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

Well, good morning, everyone. I'm Matt Sheerin, I'm the technology supply chain analyst at Stifel, and welcome to the Stifel Cross Sector Insight Conference. We're starting the conference off with Littelfuse, one of the major suppliers of electronic components across several industries, including automotive and general industry. Representing the company is the CEO, Dave Heinzmann; and Trisha Tuntland, who does Investor Relations. Dave is going to go through some slides quickly, and then we're going to go into Q&A. [Operator Instructions] Okay. So Dave is going to start off some slides. Dave?

Yes. Thanks, Matt. For those of you who aren't familiar with Littelfuse, we are about a $1.5 billion industrial tech company that empowers our customers to build a sustainable, connected and safer world. Our strong global presence allows us to utilize a deep technical and application expertise, support more than 100,000 customers in the industrial, transportation and electronics markets. Our strategies have demonstrated an ability to drive content increases and market share gains that realize growth beyond that of the end markets that we serve. Trisha, if you move to the next slide. Again, for those of you who have followed us over the last several years, you'll see that the current 5-year growth strategy is ultimately a continuation of a journey we started several years ago. We believe the success of our previous strategies have placed us extremely well in a strong position to continue to drive profitable double-digit growth over the next 5 years and beyond. Our strategy continues to be rooted in the multi-decade trends of a sustainable, connected and safer world, and we believe these trends today are even stronger than they were 5, 10 years ago when we identified them. While our customer base is quite broad, we position ourselves to drive significant gains in targeted high-growth markets. We've had strong success in the past, and we'll continue to utilize strategic acquisitions, support our efforts to better serve these strategic high-growth markets. Our foundation build around these structural growth themes and related growth drivers will enable long-term double-digit growth through our normal business cycles while delivering best-in-class profitability and top-tier shareholder returns. We now look at kind of the financial framework for our strategy. It really all starts with double-digit annual sales growth. Our focus on these high-growth markets and applications will allow us to organically outgrow the markets we serve, supported with strategic acquisitions. This growth and our focus on operational excellence will yield high teens operating margins and EBITDA from -- in the range of 21% to 23%, near-term mid-teens ROIC with execution driving our ROIC to high teens within 5 years. We feel this strategy will allow a balanced use of our free cash flow with the primary use being for strategic value-added acquisitions, but also allows us the ability to return about 40% of our free cash to shareholders as well. This is largely the same financial roadmap we've been using for almost a decade at this point in time, which has really delivered a TSR CAGR of more than 20% over that horizon. So as I look across our enterprise, our businesses are strong. We have a strong proper portfolio to address it. And we are confident in achieving this framework and the goals that we've set out. So with that, we'll hand it back over to you, Matt, and we'll field questions.

Yes. Okay. Great. Thanks, Dave, for that introduction. So just to start off, obviously, the big question everyone is asking you just on the supply-demand environment. We went from, obviously, really a tough demand situation when we got into the pandemic. Then there was this huge ramp back and obviously, component constraints and supply issues everywhere, including higher cost, weighing on things, and it certainly affected some of your end markets including automotive. So could you just walk us through what you've been seeing relative to what you saw maybe a quarter ago? And just sort of walk us through the supply chain dynamics right now.

Sure. So obviously, there's a lot of attention that comes to supply chain disruptions and limitations and things like that. And clearly, we see the impact of that in the automotive segment, for sure, that where shortages from other suppliers are kind of limiting the car build. And however, we kind of expected that when we gave our guidance for second quarter. So we did kind of guide with that in mind. And so consequently, our guide considered potentially sequentially slightly down in our automotive segment because of that. However, we continue to see ongoing strength across the electronics in the industrial end markets, demand levels, bookings, things like that continue to be quite strong in those areas.

Okay. So in automotive, I know a couple of quarters ago, you had talked about a potential imbalance of inventory where there was a big pull in for your products because you did have a relatively low lead times relative to other components that go into socket. So are you seeing that at all? Is that part of that down sequential? Is it really just a function of production coming back for the auto guys as they get the other parts?

Yes. I think at this point, we're not seeing kind of inventories shifting so much in the -- with our customer base in the auto side other than, of course, you read what we read with there are certainly OEMs who have built vehicles and completed them largely, minus some of their ECUs and things like that, and they parked them. So certainly, around the world, that has an impact to having maybe understating car build in some ways because they're sitting there and not shipping and be considered complete. But -- so really, right now, what we're kind of seeing is our sell-in to the automotive customers kind of matching their car builds reasonably well. It's just that the car builds are suppressed.

Yes. And if you look at your forward bookings, does that contemplate a ramp-up or return to more normal production. Or in other words, are your customers getting visibility into supply later this year? So they're telling you, yes, we're going to be looking at it plus 2, plus 5 or whatever the number is.

Yes. I would say there's just a lot of uncertainty out there right now on the automotive side. So relatively short lead times in that side. So the amount of visibility, we get the visibility that's given to us by the OEMs and the Tier 1s. However, there's lots of astros on those, whether it's problems with chip supply and now you have shutdowns in Malaysia that some suppliers are impacting their ability to ship and including some of the semiconductors into the auto side. So we're kind of cautiously watching that. So I'm not sure we have any better insight into what's going on car build in the back half of the year. Our projections, when we talked at the end of our first quarter, where we expect kind of in the range of kind of 80 to low 80s as far as global car build for the year. And right now, we don't have a material different view on that today.

Okay. And then in terms of the mix that you're seeing now, it seems like there was a shift, obviously, towards high end and that should be a positive for you in terms of mix right now, even though the volumes are maybe not what you want them to be.

Sure. Sure. It has been, right? And when you think about the volume of a car build rate compared to where we were a couple of years ago, it's still significantly down on car build from where we were in '18 and '19, but you're absolutely correct. The mix of vehicles that the OEMs are focusing on, I think kind of globally are on the higher end vehicles, the higher-margin vehicles as well as electrification. Those areas are getting the primary attention from the OEMs, which is a positive mix for us, certainly.

Yes. I was going to ask about EV because it seems like you and several other players in the market have talked about an acceleration toward EV, not just obviously the traditional players, but all the auto guys, right, and you're fairly aligned there. So what's your visibility into that? And does this whole component constraint issue affect the EV acceleration as well?

Yes. Clearly, none of the OEMs are wanting to fall behind on the EV introductions, right, as that is certainly a big part of what they see as the future, and they don't want to be seen as falling behind others. So they're putting certainly strong priorities on the EV side of things. Are EVs being impacted by shortages? Sure. There are shortages impacting EVs as well, but certainly, we see the OEMs putting priority on those ahead of maybe a traditional vehicle that they can't. For them, even a bit of a dent maybe to their overall profitability because EVs are not as profitable for them, but they're just kind of seeing the long-term trend on that. And so we're still seeing continued pretty strong demand on the EV side.

Okay. So sticking to automotive. Could you just talk about the content that you're seeing now in traditional cars, combustible engines versus the EV opportunity and where that's going?

Yes. If you look at our kind of circuit protection content and opportunity on vehicles, a traditional 12-volt vehicle, our content -- kind of average content is approaching about $5 of content per vehicle, which is healthy and has grown over the past years. What we see in full EV is a very significant increase because the great news is most of the 12-volt systems still are there on a full EV. And so we continue to have some of that 12-volt volume on the vehicle. But the high-voltage side really takes that up, and that can increase our content opportunity by 6 to 8x the opportunity it is on a 12-volt system. So it's a pretty significant upside for us on the electrical systems.

And then within your -- you have a lot of exposure within your electronics components area, right?

Correct.

And I know that's -- I forget, like 10% or 15% of your electronics or maybe higher, but could you talk about the content there? So on an aggregate basis, the circuit protection versus your semiconductor content?

Yes. What I would say is in the vehicle electrification side, which I just talked about, that's where -- and in the electrical system itself, that's where the bulk of the big content increases come from for electrification for us. If you look at just the electronics components in the vehicle, there certainly is content growth there as the sophistication of the electronics in the vehicle and whether they be active or passive safety systems and things like that, certainly increase the content. And those are certainly growing faster than car build. So they contribute to our overall kind of view of growing our content kind of in the range of about 4% above car build increases, that certainly contributes to that capability.

Okay. Great. And then the HVOR, heavy truck market is obviously a big part of your auto business as well in electronics. I know there's been an up cycle there. And lately, I know there's been some demand drivers. Could you talk about what you're seeing there? And are you -- is that also gated somewhat toward because of the component constraints, the growth there?

Yes. What I would say is on the on-highway and off highway, heavy vehicle side of our business, which ends up being, yes, kind of in that range of about 25% of our transportation exposures in that side. Clearly, it's a cyclical market we serve. It's a strong cycle right now, things are kind of bouncing back. And so certainly, there's growth of the end markets there that are certainly, we're seeing. Yes, the other thing we're seeing is that really in the last couple of years, a pretty strong focus on electrification efforts on that side of the business as well. Now it's a little -- maybe a little bit behind passenger car world on that trend, but it certainly is a positive trend there and electrification on the HVOR side of things as well.

And are you seeing strong demand in all regions for HVOR right now?

We are seeing pretty strong demand in all regions. I would say maybe the weakest region right now would be Europe, stronger in Asia and North America, but even in Europe, there is growth. It's just the level of growth is a little bit behind what we see in the other parts of the region.

Okay. Okay. Great. So on the electronics business, I did want to talk about the demand you're seeing there. I know you've got a lot of components that have extended lead times. Very, very strong book-to-bill ratios, very strong demand from distribution. So could you update us on the inventory there, what the book-to-bills look like and what lead times look like?

We really haven't seen a lot of change since the last time we had the update at the end of our first quarter earnings call, where we talked about the fact that our distribution partners and about 75% of our revenues in that segment flow through distribution. That normal range for us is 11 to 14 weeks of inventory there. We talked about previously, and we still see it. We're kind of at the very lean side of that. So there's not -- there's clearly not excess inventory in the channel at this point in time. It's pretty lean, really strong bookings and pretty much anything we ship into the distributor ships right through to OEM. So they're continuing to see very strong demand patterns. And I know you've got them on I think Arrow and Avnet's on later today. But yes, so we still see very strong bookings there as well. So really kind of continues down that path.

Yes. I mean, obviously, the concern when the book-to-bill is so strong and the backlog is strong, was just concerned about double ordering. And it wasn't that long ago, a couple of years ago, when we saw a pretty mean inventory correction, right, hit everybody, including you. Things do seem to be different this year. Obviously, there's a lot of growth drivers ahead of us. But what is your sense of this cycle and how this plays out, if you will?

Sure. Yes. It's in some ways, it feels a little different than a normal cycle with kind of the rebound out of the -- after the pandemic period. But in other ways, it has similarities to previous cycles that we've lived through over time. One thing that we continually watch is what drives the bigger swing for us often is -- by amplitude, is distribution inventory, right? Because as demand is really strong there, they're building inventory levels. And then, of course, they -- when demand starts to slow, they drop their inventory levels. Well, at least in our product areas, there's been no ability for them to increase their inventory levels. They'd like to, but they've not done it because of inability to do that because of demand pattern. Now perhaps there's some patterns at the end customers where they're working to carry some heavier inventory. So we know, like, for instance, on the auto side, that the OEMs have told Tier 1s, they want them to book more and carry heavier inventories right now. Now whether that's going to be a sustainable change to kind of the just-in-time start of patterns of the past or whether it will be short-lived, kind of remains to be seen. But there's certainly some evidence that where they can, OEMs, whether they're on the auto side or even on the electronics side, if they can, they're trying to build inventory. But the reality is they have not had a lot of success in being able to do that yet.

That's right. Yes. And it does sound like the auto industry is talking about that, just-in-case inventory, sort of buffer build. We'll have to see whether this plays out broadly speaking. But yes, I guess my other question was going to be, yes, the distribution sell-through was very, very strong, but how do you know there's not inventory build at their customers. And I'll ask Arrow and Avnet later, but they may be the first guys to see even though last quarter, they seemed to lag the cycle, it could be that they see it early because they are the ones shipping out really fast to customer.

Yes. And I have kind of at least monthly discussions with senior leadership of all of our distribution partners. And certainly, those are discussions we have, kind of what are they seeing. And I think what I'm hearing is they're seeing OEMs who are wanting to and trying to, but not a lot of evidence of strong amounts of inventory built because in many cases, they also have -- or in some cases, some of the larger OEMs, they have dedicated inventory they're pulling from. And so they'll see evidence, there's no need for them to, in some cases. But yes. So we continue to monitor that.

Okay. And then just within electronics. Well, actually, all of your segments, you have seen some higher input costs and materials costs. And I know there's also been talk about passing some of those costs along ASP increases. Could you update us on that?

Trisha, do you want to give some input on that?

Sure. I'm happy to. So Matt, recall that we tried to break out those higher input costs. So we are seeing higher prices related to commodities to work, which are at multiyear all-time highs on the order of 200 basis points. And so that, combined with even the higher constraints around logistics and freight, which is for another 100 basis points, we are seeing an impact across the segments right now, about 250 to 300 basis points, so significant for us. And then in addition to that, we do see some FX headwinds, but much less along with the COVID costs that are continuing about 50 basis points. So you're right, significant impact across the different segments, but what I would say is those targets that Dave laid out for the next 5 years, we're off to a good start and really trying to look at holistically the total company margins of that 17% to 19%, we are able to achieve that within our first quarter. But thinking about how do we offset those input costs, we've talked about some pricing increases that we can pass through to try to help mitigate the impact. So we have done one series of price increases and a second and considering a third. So I think, stay tuned, but trying to offset some of those, both higher inflationary costs as well as the freight impact. But all in all, I would say, off to a good start in tracking to those targets that we've laid out with the 5-year plan.

Right. And what kind of reception are you getting from customers? I know from distribution, it's fairly easier versus your direct customers, particularly where you've got contracts, right?

Yes. Yes. What I would say on that is with business flowing through distribution, it's a bit easier to do that and a little faster to be able to do that. Now we're always cognizant about not being too over asserted with customers because they have very long memories, right? So we have to be thoughtful about that and how we approach that and be fair. But we're able to pass that through faster in the businesses that flow through distribution. And certainly, areas like automotive pass car, where you have long-term contracts often, a little more challenging to be able to do that. And so that tends to be -- get some of that game, but it happens to be over a 2- or 3-year period because your contracts, you're negotiating during the period, you have ability to negotiate in a better position, right, where it's less of an immediate sort of upside.

Got it. Okay. Let's move to the margin targets and the growth targets that you've laid out. And a few years ago, you set targets. And 5 years later, you were pretty much spot on. So and certainly, your track record is strong there. The question now is really what gets -- and I know in this environment right now, it's hard to tell how much companies are over-earning versus under-earning because of costs and you've got price increases, et cetera. But as we look over the next couple of, 3 years, what is the bridge between where your margins were, you're at 14% or so to that high end of the high teens? Is that really a function of volumes and leverage off of that? Or is there a mix play into that as well?

Trisha, take that, please.

I would say it's a combination of both, Matt. So what we tend to anchor folks to is the execution from '17 through '19. So you'll recall that our prior framework for our 5-year strategy is very consistent and similar to the targets we have today. But really, pre-pandemic, we were executing to those targets, and we were achieving those targets. And when the pandemic came in 2020, shifting our focus then really on profit preservation as well as the liquidity of the company around cash generation and debt capacity. So we had to shift during 2020, but now resetting those targets this year with our investor event in February, how do we bridge getting to those targets longer-term is really different elements across the segment. So within electronics, it's electronification, electrification, return to growth because you'll recall those incremental drop-throughs that we see in electronics are quite significant for us. In addition to that, right, it gets back to product management, pricing initiatives that we have in place and then leveraging those OEM and distribution partners within automotive to bridge batch transition, it gets back to electrification, return to some element of stronger global car production, which we are seeing momentum. But then thinking about how do we continue to really build out supply chain simplification with different elements of our footprint. Within industrials, you do need some element of some return of some of those end markets around oil, gas and mining to get some of the profitability that we would see in addition to MRO. But with stability of those end markets within industrials, we've all seen a lot of footprint work. So really thinking about what does the cost structure look like, how do we ensure the profitability of the company. So I would say it's an element, as you mentioned, right, some of that top line incremental drop-through that we would historically have seen will come because of the improvements we made around the cost structure. But I would say that, again, we're off to a good start given our Q1 performance and where we're headed over the next 5 years. But I would say that those structural themes that Dave mentioned, really taking advantage of those because we were positioned, but then driving it through the different elements of our own actions internally and the cost structure really should fit with that end market demand.

Understood. Okay. That's helpful. And I did want to talk about M&A because that's obviously a part of that growth story, the double-digit growth, inorganic growth where you've also had a lot of success, not as much activity lately, obviously. I know IXYS was the last very big acquisition and the biggest acquisition you've done. I think it's 3 years now plus on that deal, Dave. Could you tell us where you are in terms of integrating IXYS? Any cross-selling opportunities that you had, and particularly in the automotive area where I know IXYS didn't have a lot of exposure, but their products like MOSFETS and other power semiconductors, obviously, are a good fit for that market?

Sure. Sure. What I would say is we've made great progress on kind of integrating that business and kind of getting it agreeing to our core, which is going well. We were upfront about the fact that there was a lot of structural work that needed to be done on that business to ultimately get it to be at the margin profile that we think it needs to be and ability to grow it aggressively. So we're still in the midst of that footprint work. In the semiconductor space, that takes a lot of time because it can take as much as 1.5 years just to get a customer approval on a move in the semiconductor side of things. So we've made great progress there. We've built a new factory in the Philippines, consolidate our back-end operations in, we're starting to ramp that up now. So we kind of see over the course of the next maybe 3 quarters or so, kind of largely finish that work and get big parts of the footprint work done. That allows us to really have the health of business where we want it to be. And the ability to support high-growth in the markets that we're targeting. The question on the automotive side, there's certainly automotive opportunities for us, and we're selling some to the automotive side. It is not our first priority. In many ways, we see still tremendous opportunity, particularly on more of the industrial side of things is where our primary focus is with our power semiconductor business. However, that kind of overlaps the auto side because certainly, things like charging infrastructure. That's a key area for the power semiconductor opportunities. We're seeing good opportunities and good gains there. Renewable energy, those sorts of things. Not quite as focused on the on-vehicle side on our power semiconductor business at this point in time. Longer term, perhaps, but when you're moving footprint and you're moving from fab to fab and things like that, it's a really bad time to be trying to get automotive approvals. We want to get our way through that before we do too much on the auto side.

Okay. Yes, it looks like we have a minute or two left. Just lastly, in terms of the M&A pipeline now and maybe areas that you're looking at -- and in the areas -- most of areas to fill in terms of technical expertise or end markets where you're looking?

Yes, certainly. So for us, we see -- our historical success in M&A and our current view is really yes, making strategic acquisitions that ultimately allow us to grow faster in these higher growth target markets that we're focusing on. And it's really about adding more value to our customers there. So areas that are significant opportunity for us. Certainly, eMobility. There are opportunities there to add some strength in overall eMobility. But renewable energy, energy storage, power conversion, commercial vehicles, HVAC space in the industrial side. In the first quarter where we closed on the Hartland Controls acquisition was really to strengthen our position and actually create between our own business and that business over a $100 million business serving the HVAC space, which we see has a good, strong growth potential in the long term. So those kind of end markets and applications where we see the highest priorities. The good news is we've got a lot of optionality.

Okay. Okay. Well, great. It looks like we're out of time. But thanks so much, Dave, and Trisha. We appreciate it, and we'll talk to you soon.

Thanks, Matt.

Thanks, Matt. Appreciate it. Thank you.

Thank you, everyone. Bye.