Littelfuse, Inc.
Q4 2013 Earnings Call Transcript

Published: 5 Feb 2014

[Operator:]

Good day, everyone, and welcome to the Littelfuse Inc. Fourth Quarter Fiscal 2013 Conference Call. Today's call is being recorded. At this time, I will turn the call over to Chairman, President and Chief Executive Officer, Mr. Gordon Hunter. Please go ahead, sir.

[Gordon B. Hunter:]

Thank you, and good morning, and welcome to the Littelfuse Fourth Quarter 2013 Conference Call. And joining me today, as always, is Phil Franklin, our Senior Vice President and Chief Financial Officer. As you saw on the news release, we had a solid fourth quarter that helped to make 2013 the best year ever for Littelfuse. Our automotive and electronics businesses performed well in both fourth quarter and for the full year, as did the electrical fuse business. Our new sensing platform also contributed to our record 2013 results. This broad diversity of products and end markets more than offset the continued downturn in global mining. I'll discuss our fourth quarter and full-year performance in more detail in a few minutes. But first, I'll turn the call over to Phil who will give the Safe Harbor statement and a brief summary of the news release.

[Philip G. Franklin:]

Thanks, Gordon. Before we proceed, let me remind everyone that comments made during this call include forward-looking statements based on the environment as we currently see it. And as such, do include various risks and uncertainties. Please refer to our press release and SEC filings for more information on the specific risk factors that may cause actual results to differ materially from those expressed in forward-looking statements. Sales for the fourth quarter of 2013 were $198 million, which was up 25% year-over-year and just above the high end of our guidance. GAAP earnings for the fourth quarter of 2013 were $1.04 per diluted share. This included foreign exchange gains, purchase accounting adjustments and special tax items. Without these special items, earnings were $1.08 per diluted share, which was near the high end of our guidance. The relatively strong profitability for what is typically a seasonally weak quarter was driven largely by our core businesses, which continue to deliver excellent margins. As previously noted, our newer businesses such as sensors and commercial vehicle products are not yet at the same levels of profitability. Plans are in place and being developed to achieve significant margin improvements in these newer businesses. These plans include focusing on higher margin, more differentiated products, driving manufacturing and purchasing cost savings and leveraging operating expenses on higher sales. Sales for the full year of 2013 increased 13% over the prior year to a record $758 million. GAAP earnings for 2013 increased 16% over prior year to a record $3.94 per diluted share. As we stated in the press release, at year end, we booked a $6.1 million charge to income tax expense related to the write-off of our investment in Shocking Technologies after it was determined that this was a capital loss instead of an ordinary loss. Adjusted earnings for 2013 increased 17% year-over-year to $4.46. The company continues to generate solid cash flow, as cash from operating activities was $117 million for 2013, up 1% compared to the prior year. Now I will turn it back to Gordon for some color on business performance and market trends.

[Gordon B. Hunter:]

Thanks, Phil. I'll begin the segment reports with the electrical business unit. Electrical sales account for about 15% of total Littelfuse sales. Total electrical sales were $30.1 million for the fourth quarter, a 10% decrease from the fourth quarter of last year. For the full year, electrical sales of $123.6 million were down 7%. The trends we saw throughout most of the year continued in the fourth quarter. Sales of core electrical fuse products continue to increase, but that wasn't enough to offset decreases in sales of custom products and protection relays in the mining segment. Electrical fuse sales were up 9% in the fourth quarter year-over-year due to continued growth in our focus areas of solar and HVAC, as well as incremental sales from distributor conversions during the year. For the full year, sales into the solar and HVAC markets increased more than $3 million over the prior year. The known residential construction market appears to be showing signs of improvement and industrial production activity remains solid. So the market outlook for the electrical fuse business remains positive. In contrast, and as we anticipated, the custom electrical products business continues to struggle. Although fourth quarter sales increased from what was a very weak third quarter, they were still down substantially year-over-year. The primary market for these products is Canadian potash mining, which is being severely impacted by declining margins and slower-than-expected demand growth. Significant mine expansion projects that were expected to begin in 2013 and 2014 have been delayed. However, we believe we are well positioned with Canadian potash producers for when mine investments rebound. In the meantime, we are continuing our strategies to diversify the custom products business and other types of mining in other geographic regions. We are also focused on controlling costs wherever possible. A positive development that has come out of the diversification strategy is our work with a number of customers in designing other types of equipment such as generator sets and pump panels that weren't part of our product offering before. This strategy has helped us to expand our engineering capabilities and broaden our product line, and it lays the groundwork for additional future sales in these new product categories. We're working very aggressively on quoting new business, both within and outside of mining and in new geographic regions. We're continually adding to the funnel. But as we've discussed in prior calls, the sales process is quite long and there's a considerable time between when the business is quoted and the product is actually shipped. With mining expansion projects being pushed out further into 2014 and 2015, we're anticipating a soft first half of the year, similar to our experience in the third and fourth quarters of 2013. We expect we will begin to see some improvement in the second half of the year, not only in the potash market, but also as a result of our diversification efforts. Moving on to protection relays. Sales slowed during the fourth quarter due to declining demand from the global mining industry, which has historically driven more than 65% of this business. As with our custom products, we're working to diversify the protection relay line. We've had some good successes in the oil and gas and general industrial markets, and in our geographic expansion. Our Arc-Flash protection relay continued to gain momentum with several significant design wins, with new customers in the U.S., Canada, Latin America and Asia. The new business is across a variety of industries, including utility, steel production, data centers, mining and oil and gas. We expect these wins to generate over $1 million of sales this year. Our success in Latin America was at, with a utility company where after 18 months of extensive testing and qualification, we received local certifications in the fourth quarter. A major step forward in our strategy to both diversify in global protection relay line was the acquisition of SymCom in early January. SymCom provides overload relays and pump controllers primarily to the industrial market, but also for oil and gas and irrigation. These products provide protection, communications and control for most types and sizes of motors and pumps. SymCom sales were about $23 million last year. SymCom has a very strong brand name and is a good fit with the existing protection relay line we built through Startco and Selco acquisitions several years ago. We plan to leverage the combined product line through our established distribution channels, as well as cross-selling to both Littelfuse and SymCom customers. We've already received some inquiries on SymCom products from Littelfuse customers and are encouraged by this initial response from the market. Our strategy to expand our presence in the industrial market also includes developing innovative new products that respond to customer needs. As an early indicator of our success with this strategy, we recently won major awards for 2 relay products designed specifically for industrial applications. Our industrial Shock-Block, which recently had a significant win with a major oil and gas customer was a winner of Processing magazine's 2013 Breakthrough Product of the Year awards. In addition, our ground-fault and phase-voltage indicator won silver award in Specifying Engineer magazine's Product of the Year competition. Both products help to protect against dangerous electrical shocks that can harm employees and significantly damage equipment. With the increasing global focus on workplace safety, these products meet a growing need in the market. They're also a testament to the capabilities of our team in defining and developing unique products that strengthen our reputation and drive sales in this targeted growth area. Next is our automotive business, which was our strongest performing business segment in terms of sales growth, in both the fourth quarter and for the full year. It accounts for about 1/3 of total Littelfuse sales. Fourth quarter automotive sales of $72.9 million were up 45% from the same quarter last year. Excluding acquisitions, year-over-year fourth quarter sales increased 21%. For the full year, automotive sales of $267.2 million increased 30% over the prior year. And excluding acquisitions, 2013 sales were up 9%. Sales of passenger car fuses and Accel sensors have remained strong and we are well positioned with high content on some of the best-selling models in today's market. Our fourth quarter results also benefited from an increase in commercial vehicle product sales compared to last year's weak fourth quarter. Fourth quarter automotive sales increased in all 3 geographies

[Philip G. Franklin:]

Thanks, Gordon. So overall, we expect the first quarter of 2014 to look similar to the fourth quarter of 2013. SymCom is expected to contribute about $5 million in sales and what for them is a seasonally weak quarter. However, we expect this to be partially offset by lower custom sales reflecting continued weakness in the mining sector. Sales for the first quarter expected to be in the range of $195 million to $205 million. At the midpoint, this represents 17% growth compared to the prior year adjusted -- compared to the prior year. Earnings for the first quarter of 2013 are expected to be in the range of $0.98 to $1.12. At the midpoint, this represents 11% year-over-year growth. While typically, our business model would enable earnings growth to exceed sales growth. Our newly acquired businesses, Hamlin and SymCom, will operate below their margin potential for much of 2014. We are making upfront investments to grow sales and to integrate these businesses, which we believe will pay dividends in 2015 and beyond. We are also actively working on margin improvement plans for both these businesses. This concludes our prepared remarks. Now we'd like to open it up for questions.

[Operator:]

[Operator Instructions] And our first question comes from Josh Chan from Baird.

[Joshua K. Chan:]

Gordon and Phil, first question on electronics. I was wondering the strong year-over-year sales growth that you achieved, how much of that do you think was with end demand? And how much do you think the restocking in Asia perhaps contributed to that?

[Gordon B. Hunter:]

I think it was a very solid year and we track very carefully the inventory level at all of our distribution channels and the sell-through, what's called the POS from them. I'm pretty confident that we ended the year in a solid position, not with a restocked channel. So I'd say that the solid performance across the year was driven by end markets.

[Joshua K. Chan:]

Okay. And then, I guess, a follow-up to that is that the electronics business, typically, 1Q is slightly stronger than 4Q but you had a very strong fourth quarter, so I'm wondering if you would expect this similar historical phenomenon to hold this year?

[Philip G. Franklin:]

Yes, I think in the last few years have been a little bit different, I think, than this year. And I think your point is correct, Josh, on the fourth quarter, we had a significantly better fourth quarter relatively than compared to 2012 and 2011. And therefore, I wouldn't expect -- I wouldn't -- as I said in my remarks, I expect, in most respects, Q1 to look a lot like Q4. And I'd echo that for, specifically, for the electronics business.

[Joshua K. Chan:]

Okay, that makes sense. And then, just asking overall, you achieved sales that were above the high end of your range, but EPS was at the high end, near the high end, but still within the range. So I was wondering if there was some element of hope that perhaps margins could have been higher given such a strong sales level or are there any other dynamics that you would highlight there?

[Philip G. Franklin:]

Well, I think -- I referred a couple of times, in my comments, to where we have, we think we have opportunities to improve margins. That would be in, mostly, in some of our newer businesses, certainly commercial vehicle products, which we've had for several years now. I referred to some opportunities there. We think that business -- those margins can come up several hundred basis points. The sensor business, we've talked about opportunities there. Although we've been, not been too specific because we're still working on some of those plans. But we think those margins can come up significantly as we get out into '15 and '16, as we've said before. And then SymCom, obviously, not in the Q4 numbers, but they're going to start out in somewhat lower margins than where they're ultimately going to end up as well due to the some of the investments that we're going to be making and some of the integration activities. So I think -- the answer to your question is that there are definitely margin improvement opportunities, but they're not going to be -- these are not going to be short-term ones, these are going to be ones that are going to happen over a longer period over the next couple of years as we further integrate and leverage the synergies in these new businesses that we have.

[Operator:]

Our next question comes from Shawn Harrison from Longbow Research.

[Shawn M. Harrison:]

Phil, Gordon, just to that last question. If we look out, say, exiting 2015, what do you think the aggregate margin potential upside from -- if we look at CVP and sensors and SymCom in terms of what it could add to the overall Littelfuse portfolio?

[Philip G. Franklin:]

I mean, it's hard to say on an aggregate basis because you've got other cross currents like what happens to our electrical business over the next year, which has obviously come down quite a bit. We've said that we're bullish about that business for the long term, but the near term continues to look pretty challenging there. What we have said is that we think that the commercial vehicle products business, the sensor business and the sensor business both can operate at margin levels, they're similar to the corporate average. And right now, both those businesses, even excluding amortization, are down in the kind of the low-double digits. So there are several hundred basis points of margin improvement opportunities in those 2 areas. And that, it's just going to take us a while to execute on those. And SymCom's a similar story. SymCom's fundamentally a high margin business as is our other relay business. I mean those are much higher than normal gross margins -- much higher than corporate average gross margins. But initially, because of, again, some of the integration activities that are going to be going on and as well as some of the investments that we're making in sales and R&D in that business, those margins are going to be below par. So I think if you put all that together, I think you can take from that, that there's a pretty significant upside opportunity. But probably not much of it's going to happen in 2014.

[Shawn M. Harrison:]

Got you, that's very helpful. In terms of SymCom, I mean what is the aggregate, I guess, integration charges and maybe if -- as well as kind of other investments you're making in that business in 2014, is there a number you could provide?

[Philip G. Franklin:]

No, I mean, there are -- I can't really comment on those activities at any specificity right now. But I think that this is a business that certainly has the potential to achieve operating margins up in the 20s. And it's going to be probably closer to the very low-double digits initially.

[Shawn M. Harrison:]

Okay. And then, as I look at -- with great free cash flow you guys generated this year, what is the kind of the minimum amount of cash you would like to see to keep on the balance sheet, Phil?

[Philip G. Franklin:]

We don't need much cash on the balance sheet. The issue we have is getting the cash in the right place. And as we've said on previous calls, we've done some restructuring works and tax planning work to try to make that cash more available, more fungible, but we still have some of the same issues that a lot of companies have where we have most of our cash overseas and that more than, certainly, way more than we need to run the business. So we have some tax planning things that we're working on. We also have some overseas acquisitions that we're working on that we think will, over the next several years, utilize that cash. But we, certainly, we would be comfortable running the business if the cash is in the right place on probably $50 million in cash. So I would look at most of that cash that's sitting on the balance sheet as it's ultimately going to be available for either to do acquisitions or in some way to return to shareholders at some point.

[Shawn M. Harrison:]

Got you. And then, post SymCom, how much availability do you have on your new credit facility?

[Philip G. Franklin:]

Post SymCom, well we just did -- we just extended that facility by $50 million.

[Shawn M. Harrison:]

Yes. Okay, so we have changed.

[Philip G. Franklin:]

Yes, we have more than ample liquidity there.

[Operator:]

Our next question comes from Matt Sheerin from Stifel.

[Matthew Sheerin:]

Yes. So I did have some questions around the margins given the flattish guidance and EPS backing into relatively weaker margins. As I think, Phil and Gordon, you explained particularly with the acquisitions and then the cost, and the plan to bring margins up as we get through the year. But I guess, the question is it looks like you're going to start off at a lower EBIT margin than where you ended last March, and I know that was a very strong quarter for you. So my question is, as we get through the year, do you expect to grow operating margin as a percentage year-over-year? And would that be for the full year as well, getting closer to 18% versus where you ended up in 2013?

[Philip G. Franklin:]

Yes. Okay, Matt. Well so right, I mean, the main reason for margins that we expect operating margins being, or EBIT margins, being less in the first quarter of '14 than they were in '13 is -- and they're not going to be that significantly less, but we do have 2 new acquisitions that I talked about that are operating at lower than the company average, at least initially. So that is the main reason. Like all the core businesses, we expect to be at least at the, in the aggregate, at the same level, if not higher than they were a year ago at this time. As far as your comment, your question about margins progressing during the year, yes, I think our expectation is that the first quarter will be the low point from a margin standpoint. And as you know, we normally have seasonal upticks in our business in Q2 and then typically, again, in Q3, which usually helps the margin as well. So we'll see that natural seasonal progression in margins. But I think by the fourth quarter, we should start to see at least some benefit from some of our integration activities in these new businesses and some of the investments that we're making in these new businesses. But for the full year, SymCom levels, margin levels significantly below where they're ultimately going to be. And with the sensor business, it's going to take us a while, as I said, to get those margins up. With those 2 businesses diluting margins for the year, I think that the full year margins could be slightly lower than they were in 2013, even though the core business margins probably are at the same level, if not higher.

[Matthew Sheerin:]

Got you, okay. That's helpful. And then, on the M&A front. I know you talked about your long-term strategy in sensors and its diversification in the electrical business. Given that you're integrating 2 separate acquisitions, are you going to be a little bit more cautious in terms of what you see near term, or are you just going to, if an opportunity arises, you're going to be able to integrate it despite what's going on already?

[Gordon B. Hunter:]

I think they're kind of separate teams within the company that are doing those integrations. The SymCom one is really part of our electrical business where at some years since we acquired the Startco business and so the team that we have during that integration, I think is very capable in the electrical segment. And the Hamlin business is really split between our automotive and electronics businesses, so I think we have the ability to move ahead with all of the things that we've done in the past, in terms of our core business. Going back to 2006, when we started the rationalization of a lot of our core business to increase profitability. So I think we have the experience to be able to work on those 2 in parallel.

[Philip G. Franklin:]

And Matt, I'll just add another comment there. I think that we're-- as we mentioned, we were at a 13% growth rate last year. I think our expectation would be that, probably, it will be likely that we find another acquisition some time before the end of 2014, in which case, would put us right on track and be even slightly above our 15% target. So we're still, based on what we have in the funnel, based on the cash that we have and the balance sheet that we have, we're pretty confident that we're on kind of on a track anyway to get up to those kind of 15% growth numbers that we referred to in our strategy.

[Operator:]

[Operator Instructions] Our next question comes from Gary Prestopino from Barrington Research.

[Gary F. Prestopino:]

Phil, you kind of answered the question with your last -- what you talked about. But I wonder, talk about or get some more color on the pipeline of acquisitions. And like I said, I think you basically answered it -- but you [indiscernible] pipeline?

[Philip G. Franklin:]

Yes. No, the pipeline, as we've said before, it's a very solid pipeline. I think we got quite a few potential targets in our key strategic target areas, those being commercial vehicles, those being protection relays and also being in the sensor area where we have multiple targets that there are potential in all those spaces. And we even have a few interesting ones in some of our core areas that could potentially become available. So we are pretty optimistic based on that and our funnel continues to be, I would say, very solid and I think, overall, on track to achieving our targets.

[Gary F. Prestopino:]

Okay. And then, as we're modeling, what kind of tax rates should we be looking at for this year?

[Philip G. Franklin:]

Yes, I think it's going to be -- it's going to probably move around a little bit during the year based on where the sales mix and where the earnings are being generated. But I still think it's going to be somewhere probably in the 25% to 26% range. I think if you want to be conservative, use 26%, it could be closer to 25.5%.

[Operator:]

We have no further questions at this time. I would now like to turn the call back over to Gordon Hunter.

[Gordon B. Hunter:]

Well thank you for joining us in today's call. With a record year behind us, we are focused on continuing our momentum in the year ahead. We look forward to talking to you again next quarter. Have a good day. Thank you.

[Operator:]

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.