Good morning, ladies and gentlemen. Welcome to the Littelfuse Third Quarter 2023 Earnings Conference Call. [Operator Instructions] And now at this time, I would like to turn the call over to the Head of Investor Relations, Mr. David Kelley. Please go ahead, sir.

Good morning, everyone, and welcome to the Littelfuse Third Quarter 2023 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 third quarter, and a copy of our earnings release and slide presentation is available in the Investor Relations section of our website. A webcast of today's conference call will also be available on our website. Please advance to Slide 2 for 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 Forms 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 on the Investor Relations section of our website. I will now turn the call over to Dave.

Thank you, David. Good morning, and thanks for joining us today. Before I begin, I would like to welcome our new Head of Investor Relations, David Kelley. I expect many of you already know David from his prior role in equity research at Jefferies, where we were part of a sell-side coverage. David brings a strong understanding of our business and industry and we'll continue fostering strong relationships with our investors and delivering valuable insights as we continue to drive the growth in shareholder value. Please join us in extending a warm welcome to David. With that, let's start with a summary, Slide 4. Our global teams delivered solid Q3 results as both sales and earnings exceeded our prior guidance. Our performance reflects strong execution, ongoing diversification and favorable content momentum within a continued challenging macro environment. We're pleased with our overall performance, yielding strong year-to-date profitability, despite the ongoing channel destocking and pockets of end-market softness were significantly improved, our financial performance versus past market cycles. This reflects our resilient business model and continued strong underlying fundamentals on Slide 5. Secular growth themes, including sustainability, connectivity and safety continue to drive our organic growth trajectory. Our recent acquisitions have further balanced our end-market exposure while complementing our diverse technology capabilities and expanding our market leadership. We remain well positioned to deliver on our long-term strategy. And I want to thank our global teams for their unwavering commitment and persistent hard work. Let me start with a view on what we are seeing across our markets. Through the third quarter, we continue to see inventory destocking across our electronics and commercial vehicle distribution channels. Our electronics book-to-bill remains below 1. And while we have limited visibility, we also believe some of our OEM customers are working through inventory reductions. While…

Thanks, Dave. Good morning, everyone, and we appreciate you joining us today. Please turn to Slide 10 to start with our third quarter results. Revenue of $607 million exceeded the high end of our guidance, as we continued working through backlog and supported several customer product launches. Revenue was down 8% and down 11% organically versus last year. Acquisitions and foreign exchange added 3% of growth. GAAP operating margins were 15.4% in the quarter. Adjusted operating margins were 16.5%, while adjusted EBITDA margins finished at 22%. GAAP diluted earnings per share in the quarter was $2.30. Adjusted diluted EPS was $2.97 higher than our projections driven by our stronger sales performance. Our GAAP effective tax rate was 23.3% and adjusted effective tax rate was 20%. We've continued to be prudent in spending while furthering investments in high-growth opportunities for our future pipeline. We're pleased with the resiliency of our business and operating execution across multiple vectors, resulting in year-to-date adjusted operating margins of 17.4%, and adjusted EBITDA margins over 23%. The strength of our business model also shined this quarter, as we generated $162 million in operating cash flow and $140 million in free cash flow. Year-to-date, we generated $250 million in free cash flow, a 115% conversion rate to net income. We are ahead of last year despite lower cash earnings, a testament to our ongoing focus on inventory and overall working capital management. We've reduced our own inventory $66 million so far this year, and lowered inventory days on hand by 15 days. With our typical fourth quarter seasonality, we expect another strong quarter of cash generation, aligned to our full year target of 100% free cash conversion as a percentage of net income. We've also maintained our net debt-to-EBITDA leverage at 1.4x, continuing to provide ample capacity…

Thanks, Meenal. Before we wrap, I wanted to highlight some additions to the Littelfuse Board of Directors as we continue to refresh our Board, adding diverse, talented and capable business leaders. Dr. Greg Henderson joined the Board earlier this year. Greg is Senior Vice President of the Automotive and Energy, Communications and Aerospace Group for Analog Devices. He's a seasoned global public company leader with extensive technology experience across the broad range of end markets we serve. His comprehensive technical expertise, management experience will make him a great addition to our Board. Gayla Delly also recently joined our Board. Gayla was CEO and member of the Board of Directors of Benchmark Electronics before retiring in 2016. Gayla's Board leadership and broad management experience across companies operating in a diverse set of end markets, will complement our Board. Her track record of driving growth with market expansion while delivering financial performance will be beneficial as we execute our growth strategy. We're pleased to add both Greg and Gayla to our Board. In summary, on Slide 16, our solid year-to-date performance and the challenging macro environment reflects our resilient and increasingly diversified business model. While our financial results will be impacted in the near term from continued market challenges, we expect to return to growth during 2024. We remain confident in our ability to deliver long-term shareholder value. As we continue to target double-digit sales and EPS growth, we believe our projected 15-year sales and EPS CAGRs of 10% and 18% exemplify our execution track record through multiple cycles. And with that, I'll now turn the call back to the operator for Q&A.

[Operator Instructions] We'll go first this morning to Luke Junk at Baird.

First question, Dave, just wanted to gear off the comment that you ended with -- you expect to return to growth in 2024. And I just want to align that with the destocking you're seeing in the business right now. I guess in our survey work, we're picking up on the fact that shorter lead times are hurting distributor order placements right now, maybe a little mixed inventory end customers as well. Just curious how that lines up with your world view, and how long or maybe short these newer dynamics could take to digest if you're also seeing them.

Thanks, Luke. It's -- as always, the challenge and the question as we look at -- kind of the destocking, particularly in electronics, certainly for Littelfuse products, lead times have been down and come back down to normal for most product lines, for quite some time now. Some of our power semiconductor products are really just reaching that stage now, to coming to more normal lead time in the environment. What we've seen is our distribution partners, we look at their inventory and where they're carrying, month-to-month, we're seeing declining inventory and dollar inventory values at the distribution partners. So it's making steady progress. We just got to reach that stage where end customers adjust their ordering lead times to distributors, distributors get their inventories where they need them to be and then things start matching up again. And when we start matching up again, of course, then that will actually drive that return to growth, even if the end markets are reasonably flat, which we're hopeful that we'll begin to see some momentum in some of the end markets later next year. So that's kind of our best view of it.

Okay. Great. And then in your remarks, you mentioned that working on actions in transportation, in the commercial vehicle portion of that business specifically to reduce costs and optimize your product and customer mix going forward. Can you just comment specifically on what products and customers you're looking at there? And I appreciate the 1% sales headwind that you provided as well.

Sure. Yes. Just taking a step back, this is not necessarily anything new that we've done. This is something we do regularly within our portfolio and especially taking a look at acquisitions and making sure that we're focusing our resources and driving the value from the right areas of the portfolio. So we are focusing on the recently acquired Carling business, even though it's been a couple of years, this is an area where you recall back in 2022, we were really focusing on the customer backlog and really delivering and trying to meet expectations of customers out there. And now that we've gotten pass through some of that, we're really taking a look at really the entire portfolio we have through that acquisition, both from a product perspective and a customer perspective. And I'll just say there are select areas that we're starting with that are -- have come forward a little bit, and there's an opportunity for us to really improve the profitability of the portfolio. I remind you, this is stuff we've done in the past, as I mentioned, as an example, we talked about this a few years back when we looked at our automotive sensor portfolio, same type of thing. So this is just part of our playbook as we think about running the company.

And if I could just sneak one last question in -- Dave, if you could just comment on the -- sort of the backlog that you've been working through in terms of the semiconductor business in electronics and just how you see the backlog for the company compared to just point of sales demand and the fact that you'd highlighted maybe just some pockets of weakness in industrial.

Yes. We've been -- like a lot of companies, particularly on the semiconductor side, particularly for us in the power semiconductor side, there has been an extended lead times there for quite some time. And we've talked in the last couple of quarters how we've been working on that and showing improvements in throughput to be able to bring that sort of inventory level down or the backlog down. We had a really strong quarter in the third quarter in the power semi business, where we were able to clean up the vast majority of that backlog to kind of get into a more stable environment there on the power semiconductor business. So it becomes a bit business as usual. We're seeing some pockets where there's some softness. That's -- if you recall, that's a very heavy industrial customer base. So we've seen some softness there. But we also have areas where we're seeing strong growth from there. Some other industrial applications like renewable, we also have a medical business there that is quite strong right now as well. So although we see some of these kind of broader-based softness, there's these pockets. We've talked about it in the industrial side, where kind of broader-based industrials are beginning to slow, we're still seeing some growth driven out of these pockets of things like renewable energy, industrial safety and things like that, that help balance that. So it's a complex business with a lot of different end markets that we're serving. And it's actually part of the strength of the portfolio, is that we do serve many different applications we've targeted that helps to balance it a bit.

We'll be going next now to Matt Sheerin at Stifel.

A question regarding your guidance on profitability. It looks like -- just backing into operating margin, it's going to be down roughly 600 basis points -- I'm sorry, 300 basis points sequentially, down significantly year-on-year. I know that the negative volume leverage plays into that. But is there a pricing or other factors? Because it looks like that the margins will be basically where they were during the pandemic, so the lowest in 4 years. So does this mark the bottom in terms of margins? Or are there other things at play here?

Thanks, Matt. Good question. So what I would say is, and we've talked in the past, for us, sales volume tends to be a pretty large driver for us in terms of margin profile as you look quarter-over-quarter, especially when you have near-term trends that are going on. So the case of the fourth quarter, as I mentioned in my prepared comments, with the sequential sales decline that we have, really the margin -- expected margin decline, and I'm not going to comment on the exact margin here. But the expected margin decline really is a function of that sales volume. As I take a step back and think about our overall margin expectations for '23 compared to past cycles, we get reminded a lot of times of what life is like in '08, '09, where our margin profile was sub-10%. And even during the pandemic period, the 2019 cycle, that '19 to '20 period, our margins finished off at about 14.5% or so. And so our expectation is, with all the work that we've done in the past few years from an execution perspective, from a pricing perspective, portfolio diversification, I expect that we will finish better than that margin profile for 2023.

Okay. And could you talk about the pricing environment? I know you've had success in the last couple of years in terms of passing along higher input costs. Are you seeing pressure the other way here?

Yes, Matt, I think the pricing environment, it's been -- we get question a lot on that and what we've seen, and I think it's kind of broad-based actually. It's not different than when I talk to our peers. Our distribution partners are seeing quite similar, that we do see pricing pressures, but the pricing pressures are more of a return to kind of our normal environment. The last couple of years have been abnormal, where we've been able to pass along the cost increases to our customers, and that's really driven pricing up meaningfully. We're not seeing that retrenching but we're kind of seeing a return to a more normal environment. The reality is, there's still a lot of cost pressures that we're dealing with, and we share that with our customers. So right now, what we see is, kind of the big increases that we had to make to cover the cost increases over the last couple of years are holding, but it kind of gets to return to that normal environment where you do lose over the course of the year, a couple of percent on the pricing side.

Okay. And just lastly, Dave, you talked about demand in China auto being a little softer. Could you talk about your position there with China OEMs, local OEMs versus international OEMs and content trends, anything positive or negative going on there?

Yes. Actually, our comments were that our third quarter was quite strong in China. There were preparations for a lot of platform launches. As you may know, well, the Chinese OEMs have lots of platforms. And as they're launching those, we have a strong position both with multinationals, but also with the local Chinese OEMs. And with a lot of launches going on there, we had a very strong third quarter in China. Car build in China, we expect to be okay, not particularly strong going forward. But we feel pretty good about it. We've been open with the fact that on the high-voltage side, we expect we may not be able to maintain the same level of share with Chinese OEMs as we do on the low-voltage side, but we continue to have tremendous success on the low-voltage side and pockets of success with Chinese OEMs on the high-voltage side as well.

We'll go next now to David Williams at Benchmark.

First, congratulations to David on the new role there. Looking forward to working with you. And just kind of going back to the inventory situation, is there a way maybe to size the magnitude that you think it still needs to be digested across your end markets? And you talked about maybe this lasting into next year. But do you think this is the end of maybe 1Q or is it into the first half of the year? Just trying to get a sense on how big of an inventory destocking we have still remaining.

Yes. That's the question we wrestle with regularly as visibility is not perfect. Certainly, visibility to our distribution partners' inventory is quite good. But to their end customers, and that's maybe a difference we've seen a little bit in this cycle than what we've maybe seen in previous cycles, perhaps end customers carried a bit more inventory than they normally did. So that's impacted the speed at which our distribution partners, and we've been able to drive down the inventory and the channels. So it's not perfect visibility there. Clearly, we would say, if we look at our distribution channels in the Electronics side, we still have a few weeks of extra inventory there. So that kind of methodically will wind down as it's been doing. If we look at that, it's going to last well into 2024 unless something changes. Exactly when, we haven't been able -- we don't have the visibility to say, is it going to be in this month or that month. But we certainly expect we should be able to work our way throughout the first half.

Okay. Great. And then back to -- maybe to Matt's question, is just on the differential in content. If you look across maybe China specifically, as opposed to maybe your domestic customers, how should we think about the difference in content there? And then maybe how that plays out from an EV and an ICE vehicle? How -- what is that differential? And is it significantly higher in China versus domestically?

Yes. Kind of interesting mix there on content. If you take ICE vehicles, the content on Chinese ICE vehicles is approaching what we would find in the West these days, because the sophistication of the vehicles continues to grow dramatically and large drivers of growth where we're working are with pretty sophisticated vehicles. So on the low-voltage side, OEMs on the EV side, but it's a tough environment in China there. So perhaps our content in an EV in China may be a little lower than our content in an EV in Europe.

[Operator Instructions] We'll go next now to David Silver at CL King & Associates.

Maybe I'll just start with a question on your CapEx guidance. But if I'm correct here, I think the number you put out for full year now is maybe $20 million, $25 million lower than it was earlier. And I'm just wondering if you could maybe comment on that in terms of maybe -- pinpoint where discretionary spending is being reduced. And if you consider this maybe more of a delay rather than suspension or cancellation. So where would the shift be in your CapEx budget? And how do you expect that to progress maybe into 2024?

Sure, David. So yes, compared to, I think, back to the beginning of the year and the forecast we had on CapEx, we have brought that down. I think, a few things. One, to answer one of your questions, this isn't necessarily a permanent reduction in many -- in most cases, it's just delays. And it's delays because -- when we start out the year, we had a view on what we thought was going to happen to the year. Clearly, it started to move a little bit softer. We talked about volumes maybe coming down a little bit and/or extending a little longer than we thought. So where we have a lot of businesses that we're anticipating capacity adds during the year, they've said, "You know what, I think we can hold off a little bit, given where the volume trends are." And we'll look at moving some of that out into 2024. At the same time, we continue to spend for the growth that we have, the growth that we anticipate, other areas like health and safety, normal maintenance and even sustainability, right? There's a lot of things that we're doing around our manufacturing and supply chain footprint around improving the energy usage, the water usage, especially when we think about new equipment. So for us, those investments matter. They're important to our customers and important to our employees, and they're important to our profitability as well. So no big shifts other than just a little bit of a delay given the macro environment.

Okay. And this is a question that has come up, I guess, with a couple of my other -- kind of electronics components-related companies. But the company's, and I think I heard some parallels in your opening remarks. So here goes. But they did draw a pretty sharp contrast between, on the one hand, continued healthy activity on the new contract wins or the new design front. But then the sluggish -- relatively sluggish demand for maybe legacy products in various end markets. And I was just wondering if you could maybe comment on that, and maybe think about it in terms of what you're hearing, which you mentioned earlier from your distribution channel. In other words, do you interpret the softness in distribution business now as something temporary? Is it something where customers are becoming more price-related? Is it cyclical? I mean, are customers waiting for the next-generation products and some of that demand might -- just might fall off due to obsolescence? But in serving the current softer markets, do you draw a pretty clear distinction between healthy activity at the leading edge versus persistently soft markets this year for serving current end markets? Sorry about the long-winded question.

Yes. No. I understand the nature of the question. Our design activity, kind of across the Board continues to be extremely robust. And certainly, in electronics, we have a great deal of design activity in many, many different end markets. So we don't see any signs of any kind of slowing of activity on designing in new products, designing in new applications. We see that extremely robust right now. So that's a healthy indicator for kind of the medium term and certainly long term for us. We see that. We've talked about the fact that there are pockets of end markets within Electronics that have been down for a while. So think of personal electronics, consumer electronics, so kind of customer-facing things like small appliances, PCs, tablets. Those markets have clearly been down. We've heard from some others that perhaps they're seeing the bottom of some of that, that some of the kind of advanced semi chip guys who are serving some of those markets are beginning to see that they think that's bottoming out a bit, which is -- certainly, we welcome that, that would be good news to see that kind of bottomed. The bulk of our challenge is the digestion of the inventory and the supply chain. That is the primary story that we've just got to work our way through. And as we get through that digestion, and we will naturally, just mathematically, of course, see a return to growth because we'll balance off between orders in and orders out. And so that in and of itself will start to show growth for us. And with the healthy design in activity and things like that, then the real growth comes when you start seeing an uptick in demand beyond that. So we still remain pretty bullish.

Okay. Great. And then just a quick one. I usually hate to grab a question from the headlines. But it's hard to ignore, I guess, a couple of high-profile labor negotiations in recent weeks, maybe the last couple of months, and whether it's the auto workers or the truck drivers, et cetera, has there been any change in your thinking about, kind of your overall labor situation for skilled industrial workers? Or how does that -- just that general environment of labor was cost and availability, how does that factor into your thinking about next year?

Yes. We don't have any kind of unusual situations from a labor perspective. We have labor pretty balanced across different regions of the world that we've had long-term positions within. We work very hard to be -- kind of the favored employer wherever we're at, and we have a great reputation in those spaces. We invest heavily into the communities where we work. And so we usually have a pretty good balanced kind of relationships there, and I don't see anything unusual. Obviously, the UAW strike had an impact -- a modest impact on our third quarter and has -- good news is it seems to have been winding down now, but it will -- even that will have a modest impact on our fourth quarter as well. But we don't see that as an overarching concern.

We'll go next now to Joshua Buchalter at TD Cowen.

Let me echo the congrats and good luck to David. I wanted to ask about inventories as well. So I totally appreciate that trying to time or quantify things in the channel is difficult, but I wanted to ask about your on-book levels. In your prepared remarks, you called out some good progress year-to-date. I was wondering, is there a target level that you'd like it to be? Because I still see it's over 100 days now and pre-COVID, it used to run sort of in the 80 to 90 days range. I just want to be -- curious how you're thinking about the level you'd like on-books inventories to be and how we should think about that as we contextualize the channel inventory as well.

Yes. That's a great question, Josh. As you mentioned, we made really good progress this year on inventory reductions. As I've been talking about the past few quarters, that's been a huge working capital focus area for us, and that's been a nice tailwind as it relates to our cash generation this year. We are running at about 115-ish days or so of inventory on hand, but they are targets somewhere 100, maybe a little bit more than 100 days of inventory on hand. The biggest change for us versus the reference point you mentioned is, as our business has evolved versus pre-pandemic times, there's different mix, some of which have longer lead time. And as we continue to grow our OEM-related business, where we're holding a lot of our own inventory also that adds a little bit more. So I would say, our target may be a little higher than historical, but at the same time, we've got more progress that we can make that's going to help us from a cash generation, still going into the end of the year and going into 2024. So I'm pretty pleased with where we are, the progress we've made and where we're heading. I think our teams have done really a tremendous job on managing through some really challenging market dynamics.

I appreciate all the color there, and you actually teed up my follow-up pretty nicely. You called out softness in consumer and personal electronics, but it's sort of stabilizing. Could you remind us of, within your electronics segment as we sort of think about this inventory digestion, the exposure between things like consumer, personal electronics, datacom and industrial and automotive. Anything you can help us quantify, it would be great.

Yes. What I would say is, on kind of the consumer facing the consumer electronics side, that's around 20% or less of our electronics business or if you think about it corporately, it's less than 10% corporately. We don't really break out industrial within electronics, specifically. But keep in mind, our power semiconductor business has a heavy industrial piece to that, and some of the core electronic as well. So it's a meaningful portion. In fact, we've talked about from an end-market exposure as a company, although we have our reporting segments, which are technology-based, kind of keeping in mind that we have about 1/3 of our revenues that are targeting -- that are ending up in the transportation space, and that's kind of split 50-50 between commercial vehicle and pass car, about 1/3 in traditional electronics and about 1/3 in traditional industrial applications. So hopefully, that helps to give you a little color.

[Operator Instructions] And it appears we have no further questions this morning. Mr. Kelley, I'll hand things back to you for new closing comments.

Thanks, Bo, and thanks, everyone, for your questions. That concludes our Q&A session. Thank you for joining us on today's call and for your interest in Littelfuse. We look forward to speaking with many of you at the November 8, Baird Global Industrial Conference and the November 9, Stifel Midwest One-on-One Growth Conference. Have a wonderful day. Thank you.

Thank you, Mr. Kelley. Again, ladies and gentlemen, that will conclude the Littelfuse Third Quarter 2023 Earnings Call. Again, thank you so much for joining. I wish you all a great day. Goodbye.