Earnings Call Transcript - LFUS Q2 2022

Operator, Operator

Good day, everyone, and welcome to the Littelfuse, Inc. Second Quarter 2022 Conference Call. Today's call is being recorded. All participants will be in listen-only mode. After today’s presentation, there will be an opportunity to ask questions. At this time, I will turn the call over to the Head of Investor Relations, Trisha Tuntland. Please go ahead, ma'am.

Trisha Tuntland, Head of Investor Relations

Good morning, and welcome to the Littelfuse second quarter 2022 earnings conference call. With me today are Dave Heinzmann, President and CEO; and Meenal Sethna, Executive Vice President and CFO. Yesterday, we reported results for our second quarter, and a copy of our earnings release and slide presentation is available in the Investor Relations section of our website. A webcast of today's conference call will also be available on our website. Please advance to Slide 2 for our disclaimers. Our discussion 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 in the Investor Relations section of our website. I will now turn the call over to Dave.

David Heinzmann, President and CEO

Thank you, Trisha. Good morning, and thanks for joining us today. Let's start with Slide 4, which provides an overview of recent highlights. We delivered very strong second quarter results, which were above our expectations. Our continued outperformance within a volatile environment was driven by strong customer pull and the persistent operational excellence of our associates. We achieved revenue growth of 18% and expanded adjusted earnings by 25% compared to last year. Across our Electronics, Transportation, and Industrial segments, we attained double-digit sales increases, driven by demand creation for our broad range of products and our leverage of capabilities and resources from our recent acquisitions. Our first half double-digit sales and earnings growth is a testament to our global team's execution across the breadth of our end markets within the structural themes of sustainability, connectivity, and safety. Advancing our strategic initiatives on July 19, we completed our previously announced acquisition of C&K Switches. I am excited to welcome C&K to our organization. C&K significantly expands our ability to serve our customers with market-leading technologies, capabilities, and talent. Later, I will share more on the strategic rationale for C&K. Consistent with our capital allocation priorities, we have increased our quarterly cash dividend by 13%. This deployment reflects our confidence in the long-term growth of the business and commitment to return ongoing value to shareholders. I would like to thank our associates around the world for another great quarter. Our global teams have relentlessly overcome daily obstacles to fulfill customer demand while working safely. They have also shown their ongoing passion and commitment to advancing our sustainability initiatives across the organization, and we look forward to sharing our continued progress when we publish our report later this year. I'm particularly proud of our sustained success, which is an outcome of our highly skilled people and the innovative, reliable solutions we deliver to customers, which continues to differentiate our company. Moving on to performance within our segments. Our Electronics Products segment delivered revenue growth across all regions, along with strong profitability, driven by our diverse product offering and go-to-market strategy. In particular, demand for our products was driven by our customers' applications, enabling greater connectivity and sustainability, like factory and building automation, data centers, telecom infrastructure, energy efficiency, electrification of vehicles, and charging infrastructure. Exiting the second quarter, our combined Electronics book-to-bill was hovering around 1 with continued strength and sell-through from our channel partners. Average weeks of inventory at our distribution partners are at the upper end of the normal range. However, there are some pockets where inventory remains lean. Our Transportation Products segment delivered solid performance in a tough environment. Our passenger vehicle business was impacted by Tier 1s unwinding last year's inventory build and lower OEM vehicle production due to the ongoing material shortages, COVID lockdowns in China, and declining car build forecasts. Since 2019, our passenger vehicle business has grown high-single digits on a compounded annual basis, while global car production has declined high-single digits. We see a number of ongoing content growth opportunities with electrification, electronification, and ADAS and expect to continue our long-term market outperformance. Within our commercial vehicle business, we have a robust order backlog, driven by demand for our combined portfolio of legacy and Carling products, and our record revenue reflects our ability to fulfill demand. Notably, we have been able to drive strong output increases at our Carling factories. And as a result, we are realizing growth above our initial expectations for this acquisition. Looking ahead, we see a healthy backlog pattern with particular strength in demand for our Carling product groups, and our target markets continue to show strength across material handling, construction, and agriculture equipment. Turning to our Industrial Products segment. Our ability to cross-sell, expand solution sets to include multiple technologies, while enhancing operating efficiency and productivity delivered record revenue performance and strong profitability. We continue to capitalize on robust demand in our strategic markets across electrical safety, renewables, and HVAC. A large part of our success comes from enabling our customers' applications focused on sustainability, such as solar, energy storage systems, and charging infrastructure to support vehicle electrification. We are also seeing robust demand for general industrial electronics applications like data centers and cloud computing. Looking ahead, the underlying fundamentals within our strategic markets remain strong. Meenal will provide additional color on our strong financial performance and third quarter outlook. Our ongoing results and successes reflect both the strength of our team's execution and the power of our strategy which is shown on Slide 5. We are investing for growth, both organically and through acquisitions, within the structural themes of sustainability, connectivity, and safety. Since early 2021, we've deployed $1 billion in capital for acquisitions, adding approximately $500 million in annualized sales to further diversify and strengthen the end markets we serve and expand our organic growth opportunities. Building on our acquisition of Heartland Controls and HVAC, Carling Technologies and Commercial Vehicles, telecom infrastructure, and renewables, and Embed transportation and industrial applications, we are pleased to complete our acquisition of C&K, which serves a variety of end markets. We continue to make organic investments in the business to advance our new product development, capacity expansions, digital presence, and sustainability initiatives. We are confident the investments we are making will continue to deliver long-term profitable growth and returns for our shareholders. C&K brings over 90 years of experience to Littelfuse and is a leading designer and manufacturer of high-performance electromechanical switches and interconnect solutions, with a strong global presence across industrial, transportation, aerospace, and datacom end markets, as reflected on Slide 6. We are very excited about the addition of C&K and its close alignment with our strategic priorities. Our disciplined approach towards M&A positions us to accelerate our success in higher growth markets through diversification, expands our geographic presence, and leverages our core competencies, creating value for all stakeholders. Moving on to Slide 7. The combination of our companies significantly expands our technologies and capabilities enabling us to deliver a comprehensive solutions offering to our broad customer base. C&K enhances our technical and application expertise, engineering and designing capabilities, and our technology leadership in high-precision manufacturing, miniaturization, and actives. Our businesses are highly complementary and enable us to leverage our selective partnerships with distribution channels, OEM relationships, and global footprints, including expanded capabilities in India and Vietnam. The integration is underway, and we look forward to leveraging our respective strengths. Now let's move on to highlights and design wins in the end markets we serve. Within our Industrial end markets on Slide 8, we are generating new business with our applications knowledge and breadth of products. We are expanding our solution set focused on sustainability. During the second quarter, we secured business by delivering multiple technologies for large-scale and home-based energy storage systems. With a large scale battery manufacturer, our product was designed into battery formation equipment. In HVAC, we captured opportunities based on our customer relationships and cross-selling capabilities. Within industrial safety applications, new standards continue to drive elevated design activity to achieve compliance. With our reputation for engineering and reliability, we expanded our market position in commercial kitchens for electrical systems and buildings with a major restaurant chain and with a beverage equipment supplier. We also won business for welding equipment used in electric vehicle collision repair shops, motor drives, elevators, and industrial power grids. With our diverse high-quality offerings, we are increasing product content with leading customers and expect this to continue given their intensifying focus on sustainability and safety. Turning to our transportation end market on Slide 9, we are expanding our wins with the electrification of vehicle platforms. During the second quarter, our investments in engineering and new products allowed us to increase our positions across multiple applications within an electric vehicle, whether a hybrid or a full battery electric vehicle. Our early engagement, reputation for quality, and strong high-voltage technology portfolio secured several opportunities in battery management and protection, high-voltage power distribution, and onboard chargers or off-board electric vehicle charging; our technical support and product performance secured significant new business. With the global ongoing transition to electric vehicles, our company is playing a tremendous role in enabling our customers' applications, and we look forward to expanding our presence with them in this high-growth end market. For traditional passenger vehicles, we expanded our leadership with our wide range of products given the increasing functionality, complexity, and architectures. In Automotive Electronics, we won global business; our long-term relationships and reliability for telematics, infotainment, and comfort and convenience applications. In Commercial Vehicles, we captured business in our strategic end markets. With an existing European customer in heavy-duty trucks, our unique technical solution met stringent customer requirements, which won us new business. In electric buses, we secured a project with our high-quality Carling products. We are pleased with our early integration success. We see a broad range of sales synergies ahead of us. In electric two- and three-wheelers, we won business for battery management systems and powertrain control modules. For commercial vehicle charging infrastructure, we expanded our wins for forklift applications. With our investments for growth, including expanded capabilities and portfolios with the addition of Carling and Embed, we are seeing new business opportunities, which continue to position us well for continued growth within transportation applications. Moving on to Slide 10. Electronics end markets, greater connectivity requirements continue to drive favorable macro trends. During the second quarter, we won business for data centers and telecom infrastructure based on product features and delivery support. These wins also included products from our Carling acquisition based on a strong global presence in telecom applications. For Building Solutions, our far-reaching go-to-market model and deep portfolio enabled us to secure multi-technology business wins for security systems and smart doorbells. Our long-term engagement support and the ongoing push towards expanded efficiencies and safety drove wins in appliances and general-purpose electronics. The pipeline of new business opportunities is robust and further expanded with our completed acquisition of C&K. We look forward to building on our collective market positions with our various industry-leading brands. Our combined successes of winning business will serve as a platform for continued growth. We are extremely well positioned to expand the proliferation of our electronics content across a wide range of applications centered within sustainability, connectivity, and safety. Our new business wins have been significant and represent a diverse range of end markets and applications. We've also worked hard to build a robust pipeline of new business opportunities that I am confident we will secure with capabilities and differentiated solutions. We fully expect that the organic growth from all of our new business activities, coupled with our acquisitions, will enhance and sustain our long-term growth. I will now turn the call over to Meenal to provide additional color on our financial performance and outlook.

Meenal Sethna, Executive Vice President and CFO

Thanks, Dave. Good morning, everyone, and thanks for joining us today. Let's start with Slide 12. We delivered another strong quarter performance, exceeding the high end of our sales and earnings guidance. Revenue was $618 million, up 18% over last year and up 10% organically. Our Carling acquisition added 11%. Foreign exchange reduced revenue by 3%, mainly due to the weaker euro. GAAP operating margins were 21.7%, while adjusted operating margins were 22.6%, up 310 basis points versus last year. Adjusted EBITDA margins were 27%, up nearly 300 basis points over last year and solidly above our 21% to 23% EBITDA margin target. Second quarter GAAP diluted earnings per share was $3.48 and adjusted diluted EPS was $4.26, up 25% over last year. Our GAAP effective tax rate was 20.6%, while our adjusted effective tax rate is 17.3%, slightly higher than we had expected due to earnings mix across jurisdictions. We continued our strong performance led by our growth and positioning across a number of diverse end markets. We'd call out headwinds related to China lockdowns, which extended longer than we had expected. We recovered quickly, and we're able to offset some of the sales impact with strength across other markets. Our teams have continued to manage pricing to offset the ongoing inflationary pressures. This, along with continued focus on productivity improvements, is reflected in our above-target margin performance. We were price cost positive again this quarter and expect to remain positive for the remainder of the year. We continue to invest across our businesses for growth and for scale while maintaining discipline on overall spending levels. We had a strong cash flow quarter, generating $114 million in operating cash flow. We generated $87 million in free cash flow, 100% conversion of net income. The continued depth of our cash generation gives us ample capacity to execute on our capital allocation priorities shown on Slide 13. Our first focus remains ongoing investments to enhance our organic growth. And with the acquisition of C&K, we've deployed $1 billion in capital on four acquisitions in the past 18 months, diversifying our end market reach by adding capabilities and talented teams across the company. Our Board of Directors approved a 13% increase in our quarterly cash dividend last week. Since inception in 2010, our dividend has grown 12% on a compounded annual basis, reflecting the power of our long-term strategy and resulting earnings growth. Over the past few months, we've strengthened our balance sheet by reducing costs and improving terms on our $700 million credit facility and outstanding debt. Through mid-July, we took on $400 million of additional debt to support our growth investments. Incorporating this activity and the acquisition of C&K, our pro forma debt-to-EBITDA leverage remains at the low end of our target range. Let's move to commentary by segment on Slide 14. We've added in EBITDA margins by segment to provide enhanced comparability given the breadth of our organic and inorganic investments. Starting with Electronics. Second quarter revenue grew 13% organically. Operating margins were nearly 30% with EBITDA margins approaching 34%, both expanding over 600 basis points over last year. We continue to drive positive price cost and to pursue productivity enhancements. We expect the combination of our execution and current market dynamics will sustain segment operating margins averaging in the mid-20% range. On Slide 15, our performance across transportation reflects the varied dynamics across our markets. Our commercial vehicle business grew 6% organically, and we are pleased with outperformance across our recently acquired Carling business. Organic sales across passenger vehicle were down about 8%, affected by Tier 1s unwinding last year's inventory build in global auto production declines. Operating margins were 10.1%, and EBITDA margins nearly 16%. Currency negatively impacted margins 200 basis points, along with negative volume leverage from lower auto sales, which more than offset benefits from price realization. On Slide 16, Industrial sales were up 22% organically. Operating margins of 19.5% and EBITDA margins over 22%, both expanded over 600 basis points, driven by price realization and ongoing operational execution. While we also benefited from reduced logistics costs in the quarter due to the China lockdowns, we'll see the inverse impact in Q3 as we resumed operations. Our teams have driven outstanding performance year-to-date with 26% sales growth versus last year, over 500 basis points of margin expansion, and adjusted EPS growth of 52%. We prioritized high growth markets and reinforced the value we drive for our customers while managing external disruptions and risks with agility. Moving to Slide 17. Demand remains strong across our end markets, including Industrial, Transportation, and most Electronic areas, but we are seeing some softness in consumer-oriented end markets such as appliances and personal electronics affecting our Electronics segment. For the third quarter, we expect sales in the range of $630 million to $644 million, up 18% versus last year and 2% organic growth at midpoint. This assumes about 20% growth from our acquisitions. With the stronger dollar, we're estimating sales headwinds of 400 basis points in the quarter and approximately 300 basis points for the full year. We're projecting third quarter adjusted EPS to be in the range of $3.71 to $3.87, down 4% versus last year at the midpoint and assuming a 17.5% tax rate. We are projecting a full year adjusted effective tax rate in the range of 17% to 18%. A few key points on our third quarter. First, on acquisitions, our forecast includes 2.5 months of our C&K acquisition, which is accretive to EPS. With two sizable acquisitions new to our portfolio in the past few quarters and integration in early stages, we're seeing about a 150 basis point dilution to company operating margins versus last year. We also navigated through a China COVID driven lockdown at another one of our sites in July, which is now back to normal operations. The combination of this shutdown and recovery from last quarter are a 200 basis point headwind to sales and about a 150 basis point impact to company margins versus last year, affecting the Industrial and Electronics segments. Slide 18 includes additional assumptions for the full year. We'll have 5.5 months of C&K in our 2022 results, which assumes about $90 million to $95 million in sales and about $0.25 of EPS, net of ongoing deal amortization. This increases our estimated 2022 amortization expense to $55 million and a forward run rate of $16 million per quarter. With our additional debt issuance, we expect $27 million in interest expense for 2022 and a forward run rate of $9.5 million a quarter, all at current interest rates. We are maintaining our projection of 100% free cash flow conversion and estimate $110 million to $120 million in capital expenditures for the year. I'd like to thank our associates for delivering on our commitments to our stakeholders who count on us everywhere and every day. And with that, I'll turn it back to Dave for some final comments.

David Heinzmann, President and CEO

Thanks, Meenal. In summary, on Slide 19, we have delivered very strong year-to-date performance, which reflects our global team's unwavering commitment and hard work to drive our results. With our ongoing deployment of resources and capital to enable customers' applications, we remain extremely well positioned to further capitalize on current and future growth opportunities within the global structural themes of sustainability, connectivity, and safety. We continue to focus on what we can control to drive our performance within a volatile market. I'm confident our talent and associates around the world, investments for growth and operational excellence will deliver ongoing value for all of our stakeholders. And with that, I will now turn the call back to the operator for Q&A.

Operator, Operator

Thank you. We will now begin the question-and-answer session. Our first question today comes from Nik Todorov of Longbow Research. Please go ahead.

Nikolay Todorov, Analyst

Thank you. Hi. Good morning, everyone, and congratulations on another quarter of strong results and execution. My first question is about the organic outlook. I think you mentioned multiple aspects—can you hear me?

Trisha Tuntland, Head of Investor Relations

Yes, we can.

David Heinzmann, President and CEO

Yes.

Nikolay Todorov, Analyst

I'm sorry. I think you talked about multiple puts and takes, but I'd just like to zoom in and kind of understand the organic outlook of 2% year-over-year in 3Q. So a slowdown relative to recent quarters. Maybe talk about some of the bets impacting that? And what are you seeing any signs of inventory adjustments outside of what you called out in Tier 1 automotive?

Meenal Sethna, Executive Vice President and CFO

So let me start by providing an overview of our sales year-over-year, which is showing 2% organic growth. We're starting with an overall growth of 18%, largely due to our significant number of acquisitions, which account for about 20% of this growth on a year-over-year basis. However, we've faced some foreign exchange headwinds that have reduced our top line by about 4% to 5%. This is how we've arrived at a 2% organic growth figure. Within that 2% organic growth, we noted in our prepared remarks that we experienced an additional COVID shutdown in July, which affected our operations, but we managed to continue partial operations. This is impacting our third quarter. Additionally, while we were able to sell inventory during the second quarter related to COVID, we have production inventory that needs to be replenished, putting further strain on our third-quarter sales. Lastly, we've observed some softness in a few of our end markets, particularly in consumer-oriented appliances and personal electronics, which is also affecting our organic growth. Would you like more information about the overall Electronics sector?

David Heinzmann, President and CEO

Yeah. Nik, so you're kind of asking about the inventory position and what's going on there. First of all, I would say, POS from our distribution partners in the Electronics side continues to be very robust. Very strong POS, so end markets continue to be quite strong, except for, as Meenal talked about a small portion of it in the personal electronics sort of space. So I think tablets, small appliances, white goods, that kind of an area. But overall demand continues to be very robust. We often talk about what's our normal inventory level with our distribution partners in electronics. And for our broad line distributors, that normal range is somewhere in the 11 weeks to 14 weeks of inventory. And as we've talked about in the prepared remarks, overall, we're in the upper portion of that normal range. However, there are still also pockets where we have some lean inventory position still as well in the channel.

Nikolay Todorov, Analyst

Got it. Very helpful. My second question is about the gross margin of 42.5%, which really stood out. If I refer back to my model, I believe it's a record since 1998. Could you discuss some of the factors affecting that? Meenal, you mentioned that the price to cost is positive. Previously, you expected that to be the case in the first half, but now it looks like it will extend through the full year. Can you elaborate on the reasons for this and the prospects for sustaining the gross margin at these levels?

Meenal Sethna, Executive Vice President and CFO

Yes, Nik. As I mentioned earlier, overall, the price-cost dynamic has been very favorable. Our teams have performed exceptionally well in addressing the rising inflationary costs by re-communicating the value we provide to our customers, ensuring that this value is evident, which has driven our pricing strategies. During strong periods like this, our teams excel. They have handled operational execution impressively. While many are discussing supply chain challenges, we have confronted them directly and managed to navigate through effectively, all while maintaining our productivity initiatives. These initiatives include numerous lean activities and automation. Although we are not heavily reliant on capital expenditures, we are cautious in our capital spending, focusing on automation projects with favorable paybacks. This approach has been evident in our results over the past few years.

Nikolay Todorov, Analyst

Got it. Thank you, guys.

Trisha Tuntland, Head of Investor Relations

Thanks, Nik, Appreciate the questions. We will take our next caller, please.

Operator, Operator

Our next question is from Matt Sheerin of Stifel. Please go ahead.

Trisha Tuntland, Head of Investor Relations

Good morning, Matt.

Matthew Sheerin, Analyst

Good morning. I have a question about your guidance. If we exclude the C&K addition, it seems like you are expecting a sequential decline in revenue. You've mentioned some challenges in Asia that are impacting this. With the book-to-bill in Electronics at normal levels and inventories being high, are you beginning to make adjustments? Should we anticipate an overall sequential decline in Electronics? I also have a follow-up question. Thank you.

Meenal Sethna, Executive Vice President and CFO

I want to revisit my year-over-year comments on sales, which align closely with sequential trends. As you mentioned, sales growth is influenced by the C&K acquisition, contributing roughly 2.5 months of impact. However, we are also facing foreign exchange headwinds, particularly with weaker currencies like the euro, which presents challenges. Additionally, the unexpected partial shutdown in China related to COVID is affecting us this quarter, contributing to some softness in consumer-oriented markets. While overall end markets remain strong, this softness is evident. We are approaching a peak revenue level based on our growth over the past two years, and while growth remains robust, it’s likely to moderate after the significant increases we've seen over the last six to eight quarters.

David Heinzmann, President and CEO

And Matt, on the Electronics side, other than those small pockets we talked about that Meenal mentioned or we mentioned in the prepared remarks, in the kind of personal electronics space, small appliances, that kind of thing, which particularly in Asia, where a lot of that demand from our customer base is, has softened a little bit, but the broader electronics market continues to be still a really strong POS that we see. So we're not expecting some major shifts there.

Matthew Sheerin, Analyst

Could you remind us what percentage is the personal Electronics segment is of your electronics business? Less than 10% of...

David Heinzmann, President and CEO

Yeah. Overall, as a company, less than 10%. Certainly within Electronics, it's well below 20%. So it's an important aspect, but it's certainly not the majority of the business.

Matthew Sheerin, Analyst

Thank you. Regarding the margins, it appears that the operating and gross margins may be impacted. Gross margin might drop below 40% due to the reasons you mentioned. As we look ahead to Q4, do you anticipate some of those offsets returning and improving in that quarter? Generally, Q4 sees lower margins because some markets experience declines. What should we expect for margins in the final quarter of this year?

Meenal Sethna, Executive Vice President and CFO

Sure. I'll discuss Q3 briefly and then we can move on to Q4. Regarding operating income margins, which are significantly influenced by gross margins, we have made several notable acquisitions in recent quarters. As we've mentioned before, we have a plan for integration and specific value drivers we're pursuing. However, during the initial phases of these acquisitions, they usually have a slight negative effect on margins, which in turn impacts gross margin, as that’s a significant area for our value creation. This impact is roughly 150 basis points in terms of margin dilution. Additionally, foreign exchange plays a role as well, directly affecting gross margin. The future trajectory of exchange rates is uncertain, making it difficult to predict their impact on the fourth quarter. Therefore, those are the primary factors to consider. I anticipate that the acquisition-related dilution will persist into Q4, while the effects of foreign exchange remain uncertain.

Matthew Sheerin, Analyst

Okay. Thank you. And just one quick last one. Meenal, in your opening comments, you talked about the operating margins in Electronics. I think you said going forward, the target is in the mid-20s. Was that sort of a near-term target or a longer term? I think your longer-term target has been below that.

Meenal Sethna, Executive Vice President and CFO

Sure. Great question, Matt. I mentioned that we are averaging in the mid-20s given the current dynamics. By current dynamics, I refer to this very unique situation we've not experienced before, where inflationary pressures have been countered by our pricing strategies. We've achieved strong price realization along with the volumes generated from that. In this environment, we believe we can sustain an average of 20% throughout the cycle.

Matthew Sheerin, Analyst

Through the cycle. Okay. All right. Thanks very much.

Trisha Tuntland, Head of Investor Relations

Thanks, Matt. Appreciate the questions. We will take our next caller, please.

Operator, Operator

The next caller is Luke Junk from Baird. Please go ahead.

Trisha Tuntland, Head of Investor Relations

Good morning, Luke.

Luke Junk, Analyst

Good morning. Thank you for taking the questions. Two transportation-related questions from me this morning. First, I want to start with the growth. And just hoping we can unpack the transportation growth down mid-single digits all in this quarter. Specifically, what it would mean potentially for the remainder of the year? Would you anticipate any additional impacts either year-over-year or sequentially from channel dynamics? Or is there anything else that we should be baking into either the third quarter or the second half in that segment from a growth standpoint?

David Heinzmann, President and CEO

Sure, Luke. As we discussed in the prepared remarks, our revenues from the passenger car segment of transportation decreased in a market where global car billings were down about 4%. First, we need to take a step back and remember that over the past two years, we've experienced mid-teens growth in the passenger car segment. Last year, some of that growth was driven by inventory builds as our customers were encouraged by their OEM partners to increase their inventory levels. Therefore, part of the revenue growth last year was due to this inventory buildup. In the third quarter, we have a couple of factors contributing to the decline. Firstly, there is no inventory buildup this year compared to last year, which naturally leads to a decrease in the year-over-year comparison since we aren't adding to inventory. Additionally, we noticed some inventory unwinding. Thus, the primary reason for the revenue decline in the passenger car segment can be attributed to inventory management. We remain confident that we are likely to exceed the 3% to 4% growth target in our long-term strategy.

Luke Junk, Analyst

Thank you for the insights, Dave. I have a question for Meenal regarding the transportation margins. I'd like to go over the year-over-year margin changes you mentioned and also examine the sequential comparison to the first quarter, where margins were around the mid-teens. I'm interested in knowing if there were any one-time factors affecting the first quarter numbers that might impact our comparison to what you reported in the second quarter. Additionally, could you share any other changes we should be aware of that could affect the margin profile?

Meenal Sethna, Executive Vice President and CFO

From our current perspective, some of the factors that Dave mentioned, whether looking at them year-over-year or sequentially, are also influencing margins. The negative volume leverage resulting from the inventory adjustments is definitely affecting our margins. Additionally, we're encountering newer challenges related to foreign exchange. Our transportation business operates globally, catering to multiple customers across various currencies. With the dollar being stronger, we've felt its impact. In certain areas of our commercial vehicle business, we are still facing challenges with Tier 1 component prices and inflationary costs. Although our team has made significant efforts to improve price realization to ensure our value is acknowledged, this process is taking longer than anticipated, especially when compared to our OEM customers and the differences in the customer base.

Luke Junk, Analyst

Okay. Great. Thank you for the color. I’ll go ahead and leave it there.

Trisha Tuntland, Head of Investor Relations

Thanks, Luke. Appreciate your questions. We will take our next caller, please.

Operator, Operator

Our next caller is Josh Buchalter of Cowen. Please go ahead.

Trisha Tuntland, Head of Investor Relations

Good morning, Josh.

Joshua Buchalter, Analyst

Hey. Good morning. Thanks for taking my question and congrats.

Trisha Tuntland, Head of Investor Relations

Thank you.

Joshua Buchalter, Analyst

I wanted to discuss the broader perspective, as we've covered gross margins extensively. I'm curious about the sustainability of these margins moving forward, particularly in light of the normalization of inventories over the last few quarters. Is this indicative of customers recognizing the value of your products and your pricing power? I would like to explore the sustainability of these levels going forward.

Meenal Sethna, Executive Vice President and CFO

Sure. Josh, you were breaking up a little bit, but what I took away from your comment is we've had some very strong margin profile for the past few quarters, and you're asking about the sustainability of that, is that what I heard?

Joshua Buchalter, Analyst

Yeah. In light of your inventory of your customers sort of normalizing. Thank you. That's right.

Meenal Sethna, Executive Vice President and CFO

Yeah. So I'll take a step back on what we've been talking about even going back to our Investor Day from about 18 months ago. We've always talked about across the company a target margin profile in the high-teens, and that 17% to 19% averaging through the cycle. So that means is there are definitely going to be some quarters where we're going to see stronger margin profiles than that. I would say, again, I keep coming back to a lot of the operational execution that we've gone through, which includes making sure customers understand the value we provide and just the internal work we're doing. We've definitely driven these elevated margins. But knowing that we have businesses where markets can go up and down at times, we'll probably see some different movements in different swings. That's why we try to talk about an average through the cycles and we still stand by that in terms of a company margin high teens.

Joshua Buchalter, Analyst

Understood. Thank you. And then in the deck, you called out a number of different EV-related wins and content drivers. Any way that you can help us understand sort of what levels that providing now to the segment's revenue as we sort of try to contextualize how that could help insulate from any potential digestion or continued unit weakness going? Thanks, and congrats again.

David Heinzmann, President and CEO

Understanding the specific impact of electric vehicle wins on our business can be quite complex, particularly when discussing successes in end markets, which relate to the applications in the industries we serve. A significant part of this comes from our Transportation segment. However, we also see successes in eMobility driven by our electronic products, particularly battery management systems and battery protection systems, as well as general electronics related to EVs. Additionally, in our Industrial Products, we design and sell products for off-board charging that support EVs. It can be challenging to quantify the exact impact of these wins, but it's clear that our transportation business is seeing significant growth due to the shift towards eMobility. The opportunity for us in fully electric or hybrid vehicles is expanding significantly, which enhances our content story. It's important to note that our 12-volt products and systems remain prevalent in vehicles, and the high-voltage systems add to our content opportunities. This transition is indeed the primary driver of growth in our passenger car applications.

Trisha Tuntland, Head of Investor Relations

Thank you, Josh, for your questions.

Operator, Operator

Our next question comes from David Kelley of Jefferies. Please go ahead.

Trisha Tuntland, Head of Investor Relations

Good morning, David.

David Kelley, Analyst

Hey. Good morning, Dave, Meenal, and Trisha. Maybe following up on that last point. And Dave, I believe you noted significant new business and off-board charging. I was just hoping you could maybe elaborate on that comment. If that's a single customer win, kind of multiple wins you've been accumulating and maybe if it was specific to either fast charging or Level 2?

David Heinzmann, President and CEO

David, as we've talked about in the past, right, our business tends to be a business of singles and doubles. So there aren't massive singular wins that drive the business forward. So if we think about off-board charging, we've had multiple wins with many different customers that we serve in the passenger car side, but also the commercial vehicle side. And so think about everything from our electronics kind of control systems in that side to high-voltage overcurrent protection. So some of our industrial-type uses that are used in those applications, some of our power semiconductor products that are used in the power conversion in there. And we kind of get wins up and down the spectrum of Level 1 charging. But certainly, also, the biggest opportunity is the content in high-speed charging and the direct DC to DC charging. And we're getting good opportunities there as well against both on passenger car side, as well as commercial vehicle side of things as well.

David Kelley, Analyst

Okay. Got it. That's helpful. And just as a follow-up, can you remind us of the dollar content opportunity you see in kind of the ramp Level 2 and fast charging opportunities?

David Heinzmann, President and CEO

The designs of these systems vary significantly by end customer, making it challenging to define a singular content story. For Level 1 charging, the content value is relatively low, around a couple of dollars. However, as you move to fast DC charging, the content can reach hundreds of dollars, especially when considering power semiconductors and their applications. Additionally, there are industrial fuses and various relays that can be integrated. The opportunities vary greatly between fleet-based charging and consumer-oriented DC fast charging, providing numerous potential avenues for revenue.

Meenal Sethna, Executive Vice President and CFO

Yeah. It's important that you think about this in terms of connections into the infrastructure build, right? It's not just the vehicle charging in of itself. So there are lots of different opportunities available across that whole value chain.

David Kelley, Analyst

Okay. Got it. Thank you. And then, Meenal, maybe a quick follow-up on the July COVID shutdown. A, just wanted to confirm that is in the rearview mirror and back up and running? And then, B, maybe if you could give us a little bit of color on the impacts to Industrials and Electronics segments. I think there's some cross-impact there?

David Heinzmann, President and CEO

Yeah. Let me give you a little bit of color on it, and then Meenal can follow up with kind of any details on it. But yes, the third quarter shutdowns and lockdowns that we've seen kind of outside of Shanghai, that impacted us. The good news is our teams had plans in place to deal with that, quickly created a bubble, continued to be able to operate. It did have an added cost operator, of course, as you kind of build out a bubble. But for the most part, we're able to keep production running at a reasonable level. Fortunately, only lasted about three weeks, that's behind us. The interesting carryover, if you will, from Q2 is particularly in the Industrial side of our business, but also a little bit in the electronics. Think about the fact that particularly in the industrial side where things are being built as inventory that we carry to serve customers here heavily in North America, plus everything on boats coming to and from. So in the second quarter, even though we had shutdowns of more than two months in some operations, we were able to continue to sell out of inventory, continue to sell out of stuff that's on the boat, right, as it arrives. If you get into the third quarter now that whole, if you will, created by a couple of months of shutdown, kind of bleeds over in the third quarter and really has more of a revenue impact into our third quarter.

Meenal Sethna, Executive Vice President and CFO

Yes. I would like to add a few financial details regarding the sequential implications of our performance. As Dave mentioned earlier, we are experiencing more of a temporary challenge on the sales front where we anticipate a slight decrease in sales for the third quarter due to inventory build-up and the lower production levels we faced. This situation does affect our margins and is reflected in the operating income impact. Additionally, it is important to note that we have taken on more debt as part of our capital deployment strategy for our acquisitions, which is also affecting our earnings per share due to increased interest expenses. This amounts to approximately $0.15 on a sequential basis. I wanted to highlight this for everyone’s awareness.

David Kelley, Analyst

Okay. Great. Thanks, everyone.

Trisha Tuntland, Head of Investor Relations

Thank you for your questions. We will take our next caller, please.

Operator, Operator

The next question comes from David Silver of CL King. Please go ahead.

Trisha Tuntland, Head of Investor Relations

Good morning, David.

David Silver, Analyst

Good morning. Thank you. I have a couple of questions that may be broader and more customer-focused. I'm going to reference the Transportation segment, but it might relate to a couple of others as well. There has been a ongoing chip shortage and other part shortages for quite some time. I understand that your development efforts are aimed not only at the current product lineup but also at the next generation of products. I'm curious if the ongoing challenges in achieving full production are causing customers to feel uncertain about the timing and reliability of receiving the next generation of automotive electronics or components for the EV infrastructure, whether those are under the hood or elsewhere. Specifically, have the development timelines of your major customers been affected in any way by the ongoing chip shortages and other supply chain problems? Thank you.

David Heinzmann, President and CEO

Certainly. Let me address that. Our customers in Transportation and other sectors have been facing shortages and ongoing challenges, which have influenced their design strategies and new product development. Specifically regarding eMobility and electrification, we have observed a significant emphasis from our transportation clients on these areas as key drivers for design initiatives. This cautious approach means they are more selective in choosing chip types and ensuring that there are multiple sources available, which affects their design processes. Previously, they would often rely on legacy products that were well-established, even if those products were not actively supported by semiconductor manufacturers, due to sufficient capacity. However, this situation has changed their activities. eMobility is definitely their main focus right now. In more traditional sectors, I would say that engineering efforts have been somewhat hindered as they have allocated resources towards qualifying alternative products rather than focusing on redesigns for cost efficiencies or similar improvements. This definitely has an effect, but I do not view it as a long-term detrimental influence on new development in those sectors. Overall, we are feeling relatively optimistic about the situation.

David Silver, Analyst

Okay, great. The next question is about the M&A funnel and your thoughts on the next opportunity. You mentioned your success in closing several deals. I believe that the final step in completing the Carling or C&K deals may have been some uncertainty from the seller’s side, and while you maintained your discipline standards, the seller adjusted their asking price. That’s my perspective. Looking ahead, do you still see an active acquisition funnel? After the C&K deal, does your balance sheet still allow for pursuing the next opportunity? Thank you.

David Heinzmann, President and CEO

Sure, David. What I would say is our funnel activity continues to be robust. So there's a lot of optionality and a lot of areas that we continue to evaluate and look. So robust activities there. From a capacity standpoint, as Meenal talked about in the prepared portions of the comments, our leverage still remains at the lower end of kind of our comfortable range of leverage from a financial perspective. From a capacity of our people within internally, we tend to have acquisitions driven and owned by the business units. .So it varies dramatically by business unit, how busy they are and where they're focused and where they're at and the digestion of the business. So C&K in our electronics business, of course, just closed. So they're pretty engaged, pretty consumed in those early days of integration. Other areas where maybe we made an acquisition that was a year ago, 1.5 years ago, they've kind of talked through the early stages of it, and they've kind of got it moving forward. So from a capacity standpoint, from a human capital, we also continue to have capacity available to do that. Those are kind of a reminder. The areas we look that continue to look attractive for us are the industrial space that we like. Commercial vehicle continues to be an area that we think there's opportunity. It's also always consolidation opportunities for us to look at as well. So the funnel activity to be robust, and we will continue to look for opportunities.

David Silver, Analyst

I appreciate the color. Thank you.

Trisha Tuntland, Head of Investor Relations

Thanks, David. Thank you for your questions. We will take our next caller.

Operator, Operator

The next question comes from Luke Junk with Baird. Please go ahead.

Luke Junk, Analyst

All right. Thanks for taking the follow-up. Just a quick follow-up for me. Then in terms of the electronics channel, some discussion of your inventory at distributor customers. Dave, you've also commented in the past on what you're seeing at end user customers, including EMS customers. And just hoping you could give an updated perspective on that part of the market as well? Thank you.

David Heinzmann, President and CEO

Sure. Certainly, if you follow and you look at EMS guys who have been public and have presented their data. Yes, their inventories are elevated for sure. Now when you look at understanding what the absolute dollars of elevated inventory are, particularly semiconductors tend to be a very heavy portion of those inventory investments for EMS or other end customers. Pricing on semiconductors has grown very dramatically also over the last couple of years. So some level of that inventory increase from a dollar perspective, it's just cost base, right? So there clearly has been an elevation in that, driven by costs, probably the biggest driver. Also volume as well as they wait for shortages of one component, they build up other components. So inventories continue to be elevated at end customers in some areas. We have not seen a lot of activity of customers trying to kind of pull back from that or adjust that down dramatically because the simple fact is there remains volatility in the supply chain. So we still see volatility, whether it's coming out of China. And now as we talk to customers, one of the bigger issues they talk about is, well, what if Europe? What if the gas supply in Europe is a problem, right? Is that going to disrupt things? So there are elevated inventories out there. We're not seeing big actions taken to kind of address those down at this stage. And it's really reflected because a lot of that flows through distribution, that's really reflected in the fact that POS levels at our distribution partners continue to remain very high and very strong. So we're not seeing that evidence at this point.

Meenal Sethna, Executive Vice President and CFO

Yes, I would add that we and many other peer companies are carrying inventory as part of our current strategy. Many strong companies are effectively managing their balance sheets. We have indeed decided to maintain higher levels of inventory to ensure we can meet customer needs. The key aspect we are focusing on is the demand and sales from end customers, which remain robust in most of our market. These are encouraging signs.

Luke Junk, Analyst

Okay. Great. That’s all I had. Thank you.

Trisha Tuntland, Head of Investor Relations

Appreciate the question, Luke. Thank you. Thank you for joining us on today's call and your interest in Littelfuse. We look forward to seeing you during the Jefferies and CL King conferences and talking with you again soon. Have a great day.

Operator, Operator

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.