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Littelfuse, Inc. (NASDAQ:LFUS)

Q4 2008 Earnings Call

February 04, 2009, 11:00 am ET

Executives

Gordon Hunter - Chairman, President, and CEO

Phil Franklin - VP, Operations Support and CFO

Analysts

Ingrid Aja - Banc of America/Merrill Lynch

Reik Read - Robert W. Baird

John Franzreb - Sidoti $ Company

Shawn Harrison - Longbow Research

Operator

Good day, everyone, and welcome to the Littelfuse, Incorporated Fourth Quarter 2008 Conference Call. Today's call is being recorded. At this time, I will turn the conference over to Chairman, President, and Chief Executive Officer, Mr. Gordon Hunter. Please go ahead, sir.

Gordon Hunter

Thank you. Good morning and welcome to the Littelfuse fourth quarter 2008 conference call. Joining me today is Phil Franklin, our Vice President of Operations Support and Chief Financial Officer.

Like many other companies this was a tough quarter for Littelfuse. However the revised guidance, we issued on December 19, proved to be correct with our results for the quarter falling within the ranges we provided. Fourth quarter 2008 sales were $105.9 million were down 25% from the third quarter. For the full year sales were $530.9 million were down 1% from 2007.

The first half of the year was on track, we then saw some weakening in the third quarter but the greatest impact by far was in the fourth quarter. As we indicated in our call in December electronic and automotive sales dropped up sharply in November and they declined even further in December.

In Europe and North America consumers concerned about their jobs and the economy held off on new comp purchases and those who did want to buy faced very tight credit market.

As a result the automotive OEMs globally slashed production rates and shutdown assembly lines for much of December with the reduced production continuing into January.

Electronic end markets also weakened substantially in the fourth quarter, as consumers continued to lose confidence in the economy and cutback on spending. We were also impacted by electronic distributors reducing inventories in response to the decline in demand on the uncertain outlook for 2009.

One bright spot was our electrical business which had another record year. But even this business began to slow late in the fourth quarter.

With that background, I will now turn the call over to Phil Franklin, who will give the Safe Harbor statement and a brief summary of the news release. Then I will provide more detail on the market dynamics in our business units our cost reduction activities and our progress in other key strategic areas.

Phil Franklin

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 the fourth quarter were $105.9 million, which was consistent with our latest guidance but down 22% year-over-year. Our automotive sales declined 32% compared to the prior year quarter. As a result of unprecedented decline in car productions as well as weakening in the aftermarket and off-road truck and bus market.

Electronics after posting modest sales growth for the first nine months of the year declined 25% in the fourth quarter with consumer electronics leading the decline.

Electrical sales after nine months of double digit growth slowed to 1% year-over-year decline in the fourth quarter. These declines were partially offset by the addition of Startco, which added $3.9 million for the quarter.

On a GAAP basis, the company had a loss of $0.42 per share in the fourth quarter, this included $0.27 per share of special charges most of which were non-cash and related to write down in both operating and financial assets.

Excluding special charges, the company had a loss of $0.15 per share, which was consistent with the low end of our most recent guidance.

Earnings for the quarter were impacted by high transfer related expenses coupled with unusually low production rates resulting in large unabsorbed overhead variances.

Despite the poor P&L results cash from operating activities for the fourth quarter was $15.8 million the best performance of the year. This was the result of strong overall working capital management and in particular outstanding accounts receivable collections.

Capital expenditures peaked at $17 million in the fourth quarter, primarily from spending on facilities and equipment to support the manufacturing transfers. From here forward, capital spending will show a significant downward trend.

Now, I will turn it back to Gordon, for some more color on market trends and business performance.

Gordon Hunter

Thanks Phil. Looking at each of our businesses in more detail; I will begin with automotive which contributes about 25% of total Littelfuse revenues. The latest data from J.D. Power shows that global car production continued its dramatic decline in the fourth quarter.

Fourth quarter production was down 18% year-over-year and down 6% from the third quarter of 2008. The declines in our key markets were even more dramatic with fourth quarter production down 22% year-over-year in Europe and 25% in North America. Asia was down 10% for the same period.

These production levels are way below the past few years and the most dramatic decrease we have ever seen in this business. What is especially remarkable is how fast the market deteriorated. While consumers who couldn't get credit or worried about their jobs stopped buying new cars, it was just a few short weeks until the OEMs slowed production.

And was just in time manufacturing, it didn't take very long for us to experience the short drop in sales of our automotive products. Actually our sales to many Tier I customers slowed even before the OEM shutdowns. Because these suppliers run out of finished goods warehouse space and had to stop production.

We also experienced a downturn in the off-road truck and bus segment, particularly in the RV construction and transportation vehicle markets.

Unfortunately, we do not see production ramping up as quickly as it went down. The reason for this is that most people can make their car last for another six months or year if they need to. So we expect when the turnaround comes it will be more gradual than it was on the downward side.

In addition, to the decrease in car production another factor in our automotive performance for the fourth quarter was the effective currency translation. Specifically the strengthening of the US dollar against the Euro. The average exchange rate dropped from 151 in the third quarter to 132 in the fourth quarter creating an additional 12.5% decline in our European business due to currency translations. We had a similar experience in South Korea with a 22% decline due to currency translation there.

Although sales were down substantially overall, we continue to pursue new opportunities and won several new pieces of business. A major win was the fuse business for the GM global Delta II platform.

In North America, this platform comprises cars that we would call compact or low mid-size. The models in the Delta II platform include the Chevy Cruze, the Pontiac G6, the Saab 93 and Chevy Volt.

Global volumes for the Delta II starts with about 287,000 vehicles in 2009, but I projected at this time to ramp up to 1 million vehicles in 2011 and 1.6 million in 2013.

In Brazil, we added the blade fuse business on old Honda motorcycles produced in that country. This includes both our MINI and ATO fuses depending on the model. This win will add more than 300,000 annually once the peak rate is achieved next year.

Also in Brazil we won another contract from GM for the Gamma 3 platform which launches this year. Like the Delta II this is also a standardized global platform but this one is for small subcompact car such as the Chevy Aveo and the Opel Corsa.

A good win on the automotive aftermarket side was with [Balkamp], a leading aftermarket automotive distributor.

The win significantly extends our Smart Glow Blaze Fuse line which has proven to be a very good acquisition for us. These fuses have an indicator that the lights when the fuse is blown making replacement simple and easy.

As I indicated earlier, the reduced vehicle production volumes have extended into the first quarter, which will impact our sales once again.

Our key focus in this very uncertain market is on wining share in under penetrated areas and taking advantage of currency translation effects where they are favorable such as in the Asia region.

We are also focusing on the North American off-road, truck and bus market where we have opportunities to build our presence with our existing products, old products that can be easily modified for specific applications.

A good example is our CablePro fuses which we are currently providing Navistar's, Mine Resistant Ambush Protected vehicles known as the MRAP. The MRAP contract is our first breakthrough in the military segment and we anticipate additional opportunities in this market.

Overall we believe the automotive business can outperform the growth of its markets with its new products and further in-roads into the North American off-road, truck and bus market. We will be extremely cost conscious and cautious in our approach.

Now let's move on to electronics which accounts for about two-thirds of our total sales. Here too, we saw a dramatic decline and sales deteriorated throughout the fourth quarter. The weakness was across all major end-markets and across all geographies.

The decline was most pronounced in Asia for over-voltage products used in applications, such as broadband and high speed Internet access equipment, set top boxes, modems and telecom infrastructure equipment. The drop in demand was so significant that many customers in Asia curtailed their orders at the end of the fourth quarter and into the first quarter of 2009.

In addition, many Asia customers particularly contract manufacturers and the original design manufacturers had extensive plant shutdowns around the Chinese New Year, at the end of January. As a result, we expect to see modest improvements in order of ship rates to Asian customers in the months ahead.

On the distribution side, the inventory levels have been reduced to modest levels which could also contribute to some improvement in demand as distributors restock their inventory.

As in the automotive business we did not let up on our efforts to win new business. One win that stands out in 2008 is for a new improved Metal Oxide Varistor which is part of a new wall outlet ground-fault circuit interrupter, being manufactured by Leviton.

Another win is our expanded relationship with Samsung for their LCD TVs. These Samsung products contain three Littelfuse circuit protection components. TVS diodes, thin film and nano fuses to protect the high-definition video transmission data and to project against electrostatic discharge.

Another win is with Cisco for TVS diodes that will protect an Ethernet application in wireless switching equipment from over-voltage surges. This new contract is expected to generate about $400,000 in 2009.

We're also onboard several recently launched consumer products in the Apple iPhone 3G, our new series of thin film fuses is protecting the high speed data and video capabilities of the new smartphone.

Panasonic's latest generation of digital still cameras, the battery charging power supply was designed using our PR series of fuses design for high power applications.

That brings us to our electrical business or POWR-GARD as we refer to it internally, which had a record 2008.

Startco Engineering which we acquired in the fourth quarter was also a solid contributor to our results and actually exceeded our performance expectations for the quarter. We also made good progress on our initiatives to expand our presence in the OEM segment and continued to benefit from price increases implemented earlier in the year.

POWR-GARD sales grew with strong levels for most of the year, but began to slow in the fourth quarter. December was especially weak as distributors paid more attention to their own year-end inventory positions.

Both non-residential construction and industrial activity has slowed and we expect this to continue in 2009 until better economic conditions return.

The newest segment we are now tacking is mining because there is a key market for Startco. Although global demand for uranium and potash has slowed none of the major mining companies have pulled back on their capital investments. So, as long as mines are being expanded or refurbished, we can expect to see demand for the Startco products.

As in our other two businesses, POWR-GARD also had some significant wins in the fourth quarter. A number of these were with OEM customers for applications such as high efficiency LED street lighting, industrial power strips for savers used in data centers, load centers for testing generators and power pedestals. We are also penetrating the emerging solar market. We had more than $2 million of sales in the solar market in 2008, an increase of over 50% from 2007.

The largest percentage of sales were in Europe especially Germany. We are also selling these products in Asia and North America.

Later this year we will launch two new fuse products developed specifically by solar applications. Both of these products improve on solutions that currently exist in the market.

Our circuit protection components are being used in two types of solar energy products. In that as turn the solar power into electricity and combiner boxes which connect several solar panels into one output.

This market is a unique opportunity for power fuses because the elevated direct current capabilities of these systems made expensive and cumbersome to apply circuit breakers. The Littelfuse products used in these applications are coming out of our POWR-GARD business. The electronics business is also involved in pursuing new opportunities in this segment.

We expect the OEM momentum to continue in 2009, as we begin to see the benefits of our work in this market over the past two years. This will help to offset the impact of the major slowdowns in the construction and industrial segments of our whole fuse business.

We plan to launch a new POWR-GARD protection relay line into the US market in 2009 through our current electrical distribution channel which should lead to additional sales.

Pricing pressure is expected to increase with the economic challenges, and as a result we do not expect to see the same level of price realization that we had in the past several years.

That completes my review of the three businesses.

With the downturn in the economy, having such a significant impact on the results, this is a time where we are benefiting from having three diverse business units. The balance we get from electrical is telling us to compensate from a severe downturn in automotive. That's another reason why we want to make POWR-GARD and Startco bigger contributor to our total business.

Just back on our markets and the economic impact on them, the next question is what you are doing in response? The answer is twofold. First, I want to emphasize the controlling costs to reducing operating expenses and our primary focus at this time. We are taking this mandate very seriously, and I can honestly say there is no area of our business that is not been touched by our expense reduction efforts.

These cost reduction programs include work force reductions. We have also implemented a global salary freeze for any one not included in a labor contract, eliminated non-critical company travel, and are being extremely selective in new hiring.

Most recently, we reduced the total compensation of our top executives for 2009. We continued to scrutinize and prioritize any and all spending for projects and programs. We are cutting costs wherever we can. We won't cut into muscle that would reduce product quality, new product development or harm customer relationships. This delicate balance is made little easier by our strong financial position with our solid balance sheet and significant line of credit.

With all of these cost reduction activities underway, we are on track to reduce operating expenses by at least $15 million in 2009.

The second part of our response to the challenges in the economy and our markets is the manufacturing transfers that began several years ago. When we started this program, we had no way of knowing how the economy will play out in 2008. With 20-20 hind sight the timing for this initiative was extremely good. While many companies are just beginning to consolidate operations, we are now in the final stages of our program.

The automotives and electronic production moves from our Des Plaines, Illinois facility to Mexico and the Philippines were completed at the end of 2008 ahead of schedule.

The North American distribution center moved from the Chicago area to Mexico was completed in November as planned. We moved it out the Ireland and Italy with the Varistor production from this facility now being handled at our new plant in Dongwan, China.

Telecom wafer fab production from Irving, Texas will be transferred to our new facility in Wuxi, China beginning in mid 2009. We are continuing to build the technical team in Wuxi as we target full operational capability later this year. With nearly all of your equipment set up and operational we begun to process wafers in Wuxi to qualify the processes. The transmission be completed by the middle of next year.

We are also transferring our semiconductor backend packaging operations to Wuxi from Mexico and Taiwan. We expect this transfer to be completed on schedule by the end of 2009. And finally the relocation of our corporate headquarters to a smaller and more cost effective location in the Chicago area is on track to be completed during the first quarter of 2009.

So by the end of this year, the vast majority of the program will be completed with the final moves and it's shortly after that. The only disappointment with the transfers is that the new facilities were designed to achieve the greatest efficiencies with higher production volumes that we have right now. That's why in 2008, a slowdown in demand for our products somewhat offset the benefits of the new facilities would expect it to achieve.

We expect the level of savings to pick up significantly in 2009 with at least $28 million of savings budgeted for the year. Longer-term when the economy does turnaround, we will be ready to run back up with efficient new plants and added capacity to meet the increasing demand for our products.

Well, our main focus right now is reducing costs in response to the turmoil on the economy. Our strategy is to position Littelfuse from the longer-term growth have not changed.

One of these key strategies is investing in new product development and working closely with our customers to get our components designed into their new products.

Even in a tough market, we made good progress on this initiative in the fourth quarter, with the GM and Smart Fuse in automotive, Samsung, Cisco and ample opportunities in electronics, and the increased OEM business in POWR-GARD.

To sum up, our strategy, we're focused right now in reducing costs in response to the economy and at the same time, we are continuing to move ahead with the initiatives that will make us a healthier and a better company and a stronger global competitor when the economy improves. We believe, we will come out of this well positioned to increase sales and improve profitability which is our over riding objective.

Beyond the opportunities and our more traditional markets, we also see good opportunities for our products in a number of emerging markets. The growth in these markets is coming from the increasing awareness of conservation and the need for alternative energy sources.

Earlier, I mentioned our role in solar energy and LED lighting, and automotive production of hybrid non-electric vehicles like the Chevy Volt continues to grow. We are excited about the many growth opportunities that we see on the horizon and new applications for our products that are still in the concept stages.

We are confident in our future and our ability to add value to our customers and shareholders in the years ahead.

Looking at shorter term, however, our visibility for the first quarter and beyond is not very clear at this point. Our markets are unpredictable and there is much uncertainty around the economy.

In that environment, the first quarter has started like the fourth quarter ended with very weak sales and order rates for electronics and automotive.

The announcement yesterday of huge decreases in North American passenger car sales in January shows just how weak 2009 has started. GM's sales were down 49% in January with Ford's sales down 40%, Toyota down 32%, and Honda sales falling 28%.

If there is any encouraging news here is that we expect to see modest improvement in February and March.

On the earnings side, we expect that profitability will improve significantly beginning in the second quarter as a result of the savings achieved through our reduced cost structure.

With that, I will now turn the call back to Phil who will comment on the first quarter guidance in the news release and then we will open the call to questions.

Phil Franklin

Thanks Gordon. Let me first summarize and recap the expected 2009 financial impact of the cost reduction actions that Gordon just described. Then I will discuss the outlook for 2009.

Our manufacturing transfer programs will generate at least $20 million of savings in 2009. We have taken further actions to reduce manufacturing cost by an additional $8 million. Also, $20 million of transfer savings and the additional $8 million look at the cost of sales volume.

Our operating expense reduction actions are expected to result in operating expenses being at least $15 million lower in 2009 compared to 2008.

Now, for the 2009 outlook. As we said in the press release and as Gordon just reiterated we had an extremely slow start to the year reflecting weak end markets cautioned by distributors of inventory levels and the timing of holidays.

With this very close start and unprecedented lack of visibility, sales and earnings guidance comes unusually difficult.

Nevertheless, we decided to give guidance for the first quarter, albeit, with wider to normal ranges. We expect sales for the first quarter to be in the range of $88 million to $98 million. Gross profit margins for the first quarter will be impacted by negative operating leverage associated with running the business at unusually low levels of sales and production.

Although, significant manufacturing cost savings will occur in the first quarter most of these savings will go in the inventory and the P&L until the second quarter when the inventory is sold.

We will get some benefit from our operating expense reductions in the first quarter but again most of these savings will not hit until the second quarter. As a result, the company expects first quarter loss in the range of $0.20 to $0.40 per share.

We are not ready to give specific guidance out past the first quarter but we do know that both manufacturing costs and operating expenses will be significantly lower beginning in the second quarter. But the cost reductions we've described by mid-2009 will have a dramatically lower breakeven point to somewhere in the range of $100 million in quarterly sales.

Assuming typical seasonal sales increases even after the depressed first quarter levels, we should be able to return to profitability in the second quarter to show strong sequential earnings growth in the third quarter.

In 2009, we will continue to focus on cash and aggressively manage our balance sheet. Capital expenditures will be reduced to approximately $27 million in 2009. Although, the first quarter is always a difficult quarter for cash but for the full-year 2009, we expect to generate enough cash from operations to more than cover our capital expenditure needs.

This concludes our prepared remarks. Now, we would like to open it up for questions.

Question-and-Answer-Session

Operator

Thank you (Operator Instructions) We will go first to Ingrid Aja at Banc of America, Merrill Lynch.

Ingrid Aja - Banc of America/Merrill Lynch

Good morning. Just, if I go back to the gross margins this quarter and maybe, if you can just add, give us a little more color. Was that just negative operating leverage and how much of that was in transfer pressures indicated a higher transfer related cost in the quarter?

Phil Franklin

Yeah, we had the final push on the transfers to get the completion of Ireland transfer to China and the transfers our Des Plaines to Mexico during the quarter and therefore we did see peak transfer costs during Q4. Those transfer costs combined with an extremely low volume and the negative operating leverage on that's extremely well volume were really the major causes of the margin being what it was. As I indicated in my comments earlier, Ingrid we had very high unabsorbed overhead because of a high level of spending coupled with very low levels of production in the fourth quarter.

Ingrid Aja - Banc of America/Merrill Lynch

Okay, so, can you quantify what those transfer related costs were in the quarter?

Phil Franklin

Well they were - we had talked about transfer related cost being in the neighborhood of peeking at around $3 million, I think, they were probably slightly above that for the fourth quarter.

Ingrid Aja - Banc of America/Merrill Lynch

Okay great. And then in terms of inventories, to add, you had mentioned the inventories completely, that will absorb some of those savings now, but what about working down this quarter. Will you be able to work down some of that inventories that you have built out this quarter. And how does that, will that further impact your margins?

Phil Franklin

Well inventories were relatively flat for the quarter but we did build up inventories during the year, largely related to the transfers as we, we have a target to take inventories down in the $5 million to $10 million range during 2009 and that's significant piece of that is related to taking excess inventories that we build to facilitate the transfers out. We also believe with fewer plans and better means - you know manufacturing processes in those plans but we can drive further tons of improvement over and above that.

Ingrid Aja - Banc of America/Merrill Lynch

Absolutely and then on the $15 million operating expense reduction. How much of that is going to be R&D related versus SG&A, is R&D going to come down?

Phil Franklin

Yes, so far it will come down. I don’t have a specific number for you but there is a meaningful piece of that, that's related to R&D and the biggest piece just relates to acceleration of the moves that we already talked about where we move R&D, our R&D the bulk of our R&D from the US and Europe into Asia. So, we had a big R&D capability here in the US for electronics and that will be moving more, we will be moving that faster and more aggressively over to Asia primarily in the Philippines and that's the major cause for the R&D reductions but the R&D, it’s a meaningful piece of the $15 million or we guess about your 25% to 30% of it.

Ingrid Aja - Banc of America/Merrill Lynch

Alright, great, thanks and I guess, finally on the gross looking forward this quarter. And what kind of incremental margin are you looking at. And what kind of operating leverage you are expecting?

Phil Franklin

Well I think, generally speaking we, for every dollar that we can take sales up, we should be able to drop around half of that or slightly over half of that to the bottom-line. So there is a significant amount of operating leverage as we scale the business back from revenue levels. Kind of in the $90 million plus per quarter up in to the over 100 and then ultimately back to the kind of levels that we would normally expect to operate in $130 million to $150 million range per quarter.

Ingrid Aja - Banc of America/Merrill Lynch

Right, and so then this quarter, a lot of those benefits you are also going to have impact because they are not going to show up.

Phil Franklin

Right. So we will, so this quarter we get impacted by a lot of things. We don’t get really the benefit of the cost reductions in a meaningful way because all the reductions that we were realizing in cost of sales for the quarter will be going in inventory and then only turn out of inventory in Q2. The operating expenses we will be executing on those. A lot of those during the quarter, so we will start to get some benefit but the major benefits will come in Q2. And then those, and then we also get hit with a negative operating leverage from the very low top line number that we are expecting for the first quarter part driven by the timing of Chinese New Year and the fact that our year started during the Christmas New Year’s holidays in Europe and the US.

Ingrid Aja - Banc of America/Merrill Lynch

Okay, great. Thank you.

Operator

Next we will go to Reik Read with Robert Baird.

Reik Read - Robert W. Baird

Hi, good morning.

Gordon Hunter

Good morning, Reik.

Reik Read - Robert W. Baird

Phil could you maybe just walk through with I take it to be a forward movement of those transfer costs in the fourth quarter. Can you talk about what the transfer costs are as we go into 2009, and then maybe can you detail out a little bit of, as you go through the year how much related to $28 million that you are talked about. Is that by and large mostly kicking in the back half of the year or can you give us some understanding on that?

Phil Franklin

No, by the time we get into the second quarter will be seeing a meaningful jump at $28 million. As well we will be seeing, we are not going to be quite at our operating expense run-rate that we hope to get to but will be certainly more than half way there. So, we will start getting the majority of that from the cost reductions we get into Q2 by Q3 we should be basically fully there.

On the transfer related question, we still have some minor remnants from the Mexico move and the Ireland move the move out of Ireland, the move from the Spain, Mexico where we have some clean off and some mothballing of facilities and things like that, that will drag on a little bit, for the most part the big numbers related to those two transfers are behind us from a transfer cost standpoint.

In 2009, the major transfer related cost relate to the moves from Irving, Texas to that of Matamoras, Mexico to Wuxi, but overall, we talked about a number that was started out in 2008 at roughly $2 million in change a quarter and peak down at over $3 million a quarter. So, something in the area of $10 million to $12 million I would expect those costs to be probably half that in 2009. That’s included in the $28 million that we talked about in manufacturing savings.

Reik Read - Robert W. Baird

So, I am sorry, for the 28 million is a net number?

Phil Franklin

Yes, it includes the reduction in transfer related costs, it includes savings, it includes additional reductions that we have done unrelated to the transfers.

Reik Read - Robert W. Baird

Okay. And so what you were saying just a minute ago on the related contribution margin, I mean, you ought to see a pretty significant movement just because you are lowering the cost that the breakeven point, pretty early on and as we get back into the back half of the year, I would assume that volume matters a lot less than it has historically?

Phil Franklin

I would say that necessarily that it matters less, I mean it has historically certainly, we are going to be able to have the business, it will be much more profitable at lower levels of sales than it was historically, but we still will have a significant amount of operating leverage as volume scales up and down. I think once we get all the facilities done in the Irving, Wuxi moved on and we are down to truly six facilities around the world, we will have a significant reduction in fixed costs as well, which not only will help us bring the breakeven point down even further than what we are talking about here, but it will mean we will be a little less sensitive to volume changes going forward.

But it is probably not going to be that dramatically different in terms of how the business scales up and down. This year we still own the Ireland plant, we still own the Des Plaines plant until we clean some of that up. We are still going to have the issue where the business has a fair amount of operating leverage both on the up side and the down side. But, back to your point, that will improve as we move forward.

Reik Read - Robert W. Baird

And then just back to the working capital side of things, just given the slowdown, the completed transfers you kind of alluded to inventory being down, would working capital be a larger source of funds in 2009 than it was in 2008?

Phil Franklin

I would say overall, I wouldn’t say that would be the case. I mean there are couple of factors there. As you saw we had a huge receivables reduction in the fourth quarter, with a big drop off that we had in sales. So, we are not going to see that repeat itself. On the other hand, we will do better in inventories in 2009. Overall for the year in 2008, we drop receivables by $23 million during the year, all of that was in the fourth quarter. We are not going to get a repeat of that. But on the other hand, our inventories actually went up, it went up by $6 million to $7 million in 2008. As I mentioned we expect that number to come down by $5 million to $10 million in 2009.

So, now the better performance on inventory will largely offset the fact that we had this huge drop in receivables in '08 that won't repeat in '09, although, we do expect to aggressively manage the day sales outstanding, but we are already starting at such a low level. It's hard to see that receivables will come down a lot more from where they are. The other thing that will impact cash flow is the amount of severance that we pay out and obviously the capital expenditures.

And the severance that we paid out about $20 million roughly in 2008 it will be about half of that in 2009, and then obviously that will drop way off as we get past 2009. And CapEx has obviously come down a lot from over $50 million to again about half that number in the $27 million range. So, there will be some things moving in different directions on cash flow, but overall even with a very challenging year for earnings we still expect to be positive free cash flow from the year.

Reik Read - Robert W. Baird

Okay. Great. Thank you very much.

Operator

We will go next to John Franzreb with Sidoti & Company.

John Franzreb - Sidoti $ Company

Good morning guys.

Gordon Hunter

Good morning.

John Franzreb - Sidoti $ Company

Gordon, could you talk a little bit about the order trends I mean clearly there is no sell-through going on the automotive side of the business, but what are your electronics customers telling you, right now that gives you confidence and profit rebound. These are in sales improvement in the second quarter of the year?

Gordon Hunter

Right in the automotive business, we really have operating on a pool system, so very quickly as sales decline they really very quickly decrease their ordering on us. So we don't really have any inventory issues in automotive it's extremely responsive to the market, so the end-market trend is really critical and it really means that we are tracking sales of vehicles around the world that very quickly translates into production of vehicles and very quickly translates into sales of our products into the Tier 1.

In the Electronics area, we have distribution channels which really slowed down as I mentioned extremely in the fourth quarter and really the period from the extended Christmas holidays right through in Asia to the Chinese New Year holidays that are just ending, people just really coming back to work has really been very slow in January.

So tracking our book-to-bill which in these circumstances not necessarily the best indicator in a normal stable business it will be a metric we would be really looking at that's tracking just below one, but on a lower sales level. But we are really, I think we are looking to see to the contract manufacturers and the ODMs start to ramp-up production now after Chinese New Year and start to put some demand on the distribution channel. So we see our distributors reordering. And that's really what we are waiting for.

In the next few weeks I think everyone in the electronics industry is going to be waiting to see demand picking up from I think really very low levels of inventory throughout the chain for all components and I think frankly for end-use products as well.

John Franzreb - Sidoti $ Company

Okay. You touch a little bit, Phil, on being positive free cash flow for the year? What are your thoughts about debt repayments here? How do you kind of think you will finish out 2009 on the balance sheet?

Phil Franklin

The only debt we have at the moment is term loan we just took out in the end of the third quarter. Though at the end of year we had an $80 million balance there. And we had a clean revolver of $75 million availability on it.

So, our view that is that we like the term loan we have, there is likelihood we are probably not going to prepay that down, just its cheap money. And we think having a cash cushion, so we get a little bit better picture of what this downturn looks like and what the shape of its really going to be, is a good thing and it also provides us with some cash, take advantage of any opportunities that might be out there.

So, our intent would not be to pay down the term loan that amortizes, starts amortizing the first quarter of $2 million a quarter. So, we would expect to just pay down the amortization and while something else to change we probably wouldn't prepay that at all we just keep the cash.

John Franzreb - Sidoti $ Company

Okay. And I apologize if I missed this. In the guidance numbers for the first quarter, are there any one-time items included in that number or is that an operational number?

Phil Franklin

It's probably going to be, for widened up range, it probably includes both. We are not anticipating significant one-time items. We may have a little bit of severance cost but the big pieces of severance related to the reduction that we described today in the press release, those reserves we have taken in the fourth quarter. So we may have a little bit of additional severance that we have to stock off, but other than that we are not anticipating any other big charges in the quarter.

John Franzreb - Sidoti $ Company

Okay, thanks a lot, Phil.

Phil Franklin

You're welcome.

Operator

(Operator Instructions). We will go next to Shawn Harrison at Longbow Research.

Shawn Harrison - Longbow Research

Hi, good morning. Just getting back to the debt question. What is the interest rate on that debt right now maybe just give a run rate in terms of interest expense?

Phil Franklin

Its LIBOR plus 175 it is what the spread is on that. So we have been running that mostly of one month LIBOR which is in 1% or so.

Shawn Harrison - Longbow Research

Okay, so looking at something that LIBOR rate plus on their 500K quarter 2009?

Phil Franklin

Yeah that's in a neighborhood.

Shawn Harrison - Longbow Research

Okay. Secondarily just two quick modeling questions, other income was up something like $3 million sequentially in the fourth quarter. How should we look at going forward and what kind of comprise that and then maybe just a tax rate here for 2009?

Phil Franklin

Yes, I mean there are number of things in there, we will have some interest income on the $70 million or so of cash that we have around the world generally invested in very safe, very short-term type of investments. We will also have some, we do get some royalties but those are generally small numbers. The biggest item that was in the Q4 number was foreign exchange, gains that we had those were balance sheet revaluations gains that we were in through the P&L and we are not anticipating those are going to reoccur, but obviously they may and that could go either way depending on what happens to exchange rates.

Shawn Harrison - Longbow Research

So something maybe in the $3 million, $3.5 million range going forward in terms of income?

Phil Franklin

Yes, I would say it certainly wouldn’t be any more than that.

Shawn Harrison - Longbow Research

Okay, and then a just tax rate?

Phil Franklin

Tax rate should be similar to the tax rate this year something in the high 20s. We were typically modeling about 29%.

Shawn Harrison - Longbow Research

Okay. Turning back to the cost saving initiatives, I want to be crystal clear on the $28 million manufacturing sales as well as the $15 million in operating expenses. Are those cumulative numbers for the year or those run rates exiting the year in terms of savings?

Phil Franklin

Those are the impact on 2009 and most of those are executed very early in the year. So it's going to be pretty close to being the same thing. But the impact we are giving you is the impact on 2009. So, it would be a little bit higher than that in terms of the exit run rate.

Shawn Harrison - Longbow Research

Okay. And then getting back to the demand question maybe just kind of another way to ask. Given that the guidance you provided for the quarter in January run rates you have seen in the business. What type or percentage uptick would you need to see in February and March to meet the mid point of guidance? The other way to ask is, if we multiply January times three would we meet the low end of guidance?

Phil Franklin

If January times three would probably get little bit below the low end of guidance. But remembering that we had week of Christmas holidays in January and also probably a little bit over a week of Chinese New Year. So, it's probably not a very indicative month. But if it continue with that rate we would most likely end up at the very low end or below the low end of our guidance.

Shawn Harrison - Longbow Research

So, but the other side of that is, you are not expecting a large kind of double-digit uptick to exit the quarter?

Phil Franklin

Actually, we really are not expecting the market to improve at all, what we are expecting is that to revert to more normal run-rates and less inventory draw down and what we have experienced. So, we do think sales rates and order rates will improve, but it's not going to be based on, any improvement in the market it's going to based on these other factors.

Shawn Harrison - Longbow Research

Okay. And I know you highlighted some ASP potential pressures out there but not a lot of negatively. Is that something that could worsen year as we progress in the quarter. Is that you are concerned with heading for during the first six months of the year?

Phil Franklin

I think in the electronics industry its always a risk. When demands are just low, that becomes more pressure on price and then that's proven out in past downturn. So, we are modeling into our plans probably a little bit higher than normal price erosion numbers for electronics. We think that automotive their concern is volume. We don’t think the pricing will be much different than this and historically it's still going to go down. But most of our automotive business is on contracts. So, we don't think that's going to change materially from what it typically would run.

The electrical business, we are going to see major price reduction issues there but we certainly aren’t going to get the kind of price increase that we got over the last year or two, in part driven by some of the commodity prices going up which obviously but not this year.

Shawn Harrison - Longbow Research

Okay. So just to summarize on the electronics, it’s modeled into the business you just haven’t seen anything greater than normal pressure to-date?

Phil Franklin

We have not seen a trend change yet, but we have modeled in some higher price erosion.

Shawn Harrison - Longbow Research

Okay. Thanks very much.

Operator

(Operator Instructions). We will take a follow-up from Reik Read at Robert W. Baird.

Reik Read - Robert W. Baird

Hey, just given your guidance to the first quarter and if you kind of applied some element of normal seasonality, it looks like revenue might be down about 20% 2009 versus 2008. I know that’s just roughing out in this environment, but I mean assuming you are down a pretty meaningful amount like that, does EPS come down at a commensurate rate given that you have got some good offset with these cost reductions, or can you hold it flat. I mean how should we think about how much of those cost reductions really kind of go to the bottom-line to help it out.

Phil Franklin

Yes, I mean we are going to get a lot of positive impact from the cost reductions, but we are talking about I think your numbers for year-over-year sales changes were probably a little bit higher than I would assume. Remembering and that we also have a full year of Startco in 2009, which should be about $20 million of revenues as oppose to the roughly $4 million that we had in 2008, or picking up $16 million on Startco. To answer your question generally right, we are expecting particularly as we get out to the middle of the year that those cost reductions are going to flow to the bottom-line, and they are going to offset, more than offset the pretty severe negative operating leverage that we are going to experience. We still believe that even with the huge negative operating leverage that you talk about that we still should see some modest improvements hopefully in operating margins and other things even at those levels. Certainly we can get up to the $120 million, $130 million quarters, we can be very profitable at those levels for the cost structure that we are going to have by the middle of the year.

Reik Read - Robert W. Baird

Okay. But if you think about, for first quarter you have huge negative operating leverage and no real impact because it's all an inventory. Second quarter, and I am just roughening this out, you think about it has drawn even and then, as you get to the back half of the year those cost reductions really kind of kick in more than the negative operating leverage?

Phil Franklin

Yes, they do. And we were expecting just seasonally, we would expect some better sales results. We expect to get pass this, what we think it is going to be a very depressed first quarter, even with the current state of the end markets, which obviously is very weak. We still think the sales numbers when we get out to Q3 will be significantly higher than the Q1 numbers, even with no improvement in the end markets.

Reik Read - Robert W. Baird

Okay. Great. Thank you, Phil.

Phil Franklin

You're welcome.

Operator

And at this time we have no further questions. Mr. Hunter, I will turn the conference back over to you for any closing remarks.

Gordon Hunter

Thank you for joining us on the call this morning. I hope our comments have addressed the current economic environment for our business and what we are doing both short-term and long-term to meet the challenges ahead while continuing to build our position as the global leader in circuit protection.

So, thank you again for your interest in Littelfuse and we look forward to talking to you again next quarter.

Operator

And that does conclude today's conference. Again thank you for your participation. You may now disconnect.

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Source: Littelfuse, Inc. Q4 2008 Earnings Call Transcript
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