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LITTELFUSE INC /DE - 10-K - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.(Edgar Glimpses Via Acquire Media NewsEdge) Littelfuse, Inc. and its subsidiaries (the "company" or "Littelfuse") design, manufacture and sell circuit protection devices for use in the electronics, automotive and electrical markets throughout the world. The following Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") is designed to provide the reader with information that will assist in understanding the company's Consolidated Financial Statements, the changes in certain key items in those financial statements from year to year, and the primary factors that accounted for those changes, as well as how certain accounting principles affect the Consolidated Financial Statements. The discussion also provides information about the financial results of the various business unit segments to provide a better understanding of how those segments and their results affect the financial condition and results of operations of Littelfuse as a whole. Business Segment Information U.S. Generally Accepted Accounting Principles ("GAAP") dictates annual and interim reporting standards for an enterprise's operating segments and related disclosures about its products, services, geographic areas and major customers. Within U.S. GAAP, an operating segment is defined as a component of an enterprise that engages in business activities from which it may earn revenues and incur expenses, and about which separate financial information is regularly evaluated by the Chief Operating Decision Maker ("CODM") in deciding how to allocate resources. The CODM is the company's President and Chief Executive Officer. 21 -------------------------------------------------------------------------------- The company reports its operations by three business unit segments: Electronics, Automotive and Electrical. The following table is a summary of the company's operating segments' net sales by business unit and geography (in millions): Fiscal Year 2012 2011(b) 2010 Business Unit Electronics $ 329.5 $ 354.5 $ 373.4 Automotive(b) (d) 206.2 197.6 139.1 Electrical(c) 132.2 112.9 95.5 Total $ 667.9 $ 665.0 $ 608.0 Geography(a) Americas(c) $ 303.6 $ 288.6 $ 227.7 Europe(d) 107.5 114.9 115.1 Asia-Pacific 256.8 261.5 265.2 Total $ 667.9 $ 665.0 $ 608.0 (a) Sales by geography represent sales to customer or distributor locations. (b) 2012 and 2011 include Cole Hersee net sales of $47.2 million and $46.9 million for fiscal years 2012 and 2011, respectively. (c) 2012 and 2011 include Selco net sales of $6.0 million and $3.2 million for fiscal years 2012 and 2011, respectively. (d) 2012 includes Accel and Terra Power net sales of $11.2 million and $1.7 million, respectively. Business unit segment information is described more fully in Note 16 of the Notes to Consolidated Financial Statements. The following discussion provides an analysis of the information contained in the Consolidated Financial Statements and accompanying Notes to Consolidated Financial Statements at December 29, 2012 and December 31, 2011, and for the three fiscal years ended December 29, 2012, December 31, 2011 and January 1, 2011. Results of Operations - 2012 compared with 2011 Net sales increased $2.9 million or less than 1% to $667.9 million for fiscal year 2012 compared to $665.0 million in fiscal year 2011 due primarily to an incremental $16.6 million from business acquisitions and growth in protection relays, custom mining products and automotive products, offset by lower electronics sales. The company also experienced $9.4 million in unfavorable foreign currency effects in 2012 as compared to 2011 primarily resulting from sales denominated in euros and, to a lesser extent, Canadian dollars and Korean won. Excluding acquisitions and currency effects, net sales decreased $4.3 million or less than 1% year over year. The Automotive business segment sales increased $8.6 million or 4% to $206.2 million. The Electronics business segment sales decreased $25.0 million or 7% to $329.5 million, and the Electrical business segment sales increased $19.3 million or 17% to $132.2 million. Sales levels in 2012, excluding acquisitions and currency effects, were negatively impacted by slowing demand for the company's electronics products coupled with channel inventory de-stocking. Sales levels in 2011, excluding acquisitions and currency effects, were negatively impacted by slowing demand for the company's electronics products coupled with inventory de-stocking in the supply chain. The increase in Automotive sales was primarily due to an incremental $12.9 million in sales related to the Accel and Terra Power acquisitions in 2012 and organic growth in the passenger vehicle market. This was offset by a decline in commercial vehicle sales and unfavorable currency effects. Lower commercial vehicle sales reflected weakness in the construction and heavy truck markets. Currency effects reduced sales by $5.0 million in 2012 compared to 2011 primarily due to the weaker euro. Excluding incremental sales from acquisitions and currency effects, Automotive sales increased $0.7 million or less than 1% year over year. 22--------------------------------------------------------------------------------The decrease in Electronics sales reflected slowing demand across all geographies. There was weakness in the telecom, PC and TV end markets in addition to distributor channel inventory de-stocking. In addition, sales were negatively impacted by net unfavorable currency effects of $3.2 million, primarily from sales denominated in euros and Korean won. The increase in Electrical sales was due to continued strong growth for protection relays and custom mining products, an upturn in solar sales reflecting the success of new products, and improvement in the industrial fuse market. The Electrical business segment also had $3.7 million in incremental sales from the Selco acquisition in 2011. The Electrical segment experienced net unfavorable currency effects of $1.2 million primarily from sales denominated in Canadian dollars. Excluding incremental sales from acquisitions and currency effects, Electrical sales increased $16.8 million or 15% year over year. On a geographic basis, sales in the Americas increased $15.0 million or 5% in 2012 as compared to 2011. This increase resulted from an increase in the company's Automotive and Electrical business segments offset by a decline in the Electronics business segment. Automotive sales increased $1.7 million or 2% primarily reflecting incremental sales from Terra Power. Excluding the acquisition, Automotive sales were essentially flat year-over-year as growth in the passenger vehicle market was offset by declines in the commercial vehicle market. Electrical sales increased $15.5 million or 15% resulting from increases in demand for protection relays, custom products and industrial power fuses. Electronics sales decreased $2.2 million or 2% primarily reflecting inventory de-stocking. The Americas region also experienced $0.9 million in unfavorable currency effects resulting from sales denominated in Canadian dollars. European sales decreased $7.4 million or 6% in 2012 compared to 2011. This resulted from decreases in the company's Electronics and Automotive business segments offset by an increase in the Electrical business segment. Automotive sales decreased $0.4 million or less than 1% in 2012 primarily reflecting lower demand in the passenger vehicle markets. Excluding the impact of incremental sales from acquisitions and unfavorable currency effects, primarily from a weaker euro, Automotive sales declined $6.5 million or 10%. Electronics sales decreased $10.3 million or 24% reflecting lower demand resulting from a weaker economy during 2012. Electrical sales increased $3.3 million or 63% primarily from the incremental sales of Selco. Excluding incremental sales and currency effects, Electrical sales increased $0.1 million or 2% year-over-year. Overall European sales in 2012 included unfavorable currency effects of $8.6 million, resulting primarily from sales denominated in euros. Asia-Pacific sales decreased $4.7 million or 2% in 2012 compared to 2011. This decrease resulted from a decrease in the Electronics business segment offset by increases at the company's Automotive and Electrical business segments. Electronics sales decreased $12.5 million or 6% reflecting slowing end-market demand and inventory de-stocking. Automotive sales increased $7.4 million or 20% reflecting continued increased demand for passenger vehicles in the developing Asian markets as well as gains in market share. Electrical sales increased $0.5 million or 9%. Current year results included favorable currency effects of $0.1 million resulting from sales denominated in Chinese yuan partially offset by sales denominated in Korean won and Japanese yen. Gross profit was $258.5 million or 38.7% of sales in 2012, compared to $256.7 million or 38.6% of sales in 2011. Gross profit in both 2012 and 2011 were negatively impacted by purchase accounting adjustments in cost of sales of $0.6 million and $4.1 million, respectively. These charges were the additional cost of goods sold for Accel and Selco inventory which had been stepped-up to fair value at the acquisition dates as required by purchase accounting rules. Excluding the impact of these charges, gross profit was $259.1 million or 38.8% of sales for 2012 as compared to $260.8 million or 39.2% of sales in 2011. The decline in gross margin was primarily attributable to the unfavorable impact of currency effects on sales as described above. 23 -------------------------------------------------------------------------------- Total operating expense was $151.6 million or 22.7% of net sales for 2012 compared to $142.8 million or 21.5% of net sales for 2011. The increase in operating expenses primarily reflects incremental operating expenses of $6.5 million from business acquisitions and $5.1 million in charges related to the settlement of pension liabilities for certain former employees. Further information regarding the company's pension settlement charge is provided in Note 13 of the Notes to Consolidated Financial Statements included in this report. Operating income was $106.9 million or 16.0% of net sales in 2012 compared to $113.9 million or 17.1% of net sales in the prior year. The decrease in operating income in the current year was due primarily to the limited sales growth and an increase in costs as described above. Interest expense was unchanged at $1.7 million in both 2012 and 2011 and is primarily related to the company's revolving credit facility. Impairment and equity in net loss of unconsolidated affiliate was $7.3 million in 2012. During the fourth quarter, the company determined that it had the ability to exert significant influence over Shocking Technologies, Inc. ("Shocking") and as a result began accounting for the investment using the equity method. In accordance with Accounting Standards Codification ("ASC") 323, the company retroactively recorded its proportional share of Shocking's operating losses, which amounted to approximately $4.0 million in 2012. The proportional amount of operating losses in 2011 was not material. In addition, the company concluded that there was an other-than-temporary impairment which existed for its remaining investment in Shocking. The company engaged a third-party valuation firm to assist in developing the fair value of the investment in Shocking. Based on the then fair value, the company determined that there was an impairment of approximately $3.3 million which was recorded as a non-operating impairment and equity loss of unconsolidated affiliate in the Consolidated Statements of Net Income. See Note 6 of the Notes to Consolidated Financial Statements included in this report. Other expense (income), net, consisting of interest income, royalties, non-operating income and foreign currency items was $2.2 million of income in 2012 compared to $2.9 million of income in 2011.The year-over-year decrease in income primarily reflects the impact of unfavorable currency translation effects (primarily due to the weakening of the euro against the U.S. dollar) in 2012. Income before income taxes was $100.1 million in 2012 compared to $115.1 million in 2011. Income tax expense was $24.7 million in 2012 compared to $28.1 million in 2011. The 2012 effective income tax rate was 24.7% compared to 24.4% in 2011. The 2012 effective tax rate is lower than the statutory tax rate primarily due to the result of more income earned in low tax jurisdictions. 24 --------------------------------------------------------------------------------Results of Operations - 2011 compared with 2010 Net sales increased $57.0 million or 9% to $665.0 million for fiscal year 2011 compared to $608.0 million in fiscal year 2010 due primarily to an incremental $50.1 million from business acquisitions and growth in protection relays, custom mining products and automotive products, offset by lower electronics sales. The company also experienced $10.4 million in favorable foreign currency effects in 2011 as compared to 2010. The favorable foreign currency impact primarily resulted from sales denominated in euros and, to a lesser extent, Canadian dollars and Japanese yen. Excluding acquisitions and currency effects, net sales decreased $3.5 million or 1% year over year. The Automotive business segment sales increased $58.5 million or 42% to $197.6 million. The Electronics business segment sales decreased $18.9 million or 5% to $354.5 million, and the Electrical business segment sales increased $17.4 million or 18% to $112.9 million. Sales levels in 2011, excluding acquisitions and currency effects, were negatively impacted by slowing demand for the company's electronics products coupled with inventory de-stocking in the supply chain. Sales levels in 2010 were positively impacted by the global economic recovery, distributor inventory replenishment and effective execution of the company's strategic growth plans. The increase in Automotive sales was primarily due to an incremental $46.9 million in sales related to Cole Hersee, organic growth in all regions and favorable currency effects. Excluding Cole Hersee, automotive sales increased $11.6 million or 8.4% year over year. Currency effects added $4.3 million to sales in 2011 compared to 2010 primarily due to the stronger euro. The decrease in Electronics sales reflected slowing demand across all geographies coupled with inventory de-stocking in the supply chain. In addition, the effects of the Japan disaster in March 2011 negatively impacted sales by approximately $3 to $4 million in 2011. The negative impact from a decrease in volume was partially offset by net favorable currency effects of $4.0 million primarily from sales denominated in euros and Japanese yen. The increase in Electrical sales was due to continued strong growth for protection relays and custom mining products and steady improvement in the industrial fuse market. This was partially offset by a slowdown in the solar market. The Electrical segment experienced net favorable currency effects of $2.0 million primarily from sales denominated in Canadian dollars. On a geographic basis, sales in the Americas increased $60.8 million or 27% in 2011 compared to 2010. This increase resulted from increases in the company's Automotive and Electrical business segments offset by a decline in the Electronics business segment. Automotive sales increased $46.8 million or 100% primarily reflecting incremental sales from Cole Hersee. Excluding Cole Hersee, Automotive sales increased $2.7 million or 6% reflecting increased demand in the passenger and commercial vehicle markets. Electrical sales increased $17.5 million or 21% resulting from increases in demand for protection relays, custom products and industrial power fuses partially offset by a decline in solar fuse sales. Electronics sales decreased $3.5 million or 4% reflecting slowing end-market demand and inventory de-stocking. The Americas region also experienced $1.9 million in favorable currency effects resulting from sales denominated in Canadian dollars. European sales decreased $0.2 million for fiscal year 2011 compared to 2010. This resulted from decreases in the company's Electronics and Electrical business segments offset by an increase in the Automotive business segment. Automotive sales increased $7.2 million or 12% in 2011 primarily reflecting increased end-market demand and favorable currency effects. Electronics sales decreased $6.9 million or 14% reflecting lower demand resulting from a weaker economy during 2011. Electrical sales decreased $0.5 million or 9%. Overall European sales in 2011 included favorable currency effects of $5.3 million, resulting from sales denominated in euros. 25 -------------------------------------------------------------------------------- Asia-Pacific sales decreased $3.7 million or 1% in 2011 compared to 2010. This decrease resulted from a decrease in the Electronics business segment offset by increases at the company's Automotive and Electrical business segments. Electronics sales decreased $8.5 million or 4% reflecting slowing end-market demand and inventory de-stocking. Automotive sales increased $4.4 million or 14% reflecting continued increased demand for passenger vehicles in the developing Asian markets as well as gains in market share. Also contributing to the increase in Automotive sales was incremental sales from Cole Hersee. Excluding Cole Hersee, Automotive sales increased $2.3 million or 7%. Electrical sales increased $0.4 million or 7%. Current year results included favorable currency effects of $3.2 million resulting from sales denominated in Japanese yen, Korean won and Chinese yuan. Gross profit was $256.7 million or 38.6% of sales in 2011, compared to $233.9 million or 38.5% of sales in 2010. Gross profit in 2011 was negatively impacted by $4.1 million of purchase accounting adjustments recorded in cost of sales. These charges were the additional cost of goods sold for Cole Hersee and Selco inventory which had been stepped-up to fair value at the acquisition dates as required by purchase accounting rules. Excluding the impact of these charges, gross profit was $260.8 million or 39.2% of sales for 2011. The improvement in gross margin was attributable to improved operating leverage resulting from higher production volumes in 2011 as well as cost reductions related to manufacturing transfers. Total operating expense was $142.8 million or 21.5% of net sales for 2011 compared to $126.3 million or 20.8% of net sales for 2010. The increase in operating expenses primarily reflects incremental operating expenses of $12.8 million from business acquisitions. Operating income was $113.9 million or 17.1% of net sales in 2011 compared to $107.6 million or 17.7% of net sales in the prior year. The increase in operating income in the current year was due primarily to the increase in sales and reduction in costs as described above. Interest expense, net, increased to $1.7 million in 2011 compared to $1.4 million for 2010 primarily due to amortization of debt issuance costs incurred related to the new credit agreement in 2011. Other expense (income), net, consisting of interest income, royalties, non-operating income and foreign currency items, was $2.9 million of income in 2011 compared to $1.5 million of income in 2010. The year over year increase resulted primarily from dividend and royalty income. Income before income taxes was $115.1 million in 2011 compared to $107.7 million in 2010. Income tax expense was $28.1 million in 2011 compared to $29.0 million in 2010. The 2011 effective income tax rate was 24.4% compared to 27.0% in 2010. The 2011 effective tax rate is lower than the statuatory tax rate primarily due to the result of more income earned in low tax jurisdictions and a large tax benefit from revaluation of a deferred tax asset. Liquidity and Capital Resources As of December 29, 2012, $227.3 million of the $235.4 million of the company's cash and cash equivalents was held by foreign subsidiaries. Of the $227.3 million held by foreign subsidiaries, approximately $28.1 million could be repatriated with minimal tax consequences. The company expects to maintain its foreign cash balances (other than the aforementioned $28.1 million) for local operating requirements, to provide funds for future capital expenditures and for potential acquisitions. The company does not expect to repatriate these funds to the U.S. 26--------------------------------------------------------------------------------The company historically has financed capital expenditures through cash flows from operations. Management expects that cash flows from operations and available lines of credit will be sufficient to support both the company's operations and its debt obligations for the foreseeable future. Term Loan On September 29, 2008, the company entered into a Loan Agreement with various lenders that provided the company with a five-year term loan facility of up to $80.0 million for the purposes of (i) refinancing certain existing indebtedness; (ii) funding working capital needs; and (iii) funding capital expenditures and other lawful corporate purposes, including permitted acquisitions. The company terminated this loan agreement on June 13, 2011 at which time any outstanding amounts were refinanced under the company's new revolving credit facility effective June 13, 2011. Revolving Credit Facilities The company had an unsecured domestic financing arrangement, which expired on July 21, 2011, consisting of a credit agreement with banks that provided a $75.0 million revolving credit facility, with a potential to increase up to $125.0 million upon request of the company and agreement with the lenders. The company refinanced this loan agreement with proceeds from a new revolving credit facility on June 13, 2011. The company's revolving credit facility is an uncommitted and discretionary facility, subject to withdrawal at any time by the lender upon due notice to the company. On June 13, 2011, the company entered into a new credit agreement with certain commercial banks that provides an unsecured revolving credit facility in an amount of up to $150.0 million, with a potential to increase up to $225.0 million. At December 29, 2012, the company had available approximately $65.0 million of borrowing capacity under the revolving credit agreement at an interest rate of LIBOR plus 1.25% (1.46% as of December 29, 2012). The credit agreement replaces the company's previous credit agreement dated July 21, 2006 and term loan agreement dated September 29, 2008, and, unless terminated earlier, will terminate on June 13, 2016. During the second quarter of 2011, $0.2 million of previously capitalized debt issuance costs were written off as a non-cash charge and $0.7 million of new debt issuance costs incurred was capitalized and will be amortized over the life of the new credit agreement. This arrangement contains covenants that, among other matters, impose limitations on the incurrence of additional indebtedness, future mergers, sales of assets, payment of dividends, and changes in control, as defined in the agreement. In addition, the company is required to satisfy certain financial covenants and tests relating to, among other matters, interest coverage and leverage. At December 29, 2012, the company was in compliance with all covenants under the revolving credit facility. During the second quarter of 2011, as part of the new refinancing arrangement discussed above, $47.0 million of indebtedness that was due on the previous term loan was settled and rolled-over into the revolving credit facility by the lender. Other Obligations For the fiscal year ended December 29, 2012, the company had $0.8 million outstanding in letters of credit. No amounts were drawn under these letters of credit at December 29, 2012. For the fiscal year ended December 31, 2011, the company had $2.3 million available in letters of credit. No amounts were drawn under these letters of credit at December 31, 2011. 27 --------------------------------------------------------------------------------Cash Flows and Working Capital The company started 2012 with $164.0 million of cash. Net cash provided by operating activities in 2012 was approximately $116.2 million and included $75.3 million in net income and $46.0 million in non-cash adjustments (primarily $31.4 million in depreciation and amortization), partially offset by $5.2 million of changes in operating assets and liabilities. Changes in operating assets and liabilities in 2012 (including short-term and long-term items) that negatively impacted cash flows in 2012 consisted of changes in accounts receivable ($1.6 million), accrued expenses including post-retirement ($9.6 million), accrued payroll and severance ($4.4 million), accrued taxes ($0.4 million), and prepaid expenses and other (less than $0.1 million). Accrued expenses including post-retirement included $10.0 million in pension contributions in 2012. Positively impacting cash flows were changes in inventory ($5.4 million) and accounts payable ($5.4 million). Net cash used in investing activities in 2012 was approximately $51.7 million and included $22.5 million in purchases of property, plant and equipment (primarily production equipment for capacity expansion and new products at the company's facilities in Mexico, China and the Philippines), $4.6 million for purchases of short-term investments, $34.0 million for the acquisitions of Accel and Terra Power, a $2.0 million secured loan to and $10.0 million of additional investment in Shocking Technologies. Offsetting the cash used in investing activities was $3.7 million in proceeds from sales of property, plant and equipment and $17.8 million in proceeds from maturities of short-term investments. Net cash provided by financing activities in 2012 was approximately $0.8 million, which included $1.8 million in net payments from borrowing, $2.7 million in excess tax benefits on share-based compensation and $16.4 million in cash proceeds from the exercise of stock options. Additionally the company paid cash dividends of $16.6 million during the year. Information regarding the company's debt is provided in Note 7 of the Notes to Consolidated Financial Statements included in this report. The effect of exchange rate changes increased cash by $6.2 million in 2012. The net cash provided by operating activities less net cash used in financing and provided by investing activities plus the effect of exchange rate changes, resulted in a $71.4 million increase in cash and cash equivalents in 2012. This left the company with a cash balance of $235.4 million at December 29, 2012. Days sales outstanding (DSO) in accounts receivable was 58 days at year-end 2012 compared to 57 days at year-end 2011 and 58 days at year-end 2010 (excluding the year-end Cole Hersee balance). Days inventory outstanding was 69 days at year-end 2012, compared to 73 days at year-end 2011 and 70 days at year-end 2010 (excluding the year-end Cole Hersee balance). The ratio of current assets to current liabilities was 2.9 to 1 at year-end 2012, compared to 2.5 to 1 at year-end 2011 and 2.9 to 1 at year-end 2010. The change in the current ratio at the end of 2012 compared to the prior year reflected increased current assets in 2012, primarily related to higher cash and cash equivalents balances. The carrying amounts of total debt decreased $1.0 million in 2012, compared to an increase of $11.0 million in 2011 and an increase of $10.8 million in 2010. The decrease in 2012 is due to lower net amounts borrowed under the revolving credit facility in 2012. The ratio of long-term debt to equity was 0.00 to 1 at year-end 2012 and 2011 and 0.09 to 1 at year-end 2010. Further information regarding the company's debt is provided in Note 7 of the Notes to Consolidated Financial Statements included in this report. 28-------------------------------------------------------------------------------- The company started 2011 with $109.7 million of cash. Net cash provided by operating activities in 2011 was approximately $120.8 million and included $87.0 million in net income and $39.6 million in non-cash adjustments (primarily $32.3 million in depreciation and amortization), partially offset by $5.8 million of changes in operating assets and liabilities. Changes in operating assets and liabilities in 2011 (including short-term and long-term items) that negatively impacted cash flows in 2011 consisted of decreases in accounts payable ($5.3 million), accrued expenses including post-retirement ($0.4 million), accrued payroll and severance ($3.2 million) and accrued taxes ($6.1 million). The decrease in accounts payable resulted from decreased purchases related to low production levels at the end of 2011. The decrease in accrued payroll and severance resulted from lower severance accruals in 2011. Positively impacting cash flows were decreases in accounts receivable ($4.8 million), a decrease in inventory ($2.6 million) and a decrease in prepaid expenses and other current assets ($1.8 million). The company's capital expenditures were $22.5 million in 2012, $17.6 million in 2011 and $22.4 million in 2010. The company expects capital expenditures in 2013 to increase to between $25 and $30 million primarily related to building expansion in Mexico to support the company's growth initiatives. The company expects to fund 2013 capital expenditures from operating cash flows. The company's Board of Directors authorized the repurchase of up to 1,000,000 shares of the company's common stock under a program for the period May 1, 2012 to April 30, 2013. The company did not repurchase any shares of its common stock during 2012 under this program. The company withheld 27,417 shares of stock in lieu of withholding taxes on behalf of employees who became vested in restricted stock option grants during 2012. Contractual Obligations and Commitments The following table summarizes contractual obligations and commitments as of December 29, 2012: (In thousands ) Total < 1 Year > 1 - < 3 Years > 3 - < 5 Years > 5 Years Revolving credit facility $ 84,000 $ 84,000 $ - $ - $ - Supplemental Executive Retirement Plan 2,422 31 62 62 2,267 Operating lease payments 37,913 8,101 8,677 4,991 16,144 Purchase obligations 27,226 27,226 - - - Total $ 151,561 $ 119,358 $ 8,739 $ 5,053 $ 18,411 Off-Balance Sheet Arrangements As of December 29, 2012, the company did not have any off-balance sheet arrangements, as defined under SEC rules. Specifically, the company was not liable for guarantees of indebtedness owed by third parties; the company was not directly liable for the debt of any unconsolidated entity, and the company did not have any retained or contingent interest in assets; and the company does not participate in transactions that generate relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities. 29 --------------------------------------------------------------------------------Recent Accounting Pronouncements In May 2011, the Financial Accounting Standards Board ("FASB") issued authoritative guidance that provides a consistent definition of fair value and ensures that the fair value measurement and disclosure requirements are similar between U.S. GAAP and International Financial Reporting Standards. The new guidance changes certain fair value measurement principles and enhances the disclosure requirements particularly for Level 3 fair value measurements. The company adopted the new guidance on January 1, 2012. There was no significant impact on its consolidated financial statements upon adoption. In June 2011, the FASB issued authoritative guidance that will require companies to present the components of net income and other comprehensive income either as one continuous statement or as two consecutive statements. It eliminates the option to present components of other comprehensive income as part of the statement of changes in equity. The guidance does not change the items which must be reported in other comprehensive income, how such items are measured or when they must be reclassified to net income. This guidance is effective for interim and annual periods beginning after December 15, 2011. The company adopted the new guidance on January 1, 2012, which resulted in a different presentation in its consolidated financial statements. In September 2011, the FASB issued authoritative guidance on testing goodwill for impairment. Under the revised guidance, entities testing goodwill for impairment have the option of performing a qualitative assessment before calculating the fair value of the reporting unit (i.e., step 1 of the goodwill impairment test). If entities determine, on the basis of qualitative factors, that the fair value of the reporting unit is more likely than not less than the carrying amount, the two-step impairment test would be required. The guidance does not change how goodwill is calculated or assigned to reporting units, nor does it revise the requirement to test goodwill annually for impairment. In addition, the guidance does not amend the requirement to test goodwill for impairment between annual tests if events or circumstances warrant; however, it does revise the examples of events and circumstances that an entity should consider. The amendments are effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. The company adopted the new guidance on January 1, 2012. There was no significant impact on its consolidated financial statements upon adoption. Goodwill testing was completed in September 2012 using the previous methodology, as permitted. In July 2012, the FASB issued authoritative guidance on testing indefinite-lived intangible assets for impairment. Under the revised guidance, entities testing indefinite-lived intangible assets for impairment will have the option first to assess qualitative factors to determine whether the existence of events and circumstances indicate that it is more likely than not that the indefinite-lived intangible asset is impaired. If, after assessing the totality of events and circumstances, an entity concludes that it is not more likely than not that the indefinite-lived intangible asset is not impaired, then the entity is not required to take further action. The amendment is effective for annual and interim indefinite-lived asset impairment tests performed for fiscal years beginning after September 15, 2012. The company believes that adoption of the new guidance will have no effect on its consolidated financial statements. Critical Accounting Policies and Estimates Certain of the accounting policies as discussed below require the application of significant judgment by management in selecting the appropriate estimates and assumptions for calculating amounts to record in the financial statements. Actual results could differ from those estimates and assumptions, impacting the reported results of operations and financial position. Significant accounting policies are more fully described in the Notes to Consolidated Financial Statements included elsewhere in this Annual Report. Certain accounting policies, however, are considered to be critical in that they are most important to the depiction of the company's financial condition and results of operations and their application requires management's subjective judgment in making estimates about the effect of matters that are inherently uncertain. The company believes the following accounting policies are the most critical to aid in fully understanding and evaluating its reported financial results, as they require management's most difficult, subjective or complex judgments, resulting from the need to make estimates about the effect of matters that are inherently uncertain. The company has reviewed these critical accounting policies and related disclosures with the Audit Committee of its Board of Directors. 30 --------------------------------------------------------------------------------Net Sales Revenue Recognition: The company recognizes revenue on product sales in the period in which the sales process is complete. This generally occurs when products are shipped (FOB origin) to the customer in accordance with the terms of the sale, the risk of loss has been transferred, collectability is reasonably assured and the pricing is fixed and determinable. At the end of each period, for those shipments where title to the products and the risk of loss and rewards of ownership do not transfer until the product has been received by the customer, the company adjusts revenues and cost of sales for the delay between the time that the products are shipped and when they are received by the customer. The company's distribution channels are primarily through direct sales and independent third party distributors. Revenue and Billing: The company accepts orders from customers based on long term purchasing contracts and written sales agreements. Contract pricing and selling agreement terms are based on market factors, costs and competition. Pricing normally is negotiated as an adjustment (premium or discount) from the company's published price lists. The customer is invoiced when the company's products are shipped to them in accordance with the terms of the sales agreement. Returns and Credits: Some of the terms of the company's sales agreements and normal business conditions provide customers (distributors) the ability to receive price adjustments on products previously shipped and invoiced. This practice is common in the industry and is referred to as a "ship and debit" program. This program allows the distributor to debit the company for the difference between the distributors' contracted price and a lower price for specific transactions. Under certain circumstances (usually in a competitive situation or large volume opportunity), a distributor will request authorization to reduce its price to its buyer. If the company approves such a reduction, the distributor is authorized to "debit" its account for the difference between the contracted price and the lower approved price. The company establishes reserves for this program based on historic activity and actual authorizations for the debit and recognizes these debits as a reduction of revenue. The company has a return to stock policy whereby a customer with previous authorization from Littelfuse management can return previously purchased goods for full or partial credit. The company establishes an estimated allowance for these returns based on historic activity. Sales revenue and cost of sales are reduced to anticipate estimated returns. The company properly meets all of the criteria for recognizing revenue when the right of return exists. Specifically, the company meets those requirements because: 1. The company's selling price is fixed or determinable at the date of the sale. 2. The company has policies and procedures to accept only credit worthy customers with the ability to pay the company. 3. The company's customers are obligated to pay the company under the contract and the obligation is not contingent on the resale of the product. (All "ship and debit" and "returns to stock" require specific circumstances and authorization.) 31-------------------------------------------------------------------------------- 4. The risk ownership transfers to the company's customers upon shipment and is not changed in the event of theft, physical destruction or damage of the product. 5. The company bills at the ship date and establishes a reserve to reduce revenue from the in-transit time until the product is delivered for FOB destination sales. 6. The company's customers acquiring the product for resale have economic substance apart from that provided by Littelfuse. All distributors are independent of the company. 7. The company does not have any obligations for future performance to bring about resale of the product by its customers. 8. The company can reasonably estimate the amount of future returns. Volume Rebates: The company offers incentives to certain customers to achieve specific quarterly or annual sales targets. If customers achieve their sales targets, they are entitled to rebates. The company estimates the future cost of these rebates and recognizes this estimated cost as a reduction to revenue as products are sold. Allowance for Doubtful Accounts: The company evaluates the collectability of its trade receivables based on a combination of factors. The company regularly analyzes its significant customer accounts and, when the company becomes aware of a specific customer's inability to meet its financial obligations, the company records a specific reserve for bad debt to reduce the related receivable to the amount the company reasonably believes is collectible. The company also records allowances for all other customers based on a variety of factors including the length of time the receivables are past due, the financial health of the customer, macroeconomic considerations and past experience. Historically, the allowance for doubtful accounts has been adequate to cover bad debts. If circumstances related to specific customers change, the estimates of the recoverability of receivables could be further adjusted. Inventory The company performs regular detailed assessments of inventory, which include a review of, among other factors, demand requirements, product life cycle and development plans, component cost trends, product pricing, shelf life and quality issues. Based on the analysis, the company records adjustments to inventory for excess quantities, obsolescence or impairment when appropriate to reflect inventory at net realizable value. Historically, inventory reserves have been adequate to reflect inventory at net realizable values. During 2012, 2011 and 2010, the company was required to step up the value of inventory acquired in business combinations to its selling prices less the cost to sell under business combination accounting. This was approximately $0.6 million in 2012 for Accel and Selco, $0.4 million in 2011 for Selco and $3.7 million in 2010 for Cole Hersee. Goodwill and Other Intangible Assets The company annually tests goodwill for impairment on the first day of its fiscal fourth quarter or at an interim date if there is an event or change in circumstances that indicates the asset may be impaired. The company has seven reporting units for goodwill testing purposes. Management determines the fair value of each of its reporting units by using a discounted cash flow model (which includes forecasted five-year income statement and working capital projections, a market-based weighted average cost of capital and terminal values after five years) to estimate market value. In addition, the company compares its derived enterprise value on a consolidated basis to the company's market capitalization as of its test date to ensure its derived value approximates the market value of the company when taken as a whole. 32 -------------------------------------------------------------------------------- As of the most recent annual test conducted on September 30, 2012, the company concluded the fair value of each of the reporting units exceeded its carrying value of invested capital and therefore, no potential goodwill impairment existed. Specifically, the company noted that its headroom, defined as the excess of fair value over the carrying value of invested capital, was 66%, 113%, 59%, 99%, 96%, 247% and 119% for its electronics (non-silicon), electronics (silicon), automotive (excluding Cole Hersee), Cole Hersee, relay, custom products and fuse reporting units, respectively, at September 30, 2012. Certain key assumptions used in the annual test included a discount rate of 12.7% for all reporting units. A long-term growth rate of 3.0% was used for all seven reporting units. In addition, the company performed a sensitivity test at September 30, 2012 that showed either a 100 basis point increase in its discount rate or a 100 basis point decrease in the long-term growth rate for each reporting unit would not have changed the company's conclusion that no potential goodwill impairment existed at September 30, 2012. The company will continue to perform a goodwill impairment test as required on an annual basis and on an interim basis, if certain conditions exist. Factors the company considers important, which could result in changes to its estimates, include underperformance relative to historical or projected future operating results and declines in acquisitions and trading multiples. Due to the diverse end user base and non-discretionary product demand, the company does not believe its future operating results will vary significantly relative to its historical and projected future operating results. Long-Lived Assets The company evaluates long-lived asset groups on an ongoing basis. Long-lived asset groups are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the related asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of the asset to future undiscounted cash flows expected to be generated by the asset group. If it is determined to be impaired, the impairment recognized is measured by the amount by which the carrying value of the asset exceeds its fair value. The company's estimates of future cash flows from such assets could be impacted if it underperforms relative to historical or projected future operating results. The company recorded asset impairment charges of $0.5 million, $2.3 million and $3.0 million for the fiscal years ended 2012, 2011 and 2010, respectively. Further information regarding asset impairments is provided in Note 12 of the Notes to Consolidated Financial Statements included in this report. The company evaluates its investments quarterly or when there is an indicator of a potential impairment. During the fourth quarter of 2012, company management determined that an indicator of impairment existed for the company's investment in Shocking Technologies, Inc. Subsequently, the company engaged a third party asset valuation firm to perform an analysis for purposes of assisting management in determining the amount of impairment. Further information regarding the impairment of the company's investment in Shocking Technologies, Inc. is provided in Note 6 of the Notes to Consolidated Financial Statements included in this report. 33--------------------------------------------------------------------------------Environmental Liabilities Environmental liabilities are accrued based on estimates of the probability of potential future environmental exposure. Expenses related to on-going maintenance of environmental sites are expensed as incurred. If actual or estimated probable future losses exceed the company's recorded liability for such claims, it would record additional charges as other expense during the period in which the actual loss or change in estimate occurred. The company evaluates its reserve for coal mine remediation annually utilizing a third party expert. Pension and Supplemental Executive Retirement Plan Littelfuse has a number of company-sponsored defined benefit plans primarily in North America, Europe and the Asia-Pacific region. The company recognizes the full unfunded status of these plans on the balance sheet. Actuarial gains and losses and prior service costs and credits are recognized as a component of accumulated other comprehensive income. Accounting for pensions requires estimating the future benefit cost and recognizing the cost over the employee's expected period of employment with the company. Certain assumptions are required in the calculation of pension costs and obligations. These assumptions include the discount rate, salary scales and the expected long-term rate of return on plan assets. The discount rate is intended to represent the rate at which pension benefit obligations could be settled by purchase of an annuity contract. These assumptions are subject to change based on stock and bond market returns and other economic factors. Actual results that differ from the company's assumptions are accumulated and amortized over future periods and, therefore, generally affect its recognized expense and accrued liability in such future periods. While the company believes that its assumptions are appropriate given current economic conditions and its actual experience, significant differences in results or significant changes in the company's assumptions may materially affect its pension obligations and related future expense. Further information regarding these plans is provided in Note 13 of the Notes to Consolidated Financial Statements included in this report. Stock-based Compensation Stock-based compensation expense is recorded for stock-option grants and restricted share units based upon the fair values of the awards. The fair value of stock option awards is estimated at the grant date using the Black-Scholes option pricing model, which includes assumptions for volatility, expected term, risk-free interest rate and dividend yield. Expected volatility is based on implied volatilities from traded options on Littelfuse stock, historical volatility of Littelfuse stock and other factors. Historical data is used to estimate employee termination experience and the expected term of the options. The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant. The company initiated a quarterly cash dividend in 2010 and expects to continue making cash dividend payments in the foreseeable future. Total stock-based compensation expense was $7.3 million, $5.8 million and $5.2 million in 2012, 2011 and 2010, respectively. Further information regarding this expense is provided in Note 14 of the Notes to Consolidated Financial Statements included in this report. Income Taxes The company accounts for income taxes using the liability method. Deferred taxes are recognized for the future effects of temporary differences between financial and income tax reporting using tax rates in effect for the years in which the differences are expected to reverse. The company recognizes deferred taxes for temporary differences, operating loss carryforwards and tax credit carryforwards. Deferred tax assets are reduced by a valuation allowance if it is more likely than not that some portion, or all, of the deferred tax assets will not be realized. Federal and state income taxes are provided on the portion of foreign income that is expected to be remitted to the U.S. and be taxable. 34 -------------------------------------------------------------------------------- The company recognizes the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position are measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement. Further information regarding income taxes, including a detailed reconciliation of current year activity, is provided in Note 15 of the Notes to Consolidated Financial Statements included in this report. Outlook The company's 2012 revenue, excluding acquisitions ($16.6 million) and unfavorable currency effects ($9.4 million), was essentially flat compared to 2011 ($660.7 million in 2012 versus $665.0 million in 2011). The outlook for 2013 is guarded due to global economic uncertainty. The electronics book-to-bill ratio is beginning to improve. Automotive passenger vehicle sales continue to be strong in Asia, solid in the U.S. and weak in Europe. The commercial vehicle market remains weak but has shown some early signs of improvement. Electrical continues to show solid performance in the powerfuse business. There is a world-wide slowdown in Potash mining which may impact the company's relay/custom business. Revenues for 2013 are expected to be in the range of $680.0 to $720.0 million. Capital expenditures are expected to be in the range of $25.0 to $30.0 million. |