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

Okay. Good afternoon, everyone, and welcome to the 19th Annual Best Ideas Conference for CL King. My name is Dave Silver. I'm the senior research analyst at CL King, and I'll be moderating the fireside chat with Littelfuse. Representing Littelfuse is the Chief Financial Officer, Ms. Meenal Sethna. And we also had Ms. Trisha Tuntland, Head of Investor Relations. So the format here is I'm going to turn this over to Meenal for her opening remarks, and I will follow with a series of questions. And with the time remaining, I will be able to ask any questions submitted from the audience. I have my dashboard here, and I can see the questions immediately after they are submitted. Okay. So with that, I'm going to turn it over to Ms. Meenal Sethna, Chief Financial Officer for Littelfuse. Meenal?

Great. Thanks, David, and good morning, good afternoon, everybody. We really appreciate you taking the time to join us today. For those of you who may not be as familiar with Littelfuse, I wanted to spend about 5 minutes or so just covering our overall strategy. The prior slide that you saw there was just the -- all the forward-looking statements, et cetera, that we have. So feel free to read that at your leisure. Littelfuse had a virtual investor event back in February, and so I'm going to show just a couple of highlights, a few summary slides from that event. But would encourage you, as you have more interest, please go to our website at littelfuse.com, and you can pull down the entire presentation as well as the webcast that was out there. So just starting out. Who are we? Littelfuse, $1.8 billion industrial technology company. We're known for a wide portfolio of circuit protection products, sensors, semiconductor products. But even more so, and you'll hear me talk about this, it's the broad range of end markets that we're selling into across electronics, transportation and industrial end markets. The secular themes that have really been a part of our growth strategy now for about a decade or so really center around sustainability. This idea of a lot of discussions stays about electric vehicles, renewable energy, and so many of our products enable our customers to really drive sustainability. This idea of connectivity, and I would even enlarge that to mobility as well. We've seen that advance over the past decade. We've seen it advance exponentially over the past 18 months with our desire to be able to be connected virtually wherever we are in a number of different ways as well as we want the same connectivity it -- at different times, in different locations and to be able to replicate itself wherever we are. And then lastly, safety. Our -- we're almost 95 years old now. Next year will be our 95th-year anniversary. And really, the foundation of our company is really around safety. Circuit protection products have been a big part of our portfolio over the years in a number of electrical applications, in a number of environments, automotive environments and other harsh environments where safety is fairly paramount. We sell to over 100,000 end customers across over 15 countries around the world. Our go-to-market strategy is a combination of distribution and direct sales through OEM, which works well for the company and the portfolio that we offer. And ultimately, we are a growth company. For us, it's about organic growth and really finding the strongest applications in end markets where we see higher-than-typical growth areas. That's where we focus on. We focus on increasing our content in those areas as well as share gains as well and also focusing across higher growth geographies as we think about that. And then lastly, strategic acquisitions for us are a complement to our growth to really help us enable and sustain the organic growth that we expect to drive, and I'll talk a little bit more about that in the next couple of slides. So moving on to a summary of our strategy. I talked about the 3 structural growth means that we have. And again, I just wanted to reinforce, while we just released a 5-year strategy, an updated 5-year strategy in the February time frame, it's really largely the same as the strategy we've had over the past 10 years or so, really focused on similar growth themes, really driving organic growth well above the market through content and share gains rather than focusing on particular technologies in our portfolio. We're much more focused on high-growth markets, applications and geographies and acquisitions, then supplement our growth. And then from an outcome perspective, I'll take you to the next slide because I think that outlines some of the specific financial objectives that we have. First of all, you heard me talk about a growth company. I referred to us as a profitable growth company starting with our revenue and expected double-digit revenue CAGR over our 5-year strategy, a combination of both the organic growth and similar growth from acquisitions. Again, acquisitions that meet our expectations around strategy, that complement our organic growth and that we believe can achieve our profitability and cash and return expectations. Secondly, we expect to leverage our earnings growth ahead of our revenue growth through thoughtful investments that we make, both from an organic perspective but also thoughtful on where we make investments in other areas. That's yielded us an average of 17% to 19% operating margins in the past, and we expect that to continue going forward and then low 20s EBITDA margin range. Our portfolio is also terrific when it comes to cash flow conversion. We typically run at or above 100% free cash flow conversion as a percentage of net income. So strong cash-generating businesses that we're in. And probably a little bit lighter on the capital expenditure side, where we spend about 4% to 5% of revenue annually on capital expenditures. A lot of that going towards growth as well as new products, new technologies as we're expanding the portfolio. From an ROIC perspective, our 5-year goal is high-teens return on invested capital with the near-term objective to be in the mid-teens returns. It's a balance of strong ROIC above these levels from our organic business. But when you make acquisitions, they rarely come into the portfolio at the returns that we've outlined here. So that is one of the things that we do around our integration, is driving a top line growth, that revenue CAGR I talked about, as well as streamlining the cost structure and cash structure so that we can get these acquisitions also at a similar ROIC level. And then lastly, our capital allocation. 40% of our free cash, we return to shareholders through dividend. We've had a dividend now in place for over 10 years, and so that's been a foundation of what we put in place. Periodic, what I sometimes call opportunistic share buyback. And then the remainder, about 60-plus percent is what we use to focus on acquisitions, as I've outlined earlier here. And so with that, that's a summary of Littelfuse, profitable growth company with a long-standing strategy around organic growth, supplemented with strategic M&A. And with that, I think, David, ready to take questions.

Okay. Great. Meenal. Thank you for that. My first question would kind of be in the area of, boy, you've got a high-class problem to deal with, and that's your record financial performance thus far in 2021. And I'm thinking about how that may impact your thinking about your long-term growth targets. So in one of your slides, Meenal, you laid out the 5-year target growth rate of between, let's say, 10% and 14% half organic and have been organic. And when I look at the first half of the year, the revenue growth is at 50% of your organic growth. It's closer to 40%. The midpoint of your third quarter guidance is in the 30%-plus range. So I'm wondering how you're thinking now about your 5-year targets, which were established early this year in light of your exceptionally strong demand recovery and a robust electronics demand backdrop.

Sure. So I would start out with we set ourselves up well, and we had talked about this in 2020 that we wanted to be ready for the recovery. We wanted to be well positioned from our people, from our products and really from a profitability and a cash perspective. And we did that. So as you said, a high-class problem to have. From there, though, what I'd remind people is we talk about our strategy in 5-year buckets. And we laid out these targets, and I emphasize this through the cycle. And by that, I mean that we are in a broad set of diversified end markets. I mentioned earlier electronics, automotive or transportation end markets, which also includes commercial vehicle as well as industrial end markets. And they each go through their cycles. There are a lot of sub-end markets in there, they go through their cycles, and so our -- the growth targets that we laid out are really meant to take us through those cycles. Because as well as things go during these times where we're seeing a lot of strong growth, I would expect that in the next 5 years, we're going to see in a number of our end markets a down cycle come through as they typically do, and so our goal is really sustaining that growth through that 5-year period.

Okay. The next question, I think I was hoping you might be able to provide your perspective on some recent news reports and in particular the effects of the semiconductor shortages and logistical challenges that are broadly affecting a number of industries right now. But during the past month, a number of leading global automakers have announced a fresh round of production cutbacks tied to chip shortages, shortages of other parts and other factors. And I would say in the past week, some very large industrial companies with significant exposure to similar end markets to yours, different products, but coatings makers like PPG and Sherwin yesterday, 3M, they've all made cuts to their current quarter revenue guidance or overall outlook. So from Littelfuse's management's perspective, I mean how has your overall demand outlook in your major end markets changed or shifted during the September quarter?

Yes. So I would take us back to some of our assumptions when we released our earnings at the end of the second quarter and offered our third quarter guidance. I think the first thing we commented on was end customer demand remains strong. Yes, there are a number of, I'll just broadly say, supply chain challenges out there relating to whether it's supply of components and products, logistics challenges, et cetera, but end market demand remains very strong. At the same time, when we thought about the third quarter, we factored in some of these unknowns along the way. We had already been, and we talked about this on our second quarter earnings call, that we were seeing a number of different supply chain challenges. We're working through all those, whether it's our suppliers having some challenges procuring the parts or even raw materials that they need to find, ranging all the way to logistics capacity and now even container capacity to get our products to customers. And then even some of our customers, maybe having enough inventory of our products to be able to continue their builds for whatever products they have but then finding shortages with other suppliers that they have. So we try to take a lot of that into account. I would say we're seeing that continue. I'd say new issues pop up every week for different reasons, for different issues that I think our teams have really done a tremendous job, especially across that manufacturing supply chain continuum, to really continue to be able to meet the needs of our customers as they're working through these times as well.

Okay. Great. Next, I think the next question I'd like to ask you about or topic would be supply chain challenges. So -- and then maybe your supply chain but also maybe that for key customers, if that's visible to you. But in addition to the rising inflationary pressures in general, I've read reports from Asia where the COVID Delta variant is affecting labor availability at production sites as well as causing potential disruptions to port operations. I would say air cargo availability is related to airline travel, which also could be affected by the COVID variant. So regarding either raw materials, labor costs and availability or logistics, can you characterize your ability to meet customer demand with that major disruption and maybe compare the current environment to what you were dealing with maybe 3 to 6 months ago?

Sure. Yes, I'll maybe talk about a few other details because I think it's an ongoing question from your last question. I mean, clearly, it's a very choppy, cloudy, pick your favorite adjective supply chain, manufacturing supply chain environment right now starting with supply base. I think the number of -- beyond COVID, the number of extraneous factors that have impacted the supply base for or not just us but a number of manufacturers has just been a lot to manage through. And so having those strong supply relationships, those by supplier relationships upfront, being able to pivot and think about are there some other options and how will we -- are there some other ways that we can procure a particular part that we might need, components and raw materials, that's part of the overall, I'd say, supply strategy, supplier strategy that we have. And so we've been working through some of that. I think some issues are getting better, but I think new issues pop up along the way when it comes to the supply chain base. In terms of our own internal capabilities and our capacity, we've been working through a lot of ups and downs, frankly, in the past 18 months going all the way back to the first quarter last year when we start to see shutdowns going through and you'd shut a factory down for 2 weeks and then have to ramp it back up immediately. So we've been and our teams have been doing a tremendous job around that. We -- I think we're managing that fairly well. We are going through a lot of different trials and tribulations that I think in different locations, as you've mentioned. Especially, Southeast Asia is probably an area where we're concerned and just keeping an eye out a little bit like many people. While we don't have manufacturing in Malaysia or Vietnam, we do have manufacturing in the Philippines, so that's an area that we're keeping a close watch on there. But our teams have done a tremendous job to continue output and really managed to meet customer needs. And then I'd say there's probably the logistics side, is probably the third one. As you mentioned, whether it's capacity, logistics capacity out there, whether it's container capacity, that's one that has required a lot of maneuvering these days, and we're working through those, again, with long-term partnerships that we have and commercial arrangements that are out there. We've gone as far as looking for different routes for some of our products. We've gone truck routes in some cases if that gives us additional capacity as well. We've done that. And then lastly, I'd say a little bit more out of our control is what's happening with our customers. And again, I touched on that with the last question, where for our customers, we can do everything we can to meet their needs of our products. But if they still can't build their finished good products, they're own products because they're missing other parts or components from their suppliers, that makes it a little bit more challenging for them to manage, and therefore, it's just coming back on us a little bit. I'd say overall, though, we're working through it. And I guess your general question was how was it compared to 3 to 6 months ago, I'd say the challenges continue. I'd say maybe some old challenges have gone away, and there's some -- as you mentioned, some new ones are coming up with new materials or new parts or port issues and railroad issues seem to be coming up more than they were, say, 6 months ago.

So it sounds like you're characterizing them as problems as opposed to roadblocks or whatever. So...

Yes. I mean a part of what we all do, right, is how do we work through these problems so that they don't turn into complete roadblocks. And again, I can't say enough about everything our teams have been doing, the creativity and just the perseverance that they have to really work our way through that for the customers.

Okay. Great. I'd like to shift a little bit over to your thoughts or your company's perspective on developments in the electric vehicle space. So your company benefits from the accelerating growth in electric vehicle development and production, and that includes both the vehicles and the related infrastructure, including charging stations. So I recognize that this is a very fast-moving sector with a lot of capital being put to work and a lot of initiatives and a number of newer companies with aggressive growth plans. However, more recently, I guess there are some significant problems, and I would just cite the recent decision to recall every [ sheddy ] bolt that has been produced due to concerns over battery, safety and performance. So just broadly speaking, can you like maybe characterize or share your thinking about electric vehicle industry growth prospects over the next few years? And what in your opinion will be the major challenges to greater EV proliferation use, whether it's vehicles, infrastructure, legislation, et cetera?

Sure. When we think about EVs, and we've turned it more broadly e-mobility, we think this is one of the most significant growth drivers for us over the next -- over the strategic plan horizon that we've laid out. For us, we've got a long history in the passenger vehicle space. And when we think about electric vehicles, the new products, the opportunities that we have around on-vehicle applications and the different facets that we have to that are additive to the existing ICE vehicle, internal combustion engine vehicle out there. On top of that, when we think about adding in the off-vehicle infrastructure, or the EV charging infrastructure some people refer to, again, that's all new, that's all additive to the infrastructure. And again, great opportunities for us, I think especially as you get into the fast charging or the Level 3 charging where there's a lot of our content from power semiconductors to a number of our circuit protection products as well. So we look at this as a tremendous growth opportunity. We've made several investments in there. We have somebody who's now leading our e-mobility efforts, not taking it away from our individual businesses because, really, all of our businesses are participating in the e-mobility effort. But it's really bringing that all together under one Littelfuse umbrella, and so until we've made a lot of investments there and also from really understanding the market and putting our customer relationships and our knowledge together to do that. I think the second part of your question was, so what does it take to really jump-start EVs? And I think clearly, we've seen that jump start this year. I think there's been -- with what's going on more broadly around the industry, with some consolidation of efforts, I would say, in development efforts. But I think also, you see the sustainability, right? Sustainability has really taken on a new light in the past year, and I think that focus around sustainability has also helped move forward electric vehicle momentum. I think the question is going to be from the number of people I've talked to, it's really that infrastructure around EVs. It's that charging capability and that charging capacity. It's one thing if you're in an urban setting and you're driving a limited number of miles every day and you can -- and you happen to have a garage or a charging infrastructure set up somewhere where you can charge your vehicle everywhere, but that's not always the case everywhere around the world. And you think about places like China or we talk to people in the U.K. and London where you don't have a garage for your house or you just don't have that capability. And so there's got to be a lot of fast, freestanding charging capability out there. So people feel comfortable with, what do they call, range anxiety that's out there and being able to really feel like they can use their vehicle without having to worry about where am I going to get the next charge from. I think that's going to happen. I think that's moving along, I think especially with electric vehicles taking off in fashion, the number of different models, the number of different manufacturers out there, number of countries, including the United States that are looking at infrastructure spend focused on that infrastructure. So I think it's going to happen.

Okay. Great. The next topic would be kind of on your M&A outlook, your thinking there. So Littelfuse has spent more than $1.5 billion on acquisitions since 2016, including, I think, roughly $113 million or so for the Hartland Controls purchase now part of your industrial segment. Can you just take a minute first on Hartland and discuss the integration progress and early financial performance of that asset? And then more broadly, how would you characterize your thinking about incremental M&A in light of the economic reopening as your target pool or funnel gotten bigger or smaller or valuations rise? Does a period of robust organic growth make you more selective about pursuing and bidding for new targets?

Sure. So just going back to your -- the beginning part of your question. So Hartland Controls was an acquisition we made in the first quarter. Really, what we like a lot about Hartland Controls was the fact that their main end market really was the HVAC space with a company we've been talking to for a while, component manufacturer with definitive purpose contactors. And so with the business and the focus we had already on HVAC, adding Hartland Controls into the portfolio, it really now -- it's a joint effort. And we talk a lot about why do acquisitions, going back to my introductory comments, acquisitions for us are really to sustain and enhance our organic growth. We felt the HVAC end market was a big growth opportunity for us. We saw Hartland Controls' terrific customer base, terrific people, the company, a lot of great ideas in putting our 2 companies together to really expand our presence in the HVAC space with a lot of terrific customers, that's really where we think the opportunity is. So, so far, the integration is going well. Teams have really been working together to figure out how to grow the business and do it -- manage through all the market challenges that we talked about a couple of questions ago. Hartland was and continues to face all the same challenges that everybody else does as well, so we're working through those. But like other parts of our business, Hartland's sales have been stronger than we were expecting, similar to what we've seen in other parts of the business. So I'd say we're off to a great start this first year and very happy with what's been going on with Hartland. As it relates to M&A in general, we've been talking about the past couple of years that, yes, M&A has gotten a little pricey. Typically, even for private transactions, we tend to look at public company comps, and we think valuations go up for public company comps. At the same time, that doesn't mean we've seen valuations go up for every single company, for every single transaction that's out there. It's the question of really finding the ones that work for us, and most importantly, finding the ones that align to our strategy. So as I mentioned earlier, for us, it's strategy first, how do we focus on those high-growth end markets, high-growth applications, finding those right targets that are out there for us. I think it's a pretty busy environment right now given -- I think given the valuations, but also I think a little bit with the potential tax planning, tax guidance that's coming out there. I think that's pulled some assets out of the woodwork as well. So I'd say, overall, we're pretty busy in a good way, and stay tuned.

All right. Very good. The next question I'd like to ask maybe relates to your order backlog and maybe if we could read the tea leaves there just a little bit. So there has been a pickup in your backlog. And from a number of companies I speak with, that increase in the backlog potentially represents a few things. One would be fundamental end market demand and other would be kind of customer defensiveness, like not wanting to get caught short out of the product and so on and so forth. And I guess I would just ask you, from your opinion, from your company's experience with your legacy customers, how much of the order backlog picked up -- started to pick up in backlog? Should we think about relating to fundamental demand versus either, I don't know, offensive or defensive strategies by your customers?

Yes. So I would talk about order backlog, I would add a third dimension to that, which is as your lead times extend, your order backlog will also extend, right? It's taking longer to get what you need. So I'd say there's definitely an extension in the backlog because lead times have extended. I mean we're not alone in that in a number of our businesses. There is definitely stronger demand, and I said that earlier in my comments that end market demand remains strong. So I think that's the second part. I think we've talked about we've been pretty open in our past few earnings calls about inventory levels, especially with our distribution partners, which is whether that's our electronics segment or industrial segment. Inventory levels are low, and our distribution partners are working on replenishing inventory levels going back into last year as it relates to shutdowns, with COVID shutdowns and things like that. So that's another area where you see demand growth because of inventory replenishment goals that distribution partners have and even some OEMs as well. Are there -- the question we get a lot, is there double ordering? Do you see double ordering out there? Or are people looking to try and think about more -- holding more inventory, et cetera? Perhaps pockets of pieces there, but I would say the other factors that I've mentioned have been more prevalent. And we can see that and we've talked to folks about that just in terms of lead times, inventory build and strong end market demand.

Okay. Great. My next question would maybe be on the labor outlook that you see, and maybe I'd like to ask about a couple of aspects. So first off, just from a skilled labor perspective, I mean your company's growth depends on acquiring sufficient, I guess, engineering design talent, and I'm wondering about the availability that you see either regionally or nationally for that. And then secondly, I guess, would just be the cost and the expense involved in acquiring that talent and then the compensation levels. So how does the labor outlook jive with your projected growth and expansion?

Yes. I would say -- I would take a step back because we've talked about we're a global company, and our footprint is across 15 different countries. And really, the bulk of our employee population is actually outside the United States. Less than 10% of our employees are in the United States, but that's also because many of our customers are outside the United States. And so when we think about labor, we think about it more holistically as we think about our global footprint. We have R&D and technology centers in a number of different countries. We put those R&D and technology centers in places where we felt there's strong availability of talent, good educational system and a good pipeline of talent there, and that's continued to work for us as we've done that. We also -- we say the same thing about our manufacturing footprint. We try to put our manufacturing locations really where our customers are located, where our customers are manufacturing because we tend to be a B2B seller and we're selling into other manufacturers as well. So as we think about that more broadly, for us, labor availability is one of the big things that we consider if we think about either adding new R&D or technology center or adding a new plant and really try to build up also our reputation in those locations as well as an employer of choice. That's a big part of it as well. So we feel -- I think with the choices that we've made and how we're -- and how our footprint is located, we feel pretty good. Yes, in a lot of countries today, United States, for sure, but in a number of other countries, there are -- you're going to go through cycles where you might find some labor shortages and some labor difficulties. But we try to plan for the long term on that and really take a look at not what do we think is going to happen in the next couple of years, but as we take a look at 5, 10 years down the road, what does that pipeline and availability look like.

Very good. Okay. So I think we're right on target here for our allotted time. I want to thank Meenal Sethna and Trisha Tuntland for participating and especially sharing their perspectives and insights on their current outlook. Meenal, Trisha, thank you very much.

Thanks, David. Thanks for having us.

Thanks, David.