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

Everyone, welcome to Cowen's 49th Annual TMT Conference. I'm Karl Ackerman, and I'm a senior analyst covering semiconductors with an emphasis on memory, RF and power semis categories. I'm pleased to present to you, the team at Littelfuse, including Meenal Sethna, EVP and CFO; and Trisha Tuntland, Head of IR. Thank you, Meenal and Trisha, for being here today.

You're welcome. Good morning, everyone.

Good morning, everyone, and thanks, Karl, for the introduction. Again, I just wanted to mention. Thank you for joining us today. I really appreciate your spending some time with us. I wanted to spend the first 5 minutes or so just giving you a little bit of backdrop, Littelfuse, our current strategy. For many of you for those who not -- may not be familiar with Littelfuse, we actually had an investor event a few months ago. So if you want more detail on the company, please go out to our website under our Investor Relations section, and you can find both the recorded session of our investor event as well as these slides and several more that are out there from that day. So let me start with who we are. Littelfuse, as Karl introduced us, we've been in business over 90 years. We were, in 2020, a $1.45 billion sales company, really a broad portfolio of technologies ranging from circuit protection, which is really how we started as a company moving on into semiconductor products, sensors, and we continue to grow our portfolio of technologies. And even more importantly our broad end market and technology focus, as we think about the end markets we participate in, and I'll cover those in a little more detail, but really across the electronics, automotive and transportation end markets as well as industrial end markets. And our goal is really empowering a sustainable connected and safer world. You can find us across more than 15 countries around the world, selling our products to over 100,000 end customers. And really, with our strategy and our focus areas that I'll speak to in a minute, we've demonstrated that we've been able to grow our content and share above the market trends that we have for the end markets that we participate in, has really led to a shareholder return over the past decade or so of over 20% CAGR. So moving on to the next slide, let me walk you through what we think of as strategy on a page, and I'll walk through some of the highlights. I mentioned that our growth themes, as we think about our portfolio, really revolve around this idea of sustainability, first being, all the trends that we're seeing really over the past decade, and we expect to continue for many, many years to come, but this focus around renewable energy just broader sustainability trends in how we live, how we work, how companies operate. And that's continued to be a successful source of growth for us as we think about those trends, think about areas such as renewable energy, like solar, and wind energy. A lot of discussion these days about electric vehicles, both the vehicles themselves as well as all the infrastructure there needed to operate electric vehicles, both on the passenger and commercial side is a couple of areas. Secondly, this idea of connectivity. When you think about connectivity, wanting to make sure that you can remain connected from your home within your home, to your office or wherever you're working these days into how companies operate today. We've seen a significant proliferation, not just in the past decade, but even in the past year, as I'm sure many of you have seen an ongoing about what that means about individual devices and operating individual pieces of equipment, to thinking about the communication infrastructure needed to enable that connectivity you get into cloud and data storage. You think about the pipes involved, you think about data centers, all that results in significant growth for us. So great focus areas for us. And then lastly, the theme around safety. A lot of our products in their core are really around safety, especially when it relates to electrical energy. And many of our circuit protection products started there. And then we think about other focus areas around safety and operating in harsh and challenging environments and a lot of our products protect people and operations in those areas. So what does that mean for our strategy? With our strategy, we expect to grow sales above the end markets, as I mentioned, electronics, transportation and industrial, we expect to grow above those general end markets, and we're going to do that through a few different areas. By the way, this has generally been our strategy for close to a decade now. So this is really a continuation of what we've started many years ago and expect to continue going forward. But one, through increased content and share gains with a number of applications and end markets that I've talked about that will enable us with our priorities and our focus to grow above the underlying end market growth rates. Secondly, really focusing our resources and our priorities around some of these higher growth end markets and geographies. And then third, we have both a strategy of strong organic growth, 5% to 7% organic growth, but as well looking at acquisitions that further sustain, enable that organic growth, perhaps by adding technology or further focused into certain end markets. And that's what we're looking at with our acquisition strategy. So what does that mean for our outcomes? And I can talk about that a little bit more on the next slide when I talk about the financial goals. Maybe just highlighting what is all -- what are those strategic imperatives? What do we expect that to result in as it relates to our financial objectives. Overall, we're targeting a double-digit revenue growth, our revenue CAGR rather, a combination of the organic growth I mentioned as well as growth from acquisitions that continue to sustain and enable that future organic growth; earnings, where we expect our earnings to grow above that revenue growth with best-in-class operating and EBITDA margins in the high teens for operating margins in the low 20s for EBITDA. One of the hallmarks of the company is a strong free cash flow conversion, the businesses that we're in. And so our target for our free cash flow conversion as a percentage of net income is 100-plus percent. And fairly capital-intensive light is what I would say at 4% to 5% of revenue. ROIC targets in the near-term in the mid-teens level and then an ongoing goal of getting into that high teens as we continue to grow organically and supplement it with the [indiscernible] acquisitions that enable that ROIC. And last but not least, as we think about capital allocation, our first priority is focused on acquisitions because we feel that acquisitions can add to the shareholder value that we've created already over the past several years, but then also a mechanism to return free cash flow to our shareholders through both the dividends and periodic share buybacks. And with that, I guess I'll take a pause here, and I know Karl has a question for us. So I'll pass it back to Karl.

Great, Meenal. Well, I really appreciate that overview. I'd like to get into some of the financial metrics that you laid out in the last slide and a little bit later in the Q&A. But I guess, maybe to start, we have been asking all of our companies at the conference to discuss just the level of visibility each has into the second half based on order backlog, inventory on hand and continuity of supply. And I was hoping maybe you could tell us regarding your ability and strategy to meet demand over the next few quarters, particularly given some of the recent COVID-19 restrictions imposed by foreign governments that may make things a little bit more murky. But if you could just comment on that, that would be very helpful.

Sure. So let me focus on a few areas because it's about not just our production and activities, but it's really, for us, our entire supply chain, ranging from suppliers to customers. So starting internally, I would say, yes, there have been some recent announcements on certain countries where production have been impacted. At this time, none of those have impacted us. I know one of the more recent ones has been around Malaysia, and we really don't have any operations in Malaysia. So at this time, all of our production facilities continue to operate as normal, and we don't have any coded restrictions this time. But like all companies these days, things can change in different countries, and so we continue to monitor that. Overall, as it relates to our ability to manage through this really strong demand environment. We've been adding in select areas of capacity anytime we need it or we are forecasting to need it. We started that back in the fourth quarter. And for us, it's not about having to add a new production facility or add a whole new line, but really looking very carefully at our production processes across a number of different businesses that we have and really adding in capacity where we have bottlenecks so that we're able to keep up with the demand projections that we have. The other 2 areas that we're focused on, if I go backwards into partnering with our suppliers, today, working very, very closely with our suppliers, whether it's raw material suppliers, whether it's partnerships, especially in the semiconductor side, where we're partnering with front end and back-end capacity suppliers there working very closely to understand their capacity, their ability to continue to keep up with us. And so as you can imagine, just like you worked through internally, the time it's been challenging with a number of natural events that have occurred in the marketplace. But we're working well through those. And then I would say on the other side, it's also right now working closely with your customers, right, because the demand is so strong. And we want to make sure we're doing everything possible to meet their requirements for production, but also helping them manage, look, do what we can around helping you perhaps some inventory that you may want to retain. But at the same time, we're very focused on just meeting everybody's needs for current day production.

Got it. No, that's very helpful. I guess, as a follow-up to that, last quarter, you spoke about automotive being down sequentially. That's similar to what your peers have spoken about, and I think kind of reflects some of the production bottlenecks from chip procurement. But I guess, given your unique position within the supply chain, I'm curious to hear may be what sort of feedback have you received from your automotive customers as they discussed, being able to meet, kind of existing production plans of what they've laid out earlier this year.

Sure. Yes. We started hearing basically a lot of the same things that you read in the news about these days. One being, when we issued our second quarter guidance, we knew that there was an expectation for OEMs and therefore, some Tier 1s to temporarily pause production in certain areas or slow down production. We knew that was coming. And I think that's been pretty prevalent in the news. I think how different OEMs have been able to manage through some of the supply chain shortages, not necessarily shortages from our side. But as you talked about, Karl, say, with some of the chip shortages, it varies a bit, ranging from we've had some customers that are continuing to manufacture and build and then store half-built vehicles. And we've seen pictures of parking lots with Ford F-1, half-built Ford F-150s out there. In other cases, there have been maybe longer production stoppages. So as I mentioned in my previous question, we're working with every set of customers right now around what they're doing really to manage through their sort of production needs and how that's working with them, whether it's a temporary stoppage or continue shipping to us because we can get halfway there. And that's an ongoing discussion with every customer.

Sure. Sure. No, I appreciate that. In your past earnings call, you did note some level of inventory build at end customers. And I think that's, quite frankly, I think that's being honest amongst what some other peers may or may not have indicated. But I'm just kind of curious, has the situation broadened maybe in the past few weeks, has it lessened? Are you seeing maybe inventory buildup in different end markets? I was kind of curious if you could just highlight perhaps where you're seeing it? And has it been, I guess, contained? And maybe more importantly, what you do to kind of combat some customers who want to perhaps over order for what they need today and how you kind of manage that relationship with them?

Sure. Trisha, do you want to talk about that?

Sure. I'm happy to, Karl. So I think the situation varies depending on whether or not you're looking at electronics inventory channel versus the transportation or automotive inventory. So if you start first with electronics, what we've been seeing really within those channels, if you look beyond the distribution partners where our products would be to look at the contract manufacturers and some of our OEM customers we do think that some of the end customers are building some inventory where possible, and that was really reflected in that higher book-to-bill that we talked about during our Q1 results. I think if you look broader than that to inventory weeks held at the distribution partners, those are within that normal range, if not at the lower end. So they're around 11 weeks. So I think that really speaks to the sell-in and sell-out being balanced for electronics, but recognizing, as you point out, that there seems to be, which is an indicator of that higher book-to-bill, probably some bookings that's being held or excess inventory at the end customer. So we're watching that closely. Where we can, we do try to manage that with the distribution partners to ensure that the sell-in and the sellout is balanced and actually passing through. We can also adjust the cancellation terms to try to encourage the customer to really be ordering in line with demand. So that's another consideration that we try to work with those partners. On the automotive side, what we really have been seeing. In Q4, we talked about the first indication of some inventory build, probably as the OEMs in Tier 1s really in response to what Meenal mentioned, some of those shutdowns that they were experiencing or in response to the supply chain shortages in certain areas. So in Q4, with that inventory build, you would have expected maybe some of that to flesh out in Q1. In fact, we didn't see any more build in terms of excess inventory. But what we think we saw in terms of our performance, which really outpaced the market growth well beyond the target that we've laid out was really that product mix. So strong demand in SUVs, luxury vehicles, other high-end automobiles. And then also electrification of vehicles, right? There's some nice momentum that we're seeing for EV. So that drove that higher growth as well. So we didn't exactly see that inventory come out probably in the channel in Q1. So that's something to still consider for the remainder of this year, and we'll have to see how things play out with a lot of the dynamics that Meenal mentioned. But I think in both situations, electronics and automotive, we're being proactive to try to manage that inventory and to work closely with those customers.

Very good. I guess that kind of dovetails into another question that I'd like to ask, which is EVs. I think there's been quite a bit of press around China and Europe's lead in electric vehicle adoption. And I was just -- I know you have some opportunity here in exposure. And so I was hoping you could just discuss your ability to address EV adoption, whether that's through the -- whether it's onboard charger, we hear DC to DC converter, external charging stations, and maybe if that varies at all by geography, for example, in China. So if you could just highlight that, that would be very helpful.

Yes, I'm happy to speak to that one. So what I would say really broadly is that we have a strong global presence across the electric vehicle end markets. When we think about our strategy, it's really leveraging the traditional passenger vehicle leadership that we have today to go to the different regional markets for electric vehicles. So we're seeing really nice progress and design wins in Europe. In Asia and within China and then North America. And so we've talked about a number of different platforms where there have been significant business wins that we would continue to see the content growth. When we think about the applications where we can participate, it's much broader than just the charging applications. If you think about the onboard applications of content opportunities that are additive to our 12-volt vehicle, for example, if you think about an electric vehicle, we have a lot of applications around power management and distribution, battery management and protection. If you think about the onboard charging aspect, that's an additional opportunity as well as the off-board. So that's where we've historically talked about this content increase, which is quite significant for us. If you think about the 12-volt content that we have, it approaches around $5. And Karl, as you're aware, that goes up to about 8x for a full battery electric vehicle. So that's an example where there's a number of applications that are really additive to the past car where we have that leadership today. So we expect to be a significant participant within the EV market, and that will continue to drive that significant growth, which, in fact, is our highest growth segment for the company. If you look at the automotive, 7% to 9% that we've talked about over the next 5 years, really driven by that ongoing progression towards EVs. So that will continue to drive significant growth for us with the global presence that we have.

That's very helpful. I guess in addition to that, so we're talking about 12-volt today and also talking about electric vehicles, but there has been this discussion as well about the shift to 48-volt, I guess, applications. And so -- and not just -- we have -- you have an automotive segment, but you also have an electronics segment. I believe you -- in the past, you've had about $100 million or so of actual electronics revenue that ends up being sold in automotive. So I want to make sure if that's still the case today. And I guess the real question is, I guess, what is your perspective on your own content growth in passenger and commercial vehicles over time, as we kind of add-in additional content within automotive, and while it sounds like electric vehicle growth is a significant opportunity for you, maybe also, just kind of highlight the opportunity you see going from maybe even hybrids or from 12-volt to 48-volt systems as well.

Sure. I'm happy to. So if you think about the ongoing technology evolutions, for the 12-volt vehicle, right? That continues to increase the complexity of the architecture. And that's really what's driving Littelfuse's content increase, which gets you to that $5 that I referenced previously. But if you think about the number of applications on a 12-volt vehicle, for example, you have applications around fluid management or motor protection or motor control. Also anything with infotainment or navigation, there's more ports, more screens. All of that content, which, as you point out, also is included in automotive electronics, which is around $100 million and is reported in the Electronics segment. But that's a consideration when you look at the total company automotive performance in terms of global car production. But in addition to those applications, then you have connectivity or greater applications around sensing, right? So comfort and convenience of seat positioning or autonomous driving features, right? All of those applications are driving greater content, greater need for Littelfuse's products. You're right. So the progression with that complexity and the technology evolutions really across passenger vehicle and commercial vehicles. Even beyond that, you have some content increase with 48 volts. Now some OEMs have skipped over that and gone to other hybrid type models or full battery electric. But that's where I had previously mentioned that 8x range for a whole battery electric vehicle. In some cases, you see 3x, and that's because that could be the hybrid, a plug-in hybrid or a full hybrid vehicle going up to the full battery electric in 8x. Generally, for 48-volt, you see around a 30% increase in that content that we see in a 12-volt vehicle. But again, it gets back to the complexity of those different architectures that's driving that growth. But really broad in terms of both the presence in passenger vehicles and a lot of those same trends are application and also drive content growth within commercial vehicles.

Very helpful. I guess I'd like to pivot to electronics for a moment. When I speak to some investors on your story and the opportunity you have on expanding operating margins for your long-term model, the discussion often kind of attempts to juxtapose today versus the 2017 and 2018 upcycle when electronic margins improved in the low to mid-20s. And so I was kind of curious to hear maybe your view on what 1 or 2 things do you think is needed for you to see operating margins move up in the low 20s for electronics. And I ask, is the market environment seems primed for your business well for further improvements here. And then maybe just to expand the aperture, is there something else beyond electronics, whether it's the industrial market or the automotive market or internal efforts that can also help drive toward that long-term operating margin model?

Sure. Yes, I can talk about that. So as part of our investor event, we reiterated margin targets for each of our product segments. And we talked about the electronics, as an example, being in that high teens range up to, say, 20% operating margin. What I try to remind everyone is really think about that, that's not a quarter-by-quarter target, but that's an average. It's an average over we talked about a 5-year strategy at one time, but it's also an average through a prototypical cycle. So Karl, you referenced the great growth periods that we saw in the '17 and '18 time frame. And then some may recall, we went through a proverbial electronics down cycle in '19. And what we've talked about is, look, within a 5-year period, the likelihood of there being a particular cycle is probably there. So we will absolutely during strong demand periods. I would absolutely expect our Electronics segment margin to be over 20%, and we demonstrated that back in that '17, '18 time frame. But when we're going through a cycle, we might expect the margin to do below that range. And so our intent is through a cycle that we can maintain that upward teens margin. And it's really the case. You mentioned some of the other segments. But that's really the same thought process that we have for all of our segments are -- with so many different end markets, whether it's our industrial product segment or automotive product segment, they will go through cycles as well. And so the targets that we've laid out are you go through a prototypical cycle at times when you have high demand period at time, this is still the target margin range we'd expect as an average over the strategy period.

Got it. No, that's helpful. Maybe just to round out that discussion as we think about improvements in operating margins. You've made some recent acquisitions, Hartland, most recently, IXYS a little bit further down the road. If you could just kind of update us on where you are in terms of integration for both of those assets? And should we look to those as a -- not just a further revenue diversification for you, but also perhaps some other opportunity to improve margins down the line as you kind of integrate those businesses, too.

Sure. Trisha, do you want to talk about the integration update? I'm happy to highlight some commentary on margins.

Yes, that sounds fit, Meenal. So what I would say, Karl, in terms of the IXYS integration, the bulk of that is behind us, and the remaining work is really around the footprint. And so we've talked about our project related to our new plant in the Philippines. That's really focused on strengthening the back-end supply chain part of the process around the assembly and test portions of the manufacturing process. So that has progressed quite well, and we're on track to complete that in 2022 but that's really where we are in terms of the IXYS integration. The growth opportunities are significant, as you're aware of, the different applications that we're targeting because of the broad power semi portfolio that we have really around alternative energy off-board charging, so additional content opportunity is significant versus onboard content that we already talked about, approaching $100 of content of little-used products for off Board charging. And then in addition to that, you have industrial automation or safety and then some of the applications that we have around power supply. So anything related to telecom infrastructure, 5G, data storage, big growth drivers or opportunities for the power semi products that we acquired through that acquisition. Hartland, I would also say going very well, on strong start. We are seeing benefits with the combined teams and the complementary products, really targeting the high-growth HVAC end marketer applications. And so now we can bring more complementary products to our customers really through those strong relationships that both Littelfuse had and Hartland has. So great acquisition for us really fits the M&A criteria that we've outlined. And then, Meenal, if you want to talk to the margins?

Sure. And really, just echoing what Trisha is saying, really, these actions for us are meant to drive, not just the cost synergy side, but Karl, as you mentioned, really revenue growth. So in the case of IXYS, right, the addition of the plant will both enable cost improvements, but also profitable growth on the revenue side. And that's part and parcel to our ongoing best-in-class electronics margins that we talked about. High teens can easily see it popping over 20% at times. And with the industrial segment, we've laid out a high-teens margin target as well. And some of these, again, profitable growth activities as well as other cost synergy activities that we're embarking on, we'll get that acquisition to -- into really that profile of the high teens because, unfortunately, most acquisitions just don't come into the new portfolio at a high-teens margin. So a little work to do, but we've proven time and time again that we can deliver that.

Sure. Sure. Well, with that, I think we're out of time for this session. I'm sure we could talk all day on the overall business portfolio. But Meenal and Trisha, really appreciate your time today, and thanks for joining.

Thank you.

Thank you for the invitation, Karl. Appreciate it.