Ladies and gentlemen, welcome to Littelfuse Fourth Quarter 2020 Earnings Conference Call. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] And as a reminder, this conference call is being recorded. Thank you. I would now like to hand the conference over to your host, Ms. Trisha Tuntland, Head of Investor Relations of Littelfuse. Ma’am, please go ahead.

Good morning, and welcome to the Littelfuse fourth quarter 2020 earnings conference call. With me today are Dave Heinzmann, President and CEO; and Meenal Sethna, Executive Vice President and CFO. This morning we reported results for our fourth quarter and a copy of our earnings release is available in the Investor Relations section of our website. A webcast of today's conference call will also be available on our website. Our discussion today will include forward-looking statements. These forward-looking statements may involve significant risks and uncertainties. Please review today's press release and our Forms 10-K and 10-Q for more details on important risks that could cause actual results to differ materially from our expectations. We assume no obligation to update any of this forward-looking information. Also, our remarks today refer to non-GAAP financial measures. A reconciliation of these non-GAAP financial measures to the most comparable GAAP measure is provided in our earnings release available in the Investor Relations section of our website. Before proceeding, I'd like to remind everyone, that we will be hosting our Virtual Investor and Analyst event, on February 23, at 9:00 AM Central time. You can register for the event in the Investor Relations section of our website, we look forward to you joining us. I will now turn the call over to Dave.

Thank you, Trisha. Good morning and thanks for joining us today. With a robust demand rebound across the number of automotive, electronics and industrial end markets, we saw stronger than expected finish to the year. We continued our return to growth and recorded fourth quarter sales of $401 million, up 18% versus last year. Through our focused execution, we achieved an adjusted EBITDA margin of 23%, and delivered an adjusted EPS of $2.23, an increase of 91% year-over-year. Despite the challenging conditions, we delivered solid performance for the full year, with $1.4 billion in sales and an adjusted EBITDA margin of 21%, while generating over $200 million in free cash flow. Turning now to performance within our business areas. During the fourth quarter, our electronics products segment continue to experience a strong recovery across our product portfolio and in all regions. Our revenue growth was driven by higher than expected demand from ongoing work and learning from home trends. Consumer demand for a broad range of electronics including laptops, tablets and gaming devices as well as small and large appliances, data center and communications infrastructure, and home automation applications continue to show strength. We also saw robust demand in automotive electronics, with recovery in automotive end market demand. Sales to our channel partners were balanced with end market demand, as weeks of inventory for our products remained within our normal range. Exiting the quarter, our electronics book to bill was significantly above one. While end markets remained healthy, we believe that strong bookings also reflect expected inventory build ahead of the Lunar New Year, and to ensure uninterrupted supply of components in the months ahead. These behaviors can create volatility in orders, and could lead to inventory build in the channel in the coming months. Our lead times are relatively…

Great. Thanks, Dave. Good morning, everyone, and thanks for joining us today. I hope everyone is off to a healthy start to the year. We concluded a challenging 2020, with a strong finish to the year as our fourth quarter results were well above expectations on both sales and earnings. We also had our second consecutive quarter of year-over-year sales growth, including another quarter of operating margins in our target range. Fourth quarter sales were up 18% over last year and up 16% organically, sales benefited 2 percentage points from foreign exchange. Adjusted operating margins were 16.6% for the quarter, up 590 basis points versus last year, a function of our strong sales growth and continued focus on cost management. This also drove year-on-year adjusted operating margin flow through of 49%, stronger than we had forecasted. Adjusted EBITDA margins finished at 23% in the quarter, up 510 basis points versus last year. Fourth quarter GAAP diluted earnings per share was $2.39, and adjusted diluted EPS was $2.23, up 91% over last year, despite a much higher fourth quarter tax rate versus a year ago. For the full year 2020, sales of $1.45 billion were down 4% versus last year, both in total and organically. Adjusted operating margins were 14.3% flat to last year, despite our sales decline. Notably, adjusted EBITDA margins finished at nearly 21%, up 50 basis points versus last year and in our target financial range. We managed the decline in our operating margin drop through to 14% for the year, versus our typical 35% to 40% range. This was an outcome of our operations quickly responding to the demand recovery, and our teams taking several early actions to reduce costs and pursue government financial subsidies, all while preserving jobs for our associates during the down periods. I'm…

Thanks, Meenal. In summary, 2020 was indeed an extraordinary year with no shortage of challenges to navigate. I want to thank our global team for their tremendous efforts throughout the year, especially related to the COVID-19 pandemic. Their commitment, sacrifice and determination during these uncertain times has been remarkable. Day-in and day-out, Littelfuse associates worked hard to support one another, and they consistently demonstrate an unwavering commitment to serving our customers around the world. We made significant progress across our businesses and have entered 2021, well-positioned to deliver continued profitable growth and value for all our stakeholders. With that, I will now turn the call over to Trisha.

Thanks, Dave. For participants, Meenal and Dave are in separate locations, so feel free to direct your questions to one or the other of them. Operator, please assemble the Q&A roster.

Good morning, Luke.

Good morning, everyone. The first question I want to ask, maybe this would be a good questions for Dave. In terms of the impact of the chip shortage, I'm thinking of the impact on electronics specifically. Could you maybe just talk a little bit more about the puts and takes there in terms of what it means from a demand side, fundamentally on an underlying basis for the electronics segment and then the supply chain impacts, some increased costs potentially coming along there, but in terms of what a potential increase in inventory might be in for the business in terms of channel inventories this year.

Sure. So the chip shortage certainly gets a lot of press related to the auto industry. But also it's a broader issue. First of all, our products we have relatively stable lead times. So we're not seeing significant shortages from Littelfuse components. But we certainly see history would show that when there are shortages in electronics components in particular, technologies, it is quite common that orders will come in heavier as there's an effort to drive some inventory increases, either at distribution or even at EMS providers or at OEMs. So, it certainly has the impact of increasing order rates and we have seen some of that. We actually saw some tendency towards putting inventory in place from our customers in the automotive segment. During the fourth quarter, we have not seen inventories rise in the electronics side yet, but that's something we continually look for. And certainly shortages and strong order patterns certainly do increase costs challenges, as you mentioned, Luke.

Okay. Thanks for that. And then second question, in the wake of the Hartland Controls deal and your commentary that you could fund just to eliminate pure debt [ph] what's on the balance sheet right now. What I'm wondering is how you're finding the market for M&A right now? Clearly, a lot of disruption last year with respect to the environment, with respect to the ability to due diligence in a traditional fashion. Just curious what you're seeing in terms of your pipeline, in terms of the, let's say, the availability of assets and sort of the meeting of buyer and seller expectations in regards to pricing as well?

Yes. No, so I think there clearly is a bit of a trend where people have become a little more accustomed to this new sense of normal on how to deal through challenges. I think visibility has improved a bit and what's going on in the markets, there's a little less volatility in most regions of the world or not, locking down manufacturing for periods of times and things like that. So that stability, I think, has kind of helped with that. We continue to drive a healthy funnel and a significant effort to continue to build and curate our funnel, if you will. So I think we have found that people have found other ways to deal with diligence and questions and management meetings and things like that. So I think it is an improving environment from an M&A perspective, and certainly, it's a key strategic part of our growth initiatives.

Great. Thank you for that. I'll pass it on.

Thanks, Luke. We appreciate the questions. We'll take our next caller, please.

And our next question comes from the line of Karl Ackerman from Cowen. Your line is open.

Good morning, Karl.

Hey, good morning, team and Dave and Meenal. It's nice to see a very strong finish of the year. So my first question, to me your full year outlook implies Hartland has operating margins in the mid-single digit range. So could you discuss any cost and/or operational initiatives from this acquisition that could help drive margins toward the company average? And I've got a follow-up.

Meenal, why don't you take that?

Sure. Thanks, Karl. Good morning. So I'd say, we just closed down Hartland last week, very early stages right now. I'd say a couple of things looking at it. Remember that when, anytime we put a company into our portfolio, you automatically start with a drag with deal amortization. And we're still one of the companies that leaves the amortization in our numbers, so that automatically will take margins down a little bit. It's still early. So, we have some estimates in there and we'll refine those as the year goes on. And I would say just overall, in terms of operating synergies right now for us, you heard Dave comment about some of the opportunities across some of the industrial end markets, especially in the HVAC space and our focus is really around revenue and revenue growth and where we can leverage our common portfolios and common customers together.

Understood, I appreciate that, Meenal. Sorry, Dave, perhaps another question for Meenal, if I may.

Sure.

I guess, we've heard several suppliers across the supply chain have raised prices, particularly given shortages across boundary. You've spoke about some higher input costs in your prepared remarks. Well, I guess maybe a question for Dave too. What is your strategy regarding the trade-off between pricing and volume commitments from your customers? I guess I'm particularly interested in electronics given that has typically seen the largest annual price declines. So if you could count on that that'd be very helpful. Thank you.

Sure. I'll take that, Karl. Pricing is certainly a dynamic environment and it's different by different end market. So there's a little less flexibility in the automotive portion of our business, as we have long term contracts with customers that kind of define some of those things. However, as you stated, electronics is where you tend to have seen higher price declines annually and things like that. And it's also if you look back in history, during strong demand patterns, particularly if they're shortages, pricing becomes a little less unfavorable. So clearly, as we manage our business, we look at what our cost basis are, what are kind of some of the variables that are driving our cost. And certainly commodities are very unfavorable for us right now, freight costs are quite high. So costs are certainly increasing, particularly in the electronics part of the business there. And if strong demand continues, it does lead to an environment where price erosion is not quite as heavy, as customers focus more on assurance of supply and demand and as we frankly pass along cost increases that we're incurring. So if these patterns continue through the course of the year, then we would expect a little more favorable pricing environment.

Thank you, Karl. We appreciate the questions. We'll take our next caller, please.

And our next question comes from the line of David Kelley from Jefferies. Your line is open.

Good morning, David.

Good morning, team. I appreciate you taking my question. And maybe the start question for Dave. Really strong auto outgrowth in the quarter. You referenced customer builds to work through some of the semi shortages, you saw content games as well and then clearly we're seeing LBP turn positive led by China. Can you just provide a bit more color on the various drivers that that outsize ramped in the fourth quarter?

Sure. Yes, it was clearly a very strong fourth quarter on the auto side for us. And, as we've talked about long term we believe our content growth above car build is in that 3% to 4% range. Clearly, during the fourth quarter, we saw growth well beyond that, both on the content side as well as this inventory build that took place. We think the content outgrowth beyond kind of our normal view of what it will be in the long term was driven by the mix of customers and the types of vehicles. So very strong demand on light trucks, on SUVs and luxury vehicles, those vehicles tend to have a higher content in general than other vehicles. So that mix of this has certainly influenced that. And we would say probably our content growth was maybe as much as double with our long term outlook during the fourth quarter. The remainder of the outgrowth is really inventory built, being done by Tier 1s and OEMs, as they're looking to try to make sure they don't have other areas of shortages, as they deal with the chip shortages.

Thank you, David.

Okay. Thank you. Sorry about that. I was on mute. Can you hear me?

Yes, we can.

Okay, thanks. Yes, maybe one follow up on that, Dave. And apologies again. Just on the inventory build comment, we've heard from others that most of the inventory is immediately being spec for vehicle production and the industry's still playing catch up. So just curious, do you think we're in a channel inventory build phase yet? Or is most of the order ramp immediately going through to production and delivery?

I would say from our perspective on our particular products, we believe there is some inventory build taking place in the channels. Now, perhaps that's because of our ability to respond to orders faster than others. But clearly, there is kind of the catch up going on as vehicle inventories particularly like here in North America have been low. There's certainly that catch up that's happening, that's impacting demand that's kind of flowing through to vehicles. But we clearly are seeing that there are also some effort to build some inventory buffers. And that's why we kind of warned that, put it in the prepared remarks or warning that, if those inventory buffers have built at some point, when things kind of normalize and supply chain kind of gets healthier in our industry, they'll go back to more normal conditions, which could have back into the year could have a negative impact on our revenues in the auto segment. So, we clearly are seeing some inventory build of our particular components.

Okay, perfect. Thank you.

Thank you, David. We appreciate the questions. We'll take our next caller, please.

Our next question comes from the line of Nick Todorov from Longbow Research. Your line is open.

Good morning, Nick.

Hey, good morning. Thanks, everyone. Maybe can you talk about your ability to improve margins on the first quarter? You talked about a longer list of impacts. It seems like some of them are within your ability to control and some of them are not. And also, do you see the first quarter as the low point of profitability for the year?

Well, certainly, there are headwinds that are impacting our ability to get the kind of normal flow through on growth that we would normally see. And Meenal talked about some of those headwinds. The largest headwinds are really coming from commodities. And as we talked about earlier over time, there are abilities to kind of help to offset that with pricing in some segments of our business. But commodities or freight rates are quite high and continuing to increase. They are at multiyear highs on freight rates. There's little we can do about that. We'll see how that kind of settles out as hopefully the pandemic situation becomes more manageable in the back half of the year and COVID-related costs. So our costs in our factories and in our supply chain related to protection of employees and support for employees and social distancing and those sorts of things, those ongoing costs are still there. And we are not seeing those go down anytime soon and we were fortunate enough. There are a lot of hard work of our teams, not so much in the U.S., but in Europe and in Asia, we were able to get some government subsidies kind of help offset some of those costs in 2020. We're not expecting that to continue into 2021. So all those things kind of create near term headwinds for us that we've kind of got to work our way through. With regard to, is that a low point, we're not giving guidance beyond the first quarter. We kind of see how the year develops, the visibility on how the pandemic situation stabilizes and settles out it's hard to call at this point.

Okay, great. And as a follow up question, I think you talked about long term content growth in auto being 3% to 4%. But clearly the industry is seeing acceleration towards electric vehicles and you guys have a pretty decent increase in content as you move from ICE to EV. So, is it reasonable to expect that your content growth will trend above the long term range here, at least in the near term future? And conversely, why not potentially raise that long term target as the shift to EV is going to continue to grow? And just as an additional one, is there any way you can quantify how much of your sales currently come from electric vehicles? Thanks.

Sure. Certainly the content outgrowth, a great deal of our content growth is really being driven out of the electrification of vehicles. Historically, we had good content growth that was driven out of kind of changing architectures and higher power loads in the vehicle. And those have kind of, if you will, over the last five, six years have been mostly adopted globally. And as kind of that outgrowth is kind of settle out and become the norm, so the bulk of our outgrowth is coming from kind of electrification of vehicles. So in the near term, certainly in the next couple of years, the growth of EVs is somewhat restrained by supply chain specifics, whether it's batteries and those types of things. Certainly in the longer term, as EVs gain a stronger position we're seeing next year, it's in that range of maybe 10% of vehicles. However, only just around a third of those are battery electric vehicles, the others are really hybrids. So the battery electric vehicles that drive the largest increase for us. So still representing 3% to 4% of the global car build, so as that continues to penetrate and certainly there may be more favorable environments today than there have been recently with regards to that. Yes, that content story could begin to grow at a faster pace in the back end portion, but for the foreseeable future, we see it in that 3% to 4%.

Thank you, Nick. We appreciate the questions. We'll take our next caller, please.

Our next question comes from the line of David Williams from Loop Capital. Your line is open.

Good morning, David.

Hey, good morning. Thanks for taking my question and congrats on the progress.

Thank you.

So, I want to touch a little bit on the some of the inventory build dynamics that you've mentioned. And do you have a sense on maybe from a term of how much of your revenue might have been from the inventory builds or just maybe quantify the magnitude of what the builds look like today?

Yes, so first of all, the only place we saw inventory builds in the fourth quarter were in the automotive portion of our business. We saw no inventory builds in the electronics portion of our business during the fourth quarter, as kind of demand on our distribution partners and our fill to them matched up very well. So specifically, we see in the automotive portion of our business. Again, we saw perhaps our kind of normal content above car build being maybe as much as double as our normal, so let's call that 6% to 8% was kind of content increase. The remainder of the growth in that segment we see was driven by inventory builds, so substantial.

Okay, great. I appreciate the color. And then maybe from an industrial standpoint, are there any areas that you're seeing maybe better or maybe softer growth? And what do you think about that outlook for the year? Just kind of given some of the dynamics that we've seen in auto and just the strength that we've seen through other areas?

Yes, so if you look at our industrial segment, there are different pieces to it that are really kind of going to drive our growth and. So a big portion of our business in industrial segment flows through North America distribution channels. Those North America distribution channels, which are highest margin portion of our industrial segment are serving MRO, they're serving non-residential construction, oil and gas, mining those types of end markets. Generally, those have not been positive, those have been pretty soft. So that portion of our industrial segment has been quite soft through 2020. And we really haven't seen that rebounding much yet a little bit on the MRO side, but non-resi construction is not, where our products tend to be at the late stage of non-resi construction. So we're not seeing anything there. And of course, oil and gas and mining is not strong either. Offsetting that, we have seen pretty strong demand and growth for us in other portions of our business, which tend to be more global. So North America, but also other parts of the world. And as I talked about, those are things like renewable energy, those are things like the HVAC space, so motor drives, those types of things have been more favorable. So it's kind of a balancing act right now. To get back to the levels of growth we'd like to see and kind of the profitability in industrial segment, we're going to need to see some improving fundamentals in non-resi construction and a kind of our distribution business in North America.

Thank you, David, for your questions.

[Operator Instructions] Our next question comes from the line of Christopher Glynn from Oppenheimer. Your line is open.

Good morning, Chris.

Hey, good morning, everybody. I wanted to ask about Hartland there. Curious, how long you've been looking at that company? What's kind of the customer breadth and diversification? And why are you guys kind of a better or the right owner for that?

Sure. Great, Chris. So Hartland is a business we've been looking at for some time, as with a lot of the M&A sorts of activities, certainly 2020 certainly slowed those sorts of activities down and communication down there. You've heard us talk quite a bit in the previous quarters about the HVAC space is a space that we like and that we've organically been building and working towards. So we've got a nice fundamental base business in the HVAC markets in our car industrial segment. And Hartland Controls is kind of squarely in that space. They sell in other regions, but primarily they're focused on the HVAC space. So the attractiveness for us is we have very strong relationships, particularly with North American HVAC customers, also some in Asia. But it strengthens our position into that marketplace. So the combination of their technologies, our technologies, we believe that together will be stronger. And so the big strategic reason for that is we like that space for the long term and as customers continually work to drive better efficiencies and more environmentally friendly approaches and more sophistication in their systems, we think that's attractive long term growth pattern. And Hartland Controls gives us a stronger position there and more access to other customers and more important to key customers there.

Thanks. And then kind of a longer range question. It's been a couple interesting years with the corrections and destock in 2019, and then the pandemic year. But before that, your gross margins were pretty consistently 39%-40% plus. Is that a good reference level to think about over time for you guys? Or are there some different investment and mix profiles that make that a relevant comparison?

Meenal, why don't you take that?

Sure. Yes. Chris, I guess, you know stepping back and thinking about what are some of the things we're seeing in our margins today. Clearly, overall volumes are still a bit lower than when we were at from a peak perspective. But you heard both Dave and I talk about some of the cost headwinds that we're still seeing, which really all impact gross margin for the most part, due to these ongoing COVID costs that we're incurring and some of the inefficiencies that are going on, the headwinds from commodities and freight and the bulk of all that's in gross margin. So, we still expect the improvements in margins to continue, some of those headwinds though, we've got to dissipate a little bit, and I would expect that over time. We're not going to be in this COVID state forever and things will start to settle back. But those are, I'd still say in the near term, those are still things that are pulling down the gross margin for us.

Okay. Thank you for that.

Thank you, Chris. We appreciate your questions. We'll take our next caller, please.

Our next question comes from the line of Matthew Sheerin from Stifel. Your line is open.

Good morning, Matt.

Yes. Hi. Good morning, everyone. I just wanted to ask another question regarding the electronics sector. Just backing into your seasonal guides on the other sectors, it looks like that could be up 9%, 10% plus sequentially, which is certainly better than seasonal. You talked about good sell through last quarter still relatively lean inventories. But what is your take on sell through and POS so far this quarter? And are you seeing distributors start to layering in inventory as lead times across your product categories and competitor's product categories continue to go out, which could lead to as you said earlier Dave some volatility as we get through the year based on inventory and supply demand levels?

Sure, Matt. Yes, so what I would say is we have not seen inventory builds at our distribution partners yet. So we have not started to see inventory increases that aren't matched through with sell through. So we're not seeing days of inventory go up. We're still a lot to kind of the bottom half of our kind of normal weeks of inventory. We're in the bottom half of that. So quite healthy inventory positions right now. Bookings are quite strong. Many of the bookings are maybe extended further out than normal, which tends to be kind of an early sign of people making sure they want to be in line with orders and get orders booked out a little further, in case, we see further demand increases that are significant. So orders are very robust certainly. So right now, it's hard to match up maybe long term order patterns with sell through. But certainly, so far with demand and sales today and sell through at POS at our distributors, it's well matched right now. So we're kind of putting some verbiage in there just out of experience. As we see these things over time, it certainly has some indications and some signs that some inventory increase strategies may be coming. Haven't seen them yet, but there's some of those early signs that we're kind of putting out there just to kind of make sure everybody kind of keeps those top of mind as you look at the next coming quarters.

Okay. And the strength you're seeing, are you seeing in all geographies, including North America and Europe, which have obviously been lagging Asia?

Yes. We're seeing really across the board in the order patterns. It's not exactly level across all regions, but strong order patterns in all three regions right now.

Okay. Thanks for that. And Meenal, I wanted to get a little bit more color on the costs headwinds that you're seeing. You just did talk about your last answer, about gross margin being impacted, perhaps most, although you've got OpEx costs going up. But sort of on an absolute basis in terms of dollars, are we talking about what a 10%, 20% increase in SG&A year-on-year based on those costs you talked about?

Yes, Matt. So I'd probably explain it two ways. One is, the bulk of the increases that we're seeing that I talked about, really are coming out of the commodities or input costs, freight, and that COVID release. As it relates to OpEx, what we've been talking about for probably the past year or so has been the fact that we cut about $40 million over the course of '19 and '20, we cut about $40 million of discretionary spend over the course of those two years, because volumes were down, and then all of COVID last year. And we were expecting in '21, that we'd add back somewhere between a third and a half of that during '21 and that's still our projection from an increase perspective. I'd say it's a range now because honestly, I think it's going to depend on how things start to recover and the trajectory of the recovery and how much traveling really happens and going out. But it absolutely includes things like the variable compensation piece, the other discretionary spend remains to be seen.

Okay, all right. That's helpful. Thanks so much.

Sure.

Thanks, Matt, for your questions. We'll take our next caller, please.

And we have a follow up question coming from the line of Nick Todorov of Longbow Research. Your line is open.

Hello, Nick.

Hi, thanks for allowing for follow ups. I wanted to touch back on auto, just to clarify a couple of things. Dave, I think last quarter you talked about seeing calendar year '21 light vehicle prediction up at least high single digit. I wonder if you have any color or update or how are you thinking about production of autos in 2021? And also, can you just clarify, how much was auto production in the December quarter from your perspective, anyway either in absolute basis or from a year-over-year growth perspective versus 4Q of '19? Thanks.

Sure. Yes. So kind of our view of 2021 and we don't have a different view than what the professionals are that are paid to look at it. It's in that low to mid-80s. It is probably what global car production is in 2021. I think it's a little unknown what supply constraints may have impact on that, some of that will be response from a handful of semiconductor suppliers and the ability to support that level. But as a reminder, that's still not back to 2019 levels. So still well below 2019 levels and certainly below 2018 levels. So, nice recovery, but not back to kind of record levels at all in 2021. It's kind of our view. Specific to the fourth quarter, we believe that car build globally was up low to mid-single digits compared to the fourth quarter, the previous fourth quarter. So that's kind of our viewpoint on car build.

Thank you.

We appreciate the follow up questions. Thanks, Nick. Thank you for joining us on today's call and your interest in Littelfuse. We look forward to talking with you on February 23, at 9 AM Central Time during our Virtual Investor and Analyst Event. Be safe and stay healthy.