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

Good morning, everyone, and welcome back to Day 2 of the 2020 Jefferies Virtual Industrials Conference. Again, my name is David Kelley, Auto Tech supplier analyst here at Jefferies. And I'm pleased this morning to host Littelfuse, a leading technology supplier of circuit protection, power control and sensing to a multitude of customers and via numerous end markets. And joining me this morning are Littelfuse's President and CEO, Dave Heinzmann; and Executive Vice President and CFO, Meenal Sethna. And for those listening, if you do have any questions, please text across, and we will be addressing those at the end. So Dave, Meenal, if you'd like to kick it off, I believe you do have a quick presentation, and then we can jump into Q&A.

Sure. Thanks, David, and certainly, for Meenal and myself, we appreciate the opportunity to join in this virtual -- new virtual way of having investor conferences. And so I'll just have a couple of slides before we move on to the fireside chat. So I'll start with -- for those of you who are new to Littlefuse story, just a brief introduction to who we are. We're a $1.5 billion industrial technology company headquartered here in the Chicagoland area. As David said, we're a leader, the global leader in circuit protection and a growing provider of leading power control and sensing technologies. We serve a very broad customer base and market base really across the transportation, industrial and electronics end markets. And every month, we deliver high-quality products to over 100,000 end customers. When you look at what drives our growth opportunities, very broad-based applications but we've positioned ourselves to really take advantage of long-term trends that we see in a safer, greener and increasingly more connected world. Our focus into those areas and positioning to take advantage of those really allows us to have a really solid, improving, accelerating organic growth pattern. We complement that with strategic M&A that helps to support that, which overall then delivers and has over the last several years, has delivered very strong shareholder returns. So from there, I want to just spend just a couple of minutes in talking about how are we dealing with the pandemic situation. Very early on, in the early days when the breakout happened in China, we established 3 key priorities. First and foremost, is the health and well-being of our associates, their families and the communities where we operate. That's the #1 priority for us. Serving our critical customer needs and long-term financial health of the business. We, like many companies, have implemented -- we implemented safety protocols, really when the issues began to happen in China, we implemented that globally. So we feel good about the steps we've taken to protect our people and the business. And obviously, during these challenging times, also worked very hard to make sure we preserve the financial flexibility and liquidity in the company to prepare for the other side of this challenge. So we think we're very well prepared for it. We're absolutely confident that we're going to be even stronger. We'll gain positions as we get through this challenge to come out on the other side. So with that, I'll hand it back over to David and let him ask some questions.

All right, perfect. Thanks, David. And maybe starting with your automotive exposure, represents about 1/3 of your sales via a couple of different segments. We've -- as we've seen, the auto industry appears to be one of the first to recover from the recent disruption. Although it looks like global production is clearly going to be poised for a third consecutive year of contraction. The bar seems to be set fairly low. Could you talk about, I guess, a, what you're seeing from customers? And b, how you feel about the automotive channel going into the back half of the year? It'd be great.

Sure. Obviously, challenging times, second quarter is really tough. After even last year, as you pointed out, kind of a challenging year. So car build is certainly a bit of a challenge. And in our second quarter, we saw the impacts of that. We clearly are seeing improving conditions around the globe and the global car build and then, therefore, our business in automotive varies dramatically by region. So of course, we're seeing the rebound much faster in Asia than we are in other regions. So we're seeing that come back relatively strong. However, in market demand, that's the question mark. Certain productions ramped back up, and sales has been improving. Will that be sustained or not? That's kind of, I think, the challenge or the question there. So certainly, Asia is leading in the recovery. We look at the other regions, North America as particularly here in the U.S., has certainly bounced back pretty quickly going here into the third quarter after shutdowns and things like that with pretty strong demand for SUVs, light trucks and things like that, they're helping that bounce back. Inventories are relatively light at dealers. So that flow-through is going reasonably well. Europe is an area where it's rebound, but certainly, the rebound has been much slower. And end-demands in Europe still are not kind of materializing so much. So we are most concerned about the rebound in Europe at this point in time. So by region, that's kind of our view. For us, ultimately, we still feel very strongly about the opportunity and growth of content for us. So in the second quarter, we were down less than the global car build because of content gains. And we continue to see those content gains in traditional vehicles, but particularly content gains for us as we get into higher voltages and electrified systems.

Okay. Great. You referenced dealer inventories. Curious to what you're seeing as far as channel inventories. There's a first quarter build, then given the steep second quarter industry decline, any outlier inventory level skewed to any specific auto regions for you?

Sure. Yes. And we talked about this on our earnings call. Certainly, in the first quarter, we talked about the fact that we thought there was an inventory build in the channel in automotive that took place. We do not see, it's our view, and it's a little fuzzy today, really on exactly where the inventories are at OEMs and as well as the Tier 1s. So visibility is not great. But our conclusion in the second quarter was, although we outperformed cargo, really didn't pull back that inventory dramatically. We still think there's a bit of excess inventory sitting out there within Tier 1s and OEMS, probably, most likely in Europe and North America, where we see that more so than China. I think probably China work through it as they ramp back up. But so there's still a little bit hanging out there that maybe it comes out in the back half of the year, we'll kind of have to see.

Okay. That's helpful. And maybe a question for me. Could you provide some color on typical margins on the auto segment? And as we think about a cycle reset and coming out of a downturn, how should we think about forward margin cadence?

Sure. So we've talked about our automotive segment margins being in the mid-teens. That's really our target, the 14%, 15% range. We did a lot of work in the past 12 to 18 months, the road to getting there. And really, at the first quarter, I call that, that's probably the last prepandemic quarter we had. But the first quarter, we were fairly close to hitting that target margin. So we know we've taken the right actions to get there. I think from where we sit now with the volumes at the record low levels that they are, we definitely need to see improvement, both in, of course, car production and consumer demand coming through. And we'll continue to take a look at are there some other cost adjustments that we need to make in our footprint and just in other areas but we're also trying to be careful because in any parts of our business, including auto, we don't want to go too far in cost and find the demand comes right back and then you're scrambling to keep up. So we're taking a bit of a measured approach around that.

Okay. Got it. And then maybe taking a step back, the long views on owned autos, and you referenced it briefly today. But just if you could talk about some of those longer-term content drivers for Littelfuse. How should we think about content per vehicle across legacy internal combustion versus hybrid and versus EVs? And what is your target as far as outgrowth versus underlying production for your automotive segment?

Sure. And David, when you look at our legacy business and look at really our protection business in the electrical infrastructure of the vehicle, that's our core business in automotive. And if you look in history, even before kind of electrification coming along, vehicles are becoming more and more sophisticated, more electronics content, more higher power draws on the vehicle systems and things like that, which had created content opportunity for us in previous years. Those things have kind of started to flatten out a little bit, other than electronics content, that continues to grow, of course, pretty dramatically. But really the movement now is more towards the electrification, higher voltage systems. And so if you look at it for our protection products and a traditional 12-volt ICE-type application, our content per vehicle is in that range of about $4 to $5, so call it $4.50. That's kind of average. It can vary dramatically depending on the platform, but it's in that range. If you look at a full parallel hybrid, that content for us goes up about 2x, 3x a so a nice increase there. Even in a mild hybrid, like a 48-volt system, we get about a 35% increase in content. Really, where you take the big step-up is if you go to a full electrified vehicle, whether it's a plug-in hybrid or a full battery electric vehicle. That's where we kind of get to that range. It's 4 to 5x the content versus a traditional 12-volt system. Now that is -- the designs vary dramatically by platform, whether you've got platforms that have dual voltage, 800-, 900-volt charging systems and 400-volt drive systems and/or just 400-volt systems, but the higher the voltage, the higher the content opportunity is for us.

Okay. That's helpful. Really appreciate the color. And I wanted to switch gears to your Electronics segment, and it is the largest segment for you. You utilized the distribution channel to reach numerous end markets and thousands of customers. Could you walk us through the health of that channel today coming out of a disruptive second quarter as well?

Sure. And first and foremost, the use of the electronics distribution. That's -- we approach that a little differently than some other companies in our market space. We see distribution as a critical part of our strategy of reaching customers. With every single month, we're shipping over 100,000 end customers in the electronics portion of our business. Using distribution is the most effective way of reaching those customers and the most cost-effective way of serving those customers. So we see that as strategic. And you look at the health of that, if you -- those who are following Littlefuse, a year, 1.5 years ago, we began to talk about the fact that inventories were too hot in the channel. A normal range for us is 11 to 14 weeks on average globally, amount of inventory in the distribution channel. And we were clearly at or above that during those time frames. So it impacted our business last year as that began to work its way down. And going into this year, we began to talk about we would hit healthy levels and then begin to see nice growth, again, on electronics. Obviously, that was pre-pandemic situation. The good news is through last year, we did burn down that excess inventory and really in the first quarter and it stayed relatively flat in the second quarter, we're at the very bottom end of that normal range. So our inventories are quite LEAN in the channel, kind of sell in, sell-through is matching right now. So our POS is maybe in that around 1 right now, our book-to-bill is and very LEAN inventory levels. So what that can mean is at some point when in demands begin to pick up, not only will that pass-through to us, but also inventory increases will take place.

Okay. Perfect. And I wonder if you could talk about some of the opportunities in electronics, areas like medical and data center. And I do think everyone's focused on the near-term tailwinds, work from home is clearly, and I just had a guest appearance a couple minutes ago walk into my background. But maybe more long term, some of the runways and the potential growth you see in some of these secular segments for you?

Sure. They kind of all kind of come from that baseline I talked about in the intro of safe, green and connected. Really, the increasing connected world is a huge driver for us, both in the near-term and certainly long term. And it's really -- it's not just equipment that's connected. It's the infrastructure, it's the backbone of the IoT world, if you will. And so that is data centers, a massive inventory of data that's being stored, and manipulate, so growth of data center and size of those, that's a content growth driver for us. The infrastructure of, let's call it the hardwired, the old ways, which still is happening, but certainly, 4G, 5G applications, lots of opportunity for us and content in those spaces as well as in the home. All of us today have routers in our homes, and we're adding replicators as we get more and more devices. When I check my router at home, the number of devices connected to my home is sometimes staggering, right? And so the sophistication and the requirements to support that grow across the whole backbone. And so we see today and certainly, going forward, that is a very strong trend. So the connected world, the connected devices. Medical, you asked about that. That's an area. We're not particularly heavily focused on medical, but we do have a nice niche business there. Obviously, in the near term, components for ventilators and things like that have been up. We also do an awful lot of components for defibrillators, power semiconductors for defibrillators. That's been a nice business. We do think there are going to be long-term trends there related to the pandemic or in response to it. So telemedicine, remote medicine, we think, is a growth area. We think that's a content story for us. Work from home, it's certainly impacting us right now. We think that's going to be a longer-term trend, too. That we see opportunities there. And then also the other areas that are driving for us are certainly kind of in industrial electronics applications, where we see pretty robust activities there, and we see that continuing to be strong.

Okay. Great. And then in the meanwhile, just wondering if you could walk us through the electronics segment margins, we come off of a 2019 distribution channel destock. And then clearly, COVID hit so I guess, a, how should we think about margin trajectory playing out if we do see a gradual recovery? And b, how would you describe normalized margins in this -- in the Electronics segment?

Sure. So for electronics, we've always talked about a high teens 20% margin profile. That would be the average typical. I'd say in the legacy parts of our Electronics segment business has been with us for a long time. We've done a lot of work over, I'd say, over the past decade, even longer to really work on our profitability profile and our footprint structure and along with the successes we've had with our strategy and distribution that Dave referred to. There were times in 2018, where we saw some strong growth, and we were well over that 20% range. As you mentioned, though, the channel destocking in '19 and now COVID, throughout, the biggest impact has been, one, just the volume drop off that's lowered margins because our incremental variable margins are very strong in the business with the prior work that we've done. And then also the addition of IXYS. The IXYS business into our portfolio. Now IXYS came in at lower margins. We've done a lot of work to improve the margins, and we had talked about, about a 10 percentage point improvement in margins in IXYS once we got done with the synergies. So we're working on -- we're finishing the last pieces on that, really around the footprint. And in the next 18 months or so, that will complete. I'd say all those pieces together, first, the volume coming back will have an immediate impact for us. We have the capacity and margins will climb fairly quickly with that. And then the gradual layering in of the continued IXYS synergies will also help. So for us, it's -- the outage we have internally is sales solves a lot of problems. And for us, sales is a big factor here, and that will help us a lot.

Perfect. And then one follow-up on that point, you referenced, the footprint actions. Could you quantify or give us a bit more color on the second half impact? And how that begins to roll off into 2021?

Yes. So we had 2 or 3 major footprint programs that we're working on now as it relates to the IXYS business. One, we're completing this quarter. So as we're starting that up with the current volumes, there's not going to be that much of an impact this year on that. And then the other big program that we have, which is really we've built a new plant on our Philippines campus that we have. We're closing one plant, part of another facility as well. That's going to be a gradual ramp-up in benefits coming through for, I'd say, as we continue to qualify customers through the year and we start to migrate production through the year, I'd say we'll see a few million dollars coming through next year, but I would say that's also going to go into 2022, just as you start to annualize and you start to ramp up volumes as well.

Okay. Great. Thanks. And I see a couple of audience questions are coming in. So maybe I'll ask a couple more and then pass it off to the audience. So I wanted to move to the industrial segment. Dave, if you could talk about some of the opportunities, applications, end markets and industrials, which has been a nice outperformer for you recently? And why you're better positioned today for growth in industrials than you've been in the past?

Sure. We kind of have -- right now, a bit of a tale of 2 stories in the industrial part of our business. So there's some of our legacy historical areas like oil and gas and mining or nonresidential construction in the U.S., those are a bit soft these days, right? But we've actually seen continued strength in renewable energy, and that's across the board, whether it's solar or wind or whatever, have great opportunities there. We're seeing nice growth there, design into power conversion applications and energy storage applications. Those are really strong areas for us as well. HVAC is also a nice area for us, where even if the market is just stable, our ability to grow share there is a great opportunity for us. So nice drivers. Why we're better positioned. I think we're increasingly focused on medium and high-power side of the industrial side. And it fits really nicely with the IXYS acquisition because the power semiconductor products that came with IXYS are also very much focused in industrial applications in medium high-power, very complementary customers, and actually, many times, the products sit next to each other. In fact, our fuses protect our power semiconductors and those applications. So nice synergies there. They really -- we feel very good about the industrial space and that segment over time.

Okay. And maybe as a follow-up, Meenal, if you could talk about the industrial segment margins in kind of the longer term, Littelfuse targets for that business, that would be helpful.

Sure. So for our industrial segment, we targeted the high teens margin profile. I'd say up through recently pre-COVID, we were at that point, mainly because we had done a lot of work. Dave referenced some of the different end markets that we have. One of them was related to a niche and potash mining as an example. And as markets adjusted, we made some pretty significant cost structure changes in the business, in the footprint, and that positioned us well last year to be back in the high teens level. We're back in a little bit of the same story, where sales volumes were down, especially last quarter, as our production was limited due to shutdowns that we had. But as we start to see the sales improve there, we're very well positioned to get back into that high teens margin profile.

Okay. Perfect. And I just wanted to jump again, we're going to go to a couple of audience questions here, and this one's for Dave. Understand much of legacy revenue has been attained from fuses and metal oxides. How do you expect Littelfuse's product mix to evolve with the rise of automotive, electronics, Internet of Things, miniaturized circuits. Would you expect higher growth in silicon components than legacy ceramic and can you talk about ability to leverage some of your recent acquisitions as well?

Sure. Yes. Obviously, from a technology standpoint, things do evolve and change over time. What I would say is some of our legacy protection products and passive components have remarkable staying power. Designs are fundamentally quite strong on that. And there are certain fundamental physics requirements that are necessary in protection, including things like galvanic isolation and a protection environment and things like that, that are going to keep our core technologies very relevant for a very long time. So we're not worried in the near-term that those are going to be a problem. However, we would say and certainly, we've increased and strengthened our investments in the semiconductor side of our business. So we do see silicon trends over time being positive for us. We're working to make sure we're prepared for that, particularly focused on the medium and high-power side of things, where we really see that impacting it. So we think they're complementary. We're not very worried about the near-term on our legacy products. But yes, over 5 years, 10 years, 20 years, there'll be some trends on that. We think we're well prepared for those.

Okay. Great. And then a question for Meenal. If we think holistically about the business, where are we as far as like cost actions corporate-wide in 2020 and savings we should expect into 2021?

Sure. So we've been talking about really a 2-year savings and cost reduction process that we've gone through. Referencing back to Dave's comments about 2019, we saw the electronics cycle impact, and that really lowered volumes for us, along with it's the flat car build. So just overall demand was down. So with that, we took a number of actions last year in 2019 on the operating expense side and along with work that we've done this year, the combined between the 2 years is an $80 million reduction, meaning compared to 2018 levels, our OpEx in 2020 is projected to be $80 million now. It's the combination of headcount reductions, probably evenly spread between headcount, compensation related actions and other discretionary spend. The question we get is, okay, well, that's great. Some of these are permanent, some are temporary. What are you expecting? What's going to come back when demand comes back, and I think about it as half is pretty permanent. We made some decisions to take costs out of the business. The other half, we would expect to come back because it's a little bit more discretionary or variable. But I wouldn't say, I wouldn't expect it all to come back in 2021, so that's $40 million. The example -- a lot of companies have been talking about are things like that. Hey, we were traveling a lot 12 months ago. Is that going to come back in the same way that we were thinking about it a year ago. And we think sessions like this that are more virtual video, I think will alter the trajectory of that. In addition to the OpEx savings that we've talked about, we've also done a lot of footprint work. You heard me mention earlier, we have some programs relating to our IXYS business and the integration efforts there. But even earlier when we were talking about automotive margins, we did some work there. We had a plant closure, also a little bit of product line pruning that we did there as well. And then on top of that, across our industrial segment, we have another project going on that we expect to finish in 2021. For us, these footprint projects are not in response to a pandemic or to a sales downturn. They're really part of our DNA of continuous improvement, how do you continue to keep your cost structure commensurate with really where you want to go with the company.

Okay. Do any of the -- and maybe as a follow-up to your point on the 50% discretionary variable, are any of those nonrecurring expenses coming back immediately into the second half, whether it's cost cuts on the labor side? I mean how should we think about any snap backs that have already come down the pipe?

Yes. I wouldn't think about it really coming back in 2020 at this point. I mean, we've made decisions, they're done. I think in 2021, there's some elements of compensation. The past couple of years, given the business performance, variable compensation has been down. We would expect to hopefully, with the business trajectory that we're hoping and projecting for that, that would come back. So I think that's part of it, but other parts around travel, a personal opinion is I think whether or not you want to travel, I think that trajectory is going to be slow regardless for people to get comfortable doing that. So I think there's other parts of those variable expenses that will take longer than people thought even 3 months ago to come back.

Okay. That's super helpful. And then we've got a couple of minutes left here. So Dave, maybe finishing up here with kind of a longer-term question. Littelfuse and you have been through-cycle ebbs and flows. Most recently, as mentioned, the 2019 distribution channel destock, and we had unprecedented COVID shock this year. I guess, can you talk about the setup coming out of COVID, what's different versus last cycle downturns? How you see Littelfuse emerging and just the uniqueness of the setup coming out of the COVID disruption?

Sure. Sure. I think last time we saw this series of sort of a downturn, right? It was '08, '09. If you go back and look at our financial deployments in '08, we were a smaller company, we had a very high fixed cost structure at that point in time. So when we hit the depths of that downturn, it was very painful financially. So we actually lost money at times during those periods. We've done a lot of work since those times to be much more effective and efficient in a broader customer base that we serve and because of that, even in kind of the depths of second quarter, we saw -- although we'd love to have much better financial performance, yes, nowhere near a breakeven business, fairly healthy given that. So I think structurally, we are better in a different business today than deep cycles in the past. Clearly, rebounds after a cycle historically, what we found is we typically find a way to take advantage of that, right? And a lot of it comes from the fact of a hyper focus on serving the customer needs during the downturn. We don't leave them in a difficult position where they have to go somewhere else. What we find is we tend to out service those customers in challenging times and customers who maybe they think about, well, will I try some small competitor to displace Littlefuse for a few bucks. They're a little less likely to do that in volatile times. So typically, and we have plans, we have execution strategies around making sure we can actually gain market share during a challenge like that. We're confident we'll be able to do that and are doing that. So as things bounce back, we think we're well positioned to take advantage of that. The difficulty is calling when, on how and what time will it come back and those things, but we feel very confident about that.

Okay. Perfect. We are out of time. So Dave, Meenal, really appreciate you taking the time this morning. And to everyone listening and participating on the line, thanks as well. Have a great rest of the afternoon.

Thanks, David. Thanks, everybody.

Thank you.