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

Okay, thanks. Welcome, everybody. We're going to start our session with Littelfuse. We have CFO, Meenal Sethna; and from Investor Relations, Trisha Tuntland is also present as well. We are doing the fireside format today [Technical Difficulty] from Meenal. And [Technical Difficulty] function. People can submit questions and I'll see them and work them into the fireside discussion. So Meenal and Trisha, thank you for being with us today. I appreciate your participation in the conference. And Meenal, why don't you start?

Great. Thanks, Chris, and hello, everybody. I'm getting a little bit of an echo, I don't know. Okay, I think it's gone. Great. Thanks, Chris. Thanks to you and the Oppenheimer team for having us here. We always look forward to this conference, one of the first, usually after our first quarter earnings release. So a good opportunity for us to continue sharing our story and provide an update on the business and what we're seeing. I'll start off again with a quick intro. So I'm Meenal Sethna. I'm the Chief Financial Officer of Littelfuse. I'll spend the next few minutes or so just going through some highlights from the company's strategy. Many of you may have already seen, but a couple of months ago, we actually provided an update to the company's strategy, a 5-year outlook on that. So I'm going to highlight some of the information that we talked about in our couple-of-hour Investor Day, but clearly, more information available out on our website for you to take a look at as you may have some interest. So let's go ahead and start with who we are, for those of you who may not be as familiar with Littelfuse. So we like to think of ourselves as a company that grows, and you'll see that as I talk more about some of our goals and objectives and our focus areas. But for 2020, we were a $1.45 billion industrial technology company. Our focus -- and we view ourselves as really a company that's empowering a sustainable, connected and safer world through the products and the technologies that we have in our portfolio and really through the end markets that we participate in, which is really across the industrial, transportation and electronics space. We're a designer and manufacturer of a number of different technologies, a variety of electronic components, including a number of semiconductor technologies, power semiconductor technologies and sensor technologies as well. You can find our products through -- in a number of different arenas, again, a number of different end markets, and we sell through 100,000 end customers. And really, our global and diverse footprint allows us to reach customers in all areas of the globe, and you can find us physically located in over 15 countries. But really, the collaboration of all of this really drives our growth profile. I'll talk a little bit more about that, but we're really an organic and an inorganic grower, and that's really the foundation of our strategy. So let me touch a little bit about, on the next slide, our growth themes and really what drives our growth. For us, the foundation is really the structural growth themes that are out there. I talked a little bit about the sustainability, connectivity and safety theme. But when we think about our products and the technologies and the end markets I mentioned, sustainability is front and center to that, whether it's through enabling sustainability for our customers with the products that we provide in a number of different applications, including renewable, the renewable space. We talk a lot about these days electric vehicles and related infrastructure. So a number of different areas where we are part and parcel with our customers from a sustainability perspective. Connectivity, thinking about the expectations, especially these days around mobility, the ability to connect from your home to your office, to your car, and think about advances in industrial applications and Industry 4.0 and a lot of opportunities around connectivity. And then some would say, our core. Our core has been safety, really where we started as a company was with fuses and with circuit protection and more connectivity really drives more safety, right? More electronics continues to drive more safety and more protection needs across our portfolio. So starting with those structural growth themes, where does that lead us from a growth perspective? Well, with these growth drivers, content and share gain is really what's driving our growth today across a number of high-growth end markets and geographies. I'll touch on some of those as part of the fireside chat. But what we do is with the breadth of electronics, transportation and industrial end markets, really choosing the sub end markets in there that we think we've got the portfolio that we have today or would like to add to, to really focus on those high-growth end markets and deliver above-market growth there. And then supplement that with strategic acquisitions, thinking about what we have in our portfolio today, what other acquisitions would make sense with our focus areas that would continue to enhance that organic growth. And from there, the outcome for us, and I'll touch on this a little more on the next slide, but really, it's around double-digit revenue growth, a combination of that above-market organic growth and supplemented with the inorganic growth, delivering best-in-class profitability and top-tier shareholder returns. And when you take a look at our profile over a number of years, you'll see that we have shown that we can deliver that. And we're -- that's why we believe that this is -- the strategy, which, frankly, isn't all that different than the strategy we've had in place for nearly a decade now, we know it's doable, and we have a lot of the right goals and a lot of the right themes in place to drive this. So as I delve a little bit further into the financial goals that we have, I mentioned the double-digit sales CAGR out there, a combination of a 5% to 7% organic growth across our portfolio. And again, that's above the end market growth profile that we see with those that we participate in as well as a 5% to 7% growth via acquisitions that complement that organic growth. We think about profitability as high-teens operating margin, 21% to 23% EBITDA margin. And we think about all this through the cycle. So when you think about normal business cycles that will happen with the end markets that we participate in as well as just normal industry-specific cycles that tend to go on, we think about these targets, it's really an average across that 5-year strategy as opposed to a year-by-year target. We're a strong cash generator as a company, really a hallmark of the company, and we continue to maintain a target of 100% or greater free cash flow conversion over net income. We look at really having strong returns in our 5-year goal, being the high teens return on invested capital. Our near-term objective is getting into that mid-teens ROIC. We had an acquisition a few years back and a fairly large-sized acquisition for our portfolio, which has, on an interim basis, weighed our ROIC down a bit, but we're on track on improving that to these goals. And then lastly, from a capital allocation perspective, really our primary focus is around acquisitions for all the reasons I mentioned before, but then also a return of free cash to shareholders through a combination of an annual dividend that we have, that we've had for over 10 years now, as well as periodic share buybacks that we do. I feel confident with the strategy that we have. It's not new for us. It's a continuation of the strategy we've had for almost a decade. And these goals have remained largely the same over that time as well. And we've proven that we can deliver these goals through the cycle. And with the sustained really strategic and structural growth themes that are out there, we're confident that we'll see this for the ongoing future as well. And with that, I'll turn it back to Chris for questions that I'm sure are out there.

All right. Thanks, Meenal. Good to hear you. I think on the acquisition strategy, you mentioned you did a chunky one a little while ago. That was IXYS, isn't? Trailing before that, PolySwitch was a decent size one as well. So curious just update us what you wanted from them strategically, how they're going operationally versus the deal cases?

Sure. So the 2 acquisitions that Chris has mentioned are really the 2 largest that we've done in our company history. The first one being back in 2016, we acquired a carve-out in the circuit protection space of -- that we now call PolySwitch. For those of you who know our history, circuit protection is really the foundation of the company. And so PolySwitch gave us and really expanded an element of our circuit protection portfolio and enriched the leading position that we now have in that space as well. The acquisition has gone very well. The integration went well. We finished that several years back. But it's been really a terrific addition to our portfolio and really driving a margin profile that's comparable. You can find the bulk of that across our electronics and automotive portfolios, and you can see that our margin profile is pretty consistent overall with those segments today. The IXYS acquisition, which we did about 3.5 years ago or so, was really a big entry for us into the power semiconductor space. It was as part of our multiyear strategy. It was an area that we felt more of an adjacent area for us in terms of building our portfolio. We had started some organic work in the power semiconductor side and the IXYS acquisition really added to that fairly substantially. I'd say the integration has gone well in that many of our goals we have achieved from the integration, but there's still an element left of the integration. And it's -- a lot of that still is in the manufacturing supply chain space. That's taken us a little bit longer with some of the different growth ebbs and flows that we've seen over the past couple of years and then more recently with COVID in the past year, it's made manufacturing transfers, which is really the last part of the synergies that we're going after, it's made that a little bit more challenging, and it float us down a little bit. But we're on track to finish that really in through the 2022 time frame. And what that's going to give us is some additional bottom line synergy benefits, but even more so, the additional capacity and opportunity for growth with the kind of expectations that we have on sales growth on the power semiconductor side. I think going forward, Chris, I think this is one of your other parts of your question. When we think about our acquisition strategy, we talked about in our Investor Day that we were really going to be focusing on bolt-ons. And when we think about bolt-ons, generally, we talk about a $50 million, $150 million kind of acquisition on the top line. We feel that those will complement a lot of the high-growth end markets and the applications that we're in. It will be a nice way to supplement our organic growth. And going through acquisitions like that, it will give us optionality along the way. The most recent example of an acquisition we did was the Hartland Controls acquisition, which we closed in the first quarter, and that fits right into that area, focused on the high-growth end market of HVAC, which we were targeting.

Okay. What is the pull-through opportunity there? Is that kind of like a strong single or you got to double or triple out of that on the cross selling?

Yes. I...

In the context of the industrial segment, not overall Littelfuse.

Sure, sure. Well, what I would say is when it comes to the -- if we're going to go through a strategy of bolt-on acquisitions, we would expect a lot of those will be singles and doubles. And that's really what the size, and what we can do with it, how do we complement what we feel is a really good portfolio today and add-on to that. And in this particular case, we were looking at Hartland Controls for a while. It's an acquisition that we said, boy, we've got a good presence in the HVAC space. Hartland Controls really had a significant presence in the HVAC space. We talked about it being about a $70 million sales target out there. So the combination of the legacy and the new business that we have has really given us a meaningful position in HVAC, especially now when you think about the focus around airflow, air quality in a post-COVID world, even more so it's a trend that I would see continuing very strongly over the next few years. And in terms of revenue opportunities, we're already starting to see that on both sides, where we have legacy Littelfuse customers interested in looking at our Hartland Controls portfolio and vice versa. So I see over the next few years, easily, some of the revenue synergy thoughts that we have, we're absolutely going to go after. And we're already seeing some -- a good start at this point.

Okay. And we're going to move to a couple from the queue. Talk about competitive positioning, market share and who's performing strong from a share perspective in your space presently?

Sure. With the breadth of the portfolio and the number of end markets we have, we always answer that question with, it depends. And it varies depending on the end market that we're looking at. I would say broadly, when it comes to, I'll call it, in the electronics space, we've got a legacy circuit protection portfolio. In that area, we would say across most of the parts of our portfolio, we have a leading position today across that circuit protection part of the business. I mentioned the power semiconductor side, which is a newer space for us. And that's one where we're definitely not a market leader nor do we have the ambition to be a market leader in the power semiconductor space. A number of other companies that stand alone are much bigger than ours. But at the same time, we believe that with the growth and the opportunities and the portfolio that we have, we can carve out a very nice niche where we can serve underrepresented customers in that space, and we can continue to grow both through content and through share. When it comes to our automotive parts of our portfolio, again, that varies related to, as an example, our circuit protection parts of our business, again, leading position, given the many years that we have in the circuit protection part of the business. Other parts of that, including sensors, we've got niche positions in different sensor applications that are out there where we think we can add value to customers. In some cases, we've got a good-sized position. In other cases, it's a very fragmented space, and we've got a position in that market with some customers that we've got long relationships with. And then I'd say industrial falls probably into that category as well, where there are a few different leading players, and we are one of those, but there are other players that are bigger than us, and we continue to grow and expand our TAM in the industrial space as well.

Okay. And another one is, the high-teens ROIC seems nearly unbelievable, especially with significant inorganic strategy in the current valuation environment on target companies, even mid-teens strikes as a stretch. So does ROIC, is that independent of subsequent acquisitions or specific incentives in place to obtain the actual ROIC target?

Sure. No, that's a -- it's a great question. What I'd say is -- and this is an area we talked a bit about it in the Investor Day, I mentioned, a couple of months ago. It's a multistep plan that I talked about. The first being is organic growth recovery. And I say that because the past couple of years, for those of you who know the company history, we had some end market cycles. When I mentioned normal business cycles, that's how I would think about 2019. We went through a traditional electronics down cycle as well as those in the automotive space, also, we saw some declines in the automotive end markets. And so we saw a decline in organic growth in '19, followed by a atypical, hopefully, once-in-a-lifetime cycle with COVID in 2020. So our organic growth and therefore, profitability profile was below our target range. We would expect 2021 to reverse that and that organic growth and the profit margins that we typically see in our organic growth trajectory, that will be the first step for us in terms of recovery and ROIC margin expansion. And then coupled with looking at acquisitions that are more of a size that are bolt-ons. I appreciate the commentary that, yes, multiples seem high right now. But when you start to look at more proprietary deals of the kind of size that I mentioned, different impact that it has to your ROIC, and we think the combination of the strong organic growth that we have and more of a bolt-on profile, allows us to get our -- move our way to the mid-teens ROIC and then above from there.

Okay. And we've got one on global supply chain. It's been a real mix in answers. Some companies have been very good. Others have said, we're going to have 100 basis points of margin headwind or $50 million or $100 million depending on the size of the company. Where are you guys scoring?

Yes. No, good question. So I do -- have seen the number of comments around, I'll call it, supply chain and input costs. In our first quarter earnings call, I tried to boil it down for us to be the 2 biggest items that we see as headwinds right now are, a, commodities. When you think about the portfolio that I mentioned, what we have in our technologies, commodities like copper, zinc, silver are key to our portfolio. And so the commodity prices, really the record highs that we're seeing on those, those, by far, are the largest headwind that we're seeing. There are some things that you can do to mitigate, of course, including pricing, but the significant and dramatic rise there has been a headwind. And then the second part has been around logistics. And specifically, it's really been around freight. That ends up being both a capacity issue and because of the capacity issue, people look at some different modes and that becomes a rate issue. In terms of headwinds for us, I mentioned in the first quarter across all of our segments, it was about a 250 to 300 basis point impact for us. And I would expect that to be a little bit higher in the second quarter. And we're taking a number of actions, including things like pricing that we're looking at. We're looking at alternative ways around logistics, what we can do in terms of building a little more inventory around the way, and then you can look at changing modes, et cetera. But clearly, those are the 2 big headwinds we're seeing right now. And I think one of the other questions, Chris, you had alluded to was, how long do you see this going on? A big question on the commodity side, how long commodity prices stay where they are? I think from a logistics standpoint, a lot of the logistics constraint out there is due to capacity, especially in airfreight. And a lot of that, as I understand, is really related to the number of flights out there, passenger flights that are flying because that really also -- people don't realize that, that carries a lot of cargo. And so as long as air travel is down internationally, I think that's going to be a bit of a drag on capacity from a logistics standpoint.

Okay. In the 250 to 300 basis points, that was on the freight and logistics side specifically, right?

That's a combination of the commodities as well as the freight and logistics side, both.

Okay. And it was an important distinction you made on the margin targets, that they are an average through the cycle rather than a 2025 target. I think for electronics, you put 20% out there. Similarly, that's kind of the target 5-year average rather than we're going to get there by 2025?

Yes. So with electronics, we've talked about high teens to 20%. That's generally the way I think about the electronics margins. What we said is that think of it as is almost a 5-year average. We're generally in that frame when we see the organic growth recovery coming back. The first quarter was a great example of that, where we had margins well in that target range. And so you're going to see with all of our segments, not just electronics, there's going to be some quarters where we're going to be above that range. There are going to be some quarters where we're below that range for different reasons. The past couple of years have been due to the top line. But I'm confident that when we think about the 5-year strategy, think about the average, that these are the right target ranges for us.

Okay. And what's the capacity to integrate acquisitions? It seemed like some companies had a nice pipeline built up last year. And then kind of like we're done, let's sign when we decided to sign. I'm curious if that's a dynamic for you guys. And if -- with the cycle taking shape and you've kind of weathered the freight logistics, you understand the dynamic now, if there's kind of on-hold activity in your pipeline that's actually further along than we might appreciate.

Yes. I think of capacity in 2 ways. I think of it as, a, do you have the financial capacity to go after acquisitions; and b, do you have the internal bandwidth to really drive the value from the acquisitions that you make. The short answer I would say is, we have both. We have the financial capacity. One of our goals during 2020 was to -- as many companies said, emerge stronger out of the pandemic, we absolutely delivered on that. Our teams did an amazing job around really focusing on really meeting customer needs along with making sure we were driving for the long-term from a profitability, but even more importantly, from a cash perspective. And so we finished off 2020 in a much stronger financial position as a company. So we're ready to go from that capacity perspective. And in terms of internal bandwidth, we continue to really build the talent and build the bench of the people that we need to really drive the value. When we make acquisitions, these are not corporate decisions per se as much as they are how do these acquisitions or these targets fit with the business strategy. And it's really our business general managers that are really coming to the corporation to say, I want to go after this acquisition, here's why, and here's where it fits in my strategy. We have resources at corporate that supplement our businesses really to help them through the process. And then we work closely with our businesses to make sure they have the resources they need and they get them ready in advance for the integration. And even if that means putting -- taking some of our corporate resources and putting them in the business for that, we do that as well. So I think we're well-established to be able to go after acquisitions, which we are doing today.

Okay. And is your pipeline populated for all 3 segments? Or is it not -- is that not the case?

Yes. I would say -- I'd look at it as our pipeline is populated across all the end markets that we serve, broadly across all electronics, the industrial end markets, automotive. So we absolutely are looking at those. At different points in time, we've said, "Hey, there are some end markets we'd like to expand ourselves more than others," say, in industrial end markets, you could find acquisitions across a couple of our segments there. But we like, as an example, the industrial end markets generally because it's got a lot of the stickiness. You find it in automotive end markets. It's spaces we know pretty well, and we have multiple technologies that we have or could add to -- that add in there. But clearly, targets across all of our end markets and all of our segments.

Great. And you talked about power semiconductor. There's bigger players there, but you've got a targeted strategy and a real role to play. Silicon carbide is another technology. Maybe a little more at the flotation level with that technology versus power semiconductor, you're a bona fide substantial player there. But how is that product category opportunity looking for Littelfuse?

Sure. So quick background stuff. We got into the silicon carbide space with step acquisition where we -- with a start-up company. And as we passed different milestones, we kept acquiring a bigger and bigger portion of the company, which was known as Monolith Semiconductor. In terms of where we are, we completed that acquisition a few years back. And really, for us, silicon carbide has been an addition or an additive to our portfolio. You'll recall that it's -- I wouldn't think of it like power semiconductor, where it's all about silicon carbide, but it's something that's more complementary to our power semiconductor portfolio. It's something where we have a lot of customers that are interested. I think that interest continues to grow over time, and where we've had some design wins come through in, some overall business wins have been in the renewable space. That's been a big area for us, especially in solar and solar inverters as well as across EV off-board charging infrastructure. So those are the 2 areas that we found where we've had some success in there, and that continues to be one of the many technologies that we like for our portfolio, especially as we think about the long term, which is where we think silicon carbide will continue to become a bigger and bigger part of that.

Great. Sounds good. And for electronics, how would you describe the extent to which lead time composition has diverged from normal, given yet unspecified, but very large book-to-bill in the quarter and a large book-to-bill even with 32% top line reported sales growth?

Sure. Yes. So as it relates to lead times and book-to-bill, if I step back a little bit, we mentioned that as your lead times change or you might even make specific changes to your lead times, that automatically will extend your book-to-bill because you've got bookings that go out further. In our particular case, yes, the majority of our -- the manufacturing we do, the lead times haven't really extended. But in several cases, we did have to extend the lead times more because of logistics issues, more than anything else for the reasons I mentioned earlier. With that, we continue to work with customers closely. That's really the key message, I would say, out of that, which is, yes, bookings are good. Yes, customers want to make sure they get their place in line. We did mention that we believe there is some double ordering going on because as you see, companies see lead times extend a little bit, they want to make sure they get their place in line, and sometimes they may put their place in line with a couple of different companies or with the same company a couple of times. And so for us, it's most critical to really spend our time working with the customers to understand where our sales patterns are with them, what they really need to meet immediate demand as opposed to, it doesn't do anybody any good if we're shipping to customers, and they're just sitting on inventory right now. So I would say we're spending a lot of our time working very closely with customers and what they need and making sure that we're able to meet those needs.

Okay. And what's the overall status of executive and division leader talent development and bench strength? And are there any key priorities for external talent?

Yes. No, it's a great question. For us, we spend a lot of time with the leadership team talking about this. When you have a growth strategy like we do, you need to be able to scale up quickly. It's different than when you have an organic strategy because with an acquisitive strategy as well, overnight, you change the size of the company. And so for us, similar to the way we think about sales growth, I would say we think about talent the same way, which is what are the steps that we need to be taking inside the company to organically grow our people through development, providing them development opportunities, moving them into different roles, stretching a lot of our folks that we feel have great potential, especially to be on that general manager track, and we spend a lot of time talking about that. And at the same time, when we make acquisitions, that's one of the things we're looking for as part of our due diligence, is what is -- what does the channel look like, what does the bench look like? And are these people that will be great assets to the company as well? Because for us, it's about that. I would say where we've been adding to that bench, we've added a few more M&A resources that are, in some cases, in the business; in some cases, in corporate, but really to enable our businesses to be more successful at looking at the front end and really talking to a lot of companies, but also being prepared to integrate as well. We continue to add in other spaces, especially with certain technologies, some engineering talent, some product management talent. And also, at the same time, looking at the HR space for us, which is important. You need good HR people to help you manage talent and think about -- even more so think about a strategy. So those are all places that we've been adding resources to continue to build our bench.

Okay. And closing one. Just wanted to go back to the Philippines transition. What -- do you expect that you might be able to have those transfers kind of done into 2022? And what's the approximate kind of size of the revenue moving in there. I think you kind of have double capacity going right now?

Yes. No, it's a great question. So again, a little backdrop. So with our IXYS power semiconductor acquisition, I mentioned that there -- the last parts of the steps we were taking around integration was a shift in the manufacturing and supply chain, really more of a simplification, and it's to build a plant in the Philippines, which we did, that would handle back end assembly, packaging and test as part of our power semiconductor business. It's going to be -- it touches on a lot of the business, I'd say about 1/2 to 2/3 of the business by the time we're done. We made good progress. We got the plant built. Largely, we finished that before we got into the throes of COVID. But with the semiconductor business, the next big step is really the transfer of the manufacturing and then the customer qualification process because most of these products are really designed into customer applications. I would say that, that's been a big part that slowed us down and in some cases, also just the equipment lead times, right, as different things have shut down, equipment lead times were slower as well. I would say, given the time line and all of those circumstances, I would expect that to go through '22 for us to complete that. And also right now with -- as you mentioned, Chris, with the capacity needs and with the demand needs that are out there, we are doing some runs in the Philippines, where we have started that transition. And we also have our legacy sites also running as well to meet demand right now.

Okay. We're up against, but I do have one in the queue. Maybe you can just touch this one quickly. China is about 30% of sales, critical yet, with Asia, a lot of talk is Japan, Korea and India. Any worry about in-roads, local Chinese competition?

Yes, there's always a lot of local Chinese competition that comes up. I would say, in general, our focus with China is still very strong, still very important -- a very important market for us. A lot of great customer relationships we have and a local management team out there. And our focus is China -- we're doing a lot of build and a lot of production, and a lot of that continues to be for China as well. So really not much of a change to our China strategy, and we continue to focus on the local management team, a lot of local production and local wins.

Great. So pretty similar as it's been all along?

Yes. I would say so.

Okay. Thanks for your time. Thanks for joining with Oppenheimer today, Meenal.

Yes. Thanks for having us. Thanks a lot, Chris. Thanks, Oppenheimer.

Thanks, Chris.

Bye. Thanks.