentially.

The market has also been strong with the most significant growth coming from Europe, China and Southeast Asia. The growth in China came from our local design wins, as well as design wins in North America. Some of our competitors are reporting extended leadtimes, but we have been carefully managing capacity to keep up with demand. This has also helped us to gain market share.

The growth in Europe came from the rollout of 4G wireless networks as well as a general market recovery across multiple segments.

Now, I'd like to highlight some of the focus markets, as well as some of our recent design wins. Along with the continued growth of smartphones and tablets has come the standardization of Universal Chargers that can be used for both devices. The new Universal Chargers use higher wattage in order to provide faster charging time. This also requires a higher level of protection against short-circuit threats. We met this challenge by developing new fuse technology that provides the high breaking capacity needed within the same small footprint of existing fuses. This innovation enabled us to participate in a new charger design for a leading smartphone and tablet manufacturer based in Korea. Initial production orders began in the second quarter and we estimate annual revenues approaching $1 million.

As we have discussed on prior calls, tablet sales have been growing at the expense of PCs. However, recently, we've seen an increase in PC sales in Taiwan. Many businesses are now upgrading their computers to newer software that also requires better hardware.

Several quarters ago, we talked about our early successes with wearable technology. We have continued to focus on this market segment and recently achieved another design win for a leading fitness tracker company based in the US. The application is for a charger with USB connectivity where our radial PTC resettable fuse helps to prevent the possibility of a short-circuit that could cause the wire to heat up and burn.

Another growth segment for us is electrostatic discharge, or ESD, protection across a wide range of end products. With more and more electronics embedded in today's consumer products, the need for ESD protection continues to grow. During the second quarter, we won new business for our semiconductor ESD products in the gaming, security, and appliance segments totaling $1 million in annual revenues.

We're also seeing more design opportunities in growth and white goods and small home appliances. And two recent wins with a leading US white goods company illustrate the diversity of our product portfolio. One win is for a power supply control board for a washing machine where the customer had a challenge with a tight layout and we were able to offer a custom form factor fuse that provided an ideal solution. The second was for the same washer where monitoring the fluid level in the washer drum unit was a key design requirement, and we were able to provide a custom float and sensor package based on our Hamlin technology. The combined incremental revenues for these two wins are about $800,000 annually and will reach peak production about a year from now.

We have many other opportunities to leverage our fuse sales channels to grow the Hamlin sensor products. This strategy can have a significant financial impact as some of the sensing solutions are priced at $1 or $2 per unit compared to fuses that typically sell for less than $0.50.

The kitchen appliance segment provides good opportunities for both our semiconductor and sensing products. A recent design win for a leading single pod coffeemaker will add an additional $1 million to $2 million in revenues, using both diode arrays and switching thyristors to control the heating elements. We are also working to get the Hamlin products approved at this same customer.

And finally, our focus on LED lightning is expanding in both the indoor and outdoor markets. Indoor LED bulb prices are continuing to drop, driving greater adoption over traditional bulbs. Our products protect the power supply in these bulbs.

In the outdoor lighting segment, we recently launched our expanded LED surge module series that is compatible with the needs of a broader range of outdoor Luminaire customers throughout North America, Europe and Asia. As municipalities push to convert outdoor lighting to LED-based fixtures, we are well positioned to offer unique modular solutions with a high level of protection and flexibility.

We estimate the total available market for circuit protection for outdoor LED lightning to be about $40 million and growing. An early indicator of the potential of this market is the 25 new business opportunities we've already identified representing $3 million in potential revenue. Overall, we expect our total LED lightning business to grow by double-digit percentage in 2014 to exceed $12 million.

We also introduced a number of new products during the second quarter. One of these is a new high current nano fuse. This is a fast acting, very high current fuse that is designed for applications such as datacom and telecom equipment, including high-end servers, base stations, power supplies and blade computing. Our new fuse provides a 50% improvement in energy handling capacity over our existing offerings.

To wrap up this section, the electronics business had an excellent second quarter. Our book-to-bill at the end of the quarter was 1.08. We believe we are successfully capturing the momentum of the market while at the same time continuing to benefit from the new business opportunities and our investments in new product development.

Next is our automotive business, which accounts for 37% of sales. The automotive team achieved another record quarter with a 27% increase in sales to $82 million. Excluding acquisitions, second-quarter sales were up 15%.

Sales of passenger car fuses and Accel sensors remain strong and commercial vehicle product sales continue to improve. The Hamlin sensor products also contributed to the higher sales.

Sales of passenger car fuses were up 12% year-over-year in the second quarter compared to an increase in global passenger car production of only 2.2%. The second-quarter growth was primarily driven by North America, where sales increased nearly 20% year-over-year. Programs, including the GM K2XX program and the Chrysler 200 midsize car platform where we have MasterFuse products as well as a high number of low current standard fuses, have increased. North American aftermarket sales were also strong in the second quarter.

Sales increased 13% in China as many new projects for local OEMs as well as European and American OEMs ramped up. These vehicles also use our MasterFuse and high current fuses as well as standard pluggable fuses.

In Europe, the car build was less than originally expected for the second quarter. This resulted in more cautious ordering by tier 1 suppliers in order to avoid potential over-stocking. However, our sales to Volkswagen and BMW remained very strong. As a result, our total European sales were up 6%.

In addition to the record sales, the second quarter was also strong in terms of new business wins. The key focus area continues to be our MasterFuse high current fuses and our high-voltage fuse line. A sampling of recent wins illustrates the broad demand for these innovative products. We won new business for two MasterFuse applications for the GM D2XX compact vehicle platform with a tier 1 supply in Korea. This program will contribute $1 million per year in sales when it ramps up.

Another win is for a BF in-line fuse for Volkswagen at various tier 1s in Europe. Peak volume for this win is an excess of $2 million per year. And in China, our MIDI fuse will be used in a new application for Geely, a local automotive OEM.

And in the hybrid electric vehicle segment, we have four high-voltage fuses per car in the junction box of the GM Volt 2. Our fuses will also be used by a Korean tier 1 for a small Hyundai platform.

The future pipeline is strong as we are working closely with tier 1 suppliers and OEMs on various new project for our ZKS MasterFuse and other high-voltage fuse programs. And emerging area for our high current fuses is 48-volt applications for equipment that requires high levels of electrical power such as air-conditioning compressors, engine cooling fans, and electrical heating. The higher voltage allows for smaller cables which in turn reduces weight and lowers costs. We have developed a new 48-volt high current fuse line that meets all of the requirements specified by OEMs and expect to see the first 48-volt applications in cars beginning in 2016.

We also continue to win market share for our standard fuses. Recent wins include our mini, micro and low-profile JCASE fuses for the Ford 150 in the US. This program will generate sales of over $1 million per year out of peak. Another win is for our mini and low-profile JCASE fuses with Beijing Automotive Group in China.

Looking ahead to the third quarter, we expect a slight reduction in car build due to the holiday season in the Northern Hemisphere. Potentially offsetting this is the ramp up of new programs in North America, Europe and Korea and a recovery of the Brazilian and Indian markets which were particularly weak in the second quarter.

The commercial vehicle products business also had a good second quarter with sales up 6% year-over-year. This reflects the strength of the heavy-duty truck market and our strategy at developing innovative new products and expanding beyond the North American market. Shipment of two products for a major construction equipment manufacturer in China that were part of a 2013 design win also contributed to the higher sales.

In terms of new business, the CVP group had nice design wins with major farm equipment manufacturers in both North America and Europe. And we also strengthened our go-to-market channel with three new sales representatives in North America and a new distribution channel in Australia.

Our automotive sensing business delivered strong sales in the second quarter, particularly in North America. In the solar sensing area, overall sales remain steady. However, the product mix improved as a trend towards more sophisticated climate control systems resulted in customers purchasing more feature-rich and higher-priced solar sensors.

We launched 10 new sensing products during the quarter. Five of these are for a North American customer for applications related to occupant safety. Once production ramps up, this win will add about $400,000 per year in revenues.

Three of the new sensing products are for an Asian transmission box application that should generate $4 million in revenue in 2015 and more than $10 million in revenue in the following years.

Another new product is for a powered tailgate application that measures how far the tailgate is opened. It's used when the vehicle is parked in a garage to prevent the tailgate from opening too far and hitting the ceiling. The value of this win is $600,000 annually by 2016.

Tailgate sensors are a new segment of our sensor platform that didn't exist just a few years ago. Demand for these sensors is growing faster than car builds as a whole. That's because tailgate sensors are a popular convenience feature that is being fitted as an option and increasingly as standard equipment across a broadening range of SUVs and station wagons. Our sales into this segment are expected to reach about $5 million in 2014, up from $1.7 million in 2013.

We also developed a new speed sensor for a North American-based all-terrain vehicle manufacturer, a departure from the traditional automotive market.

And finally, we are making progress on our strategy to expand geographically. We recently booked new business with a major Chinese OEM for a complex angular position haul effect technology sensor that measures gear shifter position in a transmission box.

In summary, our automotive business continues to perform extremely well. We're developing new products that meet continually evolving customer needs ranging from high-voltage and high-current applications to heavy-duty trucks and construction equipment to many different types of sensors. And we look forward to continued progress in the second half of the year.

That brings us to the electrical business unit, which accounts for about 13% of total Littelfuse sales. Total electrical sales were $28.9 million for the second quarter, a 9% decrease from the second quarter of last year. Excluding SymCom, electrical sales were down 26%.

We've talked in prior calls about the impact of the mining downturn on our custom electrical products and protection relay business. The electrical fuse business has been helping to offset the declines from mining. However, in the second, quarter electrical fuse sales were also down. The decline was due to a number of factors, including the long, cold winter and its effect on construction. Weather-related issues continued to have a negative impact on distributor orders in the second quarter. We expect a better third and fourth quarter for construction and while this segment will not do as well in 2014 as originally anticipated, it is expected to be up over 2013.

In addition, we lost some ground with a competitor at one of our large solar customers in the first half of the year, but we recently learned that we will be getting this business back in the second half.

Other positive developments in the second quarter include several new fuse design wins with multiple OEM customers across a variety of industries. These include solar, HVAC and utility switchgear. And these wins will add over $500,000 of annualized revenue to the fuse business.

The addition of SymCom's line of protection relays has enabled us to grow our share in the existing distribution channels as well as open doors at new distributors. During the second quarter, we secured orders that should generate more than $200,000 in incremental annual sales. Growing our distributor base is a key growth strategy for the electrical business and as you can see, we continue to make good progress.

Moving on to custom electrical products, the Canadian potash market continues to bump along the bottom of the cycle. Recently, several of our potash customers have reported their production has been increasing and they are approaching normal operating capacity levels. We have been quoting more business and to date have received several million dollars in new orders.

In the meantime, we are continuing with our strategy to expand outside of potash mining. We shipped a major project to an oil and gas customer in June and have a robust pipeline of new business opportunities. We have a number of orders that we expect to ship in the fourth quarter. However, third-quarter sales are expected to be lower than in the prior year.

Looking at protection relays, a large portion of relay sales are still tied to the mining industry but, as with our custom products, we are working to diversify the business. Our strategy includes organic efforts as well as the acquisition of Selco in 2009 and most recently SymCom. Both SymCom and Selco sell into the industrial channels, and Selco also sells products in the marine segment. Both acquisitions are enabling us to make inroads in target markets beyond potash mining.

On the organic side, we recently secured a first quarter for prototypes of a new product for a large data center customer. This opportunity has the potential to generate more than $1 million in revenue in 2014 and several million dollars a year after that. In addition, recent wins at a large steel and wire manufacturer, and a large electric utility for arc flash protection relays, are also helping to diversify the relay business.

We also secured a nice introductory order with the Army Corps of Engineers for our award-winning shock-Block product that is an industrial ground fault circuit interrupter designed to protect personnel from dangerous electrical shocks.

So, while mining remained soft and electrical business was impacted by the factors mentioned earlier, we are continuing to win new business and to move forward with our diversification strategy. Both of these initiatives are helping to position us for solid growth over the long-term.

That concludes the report on the business units. There are a few other items I'd like to cover.

As you saw in the news release, the board approved a 14% increase in the quarterly cash dividend to $0.25 per share. We've increased the payment every year since the dividend was initiated in 2010, and the latest increase reflects our solid performance and our continued confidence in the business. Consistent with that thought, I believe this past quarter highlights one of the strengths of Littelfuse, the diversity of our businesses and the fact that they are not all related. It was only a few years ago that mining was strong and electronics was soft. Today, it's just the opposite as the growth in electronics and automotive are more than offsetting the effects of the mining slowdown. This balance provides stability and has enabled us to achieve a steady upward trend in performance over the long-term.

Another highlight for the quarter was the announcement that, for the third consecutive year, we were named one of the best places to work in Illinois. We are proud to be recognized for our efforts to make Littelfuse an employer of choice.

So, in summary, we believe the lower margins and some of our other experience in the second quarter was more of an anomaly than a change in the business. And we expect to return to the path we have been on in the third quarter and look forward to a good second half of the year.

With that, I'll turn the call over to Phil, who will provide the third-quarter outlook, and then we will take your questions.

Thanks Gordon. We project third-quarter sales to be essentially flat with the second quarter as sequential growth in the electrical business is expected to offset the typical seasonal decline in automotive. Electronics, after a particularly strong second quarter, is expected to be roughly flat sequentially.

Operating margin for the third quarter, excluding special items, is expected to improve by 150 to 200 basis points compared to the second quarter. Earnings for the third quarter are expected to be in the range of $1.29 to $1.43. Capital expenditures for the year are expected to be approximately $35 million. Free cash flow for the year is expected to be in the range of $100 million to $115 million.

This concludes our prepared remarks. Now we would like to open it up for questions.

(Operator Instructions). Shawn Harrison, Longbow Research.

Good morning. This is [Gothia] calling on behalf of Shawn. I was wondering. Within the electronics business, it looks like you be your old operating margin record. How should we think about that for the second half of this year and going forward? Is it sustainable? If you could provide some more color on that.

Yes, I would expect the gains we've made in operating margin certainly as we look at the back half of the year should be sustainable improvements. Now, I think obviously the steady improvement that we've seen over the last several years as those margins get well up into the 20s%, that becomes harder to see those margins go higher and higher. But certainly for the next several quarters, which is about as far out as we can see at this point, I would expect to see similar margins as we have seen in the prior two quarters.

Okay. Great, thanks. And then the second question was just about some of the restructuring that you announced. So one, where are you with the Hamlin contract negotiation? And then last quarter, you announced the SymCom restructuring. I believe you had said about $2 million of savings per quarter beginning in mid-2015. Are you still on track with that, and are there any announcements yet to come with those businesses?

Yes, so we announced -- the only new announcement this quarter was that we did some restructuring of the labor agreement down in the Hamlin Mexico plant that is going to allow us to save somewhere in the neighborhood of $1.5 million a year, and those savings will start in Q3.

As we have alluded to for a while, we still expect additional restructuring efforts at Hamlin. Those, we will be announcing some of those probably at the next call as we get a little further along in our integration process, and so we'll have to wait to hear those. But we have indicated that, over time, we expect to be able to get the Hamlin margins up to levels approaching the overall Company average, and they are quite a long way from that right now. So, the restructuring we announced in the quarter will be a start, but there will be more actions to come there.

And then regarding the SymCom plant consolidation that we announced last quarter, we expect that is on track and should begin to deliver savings somewhere in the second half of next year.

All right. Sorry, just one clarification. So the labor agreements, are you finished with the negotiations there? Have you already reached an agreement, or is that still in progress?

No, we finished those. That's done and those savings will occur.

Okay. Thank you.

Matt Sheerin, Stifel.

Thanks. Good morning guys. A question on the electrical business, Gordon, you talked about returning to growth this year. Obviously, with the first two quarters down, you're looking at potentially double-digit sequential growth in the next couple of quarters. Is that coming primarily from the electrical side where you are seeing a recovery in end markets related to weather and other issues, or are there new programs ramping there too?

There are several things, actually. Specifically, to our fuse business that's had several quarters a couple of years now of continuous growth and it's helped offset the downturn in mining. But we had a very weak quarter. That was a bit of an anomaly in the second quarter for our fuse business. And as I mentioned, it was sort of a hangover through our distributors who had had a tough time in the first quarter for weather-related. This is almost exclusively a North America business, and the wintertime had really impacted them in the first quarter, and that meant that they were not really buying from us in the second quarter. And then I mentioned specifically a large solar company customer that we had lost some business in the second quarter. Both of those we think were really anomalies happening in one quarter. We expect that business to pick back up in the solar area and we expect construction, the nonresidential construction area, to be picking up and certainly to be growth year-over-year. So, very positive signs about the nonresidential construction part.

And then specifically in the custom products, as part of the electrical segment that were very highly tied to the Canadian potash mining, we did have some success in diversifying that, as I mentioned in June, in shipping into the Canadian oil and gas market some product. But we expect the potash mining to continue very weak in the third quarter. But the orders that we are starting to see, we'll start to see shipments of those in the fourth quarter. So we expect this business to start coming off the bottom that it's been bouncing along right now in the fourth quarter, and more optimistic about next year for that.

And then our protection relays is a very similar story, the majority of that having been shipped into the potash mining has had a couple of very difficult quarters. But the diversification has been growing, and so selling our protection relays into other segments, and certainly SymCom helps in that because they are mainly selling their products into industrial markets. So we expect to see our protection relay business similarly picking up in the fourth quarter and into next year.

So, it's a message of different product lines, different technologies, and different end markets. But I think the fuse business that's held up so well was really a one-quarter anomaly that we expect to be recovering from.

You had alluded to double-digit sequential growth in the next two quarters. I don't think I would expect that. I think we will have sequential growth or expect to have sequential growth in Q3 and then again in Q4 in the overall electrical segment, but it's going to be kind of mid to higher single digits. It's not going to be double digits.

Okay, yes, okay, but like 8% or 10% growth will still get you to sort of flat to up for the year then it looks like.

Yes, I'm not sure we're going to be flat to up for the year, but we will be approaching that anyway.

I thought Gordon said you were going to be up. Okay.

I think he might have been alluding to a specific part, maybe the construction --

Construction.

-- which only affects us (multiple speakers)

I got you, I got you, clarified. Okay, that's helpful. Thanks a lot there. And then on --

Matt, just one other point. So, I just had one other thing. We also would expect the electrical margins to bounce back to something closer to the first-quarter levels after the big dip that they took in Q2, and that was mostly related to some of these one-time and nonrecurring issues. So I do expect a meaningful margin improvement in Q3 and Q4.

Okay. That's helpful. And then on the electronics business that you talked to, it looked like there was a little bit of inventory build at customers, which is one reason why you're calling for sort of flattish this quarter when it's typically up. But in terms of what you're seeing in terms of point-of-sale and sellthrough and bookings within the channel, are you still seeing sort of seasonal trends in terms of sellout?

Yes, I think we are very much in control of that. I think the reason we are seeing it more sequentially flat is the profile of ordering in the second quarter was very strong at the beginning of the quarter, and then as we get toward the end of the quarter, it was really softening a little bit. So I think we're going to see more of -- I think we had a particularly strong second quarter, extremely strong second quarter, and we expect it to be more similar in the third quarter. But certainly the inventory levels and the sellthrough I think are very healthy. I think year-over-year we will be very healthy again in the third quarter, which is probably not going to see the usual jump from the second quarter to third quarter.

Okay. And just lastly if I may, just regarding the issues you had with materials in your Mexico facility, was that within the electronics or the automotive business? And have those issues been resolved in terms of execution issues?

Yes, so we alluded to a number of different issues.

Yes.

I think the issues in Mexico are certainly -- we had some quality issues that went back to things that happened a while back, and we think we are through with those. And we are also expecting improvement in overall performance in the plant. So, I would say largely those issues are behind us. As well, we had -- and those issues affected both electrical and there were some electrical issues and some automotive issues, so it impacted both divisions.

We also had, additionally affecting the electrical business, we had -- we alluded to some, you know, inventory charges related to the downturn in the mining industry. And that would've been up in inventory up in our Saskatchewan facility that we took a significant, almost $0.5 million, write-off of inventory there and that would've been all against the electrical business. So electrical is probably most impacted by the quality and performance issues, but automotive was a piece of that as well.

Okay, but that sounds like that's -- you are behind that.

We would not expect those issues to reoccur in Q3 and Q4.

Okay, great. Thanks a lot.

John Franzreb, Sidoti and Company.

Good morning guys. Just to stick on the electrical theme here, you alluded to the fact that ex the items that the margin would being much improved, can you give us a sense, Phil, what the margin would have been in electrical ex all those one-time puts and takes?

It still would've been probably a drop from the Q1 levels. But I think, rather than trying to say exactly what that margin is, just probably the guidance that I gave previously that said that now that we've got most of those issues behind us, I would expect the Q3 margins to go back to something looking much more like the Q1 margin, so in the kind of lower teens, 13% or so, up from the low single digits that they were in in Q2.

Okay. I think Gordon mentioned you're starting to have some success on the custom side of that business outside of the potash market. I think last quarter you warned us that the competitive landscape in that business was a little bit tougher and the margin profile would not be similar. Is that part of the reason maybe we should tap down our expectations on the margins in electrical going forward?

Yes, I think that's still consistent. We were pleased to be shipping one into the oil and gas market in the second quarter. But I think as I said last quarter, the margin profile for the non-potash mining is not going to be at the levels that we had in potash.

The good thing is we are starting to see more activity in potash, but activity in talking about planning capacity expansions and placing orders happens today, but that's not going to be delivering any product for a couple of quarters out there.

Okay. It sounds like you have some nice new sensing applications in the auto side of the business. I guess two questions here. One, is the margin profile in the sensor business significantly above the margin profile, call it the legacy auto business, or are you seeing some kind of price pushback when you roll out new products and sensors in the auto side?

Generally, at this point, as we've said, the margin profile is lower for sensors than it is for our legacy automotive business. With some of the actions that we are taking, we expect those margins to come up meaningfully over the next couple of years, but it's going to take a while for all that to happen.

The other thing that's going to help is, as we win more business and ramp up larger volumes on some of these lines and technologies, we're going to see operating leverage on that as well. So we have reasonable incremental margins on the sensor products, but the overall margins are still quite a bit lower than the legacy business at this point.

Okay. Even on the new products, Phil, right?

Yes, on the new product they are as well, although if you look at it on a variable basis, we definitely have reasonable variable margins, so the variable margins are not bad at all on those. It's just that we have a lot of costs that we need to work through through the integration.

Okay. Thank you guys for taking my questions.

Christopher Glynn, Oppenheimer.

Thanks. Good morning. Hey, I'm just wondering what the $1.9 million of scrap in inventory costs and the $2.3 million sequential increase in the stock comp, to what extent was that considered in guidance when it was first issued?

None of the $1.9 million of scrap and obsolescence was -- certainly a portion of the stock comp expense was considered in the guidance. You may recall we did guide towards higher SG&A spend in Q2 related to that stock comp issue, but it ended up being a bit higher than what we thought. As well, there were a few other smaller items that contributed to higher SG&A in the quarter, but we would expect those issues to normalize in Q3 and Q4.

Okay. Thank you for that. And electronics seem to clearly be getting a nice component of relative strength from your commercial win rates. So as we approach tougher comparisons in the fourth quarter and into 2015, wondering what these wins give you in terms of sustainability in growth as the comps really change pretty dramatically.

Yes, so it's a good question. Certainly, the last three quarters or so, we've had some tailwinds in the electronics business. And as we know, having been through a few cycles here, those don't continue forever. So at some point, we're going to start facing some tougher market conditions.

And what we've said historically, what we've said in the past and I think -- I don't think we've really changed our view of that, is the overall electronics business probably is -- it's not going to be a double-digit growth business, and it's not going to be a high single-digit growth business. It's going to probably be at best kind of a mid-single-digit growth business over == through the cycle and over the longer term, and maybe even a little bit below mid single digits. I think a little bit higher on the semi conductor side, probably a little bit lower on some of the fuse and other more mature products. So we've been doing a lot of things right recently, and we've got a lot of momentum, and so for a while, we may be able to continue at higher than normal growth rates. But eventually I think those are going to normalize to something more like mid single digits.

Okay. Thanks. And then just lastly, if you could comment how your acquisition pipeline is looking?

So, yes. The acquisition pipeline, we've got a number of projects that are active right now. We have some smaller ones. We have one that I'd characterize as more midsize, and then we even have a larger one that's a potential recent opportunity. I would not say any of those are imminent. We are working on the number. We are still optimistic about the funnel that we have. But it's certainly not a certainty that we're going to close deals between now and the end of the year, but we have a number of them that we are working on and we still feel pretty good about the whole overall M&A program. Were we not to close another deal at the end of the year, before the end of the year, we would end up at about a 13% year-over-year growth rate which would be a couple points below our target. So we do have a little bit of work to do to hit that target for the year and to stay on track with our 15%.

Great, thank you.

Tim Wojs, Baird & Company.

Hey guys. Good morning. Just I guess turning back to auto a little bit, the incremental margins there over the last couple of quarters have been kind of low to mid teens. And so just given the content wins and the growth you've seen there, how should we think of incremental margins going forward? I know you have some cost savings in 2015. Just some color there would be helpful.

Yes, certainly the sensor area is where we have the biggest opportunity to improve margins, but that's going to take -- we've said that a lot of those -- we'll have some savings next year, a lot of those savings will be out in the 2016 timeframe. But I would expect to see better margins in the second half of this year than what we saw in the first half even though volumes -- seasonally, volumes tend to be a little bit lower second half versus first half. And we are expecting that will most likely be the case this year as well. But even with that, I think we should see some margin improvement in part because of some of the one-time items that we referred to that hit us in Q2, in part because we will start to get some benefit from some of the recently announced restructurings that we did.

So, we will see some modest improvement there, but the big improvement in automotive should be out in the 2016 timeframe. But I would expect, over the next year and a half or so, two years, until we get there, that we would be printing margins at least closer to 15% to 16% rather than the 13%, 14% that we've seen in the last couple of quarters.

Great, okay. That's really helpful, thanks. And then I guess just on -- it looks like you upped your free cash flow guidance a little bit and I think CapEx is down a little, but I'm just curious what the drivers were there, if it's just working capital and if that I guess is sustainable going forward.

Yes, I think we continue to generate a lot of cash. I think the guidance that we gave would be pretty much on target with kind of the long-term cash generating capability that we have alluded to in our investor presentations, 12% to 14% of revenue for free cash flow. This would put it right in that range, the most recent guidance.

So, yes, we did back off on our CapEx a little bit. Just I think that's more of a timing issue. So that was part of the reason that the guidance is a little higher. Plus we had a pretty good second quarter for both operating cash and free cash. So, I would say we incrementally moved the guidance up just because we are a little closer to the end of the year and we had a good second quarter. And we have pulled back a little bit on our CapEx projection for the year.

Okay. And then I guess it sounds like the pipeline on the M&A side sounds pretty healthy, but then at the same -- on a different side, you actually bought back some stock this quarter. So, I guess is it possible, I guess the change in cadence by you guys in terms of can you do stock buybacks at the same time you're looking at M&A? Is one exclusive -- can you do one relative to the other, or do you think you guys can actually do both?

We said all along that we could do both, but we've also said that stock buyback will be very opportunistic. So I think, as we see dips in the stock price that we think are opportunities, we certainly have enough balance sheet capacity and free cash flow to do I wouldn't say large stock repurchases, but small to mid level stock repurchases. But we will be opportunistic about when we do that. But we absolutely do have kind of plugged into our overall model some stock repurchase kind of over the five-year time horizon alongside a more aggressive M&A strategy and certainly our cash flow and balance sheet can support that.

Great. thanks for the color. I appreciate it.

Gary Prestopino, Barrington.

Hey, good morning everyone. Most questions have been answered, but it looks like the tax rate was down a couple hundred basis points year-over-year. And what kind of tax rate should we use for modeling purposes?

Yes, it's a good question. We have historically said use somewhere between 25% and 26%. It's now looking for the year like the rate is probably going to be a bit below 25%, but I think I would, at least at this point, I would model the out quarters probably at something around 25%. Hopefully, we could do a little bit better than that, but that's probably a conservative number. And we will be talking about this more as we get further along, but we think there are some opportunities to bring that tax rate down over the next couple of years, even a little bit below where it is today. We are working on some planning things that might allow us to do that as well as bring back some cash. So we'll talk more about that as we get further along on some of those initiatives.

Okay. And then just lastly, the gross margin looked like it was down about 160 basis points. Some of that is attributed to the high scrap and inventory charge, correct?

Yes, most of it.

What about was there any of that increase in stock comp put into that cost of goods sold number?

There would be a very little bit but the majority of that shows up in SG&A.

Okay. Thanks.

[Gary Noriem], [Palisades] Capital.

I remember I think back to the analyst day in the electronics side at Samsung, is it a reasonably sized customer for you guys? I feel like I've heard some recent commentary that their supply chain has slowed down a little bit. Is that anything -- how can I understand that, how that may impact you guys?

It's, as we've said, a significant customer, but our business is really built around -- there's no one customer that's really so significant. There's lots of new applications. I talked about the Universal Charger application as an example that we will expect to sell across the whole market segment. So, I think the tablet market was characterized in the second quarter by the announcements that the iPad went backwards. But Samsung was flat and it was a complete change that Lenovo and lots of low-priced tablets were really gaining market share. So, I think the market is always changing, and one key customer doesn't significantly impact our business. We had a very successful electronics business across a whole range of customers. So, I wouldn't say we are really impacted much by that or concerned by it. It's still a good customer for us across multiple segments.

Great. And then just secondly, switching gears to the automotive side, broadly speaking, it seems like there's perhaps an acceleration in trends to hybrid and electric from where I sit. I was curious. What you guys are seeing on that side of things?

I think that's very true. I think that's what we see, more adoption of all electric vehicles and certainly hybrids. It's still a very small percentage of total cars, so we tried to play that down a little bit because although we have much more content per vehicle in a hybrid or all-electric vehicle, it's not significantly moving the dial for our automotive performance. The vast majority are still gasoline or diesel powered engines, and the content play that we have, as I explained, and the electrical architecture in vehicles are really significant for us. So, I think, in the out years, hybrid volumes may get to a level where it's something we would attribute to our performance, but at the moment it's still a relatively small amount.

Great. Thanks so much.

You're welcome. I think we might have time if there's one last question in queue, but I think we are coming up to one hour and about to end the call.

Edison Chu, G2 Investments.

Good morning guys. I just want to go back to some of the comments you made within the electronics bookings trends. And can you -- the slowdown towards the end of the quarter, would you characterize that as very atypical? And I guess when you look forward to -- and can you comment on how things have looked in July? I'm just trying to get a little bit more color on your thoughts on why the slowdown in bookings? And if it's been broad-based, is it relegated to specific end markets? Any other color would be helpful.

I think it's actually quite typical that around this time of the year, probably starting in somewhere in June and July, you would start to see those order slowdown as we approach kind of the peak months for some of the consumer builds. And usually most of those orders get placed in kind of the March/April time frame. And as we start to approach the summer months, we almost always see a drop in our book-to-bill ratio, and it's typically below 1 for the third quarter. So nothing particularly surprising there.

Probably the only thing that was a little surprising is that it was 1.08 for the second quarter, which is above normal. But I think, as Gordon said, most of that over-performance happened early in the quarter, and it get weaker as we would've expected as the quarter went on.

Okay, thank you. And a quick second question on just thinking about modeling of cost of goods for the September quarter. And it sounds like the obsolete inventory charges of $1.9 million shouldn't repeat in the September quarter. I just wanted to make sure you also have a full benefit of that $1.5 million in cost savings from the Hamlin renegotiations. Is that reasonable?

Yes. We will get a full quarter of that. $1.5 million, that's an annual number. Right? So --

That's an annual number, okay.

Yes, yes.

Okay. All right, that's all I had. Thank you very much.

Okay, thank you for joining us on today's call. With a 19% increase in sales and strong increase in earnings in the first half of the year, we believe our overall performance has been very solid, and we look forward to updating you again next quarter. So thanks, and have a good day.

Thank you, ladies and gentlemen. This concludes today's conference. We thank you for participating. You may now disconnect.