Littelfuse, Inc. (LFUS) Earnings Call Transcript & Summary

Well, good afternoon, everyone. This is Matt Sheerin. I'm the technology supply chain analyst at Stifel, and welcome to the Stifel Cross Sector Insight Conference, virtual. Representing -- the next company that we have presenting is Littelfuse, a major supplier of electronic components. Representing the company is the CFO, Meenal Sethna. Meenal will go through some slides, and then we'll open it up to Q&A. I've got some questions, but we also encourage anyone listening to ask questions. There's an opportunity on the webcast to do so. Meenal, would you like to get started?

Sure. Thanks, Matt, and good afternoon, everybody. Thanks for joining us at today's Stifel virtual conference. Again, my name is Meenal Sethna, and I'm the CFO of Littelfuse. I wanted to spend a few minutes telling you a little bit more about Littelfuse for those of you not familiar, cover some topics that have been top of mind lately around the COVID-19 crisis and what we've been doing as a company, and then just to give you a little bit more insight on the company, products, end markets and our strategy. So let me just start with a brief overview on Slide 3. If anybody wants, you can read the risk factors at your leisure. We have our presentation posted on our website. So starting on Page 3, Littelfuse, a growth company. We are over 90 years old as a company, really started in the circuit protection space, a global -- we have a global leadership role in the circuit protection space. And then over the past decade or so, we've really expanded our portfolio much more broadly into areas of power control and sensor products that I'll touch on a little bit more. We sell our products to over 100,000 end customers, and you could find Littelfuse products in virtually anything you touch across automotive, industrial and electronics end markets. We've got deep customer relationships with those end markets, whether -- that covers OEMs or Tier 1s in the automotive spaces as well as distribution partners across our electronics and industrial segments. And our strategy, which I'll cover in more detail, is really to focus on growth, both organic growth, by focusing on high-growth end markets, coupled with a complementary strategic M&A that continues us to enable a profitable growth. With our best-in-class shareholder returns that we do like to talk about in the past 7 years, we've delivered 19% CAGR for our shareholders, and our focus is on profitable growth. As we continue to grow our top line, we expect to grow our bottom line even further than that. We returned capital to our shareholders through dividends and opportunistic share repurchases. And since the inception of our growth strategy, we've had a mid-teens CAGR on sales, adjusted earnings and cash flow. Let me spend just a quick minute on Slide 4, to talk about our response to COVID-19. For those of you who may have listened to our earnings call in late April, we talked about 3 key priorities, in this order, as a company. First and foremost, it's about the safety of our associates, protecting the health and safety not just of our associates, but their families and also the communities in which we operate around the world. And part of that focus for our associates is also around the preservation of jobs, and we've continued to maintain all of our employees on our workforce -- as part of our workforce during these challenging times of furloughs and shutdowns that we've seen over the past few months. Second priority is our customers, continuing to support our customers and serve their critical needs, especially as many of our customers are operating in essential industries or with products that are key to serving the general public right now, whether that's health care and medical devices, critical communications equipment, transportation equipment and other key infrastructure areas, like energy. And then lastly, performance of our company. Not just in the short term, but really ensuring that we're focused on the long-term financial health of the company, and a variety of actions that we've taken both from a cash perspective, but also from an earnings and from an EBITDA perspective to ensure that we are focused on that long-term health. So we've taken a number of actions, I could probably spend all of my time talking about these. But just to highlight a few areas. As part of the safety, the health and safety we talked about for our associates, we've implemented a number of measures at all of our sites around the world, especially those where we have employees having to work on a day-to-day basis in our manufacturing sites and in many of our R&D centers and labs. And there's a lot of health and safety protocols that we put in place to maintain the health and safety of our employees. We've done a lot of work in the past 90 days, above and beyond what we had been doing in 2019, and what's part of normal activities we have around our cost structure. We've -- what we talked about on our earnings call a couple of months ago is that we've taken out -- we're projecting to take out $30 million of operating expenses during this year, above and beyond the $50 million of operating expenses we took out of our P&L in 2019 versus '18, about half of which are permanent cost reductions, and half of which are temporary cost reductions to align with our demand environment. And then we've also done a lot of work around preservation of financial flexibility and liquidity, a very sound balance sheet, over $600 million in cash, a net debt to leverage of below 1. And so -- and we've also talked about the fact that, in light of these uncertain times, we've temporarily suspended any share repurchases that we're doing, but it allows us to continue to focus on reinvesting in the ongoing support that we're providing our customers and employees and the long-term health of the business. Moving along to Slide 5. I wanted to touch on some of the secular growth themes that we talk about really drive our business. For those of you who may have seen us talk about our strategy back in late 2016 at our Investor Day, but we talk about this a lot still with investors, we talk about 3 main secular growth themes that really, for us, drive both the organic growth we're seeing, drive the content increases that we're seeing over market and really give us the framework where we think about our acquisition opportunities. First, just talking about safety, whether it's our industrial applications, or just in general, everyday products, where you're going to find our product in everyday products. There's a lot of global themes around safety in circuit protection. In automobiles, one of our focus areas are seatbelt buckle sensors and other safety features that you would find in autonomous driving. So safety is a big area of focus for us. Resource efficiency, whether that's a focus on LED lighting or solar, wind and other alternative energy opportunities, energy conservation and also areas like electric vehicles that are continuing to grow in a big market growth opportunity for us. And then lastly, increased content and connectivity. And as I think about the past 90 days and everything we've all gone through, you can see this every day, where you think about how you want your office devices to be connected to your home. You need to be able to function remotely wherever you are, whenever you are, and really being able to think about how you can connect seamlessly and continue to operate your factories, your offices, your homes in an efficient manner. And so a lot of our products are found in devices that didn't even exist 10 years ago. So yet another great content opportunity for us. Just real quickly, touching on Slide 6. I mentioned earlier that we cover a wide range of end markets. We're evenly split about 1/3, 1/3 and 1/3 across the transportation markets, which cover both passenger and commercial vehicle products across industrial end markets, ranging from general industrial products to heavy industrial markets that would also cover oil and gas or mining, as an example. And in electronics end markets, covering not just consumer electronics but telecom and 5G data and telecommunications, white goods, and other medical devices. So a significant span of end markets that we cover across all of our technologies, but that continues to build upon the opportunities we have to grow and grow our content in many of these devices. And then lastly, I just wanted to highlight a couple of areas where we talk about Littelfuse. Why Littelfuse? What makes us special? Why do we believe we're going to succeed? And why do we believe we're going to succeed in our strategy? For us, as we take a look at the times we are going through right now, and we take a look at our strategy long term, the secular themes that I mentioned earlier, this idea of the safe, green, connected, they continue to still resonate. They continue to still drive our growth. Even in these challenging times, if anything, we're seeing a heightened awareness around connections and content and connectivity. We're seeing a heightened awareness of really, the products that we're in and the need for safety. And the focus that we have in those areas in an ongoing discussion on resource efficiency, alternative energy opportunities, alternative energy products and really our success as a company is really driven by the foundation from these secular themes, our ability to drive above-market organic growth through the cycle, a complement of strategic acquisitions that help us to continue to bolster the organic growth, strong customer and distributor relationships along with technical and application expertise. And with that, I'll turn it back over to Matt now. I know Matt has a few questions that he thought people would be interested in.

Okay. Great. Thank you, Meenal. [Operator Instructions] But I'd like to start. Meenal, just if you can update us on what you're seeing in the demand environment. You didn't give really specific guidance, but I think you did say that revenue would be down roughly 20%. A lot of that was due to weakness that you're seeing in the auto area with production down and a lot of your customers. But I know that there were some concerns about weakness in other markets. So could you update us, to the extent that you can, in terms of what you're seeing by your markets?

Sure. So that's one of the first questions we typically get from most investors we've been talking to these days. Really, what we've been letting folks know is, we talked about at our earnings release, we talked about, call it, 2 sides of the coin. When it came to our electronics and our industrial segments, because of production limitations, because of government directives and shutdowns we had at certain factories, we were limited. Even though we saw strong demand, we were limited from a production capacity perspective. That was different than what we saw across our automotive businesses where we had sufficient capacity. The demand was a challenge because we had customers, Tier 1s and even OEMs that were also not manufacturing plus end consumer demand was down. From where we sit today, the quarter is generally continuing and progressing as we expected it to. As it relates to electronics, I mentioned production capacity being a limitation. We have talked about some of our major manufacturing sites in the Philippines, where we were producing at reduced levels, again, based on government directives. And in Mexico, where we had a -- we were in the midst of a 3-week shutdown across our 3 plants in Mexico. Happy to say that we were expecting all of those plants to either ramp back up or start reopening in the middle of May, and that's exactly what happened. And so in the case of our plant in the Philippines, by the end of May, we were running actually at higher levels because of the pent-up demand that we had. And so we're continuing to run very strong in the Philippines. And our factories opened up in Mexico at reduced levels for a couple of weeks but now continuing at levels where they're able to meet demand as needed. So that's how things are going in electronics. And in automotive and industrial, sorry, and then across our automotive segment, really with our automotive segment, we were expecting to reopen our factories in Mexico. I mentioned that we did. And then we said we were going to have to see what demand looks like. A lot of it is our Tier 1 customers. They also started reopening their factories at around the same time, whether that was in Europe or in the United States, as well as the OEMs as well. And I would say that ramp-up has been slow. No surprise when you have to take a factory from a complete shutdown to restarting it again. That doesn't happen overnight. So I would say, with automotive, it's a little bit early right now to see what's happened with consumer demand. I think that's also been moving a little bit slow because of some of the countries or cities or states that were maybe shut down a little bit longer, and then the slow ramp-up that we're seeing with our customers.

Yes. To your point on visibility, beyond just production coming back, because we know the auto plants are opening again, as you said, slowly. You're now able to ship volumes. But there are also -- there's probably a little bit of inventory in their supply chains, and they're trying to figure out what their true demand is. So -- but the expectation, at least by guys like IHS, is that there will be significant double-digit production growth in Q3. And I guess the question for the component suppliers is whether you'll see that commensurately in terms of a bigger jump. Or will it be sort of a slower rebound?

Yes. It's a little tough to say. And Matt, you bring up a good point. We had also talked about on our earnings call that car build was down 26% in the first quarter. Our sales, which generally -- in our automotive segment, which generally run better than -- at a higher growth rate than car build because of content improvements we had, we were substantially better. And we said the biggest reason for that is because we had a lot of our customers taking inventory from us, and then they went into shutdown. So the piece that we have to see is how long it takes them to work through their inventory, some of which is going to be dependent on demand as well. In terms of what do we think end consumer demand looks like right now for automotive, it's tough to call this right now quarter-by-quarter. But what we talked about back in April is our view is -- our expectation, I should say, is that we would expect global production to be down over 20% in 2020, somewhere around 70 million cars, which I think aligns to some of the market forecasts that are out there as well.

Okay. And you've generally trended better, although you've pruned the portfolio a little bit. So not apples-to-apples, but generally because as you earlier said, you've seen content growth. And so the weakness you're seeing now should at least rebound somewhat to that 20% level?

Yes. Typically, we talk about our content growth being 3%, 4% range higher than what car build is. So we've always talked about if car builds were flat, as an example, we would still expect to grow because we have content increases from the ongoing electrification out there, the content increases of our products in vehicles overall, the continued slow ramp-up of electric vehicles and in different xEVs that are out there. And that's another one of our secular themes that continues to hold strong for us in the automotive space.

Okay. Great. And turning back to electronics, where I believe you had talked about your fairly good book-to-bill coming into the quarter. As you said, there were some capacity constraints on your part as well as some of your peers. And we've had -- we had another supplier on an earlier panel today talk about a little bit of bookings, weaker in [situations ] in the month of May just as customers are coming back and realizing what true end demand is. So it sounds like there's a little bit of movement there, but doesn't -- just from what you're saying, it doesn't sound like there's been any surprises in terms of customer behavior yet.

Yes. Things have continued to play out as we were expecting. We had talked about that we expected our book-to-bill to drop off a bit during the quarter. We talked about -- in April, we talked about our book-to-bill being well over 1, and we were expecting it to come down. And we are seeing it trending down, but demand continues to remain strong right now. I think it's a combination right now of people wanting to make sure, especially with the supply disruptions that we've seen in the past 3 months, people wanting to ensure that they have sufficient inventory on hand. The, I'd say, unclear demand signals that are out there, even from an end market perspective, that's part of it. But we definitely have gotten feedback through our distribution partners and through end customers. But there definitely is inventory sitting along that entire customer supply chain.

Yes. Understood. Okay. We are getting a question from an investor regarding your Mexican operations. You talked a little bit earlier about that starting to ramp. Could you update us on that -- those operations, and what you're seeing in terms of demand? And I know part of that is automotive. I know the automotive part of the manufacturing came back later than some other sectors, right?

Yes. So for us, things -- basically, we have 3 plants in Mexico, let me start with that, 3 plants in Mexico that cover our automotive businesses. They're not the only plants, but they cover a lot of our automotive businesses. It covers lot of our commercial vehicle business within our automotive segment, and also covers a lot of our industrial segment, and our fuse part of our business. We reopened all 3 plants at the same time. So they've been -- even though they're in 3 different cities, based on the government direction that we had, we did partial ramp ups in the last 2 weeks of May. And then really now, in the first couple of weeks of June, we're ramping -- pretty close to ramping back to normal levels now for those products. As it relates to demand, you're right. I mentioned automotive. The demand has been slower on the automotive product side. But I also mentioned commercial vehicle products, and I also mentioned industrial products. And there, we have continued to see strong demand, especially because our products in both of those businesses end up in products that are considered essential products or an essential industry, whether those are commercial vehicles or certain high-power products that require some of our fuses in industrial applications. So we've worked really hard to match our production capacity right now as much as possible with the demand that we're seeing in those areas.

Okay. Great. And I wanted to get back to a slide that you showed that shows your end market exposure. And within the electronics, there are several key end markets that you talk about, medical, building and automation, consumer electronics, et cetera. And I get this question a lot from investors, but can you give us a rough sense of the revenue breakdown within electronics?

Sure. It's -- I mentioned we sell to over 100,000 customers, and in many cases, we're selling or fulfilling to sell products through our distribution partners to EMSs. So at times, I can appreciate -- it's a little fuzzy, but I'll try to give you maybe some broad strokes here. I'd say about 10% of our segment covers consumer electronics. And by that, I don't necessarily mean things like just phones, but because we really don't have our product in some of the lower end products like phones, but think of it as other types of mobile devices, gaming devices, wearables. And so some higher-end products where we've seen a lot of nice growth in demand. Another 10% or so are sold into the automotive end markets, and we call this automotive electronics. As an example, if you think about the number of screens and ports that are in an average car these days, and you think about protecting those screens and ports, those are the types of products that we're selling. Electronics products, made automotive-grade, sold into automotive end markets. Another 10% or so falls into white goods and building automation, which includes many of our sensor products as well. We have a nice business that's grown fairly significantly in the past 4 or 5 years of selling sensors into these white goods and even some light industrial applications as well. Another 25% or so, probably around what I would call IT infrastructure, including cloud and data centers as well as other areas, like data and telecommunications. And then what's left is probably a little bit less than half, which are sold into general industrial applications. So think about areas like alternative energy, like solar products, or LED lighting, smart meters, as an example, medical products. We might sell in the medical products as well. So a lot of different devices that fall into that broader general industrial category.

Okay. And that's very helpful. And I know that you have, as you talked about earlier, a strong distribution channel. And distribution is a big part of that. And I know that channel inventories, after a multi-quarter correction, were finally getting into kind of more stable, a normal environment. What are you seeing from your distribution partners and channels in terms of where they're positioned as we get through this pandemic?

Yes. So we -- of course, we continue to work closely with them and talk to our distribution partners about what they're seeing in the end market. So definitely a portion of the color we're getting about inventory across what I call the customer supply chain, and when I refer to that, I'm talking across our distribution partners, across EMSs along the way, et cetera. They're generally seeing what we've been talking about, which is that everybody wants to make sure that they have sufficient inventory on hand. And when you think about a distributor, that's really the role that they play, that they play very well is to make sure when you need it, we have it on the shelf for you. So they're doing that. EMSs want to make sure that they're meeting the requirements of their OEMs, so they want to make sure that they can produce what they need to without being short some small components. So they're carrying inventory as well along the way. So it's -- they're not really seeing anything different than what we're seeing with our own checks outside of distribution.

Okay. Turning to your margin and cost structure. Your gross margin target, I think, is in the 40% range. And you really just talked about it being a question of volumes in terms of when you get there. You were at that level in fiscal '18, when revenue was in, I guess, around $1.7 billion. Is that the top line that we need to reach to get there? Or would that be lower given some of the cost-cutting efforts that we're seeing as well as the IXYS acquisition and synergies you're seeing from that?

Yes. I wouldn't say with -- I think you hit the nail on the head. With some of the works that we're doing around some footprint activities, non-pandemic-related, not related to any near-term headlines, but more the footprint programs that we have relating to our IXYS business that we acquired about 2.5 years ago, and these are our synergy actions that we said we wanted to take to increase capacity, reduce our costs and improve just the overall product availability that's out there. So we're working on a few different programs there and a couple of other initiatives that are going on across our other businesses. Those will definitely help us reduce the sales level to which we need to get to, to hit that 40% target gross margin again.

And are those drivers both in the auto business and electronics? I know you've got somewhat different EBIT margin targets, just a little bit lower in auto, a little bit higher in electronics. But basically, is it the same playbook on both areas?

Yes. I would say it's a little bit different just because of the construct of the different businesses. Across electronics, our biggest focus has really been around the IXYS acquisition. And I mentioned some of those, we have large initiatives, building a new plant in the Philippines and consolidating back-end assembly and test of some of our products as well as module assembly in the Philippines. We also have 2 epitaxial manufacturing sites in the United States, and we're consolidating to 1. So the bulk of our electronics work is related to that across our industrial segment. We did a lot of that work over the past 2 or 3 years. So we've seen, I'll call it, the fruits of our labor, come through. Our industrial segment last year continued its strong growth trajectory, and we saw the target margin profile we were looking for. But in addition to that, we mentioned on our first quarter earnings call that we were also working on a plant -- another plant consolidation across our industrial segment that we would expect to complete in the beginning of 2021. And then across automotive, I'd say also a little bit different in that. In the past 2 years or so, we talked about improving the margin profile of our automotive segment, really with a focus on our auto sensor business. It's really the newest platform in our portfolio. We have been focused on growth, sales growth, for that business. We didn't want to disrupt our customers. We didn't want to start changing designs. We didn't want to move products around to different plants. But when you do that, at some point, you start to get a little bit of a sprawl of a manufacturing site and maybe you're not as efficient as you need to be. So we started really working on some cost reduction actions there, which range from just an overall thinking about how we organize the sensor business. We also, late last fall, closed a factory that we had across our sensor business. And we were well underway, even through the first quarter, of achieving our target margins, our target operating margins in the automotive segment to about the mid-teens. Unfortunately, now, with the latest drop in volumes that we've seen, which is fairly significant to go from 90 million cars to an estimated 70 million cars. We're going to have to take a look at, okay, but what does this mean? And how does our automotive footprint look? And what really happens with the automotive production capacity or automotive production projections over the next few years? So that's something that we're working on right now to understand where really the market's going.

In other words, whether you need to resize that business?

Yes. It's just -- you don't want to be in a position where you're making decisions and reductions based on the current volume, or if it's for 1 year and things get substantially better than next year. So that's why I use the cliché, measure twice, cut once. And that's what we tend to do in situations like this. Sometimes people may say, "Well, it took you a little longer." But we said, "Yes, but we were very thoughtful about the way we did it," and made sure that -- if you go back to my opening slide, when we talked about what is our focus area of the coronavirus, our associates come first. And any activities we do impact our associates, so we want to make sure that we're measuring twice and cutting once.

Yes. Okay. It looks like we're out of time, but this has been very helpful, Meenal. We certainly appreciate it. And we hope to see you soon. And for everybody else, thanks for joining us.

Yes. Matt, thanks a lot. Appreciate it. And also for everybody on the phone, appreciate having you with us today. Thank you.

Okay. Thanks a lot.