Littelfuse Inc (LFUS) 2004 Q4 法說會逐字稿

Good day everyone and welcome to this Littelfuse fourth-quarter earnings conference call.

Today's call is being recorded.

At this time I will turn the call over to CEO, Mr. Gordon Hunter.

Thank you.

Good morning and welcome to the fourth-quarter Littelfuse conference call.

This is Gordon Hunter, the Littelfuse CEO and with me this morning is Phil Franklin, CFO and also Vice President of Operations and Support.

We are assuming that you have seen the press release which we issued earlier and Phil will be going through some of the details of that release later with you.

We would like to give you an overview of the fourth-quarter and also an overview of the results for fiscal year 2004.

We would also like to give you some background from the end markets that we serve and then we intend to open up for questions.

We expect this call to last about 40 minutes.

I will now hand over to Phil for our Safe Harbor statements and some further details relating to the press release.

Thanks Gordon.

Any forward-looking statements contained herein involve risks and uncertainties including but not limited to product demand risks, the effect of economic conditions, the impact of competitive products and pricing, acquisition and integration risk, commercialization and technological difficulties, capacity and supply constraints, exchange rate fluctuations, the effect of the Company's accounting policies, labor disputes, restructuring costs in excess of expectations other risks which may be detailed in the Company's SEC filings.

Fourth-quarter financial results were somewhat better than our revised guidance issued on December 21.

Sales of 124 million exceeded our range of 120 to 122 million as we did a good job cleaning up our shippable backlog at the end of the year.

Earnings per share of 21 cents included a $2.2 million non-cash charge but also benefited from a reduced income tax expense as we reduced our effective tax rate for the year from the prior rate of 36 percent down to 34.8 percent which should be close to our go-forward effective rate.

Excluding the non-cash charge and the favorable income tax adjustments, diluted earnings per share were approximately 25 cents compared to our guidance of 20 to 24 cents.

That said, it was a difficult quarter in which sales weakened as the quarter progressed forcing us to cut back production rates across most of our electronic product lines.

At the same time operating expenses increased as we incurred additional costs in the quarter related to the year-end push to achieve 404 compliance and costs to complete several consulting projects as well as higher marketing and legal costs.

The drop-off in sales with higher operating expenses resulted in compression in our operating margin to 7.4 percent.

As you may have noticed in our press release we did not report the gross profit in operating expense line that we normally report in our income statement.

This was due to difficulties we encountered at Heinrich in determining the appropriate split between cost of sales and operating expenses.

As we said in our press release this will not affect anything related to operating profit or net income.

We will resolve the issue with the reclassifications within the next week so that we can report these expenses properly in the income statement filed in the 10-K.

Before I turn it back to Gordon for some detailed comments on the markets, I'd like to just emphasize that despite the difficult fourth quarter, 2004 was an outstanding year for Littelfuse.

We fully integrated Teccor.

We acquired Heinrich.

We broke the $500 million sales barrier for the first time.

We more than doubled earnings per share and we delivered over $35 million in free cash for the second consecutive year.

Gordon?

Thanks, Phil.

I would now like to give some further detail about our three strategic business units, the status of the business there, the developments of the end markets that they serve and then also give an update on the status of our Heinrich business.

First, our electronics business unit which is approximately 65 percent of our total revenue as stated in our press release this morning, our electronics business grew by 45 percent in 2004, excluding Heinrich.

Many strategic initiatives were accomplished including the complete successful integration of the Teccor productline and the Teccor team as well as several key cost reduction initiatives linked to our lean manufacturing initiatives.

However, as we mentioned in our mid-quarter call on December 21, we expected to see orders and shipments in our electronics business soften during the quarter.

This was due to the slowdown in growth in some of our end-user segments such as digital electronics and telecom which combined with an inventory correction in our distribution channels, especially in North America and Asia caused us to report sales for the quarter sequentially down from the record third quarter by approximately $10 million or 13 percent.

This level of $69 million was however still up 3 percent over the fourth quarter one year ago.

The electronics business unit competes in a variety of end markets including wired telecommunications, computers and peripherals, automotive electronics, hand-held, consumer electronics and a general industrial category.

In 2004 the computer market grew 12 percent by units; mobile phones grew by 32 percent by units but heavily on the commodity side; digital cameras grew by 45 percent; our portion of the wired telecom grew 20 percent; and consumer electronics grew 11 percent, again on a unit volume basis.

If we factor in price erosion in the middle single digits for our electronics business, our end markets grew a bit over 12 percent in dollars last year when weighted for our sales in each of those segments.

Looking forward into 2005, the computer market is expected to slow down to about 10 percent; mobile phones dramatically down to an expected 8 percent; digital cameras to 20 percent; our portion of the wired telecom to 8 percent; and consumer electronics we expect to be flat at 11 percent.

This is expected to cause our weighted sales growth to be cut to around 6 percent in dollars for these markets.

In addition to the strong end market performance of 2004 there was an inventory build in many of those segments, specifically wire telecom, mobile phones and to a smaller extent, the computer segment.

This inventory build was evident in both the end-user, the OEMs and ODMs as well as in the distribution channels which supply these OEMs.

This inventory overhang affected our fourth-quarter sales and will continue to affect our first-quarter performance.

There are still however, some segments where we expect to see continued increased growth, for example in consumer electronics which is expected to grow at 11 percent in 2005, the MP3 and satellite radios are examples of high-growth subsegments.

For example unit demand for MP3 players doubled to 7 million in 2004 and is expected to grow another 50 percent in 2005.

We're working closely with many of the OEMs and ODMs in this fast-growing portable segments of the consumer market.

Our full line of ESDs are designed in expertise and the relationships with this important customer base position us well for this fast-growing area.

Worldwide Voice Over Internet protocol or VoIP market is now experiencing significant growth as the deployment benefits of packetized voice are being continuously proven to service providers, to businesses and consumers.

Accelerated adoption across all systems segments will enable the market to grow at 48 percent compounded annual growth rate for 2003 through 2008 according to a new forecast from IDC.

IDC also estimates that corporate spending on Voice-over Internet protocol phone systems should grow about 31 percent to 4.5 billion in 2005.

Within this market the broadband gateway segment targeting consumers will drive the strongest increase as DSL and cable modem customer premise equipment increasingly integrates VoIP functions.

VoIP is becoming a mainstream service accounting for over 6 million access lines last year and expected to be 26 million plus in 2008.

The server protection content, for protected VoIP port is now up to $1.00 potentially using up to four of our technologies; fuses, protection high-riskers (ph), gas discharge tubes and resettable fuses.

This is a key area where we can leverage off our circuit protection expertise and product offering none of our competitors can match.

Many times the circuit protection solution for these types of telecom applications require coordination of components and we feel that our portfolio of products and design and expertise gives us a strategic advantage within these applications.

We also feel that our strong presence in Asia where much of this customer premise equipment is made, our technical expertise and broad portfolio positions us well.

In summary, for electronics, while we are disappointed with the recent slowdown and the distributor correction which we believe will continue to impact us through the first quarter of '05, we continue to see our end markets segments as fundamentally strong and we believe in our business model of bringing the broadest offering of circuit protection products combined with application support on a global basis to our customers.

Now let me switch to our automotive business which is about 25 percent of total Littelfuse revenues.

They grew sequentially in the fourth quarter over the third quarter by 5 percent but was lower than the corresponding quarter one year ago.

This was due primarily to slower car builds in North America and Europe than previously announced and a recall program which we benefited from one year ago.

Car builds in Europe and North America where Littelfuse and Pudans (ph) Division of Heinrich have most of their presence declined by 2.2 percent and 2.6 percent respectively in fourth quarter versus the same period one year ago.

Meanwhile Asia car build grew by 6 percent and this is the geography in which we have started to increase our presence and our focus.

For 2004, our automotive business grew revenues by 5 percent.

We began investment in several new product and segment initiatives and made progress in many cost reduction areas and overachieved its profit targets.

In addition to the benefits we expect to get from the Heinrich acquisition for automotive, which I will come to later, we continue to invest in two key areas for this business unit.

One is new product development which although it takes time for new products to be designed into new car platforms and to ramp up with those platforms, we are very encouraged by the opportunities we see ahead.

Our new low-profile products, low-profile Mini, and the low-profile J-Case (ph) have been very well received by our customers.

The other investment area is in new segment development.

This can be both geographical and customers segments; for example, in areas of the world where we have little presence such as China or in segments such as the off-road truck and bus segment and the hybrid electric vehicle segments.

J.D. power has recently forecast new car build to grow by 5 percent worldwide in 2005 to a total of 63 million cars with North America expected to grow by 5 percent, Europe 1 percent and Asia by 10 percent to almost 25 million vehicles, another reason for our Asia focus.

We expect our automotive business to start showing signs of growth from these new investments late in 2005 and with much more strength in 2006.

Let me talk about our electrical business.

This business unit which is approximately 9 percent of our revenues and is almost exclusively a North American business achieved 8 percent revenue growth year-over-year.

Price realization and market share gains attributed to these strong results in 2004.

In addition, recent marketing programs which support plant maintenance engineers in terms of safety and organization of their circuit protection inventory are expected to contribute to another strong year in 2005.

In addition, cost reduction activities in 2004 with the completion of the moving of our manufacturing to Mexico are also expected to contribute to the profit improvement in this segment.

The three end markets for these products in North America which are plant MRO, the electrical OEM activity and nonresidential construction are all now showing solid growth in the mid single digits as we enter 2005.

This is very encouraging after the weak performance of recent years with so much manufacturing moving offshore.

Now if you will let me talk about our Heinrich business in Germany.

Our Heinrich business in the fourth-quarter experienced similar challenging market conditions as we did at Littelfuse.

The slowdown in the end-user markets in electronics and the usual seasonal impact were the main reasons for the 12 percent sequential decline in revenues when that business is measured in euros.

The slowdown in electronics was similar to that experienced by our Littelfuse Electronics SBU and similar to our industry in general and is expected to continue through the first quarter of '05.

We expect to complete the squeeze-out process of Heinrich in midyear and be able to more fully integrate the business into our SBU structure.

We are confident that will bring us the expected synergies that we planned when the first acquired the majority shares in the Company and continue to be optimistic especially in the automotive area about the new products and the customer relations that we will integrate into our existing businesses.

I will now hand this back to Phil for some further comments and then we will open for questions.

Thanks, Gordon.

As expected we have had a slow start to the year due to the remnants of the electronics overhang that Gordon referred to but also Chinese New Year.

We expect to see our electronics sales begin to ramp up in late February, early March and finish the quarter flat to slightly down compared to Q4.

As mentioned in a recent press release we reduced staffing levels in the first quarter and we will record a charge related to these reductions of approximately $3.5 million pretax.

These staff reductions will result in annualized savings of approximately $5 million.

Excluding this charge, we expect operating margins to be similar to Q4.

While operating expenses will be lower than those in the fourth quarter, we also expect a lower gross margin due to higher cost inventory that will run through the P&L in the first quarter.

This higher cost inventory results from the recent slowdown in production rates and the associated under-absorption of overhead.

Margins should begin to improve in the second quarter as sales ramp up and production rates increase.

This includes our prepared remarks.

Now we would be happy to take questions.

(OPERATOR INSTRUCTIONS) Amy Junker with Robert W. Baird.

Phil, just a quick question on the issues with the reporting of the gross margins in SG&A from Heinrich.

That didn't seem to be a problem the last couple of quarter so I'm just curious did something specifically change what really happened there?

Amy, what happened was that as we got deeper into it in the year-end audit it became clear that there were some inconsistencies with the way Heinrich was categorizing certain costs related to the way we do it here at Littelfuse.

And they assemble their statements consistent with German GAAP which has quite a bit different presentation of the income statement.

We discovered this problem late enough that we thought it was better to do a thorough analysis and get the numbers right as opposed to try to rush something out for this press release.

We are confident that anything we changed there will be purely reclassed between SG&A and cost of sales but it won't affect any of the bottom line numbers.

That is helpful.

Thanks.

To follow up on your comments as far as your expectations in electronics, would you classify or would you say that the Telecom and consumer markets have flattened off at this point or do those continue to decline -- do you continue to see those weaknesses?

I guess what I am getting at and not just in electronics but in all in revenue, would you expect revenue levels to be down sequentially in the first quarter versus where they came in in the fourth quarter or should we see more flattening to up?

Yes, I think that overall we -- let me step back maybe to what we saw in the fourth quarter and give you the shape of the curve here.

The fourth quarter started out -- we started out reasonably strong with some of the momentum that we carried in from Q3 and then things just got weaker progressively as we got into the year as we got towards the end of the year.

Early January was similar to December and so right now we think that we have seen some pretty good signs that things have bottomed out.

And we are expecting as we get toward the back half of February that we are going to see some improvement here.

You have the shape of the curve that it starts out high and then declines into December.

It flattens out in January, early February, and our expectation is that we see that ramp up as we get towards the end of the quarter.

Net-net it is going to be a similar number to Q4 but with just kind of a mirror image shape to it.

We think it is similar to possibly slightly down from the Q4 number though overall.

Okay.

Last question from me is just understand Heinrich remains a little weak at this point.

What is your expectation for EPS contribution from them?

Will that start to be accretive in the first quarter or does that push out maybe until the second quarter now when we start to see demand really pick up?

We said it was neutral -- it had been accretive back in Q3 when revenue levels were a little bit higher.

With the drop off in revenues, it went to around neutral for Q4.

I would expect Q1 to be similar to Q4, i.e., roughly neutral and I think assuming they get the same kind of ramp up that we would in particularly in the electronics business which has been the one that has been the most depressed for them as well, we would see it be accretive in Q2.

And then in the back half of the year as we are able to execute on some of our integration plans and cost reductions around the midyear time frame, sometime in the third quarter probably, we would expect to see some reasonably significant improvement as we get out towards the end of Q3, early Q4.

It will start out being flat to neutral to then modestly accretive in Q2 and it should get more accretive as the year goes on.

Great, thank you.

Jeff Rosenberg with William Blair.

Phil, can you tell us what the operating margin was more Heinrich and then maybe a gross margin and a SG&A percentage for the rest of the business?

Is that something that you can break out?

I can give you some directional guidance there.

The Heinrich operating margin was in the 2 to3 percent range which is kind of where it has been.

It has been running maybe that to a little bit higher.

So probably closer to 2 percent.

They had some below the line expenses that really brought that to kind of a neutral number.

On the Littelfuse side we saw -- as we alluded to in the press release and I alluded to again in the statements this morning, that we did see a pretty significant ramp up in the base in SG&A to the tune of -- over the Q3 number to the tune of 3 or $4 million.

Some of that we expect to be one-time type costs that will not reoccur in Q4 or in Q1 some of it related to some Sarbanes-Oxley stuff not that we won't have to spend money in 2005, but it certainly won't be at the rate that we were spending at the end of 2004.

But SG&A was up quite a bit.

Gross margins for the base business were down some probably not quite as much as what we had guided to.

Relative to our December guidance that we gave, the SG&A was probably a little bit higher than what we guided to and the gross margins were also a little bit higher.

And yet you are -- I guess the one thing I'm hearing in terms of the difference between the Q1 guess you gave in December versus today is you think gross margins will be lower?

Right, yes.

And then in terms of Heinrich just taking a setback relative to your -- I guess maybe not a setback -- but is this delay in the squeeze-out hurting you at all in terms of the -- or is it all market and you that will continue to basically go along as planned and it is really just a matter of timing, not any real distraction as they sit there waiting to get this completed?

I will let Gordon give a comment on that.

Let me just say that certainly we don't -- we have delayed some of the integration and some of the cost savings that are out there just because of the squeeze-out but that was consistent with what we thought.

I think on other fronts, we certainly we are moving toward some of our strategic things in terms of combining our sales efforts and those kinds of things.

We haven't slowed up on those.

It is mostly related to their cost savings I think where we have been inhibited here.

I would agree with that.

I think that there probably are some deeper integration at the sales and product level that we probably could do in some places if we were fully owning the business.

I would say it is having some market impact but I think that what we are seeing in their business quite reflects what we are seeing in our own businesses really.

Okay.

I think you have answered this but I'll maybe ask a little bit differently.

Have you seen any improvement in orders in a first 5, 6 weeks of the year or is it really still at the level that it bottomed at during the fourth quarter?

Yes.

We have seen a modest improvement in the order rate.

We have seen our book to bill go from the .8 to .9 range which is what it was in for most of the fourth quarter to go a little bit above 1, although some of that is just that the billings rate has come down some.

But if we look at the actual bookings, we are at a slightly higher rate so far for the first quarter than the run rate we ran at in the fourth quarter.

Okay, that helps.

Thank you.

Also just to add to that.

As more and more of our business becomes Asia focused, this is Chinese New Year;

China becomes a very important place for us.

We did see a slowdown significantly in China recently from the OEM level and certainly from the channel level which we now have to monitor much more carefully.

Of course we really expect when they come back after Chinese New Year that we expect to see that picking up.

That is our strong belief and I think you may hear that from other people in the industry -- that the slowdown in China has really impacted everyone but we expect to see them recover after their New Year.

John Franzreb from Sidoti & Co.

I wanted to just think about Heinrich and once it is fully integrated, what kind of operating margins we can look at maybe on two years down the line?

What kind of target margins do you think the consolidated business can pull together after everything has been consolidated?

John, I think obviously we are not going to have a highly confident answer to that question until we get a little bit further into the integration but we still believe what we believed shortly after we bought Heinrich and had a chance to get into the Company a little bit and get into the numbers.

And that is that we think we can achieve our corporate target of 15 percent operating margin for that business and we haven't seen anything so far that would deter us from that belief.

Do you think integrating Heinrich will be more on par with the Harris integration or more on par with the Teccor acquisition in regards to the timing and the difficulty of integrating the purchase?

It is clearly more difficult in several respects than Teccor.

It's got more different businesses, it's got more facilities and more different places and they are all in foreign countries all of which add to the difficulty plus we've had this issue with the fact that it was a publicly owned Company and we've had to go through this squeeze-out process.

So in almost in every dimension it is more difficult than what the Teccor acquisition was.

One of the things that gives us a high-level of confidence though is these businesses are very similar to ours and more so than Teccor and we believe once we got moving forward with this that we have a high-level of confidence we are going to be successful.

It's just going to take longer.

Thanks a lot.

Rob Crystal (ph) with Grant Point Capital (ph).

I had one quick question for you on the cost saves, the $5 million annually you referenced.

Is that savings from the consolidation related to Heinrich or is that the above and beyond that?

It really doesn't have anything to do with Heinrich.

These are all savings from the base Littelfuse business.

Integration savings from Heinrich would above and beyond but really are not going to occur in a meaningful way until the back half of 2005.

Can you refresh my memory on what you thought the Heinrich savings would be when all was said and done?

I think we had given a number -- a minimum number we though we could achieve in the $5 million range and when we get a little bit closer to doing that we will give some updated numbers but I think that it's going to be certainly at least that number.

Great.

Thank you very much.

Jeff Osher (ph) with JMP Asset Management.

Just two quick questions.

I jumped on the call late.

I may have missed it.

Did you say how many shares you repurchased in Q4?

We didn't repurchase any shares in Q4.

We had some repurchases in Q3 but not in Q4.

Can you give us just a rough feel for where DSIs may have trended in Q4?

I know it is like Jeff's question, tough without the Heinrich cost allocations but were they up 5 days from the 82? 10 days from the 82 in Q3?

What do think about that?

What trended?

Days sales and inventory.

Oh, in inventory.

No, I think that the overall -- I haven't done the math on that but the overall inventory was roughly flat for the quarter so --.

I'm just looking at it though on a days sales basis.

I think a reasonable assumption to make is look at the cost of sales for Q3 and reduce that by the percentage decline in sales and you'll get a number pretty close to that.

I don't know what that will calculate out at.

Just keep your gross margin.

Okay.

Yes, I would just keep it constant.

Thank you.

Greg Halter with LJR Great Lakes Review.

My question for you regarding the uses of cash you are at -- 2 or 4 percent net -- net debt, how do you prioritize the uses of cash going forward?

I think that a couple of things obviously over the past 9 months or so we have used some of that cash for acquisitions and we've used some of it for stock buyback.

I would say that both of those are certainly still on the table.

We have a number of acquisitions that we are continuing to look at.

We also happen to like the stock at the current price. (multiple speakers) We happen to like the stock at the current price and so I think those are two strong considerations for use of cash looking forward for the next 6 months.

On a capital spending basis, what is your budget for '05?

Capital spending it looks like it will probably be in the mid-20s someplace, 25, 26, somewhere in that range.

And that includes Heinrich?

Yes, that would include Heinrich.

And what would the depreciation and amortization on an annual basis now be including Heinrich?

It's going to be a fairly similar number to that.

If you look at the fourth quarter cash flow number, -- let's see, it's --.

About 26?

Yes, it's going to be right in that range.

D&A and CapEx should be quite similar in 2005.

Relative to your capacity utilization, what does that look like now in the current business -- in the businesses?

We've got to talk about that by business because it is quite a bit different but in our electronics business you'll recall at the peak where everything was blowing and going back in the middle of last year, we were in the lower 80s I believe in terms of capacity utilization 82, 83, 84.

The number now has dropped into the 60s.

It has dropped off quite a bit related obviously to the pull back in production that we did in the fourth quarter.

Okay.

Automotive is still -- that has been pretty steady.

We are probably in the 90s there, lower 90s.

POWR-GARD capacity is really not an issue.

Okay, thanks.

(OPERATOR INSTRUCTIONS) Senel Novtarter (ph) with Bramwell Capital Management (ph).

You mentioned about voice Over IP.

Could you give us an idea who your customers in the Voice Over IP segment now and how is the business momentum in that?

And is it high enough to offset some of the weaknesses in the electronics area in the coming quarters?

Thanks.

No, it was more an example at this stage of a very good design win where we see growth in the future and we see that having four technologies being able to be designed in and get a significant dollar content report, at the moment, it is still relatively small.

A lot of their customers tend to be in Asia which we think is to our advantage.

A lot of the premise equipment that is going to be built by the ODMs is a place that we have had particular focus.

It is not big enough yet to be anything which is going to upset the significant other market segments but we do believe it is an example of a focus area for the future.

Okay, thank you.

Todd Peters with American Century.

Thanks for taking my call.

I apologize, I missed your commentary on the utilization rate.

I know I heard you say auto is still sitting in the 90s and then you said something -- another segment was in the 60 percent utilization rate.

Was that the electronics segment?

Electronics, yes it is probably in the 60s someplace at this point in time.

Obviously that will start to increase as we see our production rates rise up toward the end of this quarter.

How do you feel with your own inventory levels and the distribution inventory levels?

I know you said that you are still seeing impact during the first quarter from the distribution channel on inventories.

But how do you feel about your own?

I think we managed our inventories pretty aggressively in the fourth quarter.

With a sharp pullback in production and in sales in the fourth quarter we were able to keep our inventories roughly flat to Q3 which was really our intent for acting pretty quickly on the production side.

As we look forward into 2005, we still think there are some opportunities certainly to turn our inventory faster than it is turning right now.

We are doing some things with lean manufacturing.

We are going some things on the supply chain side with demand management and planning and logistics that should allow us to achieve higher inventory turns than what we achieved in 2004.

Thank you.

We have no further questions in the queue at this time.

That is almost right on time of the 40 minutes that we allocated.

I'd like to thank you all for your questions this morning.

This does conclude today's conference.

We thank you for your participation and you may now disconnect your lines.