Gordon B. Hunter - Chairman, Chief Executive Officer, President and Chairman of Technology Committee Philip G. Franklin - Chief Financial Officer, Principal Accounting Officer, Senior Vice President and Treasurer.

Gausia Chowdhury - Longbow Research LLC Matthew Sheerin - Stifel, Nicolaus & Company, Incorporated, Research Division John Franzreb - Sidoti & Company, LLC Christopher Glynn - Oppenheimer & Co. Inc., Research Division Timothy Wojs - Robert W. Baird & Co. Incorporated, Research Division Gary F.

Prestopino - Barrington Research Associates, Inc., Research Division Garo Norian - Palisade Capital Management LLC Edison Chu.

Good day, everyone, and welcome to the Littelfuse, Inc. 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 on the news release we issued this [ph] 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 will turn the call over to Phil who will give the Safe Harbor statement and a brief summary of the news release..

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 2 years, we repurchased shares during the quarter as we took advantage of the mid-quarter pullback 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 electronic 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're 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 during 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 is also being 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 lead times, but we've 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 focused 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 charges 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've 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 newest software that also requires better hardware. Several quarters ago, we talked about our early successes with wearable technology.

We've continued to focus on this market segment and recently achieved another design win for a leading fitness tracker company based in the U.S. 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 into these consumer products, the need for ESD Protection continues to grow.

During the second quarter, we won new business for our semiconductor ESD product in the gaming, security and appliance segments, totaling $1 million in annual revenues. We're also seeing more design opportunities and growth in white goods and small home appliances, and 2 recent wins with a leading U.S.

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. 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 2 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 to 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're also working to get the Hamlin product to prove at the same customer. And finally, I'll focus on LED lighting 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 lighting 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 lighting 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. And 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 axle sensors remained strong, and commercial vehicle product sales continued 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 truck program and the Chrysler 200 midsized 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 used 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 overstocking. 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 a 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 2 Masterfuse applications for the GM D2XX compact vehicle platform with a Tier 1 supplier in Korea.

This program will contribute $1 million per year in sales when it ramps up. Another win is for a BF inline fuse for Volkswagen at various Tier 1s in Europe. Peak volume for this win is in 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 vehicles segment, we have 4 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 projects for our ZKS Master Fuse and other high-voltage fuse programs.

An 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. A higher voltage allows for smaller cables, which, in turn, reduces weight and lowers costs.

We've 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 continued 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 U.S.

This program will generate sales of over $1 million per year at a 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 comp 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 of developing innovative new products and expanding beyond the North American market. Shipments of 2 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 3 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 remained 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 Hall effect technology sensor that measures gearshift to 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.

And 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 continue 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 includes 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, 7 of our potash customers have reported their production has been increasing, and they're approaching normal operating capacity levels. We've 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 are selling to 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 the first order 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 billion 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 dangers of electrical shocks.

So while mining remained soft and the electrical business was impacted by the factors mentioned earlier, we're 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 on 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've 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 a third quarter outlook, and then we'll 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 is 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'd like to open it up for questions..

[Operator Instructions] The first question comes from Shawn Harrison from Longbow Research..

This is Gausia calling on behalf of Shawn. I was wondering, within the electronics business, it looks like you beat your old operating margin record. How should we think about that about -- for the second half of this year and going forward? Is it sustainable? How -- so if could you provide some more color on that..

Yes. I would expect that the gains we've made in operating margin certainly as we look at the back half of the year, those should be sustainable improvements.

Now I think that the -- obviously, the steady improvement that we've seen over the last several years, as those margins get well up into the 20s, that it becomes harder to see those margins go higher and higher.

But certainly, for the next several quarters, which is about as far as we can see at this point, I would expect to see similar margins as we've seen in the prior 2 quarters..

Okay, great. And then 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 -- I mean, the only new announcement this quarter was that we did some restructuring of the labor agreement down in that Hamlin Mexico plant that it was going to allow us to save somewhere in the neighborhood of $1.5 million a year, and those savings will start in Q3.

We -- as we've 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're quite a long way from that right now. So the restructuring we announced in the quarter will be a start, but there'll be more actions to come there.

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

All right. And 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, that -- we've finished those. And those are -- that's done, and those savings will occur..

The next question comes from Matt Sheerin from Stifel..

A question on the electrical business, Gordon. You talked about returning to growth this year. Obviously, with the first 2 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're seeing a recovery in end markets related to weather and other issues? Or are there new programs ramping there, too?.

Well, there's 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 would -- 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 1 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, they were very highly tied to the Canadian potash mining. We did have some success in diversifying that, as I mentioned in June, shipping into the Canadian oil and gas market some product. But we expect the potash mine 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, 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 in the 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 has held up so well. It was really a 1-quarter anomaly that we expect to be recovering from..

Matt, you had alluded to double-digit sequential growth in the next 2 quarters. I don't think I would expect that. I mean, 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-digit. It's not going to be double digits..

Okay, well, yes. Okay, but like 8% to 10% growth will still you 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'll be approaching that anyway. [indiscernible].

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

Yes. I don't -- I think he might have been alluding to a specific part, maybe the construction section....

Yes, construction..

Which only affects us, so....

Oh, I got you, got you. Clarified. Okay, okay, that's helpful. And then on....

Wait, let me just -- a bit, Matt, just one other point, so I'll just add one other thing. So we -- and 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 onetime and nonrecurring issues.

So I do expect the margin -- a meaningful margin improvement in Q3 and Q4..

Okay, that's helpful. And then on the electronics business that you talked, looked like there was a little bit of inventory build at customers and which is one reason why you're calling for sort of flattish this quarter when it's typically up.

But -- and you, in terms of what you're seeing in terms of point of sale and sell-through and bookings within the channel, do you still -- are you still seeing sort of seasonal trends instead of -- in terms of sellout?.

Yes, well, I think we're very much in control of that. I think 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 got towards the end of the quarter, it was really softening a little bit.

So I think we are going to see more of -- I think we had a particularly strong second quarter, extremely strong second quarter. We expect it to be more similar in the third quarter. But certainly, the inventory levels and the sell-through, I think, are very healthy.

I think we're -- year-over-year, we'll be very healthy again in the third quarter but just probably not going to see the usual jump from the second quarter to the third quarter..

Okay. And just lastly if I may, just regarding the issues you had with the 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. 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're through those, and we are also expecting improvement in overall performance in the plant. So I'd say largely, those issues are behind us.

As well, we had a -- and those issues affected both electrical, and there was 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 inventory charges related to the downturn in the mining industry.

And that would have 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 have been a lull against the electrical business. So electrical was 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're behind that..

We would not expect those issues to reoccur in Q3 and 4..

We have a question from John Franzreb from Sidoti & Company..

Just to stick on the electrical theme here, you alluded to the fact that, x the items, that the margin be much improved.

Can you give us a sense, Phil, what the up margin would have been in electrical x all those onetime puts and takes?.

Yes, I mean, it still would have 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 margins.

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 that 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 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're starting to see more activity in potash, but -- activity and 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. Sounds like you had some nice new sensing applications in the auto side of the business. I guess 2 questions here.

One, is the margin profile in the sensing business significantly above the margin profile of the "legacy" auto business? Or are you seeing some kind of price pushback on -- when you roll out new products in sensors in the auto side?.

Generally, I mean, at this point, as we've said, the margin profile is lower for sensors than it is for our legacy automotive business. We're -- with some of the actions that we're 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.

And the other thing that's going to help is 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. And 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, even -- well, on the newer products, they are as well. Although if you look at it on a variable basis, we have -- 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..

The next question comes from Christopher Glynn from Oppenheimer..

I was just wondering with 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. We -- you may recall, we did guide towards higher SG&A spend in Q2 related to that stock comp issue. But it was -- 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, so -- but we would expect those issues to normalize in Q3 and Q4..

Okay. And electronics seemed 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 '15, wondering what these wins give you in terms of sustainability and growth as the comps really change pretty dramatically..

Yes. So yes, it's-- I mean, it's a good question. Certainly, we've -- the last 3 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 said historically -- what we said in the past, and I think -- I don't think we've really changed our view of that, is that 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 the -- 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 semiconductor side, probably a little bit lower on some of the fuse and other more mature products.

So that -- 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. And then just lastly, if you could comment how your acquisition pipeline is looking..

So yes, the acquisition pipelines, so 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're working on the number.

We're 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're working on, and we still feel pretty good about the whole -- the overall M&A program.

Were we not to close another deal at the end of the year -- before the end of the year, we'd end up at about a 13% year-over-year growth rate, which would be a couple points below our target. And so we do have a little bit of work to do to hit that target for the year to stay on track with our 15%..

The next question comes from Tim Wojs from Baird & Co..

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 areas where we have the biggest opportunity to improve margins, I would -- and -- but that's going to take -- we've said that a lot of -- we'll have some savings next year. A lot of those savings will be out in the 2016 timeframe.

But we -- 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 may not -- seasonally, volumes tend to be a little bit lower second half versus first half. And we're expecting that that'll 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 onetime items that we referred to that hit us in Q2, in part because we'll start to get some benefit from some of the recently announced restructurings that we did.

So we'll 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 1.5 years or so, 2 years until we get there that we'd be putting margins at least closer to 15% to 16% rather than the kind of 13%, 14% that we've seen the last couple of quarters..

Great. Okay, that's really helpful. 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 mean, I think that we continue to generate a lot of cash. I think the guidance that we gave would be pretty much on target with kind of a long-term cash-generating capability that we've alluded to in our investor presentations, 12% to 14% of revenue from free cash flow. This would put it right in that range, the most recent guidance.

So yes, I mean 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 were a little closer to the end of the year, and we had a second -- 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 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 that you're looking at M&A? Is one -- can you do one relative to the other? Do you think you guys can actually do both?.

I think we've said all along that we can do both. We -- 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 midlevel stock repurchases. But we will be opportunistic about that when we do that.

But we absolutely do have kind of plugged into our overall model some stock repurchase kind of over the 5-year time horizon, alongside a more aggressive M&A strategy. And certainly, our cash flow and balance sheet can support that..

The next question comes from Gary Prestopino from Barrington..

Most questions have been answered, but it looks like the tax rate was down couple hundred basis points year-over-year.

And what kind of tax rate, Phil, should we use for modeling purposes?.

Yes, so it's a good question, Gary. And we've 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'd model the out quarters probably at something around 25%.

Hopefully, we could -- we can do a little bit better than that, but that's probably a conservative number. And we'll be talking about this more as we get further along. But we think there's some opportunities to bring that tax rate down over the next couple of years, even a little bit below where it is today.

We're 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? And....

Yes, most of it..

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

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

The next question comes from Garo Norian from Palisade Capital..

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

Is that anything that -- how can I understand 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'll 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 -- and Samsung was flat, and there 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 have a very successful electronics business across a whole range of customers. So I wouldn't say we're 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, I mean, it seems like there's perhaps an acceleration in trends to hybrid and electric from where I sit.

I was curious, what are you guys seeing on that side of things?.

I think that's very true. I think that's what we see, the more adoption of all electric vehicles and certainly hybrids.

It's still a very small percentage of total costs, so we try to play that down a little bit because although we have much more content per vehicle in a hybrid or electric vehicle, it's not significantly moving the dial for our automotive performance. The vast majority are still gasoline- and 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, they get to a level where it's something that we would attribute to our performance. But at the moment, it's still a relatively small amount.

I think we might have time if there's one last question in queue, but I think we're coming up to 1 hour and about to end the call..

The last question will be from Edison Chu from G2 Investment..

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 -- or -- and can you comment on how things have looked in July? And 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 June, July, you'd start to see those orders slow down 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 timeframe.

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. I mean, the -- 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 overperformance happened early in the quarter, and it got weaker as we would have expected as the quarter went on..

Okay. And quick second question on -- just thinking about modeling the 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 want to make sure you also have a full benefit of that $1.5 million in cost savings from the Hamlin renegotiations.

Is that so?.

Yes. That'll -- we'll get a full quarter of that $1.5 million. That's an annual number, right? So....

It's an annual number, okay..

Yes, yes..

Okay. Well, 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..