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

All right. Good morning, everyone. Welcome back. My name is David Kelley. I'm the auto tech supplier analyst at Jefferies here. Pleased to have Littelfuse this morning and we've got the CFO, Meenal Sethna, who I believe is going to start off with a quick presentation, and then we're going to go right into fireside chat, and we'll definitely have time for questions at the end. So Meenal, I'll kick it over to you.

Great. Thanks, David, and good morning, everyone. Nice to see everybody in person. We were saying it's been 2.5 years, so nice to see a gathering today. So let me just start with, as always, the disclaimers, which you can read at your leisure, but really wanted to take you through our first slide. And just a quick overview on Littelfuse. Really, who we are? We are a company, as we talk about a company that grows really with a focus around products that enable our customers around safety, reliability and performance of their products that use electrical energy. $2.1 billion in sales, more in the industrial technology space. We are -- and I'll talk about this a little bit in addition to our organic growth, strong acquisition strategy that complements our organic growth. And so now we're up to over 17,000 employees as part of that. I'm just glancing at my slides over here. And really, you'll find our products in a wide variety of applications across industrial, transportation and electronics end markets. So a little bit about our growth strategy. Back in the beginning of 2021, we had a virtual Investor Day. And we typically will go through and update our strategy about every 4, 5 years or so. Really, the update we did in 2021 is a continuation of a strategy we've had in place for really around 10 years. And it really starts with the structural growth themes that are the foundation of our company profile, the markets that we serve and really the trends that we're seeing that we believe will enable growth for years to come. And that falls in around sustainability. It's an idea of everybody is talking about sustainability these days, but you think about renewable energy, near and dear to David's [indiscernible] EVs fall into that category, energy storage, power conversion. Secondly, around connectivity. We've seen a lot of that in the past few years, especially around mobility, data centers, cloud, data transmission. So that's a big area of growth and growth opportunities for us. And then lastly, around safety. And given that a lot of our products -- our products really are -- our portfolio is focused on enabling our customers that are utilizing electrical energy. Safety becomes a very important element around that when it comes to electrical energy, as do some of the newer products in our portfolio that are supporting applications like medical applications, where safety becomes paramount as well in those areas. And then lastly, just switching -- I meant to just talk really briefly here about some of our growth drivers and outcomes. So really, how do we grow, right? Because our strategy is really a strategy around profitable growth. We look at growth as content and content gains. Some of that through increased functionality in application as well as share gains as we enter into new spaces. We really look at resource deployment across high-growth end markets and high-growth geographies, as well as strategic acquisitions really adding to and expanding our organic growth profile. And the outcome that we're really looking for is profitable growth. best-in-class shareholder returns through double-digit sales growth, organic and inorganic, best-in-class margin profile, strong cash generation and cash returns -- cash in and cash returns. And then lastly, just a couple of highlights, maybe to catch you up to where we are as a company today. We just released our earnings last week for the second quarter, we're at December 31 fiscal year-end. So for the first half of 2022, we've had sales growth of 26%. Some of that coming from acquisitions as well, but really also a very strong organic growth of 16%, adjusted EBITDA margins close to 29%, expanding 500 basis points over last year. It's all resulted in a very strong earnings profile, but also at the same time, we've also deployed $1 billion in capital over the course of the past 18 months, about half of that in the first part of 2022 through 2 acquisitions that I'm happy to answer questions on, but really a strong capital deployment that aligns to the strategy that I discussed before in terms of end market composition, growth opportunities and sustained profitable growth profile. And with that, I'll take a pause there. I know David's probably got a list of questions, as I'm sure many of you have, and I'll take a seat.

All right. Great. Thanks, Meenal. Maybe let's start with the kind of working backwards. So the near term and then some longer-term questions I wanted to hit. Starting with the setup into the back half of the year, can you talk a bit about some of the impacts you're seeing, one, the China lockdowns, some of the inventory dynamics from that and how you expect that to impact third quarter margin versus the second quarter?

Sure. So specific around China, if I take a quick step back, we've got a pretty global footprint. We locate our operations really close customers. So given that we've got a good-sized footprint in China. As like many companies, we have some facilities pretty close to the Shanghai area. So we experienced shutdowns in the second quarter as part of that and also into the beginning part of the third quarter. The good news is for the second quarter is we were able sell a lot of product out of existing inventory that we had built and/or we had strength in other areas of the business. So we were able to mitigate some of the impacts in the second quarter. So really finished very strong on sales ahead of our guidance. and very strong margin profile despite some of the costs that we were incurring. And going into the third quarter, though, we found that the second quarter lockdowns extended far longer than anybody had expected. And so that rebuild now of inventory as our operations are all up and running as normal, but that rebuild of inventory is taking place at the end of the second quarter, beginning of the third quarter, so that's dampening sales a little bit in the third quarter, add this additional costs that we've incurred also in the third quarter with further shutdowns. So that's weighing on margins -- sales growth and margins a little bit about 200 basis points on the sales line in the third quarter. I'd call that transitory as well as about 150 basis points from a margin perspective. Again, I would call that transitory.

Okay. Great. And maybe on the theme of automotive, you guys have talked about the strong demand there, maybe a little bit of Tier 1 supplier inventory dynamics. But I think the question we're getting the most over the last couple of days is, what are you seeing in Europe? There's been some more negative commentary over the last couple of weeks. But still a pretty wide range of opinion. So maybe specific to Europe, can you talk about demand that you're seeing in automotive and kind of back half expectations?

Yes. I'd say overall, when we look at all the different dynamics that are impacting in the automotive markets these days, it still feels like overall, it's more a supply, other types of market dynamics impacting supply more than demand right now. I think to your point, David, I've seen a lot of the same articles, it remains to be seen a bit. But the combination more recently of the China lockdowns that impacted demand in China, the Russia-Ukraine conflict, very unfortunate situation there, but that also impacted suppliability there. The well-known well telegraph semiconductor, the ongoing semiconductor challenges that are there. So I think there's still much more going on, on the supply side than there is on the demand side, but we too are keeping a close eye on the demand side. And what David was referring to, just to clarify that, you know what we are a Tier 2 when it comes largely to the automotive space. And so we're selling into Tier 1s. We're designed in with OEMs, we're selling to Tier 1s. We've had very, very strong growth in the past few years on the automotive side. So even though in the -- since 2019, car build has been down high single digits, our growth in our automotive space has been up high single digits. So really a high-teens delta. A big chunk of that is content because our expectation is to outgrow car build, our target is 3% to 4%, but clearly, that's running higher than that. Some of that has been from vehicle mix. Clearly, some of that -- a lot of that is coming from EVs, but also a portion of that is coming from some inventory build that was going on at Tier 1s waiting for those last products to come in. And now we're seeing Tier 1s unwind a little bit of that inventory, which we expect, again, transitory, but we expect that to continue in the next couple of quarters.

Okay. So a little bit of the Tier 1 inventory unwind. Can you talk about the electrification impact? That seems to be the one area in autos where even with the supply disruptions, everybody is still very confident in the build schedules there. So maybe talk a bit about EV demand and more broadly to investors new to the story. Can you remind us of your EV content per vehicle opportunity?

Sure. Sure. So for us, the EV spans, and I will talk about the passenger vehicle side. But when we think about our portfolio, our organic growth opportunities, they cover passenger vehicle, also commercial vehicle because that's a big part of our portfolio as well, as well as the infrastructure side, the off-board charging as well. David, I know you're referring to specific on the automotive side, and we've been open in our commentary that today, when we look at ice vehicles, we have when it comes to our circuit protection portfolio, about $5 of content vehicles. We've got a very strong leadership, a historical and very strong leadership position in that. When we move ahead thinking about the different iterations of electric vehicles, the content growth is pretty significant over that. In any electric vehicle, you're going to find that base continuing, you're going to find that 12-volt architecture still there. But on top of that, depending on if it's a hybrid vehicle, 2 to 3x additional content, all the way up to a battery EV at 6 to 8x the content. And again, that's on the automotive side of the business as well. In addition, we're looking at a number of different opportunities and had some wins on the commercial vehicle side, which includes areas like truck, buses, et cetera. And then lastly, I would say on the EV infrastructure side, when we think about charging Level 1, Level 2, Level 3, Level 1 is the most prevalent right now. Small dollar amounts of content for us, a few dollars per charging unit there, really where you see the content growth and content escalation is really when you get into the DC fast charging. So I think with a lot of the investments that many countries are starting to make around bad and the needs around that, that's where we view a strong opportunity as we look ahead as well.

Yes, a lot of excitement in the coming years in autos. I mean, I guess taking a step back a bit, pricing, can you update us kind of where we are in the pricing dynamic, it's been a nice meaningful tailwind, offsetting input cost inflation. If you see any other kind of incremental pricing opportunities on the horizon, just kind of level set on where we are with the rate..

Sure. So stepping back across our portfolio. For those of you who have known the company for a while, typically, a lot of our products are negotiated with price reductions or price downs every year. That's been more typical of our company. On average, I would say, 2% to 3% ranging broadly across the customers and end markets we serve. And what we've done to maintain margins is we work on continuous productivity improvements, efficiencies, volume opportunities, and that's really what maintains the margins that we enjoy for the past several years. What's been going on in this unique environment, I don't tell everybody this, but inflation, right, as we've seen pretty significant amounts of inflation, we've seen our costs go up. And we've had some, I'll say, a number of very challenging discussions with our customers at multiple levels, whether that's distribution customers, OEM customers, talking about the value we bring in outlining where we're seeing our cost increases. And so we are now in a position where in the past few years, we have increased prices. And that varies across the customers and the end markets we serve and also dependent on the go-to-market strategy, where we use distribution partners, especially across our electronics segment and parts of our industrial segment, we've seen the pricing move faster to offset our cost increases and also seeing a little bit more around price cost positive, and I've talked about that on earnings calls, the past several earnings calls, -- this year, we are running price/cost positive as a company. A lot of that because of the work that we've been doing, and we expect to be price/cost positive for the year. Conversely, when we look at other parts of the business, for example, our Transportation segment, which is a combination of automotive and commercial vehicles, those are almost all OEM customers we're working with contracts, in some cases, some longer-term contracts. Those have been longer conversations, as you can imagine, some challenging conversations, but also, really, for us, the importance is for us to outline the value we bring to customers, what we're delivering in the cost profile that we are incurring. And so we have had some successes there and some benefits coming through on price realization. But again, across the company, when you put all the puts and takes together, we are net price/cost positive in the first half of the year and expect to remain so for 2022.

Okay. That's super helpful. Maybe one more on the near term. Specifically acquisitions, C&K being most recent, but one that really stood out to us was Carling, it seems to be tracking well above your expectations at close. So maybe if you can talk a bit about what you've learned post close about Carling, some of the opportunities that Littelfuse has been able to unlock and go forward some of the synergies with your core operations?

Yes. So -- I could talk about Carling, but we saw a little bit of the same phenomenon also with an acquisition we did in the beginning of '21, our Heartland Controls acquisition, so what David is referencing, if I step back, past 18 months, 4 acquisitions, $1 billion of capital deployed. The first 2 acquisitions that we made were one, Heartland Controls component business really focused very heavily on the HVAC end markets, a little bit in the e-mobility space. As you can imagine, in 2021, you make an acquisition in the HVAC space which was already a high-growth end market. But with the focus around air, air quality, air circulation, really a business that took off pretty rapidly from the time we purchased it. So a lot of work we had done was really working on, a, improving throughput when we think about production and supply chain, really working quite a bit on that; b, working with customers around pricing and the last question talking about the inflationary environment there. So with all acquisitions, you start out with a plan. We have a playbook, and we pick the elements of the playbook that we deploy on our acquisition. In this case, what you've also got to do is you've got to adjust your plan very quickly when you see market dynamics changing. So we did that, and we were very quickly focused on improving production, increasing production and then starting to work on pricing because of some pretty significant cost increases, cost headwinds we saw. As David referencing Carling, it was a little bit of a similar situation there as well as the Carling Technologies acquisition, a really terrific commercial vehicle business. This is where we participate as a Tier 1 switches, modules -- power distribution modules, things like that. And so this was another area where very strong commercial vehicle markets from the time that we purchased Carling Technologies, very quickly evolved our playbook to focus on how do we increase production, how do we get efficient with the people that we have and being able to scale more. Ultimately, when you do things like that, that does benefit the long-term integration plan because efficiencies, increasing your capacity, you're not always going to do it through bricks-and-mortar and equipment, you're going to do it through people and processes. And so that ends up being a win for the long term, but that ended up being prioritized pretty quickly for the short term. And in both cases, the Carling acquisition, which was under $200 million when we bought it and now it's much stronger than that as well as the Heartland acquisition, again, sub-$100 million when we bought it better than that now. Both are performing really well, great end markets. And a lot of our integration strategy is going to pay off dividends as we think about that going forward.

Okay. That's great to hear. And maybe bridging the gap to longer term and I always think about acquisitions as being core to the story and I think you target kind of 5% to 7% annual growth through cycles. And that can ebb and flow a bit, and we're currently tracking above that. But correct me if I'm wrong, it doesn't sound like you're looking to be in a period of acquisition digestion, you're still looking into the market. So maybe if you can remind us of how the balance sheet stands today, the current M&A environment that's out there and how you think about go-forward opportunities?

Sure. So let me talk about us a little bit. So we think of an acquisition funnel, like we do a customer funnel, you never stop, right? You're always building your acquisition funnel, targets you're working on today. I mean, there are some targets that we've looked at that have taken maybe years. I'll just leave it at that to come into the portfolio. So you always want to be working your funnel, and this is no exception. The way our business operates today, the businesses own the really the goal of filling that funnel and identifying the targets that they believe aligned with their strategy. Even if they have made recent acquisitions, they continue to do that. They rely on some corporate resources to help them, but really, they own their strategy and they own those targets. And so really, we're continuing on that. We continue to add to the funnel. If we feel like we need resources, the businesses will be the first to identify that, and we'll look at putting in some resources, whether that's in the businesses or whether that's people resources also at corporate as our corporate functions, a lot of the back office, they're doing work for every single acquisition that we have. The second part for us on acquisitions is the financial capacity for us. A lot of time spent on that one is you can imagine. But what I would say is we definitely have the capacity. We tend to, a, be a little bit more conservative in terms of balance sheet management just because some of our end markets go through cycles; B, we want to be prepared for acquisitions. And we had really built out a very strong balance sheet through COVID, so we could deploy $1 billion in cash for acquisitions. And then I would say, C, our current leverage sits a little bit below our target profile, which is about 1.5x to 2.5x. If I pro forma where our leverage is compared with the recent acquisition we made, we're just below the low end of that target right now. So we feel pretty comfortable in being able to look at further acquisitions that might come about in the coming months.

Okay. Thanks, Meenal. If there are any questions in the crowd, definitely happy to address those. I think we've got a microphone kind of making rounds.

Just curious on China. I mean I feel like it's a very mixed commentary that we're hearing in terms of -- obviously, the lockdowns have mostly ended, but consumer confidence doesn't seem to have bounced back so quickly. So I'd just be curious what you guys are seeing in the region?

Yes. I would say back to some of my earlier comments, China is -- we have a strong presence in China, mainly because for us, our footprint starts with where our customers are. So we're in a number of end markets. We have a strong customer base in China. And so a fair amount of our footprint is in China to be able to service those customers. And we're going to go where our customers. The great thing is for us is we have really a very, very strong local leadership team. We don't really focus on ex Patriots, really focus on building a local leadership team. That team has really done an amazing job over the past, whether it's a couple of quarters or really over the past several years around that, and they've managed through that very well. We continue to make the appropriate investments in China as it aligns to our customer growth profile. So it remains an important place for us. But we continue to also watch where -- are there -- is there some mitigation we need to think about? Are there a few select areas, especially where our customers ask us that we might want to build a little bit of redundant capacity outside of China in a couple of places, especially where maybe some of our customers might look at moving some of their production outside of China. So again, we follow them, but China remains really an important location for us.

I believe there's one more in the back there.

Sure.

Can you just talk a little bit about inventory at your distributors? And can you remind us how much of your sales are via those types of distributors and kind of where you see that going throughout the remainder of the year?

Sure. So no, great question. So typically, when we talk about distribution, we sell through distributors in both our Electronics segment and through our Industrial segment. In our Electronics segment, it's really 2 parts. In some cases, there's partnership where our distributors are working with OEMs that are doing some design-in work, we're on the line card. And so that's a big part of how we're benefiting through their reach with over 100,000 end customers there. But in a lot of cases, it's also through fulfillment, where we're working directly with OEMs around design in. They don't want to manage their own supply chain, so they're asking us to work through our distribution partners for that. So about -- for our Electronics segment about 70%, 75% goes through distribution. In a lot of cases, as I mentioned, that's through fulfillment. We have standard weeks of inventory that we continue to monitor closely with our other distribution partners. You don't want it to get to get too light because then they can't service customers well, don't want to get too heavy. So there's a Goldilocks formula that's there. I would say we're in the range. We're at the higher end of that range on inventory. And again, we'll work with our distribution partners on what that looks like and if there are adjustments to be made there, but that's something that we work on very closely month after month. The other piece where -- while smaller that we're selling through distribution partners is in our Industrial segment through other master larger industrial distribution partners, and I would say their inventories at normal, in our range, in our normal weeks there.

I can maybe -- we've got one more question there.

Sure.

Just as it relates to M&A, when you look at the 3 segments, the way you break -- I assume there's 3 business heads. When you think of M&A, is there an area that you see more M&A versus less to help us kind of understand where the future might lie in that thing?

Sure. Yes. So our segments are a little bit more technology based. And what we do is we focus a little bit more on end markets. And so the cross reference to that is sometimes we have segments like our electronics segment that is selling into multiple end markets. I step back because many times when we're looking at acquisitions, they might straddle a couple different segments. But in general, when we think about the acquisitions that we're looking at, we like end markets, as an example, a broad set of industrial end markets. I talked about HPC as an example, end markets that will test further into renewables as an example, safety elements, commercial vehicle. We also enjoy that as well. Again, strong OEM customer relationships also become a part of that. So that's pretty good. Anything that's furthering electrification that we talked about in the transportation area, then also consolidation plays. In some cases, we've done acquisitions that aligned to our legacy portfolio. They give us greater mind share with our -- from a go-to-market strategy with our customers, with our distribution partners. And so we'll look at those as well. So that gives us a pretty wide berth when it comes to acquisition opportunities in that funnel that we were talking about.

Okay. Great. I believe we're out of time. Meenal, thank you for your time today. Thanks, Tricia, and thanks, everyone, for joining us.

Thanks for joining.