Littelfuse Inc (LFUS) 2007 Q3 法說會逐字稿

Good day everyone and welcome to the LITTELFUSE, INC.

Third Quarter 2007 Conference Call.

Today's call is being recorded.

At this time I would like to turn the call over to your Chairman, President and Chief Executive Officer, Mr.

Gordon Hunter.

Please go ahead, sir.

Thank you.

Good morning and welcome to the LITTELFUSE Third Quarter 2007 Conference Call.

Joining me today is Philip Franklin our Vice President of Operation Support and CFO.

As you saw on the news release we were slightly above our third quarter guidance both for sales and recurring earnings.

All three businesses were on track for the quarter with electronic sales developing a little stronger for the quarter than forecast.

The third quarter performance, which is normally a strong seasonal quarter for us, signals a return to stable market conditions for our electronics business after working through excess inventory in the distribution channel and at end customers in the first half of the year.

This improved sales level led to recurring earnings performance of $0.48 for the quarter which was just above the high end of our prior guidance.

As we indicated in the press release, we expect fourth quarter sales to decline approximately 5% sequentially driven by normal season factors primarily in the electronics business.

Overall we expect to end 2007 healthier than at the start of the year with improved electronic fundamentals, record performance for our automotive and electrical businesses and significant cost reduction progress in our multi-year path towards achieving a 15% operating margin level.

I will discuss the third quarter results and our outlook in more detail in a few minutes.

But first Phil will give the Safe Harbor Statement and a brief summary of our press release.

Thanks Gordon.

Before we proceed let me remind everyone that comments made during this call include forward looking statements.

These statements are subject to various risks and uncertainties, and as a result actual results may differ materially from those expressed in forward looking statements.

A discussion of these risk factors may be found in the quarterly and annual reports filed with the SEC.

Sales for third quarter were up 9% sequentially and adjusted earnings were $0.48 per share as all three businesses turned in good performances.

Compared to the prior year quarter, which was a LITTELFUSE record, sales declined 2% as lower electronic sales were partially offset by growth in both our automotive and electrical businesses.

Gordon will give more color on these in a moment.

As a result of the strong sequential sales growth, adjusted operating margin improved to 10.5% which was our best performance so far this year.

It is still below the prior year quarter of 11.3% due primarily to incremental costs related to our three large manufacturing transfer projects.

These transfer related costs ran at about $1.5 million for the third quarter and will ramp up to approximately $3 million per quarter by early 2008 before beginning to subside in early 2009.

These costs include retention bonuses, hiring and training costs, redundant factory overhead, incremental depreciation on [swing] equipment, and equipment move costs.

The third quarter was our strongest quarter so far this year for cash flow with $15.3 million operating cash and over $10 million of free cash.

The main cash drivers for the quarter were improved profitability and excellent inventory management with inventory dropping $6 million during the quarter which drove inventory turns above 6 for the first time in our history.

Now let me turn it back to Gordon for some market commentary and more detailed discussion of our business performance.

Thanks, Phil.

[Telecom] sales for the quarter were 9% below the third quarter of last year.

Our automotives and electrical businesses continued to perform well.

And in fact both businesses had record quarters.

Automotive sales increased 12% and electrical sales were up 15% over the third quarter of last year.

Electronics was up against what was a record third quarter of 2006 making this year's third quarter a tough comparison.

And as we called out in the second and third quarter earnings calls of last year, this strong prior year sales level was due in part to inventory building in the channel.

Geographically sales for the third quarter compared to the prior year were down 5% in the America's, down 2% in Asia and excluding favorable currency effects were down 7% in Europe.

In all regions electronic product sales decreases outpaced gains in automotive and electrical products.

Starting with electronics I will provide some additional comments by business unit.

Then I will comment on our major cost reduction initiatives and a new product development progress before turning the call back to Phil to provide guidance on the fourth quarter.

The fact that our third quarter results were at the high end of our expectations was due primarily to the improved electronic business fundamentals.

With electronic sales accounting for about 65% of total LITTELFUSE sales, this business unit is the primary driver behind overall results.

Although electronic sales of $92 million were 9% below the strong third quarter of 2006, they were up 12% sequentially over the second quarter.

This improved performance reflects a return to normal inventory levels in the channel and at end customers as we discussed in last quarter's call.

This sequential electronics sales increase was driven by strength in Taiwan and Korea where sales were up approximately 30%.

And strong fuse product sales with record revenue quarters for our Nano and Cartridge fuses.

Ceramic and Polymer products were also up significantly driven by seasonal demand and the Song Long acquisition.

Our strong market position in LCD and plasma screen displays, notebook PCs and on the Nintendo Wii were all strong contributors to the quarter.

Looking ahead to the fourth quarter we expect a normal seasonal decline in fourth quarter electronic sales compared to the third quarter, but we now expect to be ahead of the fourth quarter of last year.

Moving on to automotive, which accounts for about 25% of total LITTELFUSE sales, this business achieved another strong quarter.

In fact, this was the third consecutive all-time record quarter for our automotive unit, a strong indication of the momentum we have going for us in this area.

Global automotive sales of $34 million increased 12% in the quarter from a year ago and were up 8% excluding the favorable effects of currency.

LITTELFUSE automotive sales outpaced car production in all three global regions for both the third quarter and the year to date.

Automotive sales increased 7% in North America, 8% in Europe, excluding the effects of the strong Euro, and 16% in Asia.

This strong performance was due to successful new product penetration resulting from our multi-year designing focus and good progress in our off-road truck and bus initiatives.

In the Americas we saw continued strong sales of our CablePro fuses used in high current applications.

In Europe we continued to benefit from the persistent strength of the Euro and master fuse opportunities.

In some cases we are working to supply our customers the master fuse as more of a system than a component.

In Asia our strongest gains continue to be primarily in Korea and China.

In Korea business that we won two to three years ago has finally ramped up to its peak annual revenue rates.

In China we have won market share and expect to see significant growth in our CablePro sales with the launch early next year of a CablePro line that supports a new program with GM that starts production in China in 2008.

We are continuing to make progress on our expansion into the off-road truck and bus market.

An example is a recent with Volvo Mac truck for the North America fuse needs which may lead to further opportunities with this new customer.

We are also pursuing opportunities for our CablePro and master fuse products in various off-road truck and bus applications.

In summary, the automotive business continues to perform well and we are making good progress on our strategies to expand in Asia and into the off-road truck and bus market.

Moving on to the power guard electrical business, we achieved a 15% increase in sales in the third quarter.

This was the second consecutive all-time record quarter for this business following a record first quarter.

The sales increase was driven once again by strong price realization along with wins resulting from our strategic initiatives to engineer custom products for OEM applications and to expand our services business.

The market fundamentals in the non-residential construction and industrial segments are being good but we expect growth rates to slow in the coming quarters.

Offsetting these potentially slower 2008 market growth rates are solid progress in our OEM products and services initiatives.

Our service initiative continues to gain traction.

Last quarter I mentioned a new contract to conduct electrical hazard assessments in several large distribution centers of a Fortune 50 company.

The same customer is considering extending these services for its headquarters and regional office locations in 2008.

We also added another major new safety consulting services customer during the quarter, a large manufacturer of consumer and commercial products.

As these examples indicate, there is positive activity in this area.

In summary, the outlook for the electrical business continues to be very positive.

We are seeing some solid results on the service initiative and they are continuing to develop custom products for OEM customers that I will cover in a few minutes.

Moving on to the cost reduction initiatives, we continue to be on track with our production moves from Ireland and the US to Mexico, China and the Philippines as discussed in more detail in the last earnings call.

Some highlights of progress in the quarter on these initiatives include building construction is progressing in Mexico, China and the Philippines with occupancy expected by early 2008 at these locations.

We are still on track to begin transferring wafer fab production from Irving, Texas to Wuxi, China in the middle of next year.

Our acquired varistor team and operation in Dongguan, China continues to ramp up to receive Ireland production.

Additional planning and further steps are being taken for the transfer of the remaining electronic and automotive production lines from Des Plaines to the expanded buildings in Mexico and the Philippines.

We are on track with these projects and still expect to complete our Des Plaines move in the middle of 2009 as previously announced.

While these transfer activities cause additional costs to the P&L in the short term, we remain focused on and committed to the actions necessary to reduce our cost structure.

Because these initiatives are a significant part of our multi-year path to achieve a 15% operating margin, we have also taken steps to reorganize our operations leadership.

During the quarter we announced that Dave Heinzmann has assumed leadership for all manufacturing operations and supply chain functions in the new position of Vice President Global Operations.

Most recently Dave served as Vice President and General Manager of the Automotive Business Unit.

Dave's many years of operations experience in managing manufacturing plants and significant production lay moves plus his breadth of experience with LITTELFUSE will provide the necessary focus for our team in this critical area.

Over the last several years Dave and the automotive team have done an outstanding jog shaping the automotive unit into a growth business.

A seasoned member of that team, Dieter Roeder has assumed the role of Vice President and General Manager, Automotive Business Unit.

Dieter's global automotive experience and expertise in sales and marketing is an excellent addition to the executive team.

We continue to be optimistic about the automotive opportunities to develop new products, grow internationally and penetrate the off-road truck and bus markets.

Turning to new product developments we continue to pursue major programs across the business.

Following are some highlights of our progress during the quarter.

In the electronics business we had several wins for our TVS Diode products during the quarter including one for a new [set top] box and one for a mobile phone base station for Nokia.

We launched our new environmentally friendly halide-free thin-film fuse in the third quarter and already have a win with the new Apple iPod Touch.

Our efforts to ramp-up the TMOV product line are proceeding on track and demand remains strong.

Our expanding TMOV product combines a varistor with a fuse into one hybrid product.

These products are designed for transient voltage suppression system applications in industrial products and high-end PC products and set top boxes.

Several other new product launches are scheduled for the fourth quarter including a new series of ESD protection devices for high speed applications and several new SIDACtor high current surge protection products.

On the automotive side we are continuing to gain traction with global passenger care manufacturers of both our master fuse and our CablePro products as they design their new vehicle platforms.

In the electrical business I mentioned our initiative to engineer custom products for specific OEM applications.

One of our latest wins in this area was a product designed in the systems for industrial and commercial markets.

We should begin seeing sales from this customer beginning in the first quarter of 2008.

We have also designed a new product for industrial material handling equipment which should be designed into the OEMs lines over the next year.

We will continue to update you on new product development progress and sales penetration over the coming quarters.

In summary, the automotive and electrical businesses are performing very well with record quarters for each of these units.

Electronics suffered through slow downs due to excess inventory in the channel and the customers in the first and second quarter, but returned to stable conditions in the third quarter.

In the fourth quarter we anticipate that electronics will be back into a growth mode and that we will see continued strong results from the automotive and electrical businesses.

Now I will turn the call back to Phil who will provide additional comments on our guidance for the fourth quarter and the year and then we will open the call for questions.

Thanks Gordon.

As we said in the press release, our guidance for the fourth quarter is as follows.

Sales are expected to follow the usual seasonal pattern and drop approximately 5% sequentially.

Gross margin is expected to decline about 100 basis points in the third quarter due to lower sales and December plant shut-downs coupled with increasing transfer related costs.

Tax rate for the fourth quarter should return to a more normal rate of approximately 32%.

Diluted earnings per share are expected to be in the range of $0.33 to $0.37.

Now looking forward to 2008, we expect sales to increase 6 to 8% over 2007.

Gross margin for 2008 is expected to be approximately flat with 2007 as volume leverage and cost savings will be offset by higher transfer costs and price erosion.

Diluted earnings per share expect to be in the range of $1.80 to $1.90 for 2008.

In 2009 transfer related costs will decline throughout the year.

Savings from the major transfer project will ramp up to a $30 million run rate by the end of the year.

This will drive significant margin improvement as the year progresses and is expected to result in 2009 earnings per share of approximately $2.50.

At the completion of the major transfer projects we are still confident of achieving a 15% operating margin.

This concludes our prepared remarks and we would like to open it up to questions.

The question and answer session will be conducted electronically.

(OPERATOR INSTRUCTIONS) And we will take our first question from Alexander Paris with Barrington Research Asset Management.

Please go ahead.

Hello.

Hi Alex.

Nice quarter.

Thank you.

Just a little color looking at 2008.

It sounds like you are assuming that electronics contraction in inventories and so forth has pretty much ended.

So electronics will be fairly normal growth which I don't know what that is for you, something above the industry growth, right?

That is correct.

And then are you assuming both autos and electrical will be up for the year?

Absolutely.

I think that they have a lot of momentum and we would expect to see them both having solid growth.

And then in 2009 it sounds like Des Plaines is the last of the transfers so when that is done in mid 2009 pretty much all of those 3 major projects will be done by then?

Yes, the last one to complete will really be the Irving transfer to Wuxi, but they all complete pretty similar timeframes.

Des Plaines completes in kind of the middle of the year and the Wuxi one completes a little bit later in the year.

Okay.

That's all, thank you.

Thanks Alex.

And we will take our next question with John Franzreb with Sidoti & Company.

Please go ahead.

Good morning guys.

A couple of questions here.

Just to follow up on what Alex brought up.

Your growth assumptions for next year, that 6 to 8%, could you just provide some color what your expectations are by business unit.

I know you mentioned that you see stable conditions in electronics and at growth mode returning in 4Q.

But going into next year what are your sales growth expectations by business unit?

John, we are not going to parse that too finely at this point.

But suffice it to say at this point that really all three business units we expect to be reasonably close to that target level, probably all kind of within that 6 to 8% range.

So electronics clearly will have a better year this year, and as Gordon said, we expect to continue the momentum we have in electrical and automotive.

Okay, what are you hearing from your distributor base that gives you confidence that there is not another type of inventory build scenario that could kind of play out?

Could you talk a little bit about what your distributors are saying to you?

Well, as you know where we were a year ago and the sort of industry reaction to it being clearly too much inventory in the channel, not just at distribution channels but I think also into the OEMs and the CEMs even at some end customers that I think we are just having to really try and get information from much further into the channel then just our own distribution reports that we had on POS activity.

And I think everyone feels that after what happened last year that things have returned to normal and that sort of euphoria that we were having in the second quarter and the summer of last year is back to people being much more cautious.

So I think it is not just the data that is showing us that because some places we have much better POS data than others but I think it is the whole communication that we get from customers and the CEMs too.

Okay and your cost expectations regarding the consolidation.

We went from a couple of million to roughly now $3 million per quarter, what is the biggest delta there between the assumption of say a quarter a ago versus what they are today?

Well I think it is a couple of things John.

I think that as Gordon mentioned we reorganized the operations group into one global group under Dave Heinzmann and he has had a chance to really dig into the details of the plans with the guys, I think we have come up with some higher numbers for a few of these transfer related items than what we had previously.

And then I think also in addition to that we just made some decisions to spend a little bit more money in a few areas, hiring and training particularly training being one to ensure that we are successful with these programs.

So we are willing to spend a little bit of extra money in 2008 to ensure that the projects (a) remain on schedule and (b) that we achieve the $30 million of savings that we are very committed to.

Okay, one last question.

Could you talk a little bit about market conditions in terms of market share?

Are your market shares stable right now?

Improving?

Or are you finding competitive pressures out there, is it a little bit more difficult than you anticipated?

Just talk a little bit about the market share environment right now.

Well I think that the very strong growth that we have had in automotive and electrical, I think it is fair to see that we believe we have seen market share gains there; we are clearly growing ahead of the market.

And I think the passenger car market, for example, worldwide we have been beating that in every geography in automotive.

So I think it is fair to say that in that business we are clearly gaining market share and we have been investing in new products and we started that program in automotive about three, four years ago.

And those new products coming through are really helping us.

In electronics I think that in the correction that we have seen from last year I would say that is best described as really pretty flat.

I don't think that we are really gaining market share tremendously in the electronics business.

I think that the sort of correction that we have been through, we are probably growing at around market and maybe with some of the new programs we are making some inroads with some specific programs but I think we need to see more of those new programs coming through and more design wins, an example would be the new ESD products.

We only started to invest in an R&D group for that about a year ago.

And we start to see those first products get released at then end of this year.

So I think those new product areas we expect to see gains.

Okay, Gordon, just to summarize, you are saying that your holding share is nothing material being lost in share and you just need to get new products out there to improve that share?

That is correct.

That's fair.

Okay, thank you very much.

And we will take our next question with Ingrid [Adja] with Merrill Lynch.

Please go ahead.

Okay, she dropped off.

(OPERATOR INSTRUCTIONS) And we will take our next question with Jeff Rosenberg with William Blair.

Please go ahead.

Good morning.

Gordon, did you say much about Telecom and that is obviously apart from the distribution ebb and flow has been a volatile portion of the business.

Did you give us any color there?

I didn't mention it.

Actually not much has changed.

I mentioned on the last call you may remember that some of the programs, particularly one that had been a major program in 2005 and ramping it in 2004 originally I think it goes back to starting which is with Tyco and British Telecom.

And on the last call we had said that that is program which has really stalled in terms of the deployment, that they have plenty of inventory and that we expect to see that starting to ramp in the fourth quarter.

And that was what we announced a quarter ago.

That is probably going to be more into the first quarter now.

But we still expect to see growth in that for next year.

But really the telecom market was pretty steady.

Up a little bit.

Up a little bit but there is not any major changes there.

Okay.

And then as we look at your expectations for next year, I'm thinking your gross margin numbers are lower than what I was originally thinking at the same time the earnings reductions is not as much.

So is there, given the revenue growth, I'm interested to hear a little bit more about the operating expense, leverage or reduction as a percentage of sales you think you can achieve.

Yes, Jeff, I think what you just said I would agree with.

I think the margins are a little bit lower than maybe we had previously had thought and almost entirely related to these additional transfer related costs that we are going to be incurring in 2008.

On the other hand we are getting some decent, we do expect to get some decent leverage on operating expenses.

We are making a concerted effort as we talked about in our plan to get to a 15% operating margin.

We are making a concerted effort to really get leverage in the SG&A areas.

And we are going to definitely see that as we grow the top line in 2008 we are going to see our SG&A as a percent of sales comes down maybe as much as 100 basis points.

And so given that you are not growing, it's not like you are looking for an unusually high growth year on the top line, are we saying that SG&A will grow very little on an absolute basis?

That is really what we are saying.

And it is in part just executing on some of the plans that we have had for awhile which is really to hold the line on spend and some of the areas like finance and IT where we have made pretty big investments over the last few years to build global functions and build global SAP platforms and we are going to hold the line on those costs as we grow the top line so we are going to get some good leverage there.

And we are also not going to see that kind of ramp up in R&D that we saw in the prior years.

That is going to level off and we are probably going to see a little bit of leverage on our selling expenses particularly in the electronics areas as we get some better growth numbers there.

So overall operating expenses are going to be pretty tightly controlled in 2008 and we are going to get some nice leverage.

Okay, alright.

And then just one question on auto.

Did you see any tendency for customers to build any inventory in anticipation of potential work stoppages or anything kind of unusual year over year that led to that growth rate and any effect that has on you as you look to the fourth quarter?

No, I don't think so.

I think that we feel that we have seen pretty steady growth and we have certainly seen new products pick up on platforms that were designed in a few years just starting to ramp as they start to get into volume production.

Okay, great.

And then you have been asked a couple of questions on distribution, but when you look at North American sell-through, some other people have commented on weakness there.

What have you seen in terms of the places where you actually do get visibility?

What kind of POS are you seeing?

No, it has actually been pretty steady.

We have really looked at that pretty carefully after last year.

It is the one area, although the US sell-through distribution part becomes a decreasing part of the total part of the total pie as Asia grows so much faster.

It is the area still we get the best data from.

And it has looked very steady in fact.

Okay, that's good.

Thanks.

Thanks Jeff.

And we will take a follow up question from Alexander Paris with Barrington Research.

Please go ahead.

Just a quick question on the auto industry.

I have seen estimates of a 5% drop in production in the fourth quarter and you are doing so much better in Asia and Europe.

Could you give us a rough idea of how your auto breaks down now as far as North America versus Asia and Europe, that is is your vulnerability to the big three declining?

I would say it definitely is, Alex.

It is still roughly 40% of our business is still in North America, but it is not all passenger vehicles related anymore.

We have a growing piece of that; there has always been a piece that is the after mark, but a significantly growing piece is this off-road truck and bus business that we have that is part of that 40%.

So I would say overall as we grow Asia, as we grow off-road truck and bus and as we grow new products that is kind of independent of the car build from some extent we are becoming much less dependent on the big three and much less dependent on North American car build then we were in the past.

Good.

Thank you.

And we will take our next question with Stephen Fox with Merrill Lynch.

Please go ahead.

Hi, this is Ingrid Adja, I got cut off before.

I apologize.

Can you go back over how much conservatism you think you have baked into your 2008 sales outlook given the economic growth?

Into the sales outlook, I don't think we have been overly conservative there.

I think that we certainly believe as Gordon indicated that we have confidence that we are going to see some growth from some of our new products and as well as some of our pushes into areas like off-road truck and bus and services in the electrical business.

So we do have some growth elements there.

I think we have been a little bit cautious about kind of the overall economy and what we expect out of that in 2008 and in particular I think we have been a little bit cautious about what we think consumer demand will be coming out of the Christmas season.

We are not expecting any real positive surprises there.

So we have been a little bit cautious there.

But we feel quite confident of the 6 to 8% number, largely driven off some of these growth programs that we have in place.

Great.

Thanks.

How much do you think of the new product sales are contributing to these sales projections for '08?

Well I would say that it is accounting for most of the growth over market if you figure our overall markets, if you kind of weight it out, are probably growing in the 4% range.

Most of the overage over that is directly attributable to the new products.

Okay, great.

Thanks.

And then one last question.

Given the restructuring should we expect anything on the acquisition front?

I don't think the restructuring will affect our acquisition program.

I mean we are still actively pursuing acquisitions.

We are not going to do any acquisitions that we think would have any kind of a negative impact on the restructuring programs but there are a number of areas that we are looking at that we think we could do that would be totally independent of some of the focus we have on restructuring and wouldn't compromise that.

So I don't think you should expect that to have a dampening effect on our acquisition activity.

It is just a question of finding the right properties out there.

Okay, thank you very much.

(OPERATOR INSTRUCTIONS) We will take our next question from Satis [Atavail] with KSA Capital.

Please go ahead.

Good morning.

Gordon, a question on the various businesses that you are in.

could you provide a little more color on price, volume mix, that you saw during the quarter?

Well the automotive business is very stable for us.

It is very predictable and so we typically see moderate price decreases that are really negotiated into contracts and the growth is really coming from new programs and new products and geographical expansion.

So it is really a very predictable, on the programs that we do have in terms of where the volumes are going and where the price declines are and it is very steady and very predictable in automotive.

In electronics I think that we obviously saw some good volume increases sequentially and we typically expect to see price declines in the electronics area more than automotive but we are not an electronics business that has very high annual price declines.

It is usually in the single digits area, the sort of mid single digits area and we probably have seen that.

When our electronics business is growing very fast price declines are much less.

And when the market is declining you also have much more pressure on prices.

And I think we have sort of returned to a stable case.

So I would say that the third quarter has really been a stable, moderate volume growth and moderate single digit price declines.

Okay.

And maybe just add in the electrical business where the form factors of our products are much large and they do actually use a lot of copper and as copper prices are still at historical highs, we have been able to pass through those raw material cost increases in our pricing.

And so we have seen as well as volume increases in our electrical business where we have been gaining market share, we have seen good price realization as contributing to the very strong growth in the electrical business.

Okay.

If I can switch gears.

Phil, the CapEx during the quarter was a little higher than anticipated.

What kind of CapEx do you see for the remainder of '07 and also 2008?

Right, so we have been talking for awhile about a step up in CapEx related primarily to these major transfer programs where we are investing in bricks and mortar as Gordon alluded to as well as quite a bit of equipment for these.

So the next couple of years are going to be, through 2009, we are going to be spending more than our normal 5% of sales on capital.

I think this year the number will end up being on a gross basis between $35 and $40 million.

So that would indicate that we probably have another quarter to similar to maybe lightly lower than what we had in Q3 for CapEx.

So maybe something in the $11 to $13 million range for Q4, bringing us to maybe a little over between $35 and $38 million let's say on CapEx.

And then in the next year it could be even a little bit higher than that as we complete some of these major building projects.

It could be up into the low to mid 40s.

But we also may have some offsets like we did in the third quarter with some sales of properties as well.

But we will net that down to a smaller number.

And then as we get down into 2010, I would expect CapEx to pretty quickly revert to something more like 5% of revenues which is really where the historical number has been.

Okay, great.

Thank you.

You're welcome.

(OPERATOR INSTRUCTIONS).

And there are no further questions.

I would like to turn it back over to management for any additional or closing remarks.

Well thank you for joining us on our call again this morning.

We appreciate your interest and we look forward to talking with you again next quarter.