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

Okay. Thank you, Tim, and welcome, everybody. I'm Chris Glynn, cover Littelfuse at Oppenheimer. And big thanks to Meenal, Trisha and Dave for joining us today. A good audience on the line. So please use the discussion form, you have a place to submit questions. I'll work those into the fireside format for sure, anything that comes in. And we're going to start out. Dave's going to walk through a few introductory slides and then we'll pick it up discussion style. So Dave, why don't you lead us in, please?

Thanks, Chris, and good morning to everybody who's joining for the Zoom presentation. We, of course, have the safe harbor statements like you see every time -- you see a presentation but if we go to Slide 3, I wanted to kind of remind people of the 5-year growth strategy for Littelfuse. And for those of you who have followed Littelfuse over the last several years, you'll see that our current 5-year growth strategy is really ultimately a continuation of the journey we've been on for the last several years. And the strategy is really rooted in these multi-decade structural growth themes, sustainability, connectivity and safety. So we build up our strategies and focus our organic investments and focus in those areas to drive outsized growth as well as focusing energy in our M&A strategy in order to take advantage of those. So when we think about those growth themes of connectivity, sustainability and safety, examples to think of there when you think about sustainability, think about electrification of vehicles, electrification of many types of applications, renewable energy, energy storage types of applications. When you think about connectivity, it's really the entire ecosystem of the connected world, whether it's devices, backhaul, telecom, infrastructure, data centers that are storing the massive amounts of data, those sorts of things. And on the safety side, some of that's our core, but also there's an increasing focus on the value of human life and standards around employee safety and workplace safety, electrical safety sorts of requirements as well as medical applications that are driving long-term growth for us. From an acquisition standpoint, we focused our acquisition strategies in order to kind of prop up our ability to drive outsized organic growth driven out of these areas. So last couple of years, we made an acquisition of Hartland Controls, which was focused in the HVAC space. We acquired Carling Technologies, which was really expanding our offering in the commercial vehicle space. We invested in an embedded firmware company called Embed, really support our organic efforts into the modules that we serve the market with. And then also C&K Switches, which we acquired last year, which has a focus heavily in the industrial applications. And then lastly, our most recent acquisition was Western Automation, which has a really strong focus on off-board charging infrastructure as well. So we believe that these focus areas and these growth themes are really going to drive outcomes that are kind of at the top of the pyramid here. And what I'll do is I'll hand it over to Meenal to kind of expand a little bit on an overview of that financial framework as well as our long-term performance against it.

Great. Thanks, Dave, and also good morning to everybody. Thanks for joining us. So really taking what Dave talked about as it relates to our strategy and our broader objectives, and now you can see we've got our financial goals as part of that strategy noted here. And similar to what Dave talked about, our strategy is rooted in many years, and it's really not changed as much because of the long-term growth things that we're focused on. I would say our financial goals are similar in that these are many of the same goals we've had over our strategy updates for the past decade. It really starts with our revenue, right? Double-digit revenue growth, a combination of that organic growth that Dave talked about, really focusing on those growth themes, we're thinking about content growth and share gain as we think about new opportunities and new acquisitions that we're making because 5% to 7% of that growth is coming from acquisitions. But again, that, over the long term, supplements and adds to the organic growth that we're driving. Earnings, our focus is really leveraging our earnings growth versus the revenue growth and for us, it's balancing the organic investments that we're making really to drive that outsized above-market revenue growth that we have, but also allowing for scale as we continue to grow on average over 10% a year on the top line, how do we to make sure we're scaling our organization and continuing to invest in our growth for the future, continuing to drive upper teens operating margin, low 20s in the EBITDA margins on average. Cash flow for us always -- it's really been a hallmark of the company as we think about our business model. And ultimately, you can see that in the cash that we generate with 100% free cash flow conversion from net income on average over the past several years. That incorporate about 4% to 5% of revenue being spent on capital expenditures, again, as part of the organic growth and supplementing the acquisitions. We expect all of that to drive an ROIC or return on invested capital in the mid- to the upper teens and we've continued to demonstrate that we can do that even with adding in acquisitions in the near term as we look at the long-term average. And then lastly, capital allocation to our shareholders. We prioritize the investments that we're making organically and for acquisitions, but also want to make sure that we're thinking about return of capital to our shareholders, both in the context of the dividend that we've had since 2010 as well as periodic share buybacks that we do when we feel like there's an opportunity in the market, maybe our company value has been displaced a bit, and that's when we might look at share buybacks as well. So I wanted to take a look at last slide that we have is really -- well, Meenal, if you think about these financial objectives, what gives you confidence in being able to achieve not just your strategy and the financial outcomes? But I'd point you to this chart, which is a 5-, 10- and 15-year chart of our performance, both from a revenue perspective as well as adjusted EPS. You can see driving 11-plus percent sales growth over this time depending on the period that you're looking at and earnings growth in all those periods on average, above those levels. It's really a combination of what we've been trying to do over the years. It's around diversification of our portfolio as we continue to grow organically in the acquisition, the technologies, the end markets, the applications that we are -- we're participating and continue to grow and it really drives the resiliency of our business through cycles, through the ups and downs, we've been able to demonstrate really best-in-class sales and earnings growth. And with that, I'll take a pause here. I know Chris has probably got some questions for us, so we'll start with those.

Great. Thanks, Meenal and Dave. So yes, I think -- the last couple of years, you had absolutely tremendous growth in electronics and there's a little bit of a pullback right now, but you're maintaining really high profitability and the downturn is just pretty manageable at least for you guys. Is this the secular -- I'm curious about the operational perspective, but also in the markets. Is this the -- do you see the secular intersecting more with the cyclical timing than you have in the past?

I'll take that, Chris. I think really, what you see is, I think you're accurate in the view that perhaps the cyclicality that tends to be a bit more outsized in the electronics portion of our business is it's certainly still there, and we see that. However, the work we've done over the last few years to really diversify both the product offerings and the market segments and applications that we target has really helped us position the business to be -- to handle kind of cycles and downturns in particular segments like electronics, be a bit more resilient. And I think that is showing up in the financial performance of the business that's a little less impacted, a little less negatively impacted by a time where electronics is really rebalancing inventory on that. So I think that's been very effective for us.

Okay. And I think electronics isn't a model. It's your biggest segment. It's got the power semiconductors and a broader semiconductor side that's a little more resilient to pull back in the passives. We get an inventory correction when you have a slowdown in growth or a moderation in growth sometimes too of a dynamic like the pandemic. Are you seeing -- do you think you're seeing a point yet where actual end demand and POS data is leveling off on the consumer side? Or is that still a moving target?

Yes. I think the -- as you stated, even within the Electronics segment, it's not a monolith of markets that we're serving. It's very broad base of markets. And we've talked about the last couple of quarters that consumer-facing products, so think small appliances or handheld devices, tablets, et cetera, certainly, that in demand started dropping off pretty meaningfully a couple of quarters ago, 2 or 3 quarters ago, and we've certainly seen that continue to be relatively soft. I would not say we've seen particular evidence of that turning a corner or anything at this point in time. However, what I would say is the point of sales data we get from our distribution partners, which serve a lot of the electronics end markets for us is still pretty robust and relatively stable. So when you see the impacts on us and our revenues being down, it's really driven largely by that consumer-facing side and inventory adjustments that are being made by our channel partners and customers with in demand being relatively stable at a reasonable level.

Okay. Great. And I wonder if you could kind of talk about your competitive landscape for each of the 3 segments in terms of your relative scale, strategic positioning. I know electronics, for instance, you're really the blue chip name In Industrial, you seem to be accelerating some really strong success on a pick and choose basis. But the competition is often localized and a little not totally transparent to the outside. So curious if you could edify us on that.

Sure. It's a complex question, quite frankly, as our business is pretty diverse. And even by segment, if you look by segment, we don't have singular significant competitors in a segment because our segments have a pretty broad offering of technologies across those segments. And each one of those sets of technologies tends to have a unique set of competitors. So we've built out this portfolio of technologies and even in-market applications we're focused on. And in most cases, we would be one of the market leaders within that space. So as an example, in our legacy fuse business, we would have even different competitors in each of the 3 segments between Electronics, Automotive and Transportation as well as Industrial, but we would be a leader in each one of those markets. So if we think about like our Electronics Passive business, we would be the market leader or at least top 2 in each category of technology that we have in that offering. In our protection semiconductor business. Also, we see that where we're #1 or #2 kind of neck and neck there as well. Passenger car, circuit protection business, we're clearly the leader. As you talked about in Industrial, we've identified some specific applications and technologies where we're building up leadership within them, maybe not the full breadth of the Industrial segment yet. So as a whole, we really identify niches, where we can create unique value and really become a market leader from a technology and an application understanding. So it's a very broad set of competitors that we deal with.

Okay. And yes, on the destocking, I think you guys started to put out some benchmarks on seeing things clear. I think automotive, the light vehicle side that might resolve in the second quarter, commercial vehicle maybe take a little longer. And then there's the consumer side and electronics. As you can best assess demand trends and cyclical junctures for the different businesses today, when do you expect these different pockets of inventory adjustments to peter out?

Meenal, maybe you can take that question.

Sure. Yes, there's a lot of different activities going on across the portfolio. But I think you highlighted what we had commented on pretty well, Chris. When we think about our Electronics segment, we do have some visibility as we go out into a quarter or 2, as we work very closely with our distribution partners. And from where we sit today, given the current state of the market, as Dave mentioned, we do see POS today continuing to remain stable. So it's really just a question of really getting the right inventory levels at our distribution partners, especially with our lead times coming down, we're similar to what we're seeing across the industry where lead times are coming back to a more normal range and so we see the destocking going into the third quarter from where we sit today. And as we think about our Transportation segment, as you highlighted, we've had a few quarters now where across our Automotive customers, we've seen destocking going on and we think really the second quarter should be it, especially given where demand seems to have stabilized out maybe flattish versus last year, while on the commercial vehicle side, we just started seeing this from a lot of our customers, both OEMs and some distributors that we have. And so we expect that to continue a few quarters out.

And then C&K was I think your second largest deal ever closed last July, seem not too long, but it's been a little bit. Curious about the strategic opportunity focus over the next couple of years, how you are adding value operationally and commercially.

Yes. First and foremost, we're very excited about the acquisition. It's off to a strong start. It's a great team and a great set of product lines that we've taken on, which is exciting. And as with any acquisition, clearly, there is some short-term cost synergy opportunities that the teams have taken actions on and are driving in the near term. But ultimately, we see C&K as really a growth synergy driver. So we'll be leveraging our strong global distribution relationships and helping to grow C&K's business through our global distribution network. So we think we can leverage that and really get some gains in that area but also from an OEM perspective. They have strong OEM relationships as we do. In some cases, those are quite complementary. So we see there's good opportunity to leverage both sets of products across those OEMs with the relationships. We've already seen some early success with design wins and kind of Industrial applications in passenger car applications and in datacom markets as well. So already off to a good start there, and we're excited about really the growth synergy that comes from the C&K acquisition.

Okay. So when you say -- talk about some complementary customers and some really design win successes, those are wins that they wouldn't have won independently or you wouldn't have as...

Yes, those are wins that both directions, either we had relationship with OEMs, we were able to bring in C&K products already to them and get design wins with C&K products with our customers. We also have had some examples of our C&K has had great relationships with a particular OEM that they were serving with a singular technology, they had a higher level relationship than we did. And so we were able to leverage that and get design wins of Littelfuse products with those customers with the help of the C&K team. So -- and it works both directions on that.

And then similarly on the Carling update, wondering if you could discuss the value add there from strategic and operating perspectives, what struck you the most since you've gotten it? Has it been every bit of what you envisioned. Just given that I assume as you're closing a deal, you think the world has opened up, hopefully. So what's the measure there 1.5 years in?

Yes. I think that's also an interesting one where year 1 for us, quite frankly, was a heavy focus on serving customers. As we took on that business, they had a very large backlog of orders and with a heavy focus on the activities there, particularly at the factories and improving efficiencies and throughput and supply chain issues, year 1 was heavily focused on that. And it really drove year 1 revenues increased 20% from the year prior to acquisitions. So big step up in revenues in year 1, which, of course, was fantastic with the team heavily focused on that. As we clean that up, we continue to focus on operational improvements in Carling at the plant locations and ultimately driving long-term cost gains in that business. Longer term, of course, there's also the synergies for growth in the commercial vehicle space as well as telecom applications, renewable energy, broad-based industrial types of applications.

Great. And then transportation, curious what -- or maybe it would be helpful to just review your content growth expectations on the light vehicle side and CB, just given I think we have a mix of people listening in today.

Sure. Well, let's start by -- on the passenger car side of things. Clearly, the content growth opportunity, that's the biggest driver of growth, is electrification of vehicles. Maybe one of the largest technology shifts that we've seen in that space or will see in our lifetime. So really across our entire product portfolio, which goes beyond just our Transportation segment, we've actually, over the last couple of years, driven double-digit content outgrowth and the design wins that we've already accomplished. We're confident in our ability to continue to drive double-digit outgrowth in the passenger car side. So fantastic growth opportunities there, mainly driven on electrification, but also electronification, if you will, the electronics in the vehicle continue to be more and more sophisticated. A lot of those same trends kind of carry over into the commercial vehicle side as well. In the commercial vehicle, we have a little smaller market position there versus pass car. But as we see electrification and electronification taking place, in commercial vehicles as well, we also see significant content growth opportunities there. And as a segment, overall, we do expect kind of high single-digit revenue growth coming from that segment over the 5-year strategy period that we've laid out. So it's a strong content growth opportunity for us.

Okay. Great. And I think it's, what, 6 to 8x for electric vehicles?

Yes. If you look at a typical pass car, the 12-volt systems where we've had the strength and we're the market leader in the circuit protection in the 12-volt side of things. The good news is that part of the business doesn't go away with electrified vehicle. The vast majority of those applications remain 12-volt applications in an EV. So we continue to maintain our position there and are not losing really ground on that. So all the growth comes from the high voltage side, and that's all additive. We've been open with the fact that we won't have the same market share in the high-voltage side as we do the low voltage side, but yes, it can create an EV, it can have a 6, 7, 8x content opportunity for us. So it's a big market opportunity for us.

Okay. And historically, the transportation margins have been pretty volatile even within a given year. I think it's a little more sensitive around FX and commodity price cost cycles than your other segments. What is your potential? I think you have a mid-teens long-term target ultimately. Do you see an ability to get there and be there consistently or is that something more that you have the Electronics segment that can buffer it when margins go a little bit the other way in transportation?

Sure. I can take that. So just stepping back across the Transportation segment, the last part of your question, yes, we still believe that mid-teens target is the right target. But I think there's 3 or 4 areas that we -- some of which we have to focus on, some of which are market and I would say price, volume, some of the material costs you alluded to and then just a bit of the cost structure. And I would start out with when I think about price, we talked -- we've been getting a lot of questions in the past several quarters about what your price/cost equation look like for the company, it's been positive, neutral to slightly positive for the company. Transportation has been though a little bit on the negative side, really because when you think about all the different customers we have, largely OEM customers, contracts are negotiated one by one and they're coming up. And so from a margin perspective, we've been doing some catch-up around pricing. We continue to focus on price selectively where that continues to make sense. But that's been a bit of a drag I would say on the negative side of the equation. Volume has been a bit of another challenge. If you step back and think about transportation in general, tends to be a bit heavier when it comes to capital investment and investments in general. And so you end up with a bit more of a fixed cost structure. And if you think about passenger car, maybe a little different than commercial vehicle, volumes have been basically flat for the past now, we think, 4 years but that's down over 10% since 2019 and down close to 20% since 2018. So while there's work we've done around cost structure there, that still remains a bit of a challenge there until volumes come back, and even on the commercial vehicle side, right? Heavier volumes, we've got destocking going on now. That's been a bit of impact. We talked about material cost. Commodities are a big component of what we do across the Transportation segment. We've seen spikes there. They're coming back, which is definitely going to be a help and then the last piece is just cost structure, right? There's work that we have to do, whether it's around our cost structure, which we're doing and have done already in the past couple of quarters as well as Dave talked a bit about the Carling acquisition. Terrific acquisition on the commercial vehicle side of the business. Of course, we are very focused on growth opportunities but because of some of the similarities in the business, we're taking a look at the footprint and other areas of similarity to see where there's an opportunity for us to get leverage across our commercial vehicle business. So those are the actions we have in place, some we can drive, some we've got to wait for the market, but we continue to focus on that mid-teens margin.

Okay. That all makes sense. There was one thing you mentioned in terms of some commodities coming through a little bit better. Is that something you see in your capitalized cost of inventories so that sort of a time line, you can watch it approach, and it will start coming through later this year? Is that the idea?

Yes. I would say there's been -- at various points of time, we've seen commodities spike up. For us, it's a -- the one we follow generally copper, zinc, silver tend to be big ones. At various points in time, we've seen some of those come down while others have spiked up. So we tend to see either the detriment or the benefit come through within a few months, pretty quickly. We're not holding a lot of stock of the commodities. And we don't -- we choose not to hedge those because hedging for us really provides just a temporary or interim price stability, but it doesn't really give you long-term reduction. So it's something we watch for. We try to optimize where possible but we're really focused our activities on other areas.

And then in electronics, you've got such broad drivers in end markets, and you've highlighted the main themes you pursue but how do you manage long-term capacity planning and mix strategizing because I imagine you see more opportunities come at you then you might think about a lot of them in different ways strategically.

Yes. It's -- as you stated, it's a very broad customer base that we're serving in the electronics segment. And those businesses can be on different cycles and also have different growth drivers. And whether that's components going into pass car applications out of our electronics business or into Industrial applications or medical, et cetera, that's they're all kind of moving in opposite directions at times. But overall, we know electronics is a bit more cyclical. But the good news for us is that in that cyclical part of the business, the capital intensity of that business is fairly modest. So it's not a huge fixed overhead cost structure there. What that allows us to do is invest in capacity ahead of time. So we typically try to make sure we have capacity in place beyond what our current demand cycles are at because when we do see an up cycle, we want to take advantage of that. So we're not overly burdened with the fixed cost of the capacity. And that allows us, when you do see a spike, take advantage of that spike up. We outserve those customers compared to our competitors typically. And then if it goes through a correction and a down cycle and goes through that, what we find is when we come out of that cycle, we end up with a slightly higher market share because we've been able to outserve customers. So that's part of the strategy, and we continue to do that and we kind of fully expect the same sort of thing as we get through this sort of a cycle. We'll probably come out a bit stronger on the other side of it as well.

Okay. Great. And we're within 5 minutes. So I wanted to remind the audience if you want to get a question, and actually, as I speak, I see one. Okay. So what role do you see M&A going forward in the growth strategy? And then it says I joined late so ignore if I already addressed, but maybe I'll put a tweak on that since we did talk about it. You've been very busy the last few years. Is there a pause period to integrate what you have just in terms of how would you frame up the bandwidth to say, "Hey, well, we're not going to slow down."

Meenal, why don't you take that?

Sure. Yes. So Chris, great question. So echo it -- well, I'll start off with to answer the earlier question, yes, M&A remains a core part of our strategy. And as Dave -- when Dave talked about our strategy overall, for us, it is a long-term driver of organic growth. We think about acquisitions and adding other new pieces of the portfolio or adding complementary pieces that will continue to drive organic growth for us. So it's really part and parcel of our growth strategy. In terms of capacity, we think about it in 2 pieces right now. One is on everybody's mind, it's the financial capacity, but also resource capacity and then there's what's available in the marketplace. From a financial capacity perspective, we've had a strong balance sheet. A lot of that really being driven from the cash conversion that we have and the cash generation we have that I talked about earlier. That being a hallmark of the company, we've been able to fund a lot of acquisitions off our balance sheet. So that's helped keep our leverage, which is now at about 1.4x net debt to EBITDA. So we still feel very comfortable that we've got capacity ahead of us. From a resource perspective, we're very mindful, right? We have different businesses that are at different points of integration, maybe some a little bit busier than others. But they still continue to look, but we also balance where they are in their integration process with the businesses that they're integrating really because integration today is led by our businesses with support coming out from corporate. So we've got definitely some bandwidth in several areas to do that. And then lastly, I would say it really comes down to market. We've got resources that continue to really drive and maintain a healthy pipeline for us. And I would also say, as we continue to grow, right, we add to our portfolio, we expand our markets, our technologies, our applications, that in itself really drives an enhancement the pipeline that we have because there's new and bigger opportunities for us also with our scale. So I feel really good about the acquisition opportunities ahead of us. I think one of the questions out there and been really around, well, do you have focus on integration? Or do you leave that behind and focus on new targets? We do both. We're going to focus on integration, and we're going to continue looking at new targets.

Okay. Great. And we're within the last minute, I believe, there are any particular things you wanted to show today? Or do we kind of cover the ground?

I think we cover most of the ground. I think kind of -- to a parting thought to think about is although we may be in a bit of a correction cycle on distribution, inventories and inventory corrections going on, we remain in a very healthy financial condition and strong financial performance while we're doing that. We've demonstrated over the last 5, 10, 15 years, the ability to drive double-digit top line growth, double-digit bottom line growth through cycles, and we remain very confident in our ability to continue to do that. So we're excited about the future.

Sounds good. Thanks for the comments.

Thanks, Chris.

Thanks.

Thanks, everybody.