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Hubbell Inc.

Q3 2008 Earnings Call

October 23, 2008 10 am ET

Executives

Timothy H. Powers - Chairman of the Board, President and CEO

Bill Sperry, Vice President of Corporate Strategy and Development

David G. Nord - Sr. VP and CFO

Analysts

Robert Cornell - Lehman Brothers

Christopher Glynn - Oppenheimer

Steven Gambuzza - Longbow Research

Operator

Good day, and welcome to the third quarter 2008 earnings release conference call for Hubbell, Inc. Today’s call is being recorded. For opening remarks and introductions I would like to turn the call over to Mr. Bill Sperry, Vice President of Corporate Strategy and Development of Hubbell, Inc. Please go ahead, sir.

Bill Sperry - Vice President of Corporate Strategy and Development

Thank you. Good morning, and thanks for joining us. This morning we released our third quarter earnings. That release is available to you from a number of sources. The easiest way is to go to the Hubbell website at Hubbell.com and access the complete release by clicking on the investor information tab and then click on financial releases from the drop-down menu. It’s also available from the usual wire services.

This conference call is simultaneously being webcast from the Hubbell website. Audio replays of the conference call are available in three ways. First you can have a telephone replay of the call starting two hours after its conclusion, and that replay will be available for a week. To access the telephone replay dial 719-457-0820. The pass code is 4568303. You may also hear the replay on the Hubbell website again from the investor relations tab and then click on audio archives from the drop-down menu. You can listen to the audio as a podcast by downloading it from the Hubbell website.

Let me refer everyone listening to the call today and those who hear a replay to the paragraph in our press release regarding forward-looking statements. That release and this call may contain some expectations based on assumptions in the future and Hubbell’s performance in the future, particularly regarding our earnings. Clearly, these comments are forward looking. We also may make some comments or answer questions today during the call which may include forward-looking statements. All of these involve inherent assumptions with known and unknown risks and other factors that can cause our actual or future results to differ from what we may discuss or project here today. Please note this paragraph in the press release, and I would like to consider it incorporated into this call here this morning by reference.

With that I’d like to turn the call over to our Chairman, President, and Chief Executive Officer, Tim Powers.

Timothy Powers - Chairman, President and CEO

Thank you, Bill. Welcome and thank you for joining us this morning. I am very pleased to have an opportunity to share with you our strong results for both the third quarter and the nine-month period for 2008.

Before we get started I want to make sure I introduce two new people who will be interfacing with you in an investor relations capacity - Bill Sperry and Jim Farrell. Bill joined us in August with the responsibility for our strategy, corporate development and investor relations function. His expertise in strategy, acquisitions, and corporate finance represents a skill set that we can put to good use here. Jim has been a valuable member of our finance team for five years, including supporting Tom Conlin behind the scenes. He is very familiar with the process, and is now director of investor relations.

I know that many of you have talked to Bill and Jim already, but we look forward to all of you getting to know them better in the near future.

Now let’s turn to the structure of the call today. I’m going to provide you with a summary of results that we announced this morning, as well as an update on the markets we serve. Then Dave will walk you through a more detailed discussion of the financial performance. I will conclude with my perspective on the outlook for the rest of the year, 2009, and add some closing remarks. Then we will turn it over to all of you for Q&A.

Moving to the results, I am very pleased to report that, despite the challenging conditions we face, the results are even better than what we promised you at the beginning of the year. We generated sales of $735 million, a growth rate of 13% over last year’s quarter. We had an operating profit margin of 14.1%, a 50 basis point increase over last year. Our fully-diluted earnings per share were $1.18, an increase of 17% over last year after adjusting for a tax benefit to make the periods comparable.

We also generated $100 million of free cash flow, an increase of 42% over last year. These are the best results in our company’s history, and are a testament to the talent and strength of our businesses, and the dedication and focus of the team.

For the nine-month period year to date our sales grew nearly 7% to over $2 billion, while our operating profit margin increased to 13.3% or 130 basis points above a comparable period in 2007. Our earnings per share increased 16% to $3.12 per fully-diluted share. We generated over $200 million of free cash flow, an increase of 14% from the prior year. I am particularly gratified with these results because they show Hubbell to be performing well along several dimensions. The accelerating sales growth demonstrates the ability of our brands to earn price increases from customers, as well as the introduction of new products and the execution of a successful acquisition program.

Our ability to expand margins in the face of a dramatic ramp-up of commodity prices is due to the relentless focus on low-cost sourcing and productivity improvements. Let me comment quickly on the acquisition front. We invested in three acquisitions in our power segment in the most recent quarter. In our lighting business we acquired a high-quality specification-driven business called Kurtversen in January. These acquisitions added four percentage points to the sales growth we experienced in the quarter and three percentage points to the 9-month period. In all, we invested about $200 million year-to-date on acquisitions and they are immediately lucrative.

We have also maintained a conservative balance sheet with low leverage and sufficient liquidity. This structure is appropriate in our view given the environment. Obviously, we are seeing a remarkable level of volatility in the financial sector at a time of economic uncertainty looking forward. I will offer my outlooks later in the call, but will turn it over to Dave now to let him discuss the financials in more detail.

David Nord - Senior Vice President and CFO

I’m going to speak about the financials in more detail focusing on the third quarter. I’ll start with the P&L. As Tim mentioned, sales of $734.8 million is up 13% from the third quarter of last year, with acquisitions and selling price accounting for about 4% and 3% of the growth, respectively.

Our gross profit margin in the quarter was 30% even, slightly better than last year’s 29.8%. It’s important to note that it was impacted by the quarter when we expected to still be fighting significant cost price headwinds, and we ended up slightly negative in the quarter. That had a nearly 50 basis point impact on gross profit. Many have seen the impact of the significant price increases, where we’re just getting parity, having a negative impact on our gross profit margin too. That can be almost as much as another point, so it was a really good performance considering those two factors.

Selling and administrative costs were $116.9 million in the quarter, which was up $11.2 million. Nearly all of that is due to the new business acquired. In fact, as a percent of net sales, selling and administrative costs were down 30 basis points year over year to 15.9%. All that led to a net operating profit margin of 14.1%, 50 basis points or half a point better than last year’s third quarter.

Continuing down, the interest expense of $6.8 million, higher than last year by $3.3 million, is due mainly to higher debt balances, particularly as a result of our long-term debt from the $300 million bond offering in the second quarter of this year.

Our effective tax rate was 30.5 in the quarter, consistent with our guidance to date. Keep in mind, however, that it’s higher than last year which had a rate of 23.8 in the third quarter, as we had favorable benefits from finalization of our Federal Tax Return. Relative to the tax rate, jumping ahead a bit, we expect to see a decrease in the full-year rate to 30% from our 30.5% guidance solely as a result of the recently enacted tax legislation that reinstates the R&D tax credit. It happened earlier this month so it’s a fourth-quarter item. We’ve got to reflect that in the fourth quarter. That will give us a rate for the year of 30. Our rate for the fourth quarter is currently anticipated at 27.6.

Net income for the third quarter is $66.5 million up $1.2 million or 2%. Our diluted shares outstanding were $56.4 million in the third quarter, compared to $59.2 million in the same period last year. So all this results in earnings per share on a diluted basis of $1.18 up 7% on a reported basis from last year’s $1.10. But, of course, adjusting for the tax benefits in last year’s third quarter, it’s up 17%.

Let me turn to the balance sheet. We continue to maintain a very strong balance sheet as Tim mentioned with cash balance at the end of the third quarter of $194 million, more than $100 million better than we started the year. We have a net debt of $268.6 million, up only $24 million in the quarter, despite funding over $100 million in acquisitions in the quarter.

Receivable quality continues to be strong with our days outstanding at 53, six days better than a year ago. Past due balances continue to be at historic lows.

Our inventories continue to improve with days outstanding at 59, three days better than last year and last quarter. There’s still more work to be done there.

There was good performance in balancing the trade working capital cycle with a two day improvement in our accounts payable days. So all that leads to a trade working capital as a percent of sales in the third quarter of 19.1% compared to 21% last year.

Our debt to capital is just under 31%, and our net debt to capital is just under 17%.

Cash flow from operations was $109.7 million in the quarter, $28 million better than last year’s third quarter due to improved working capital performance and also to the timing of tax payments. Our free cash flow, which we define as cash flow from operations less capital expenditures, was $99.8 million in the quarter compared to the $70.2 million in last year’s third quarter. This was due to higher operating cash flow, slightly lower capital expenditures of $9.9 million in the quarter versus the $11.6 million last year.

Let me now turn to the segment results. First on the electrical segment we had sales of $522.9 million up $26.5 million or 5% compared to the third quarter of last year. Half of that increase was due to price and half was due to acquisitions. Excluding the residential impact on volume, the growth was equally split between price acquisitions and volume.

Operating income was $68.7 million up $4.4 million or 7% from last year. Margins were up slightly at 13.1 from the 13.0 in the third quarter with the continuing drag from residential being worth about a half point on margins.

Within the segment all of the businesses, excluding residential, showed improved top line growth, with the electrical products and wiring businesses up double digits. Wiring, in addition to volume growth had profit-margin improvement as a result of higher volume and productivity improvements. On the lighting side, there was growth in the C&I business while residential was down 23% in the quarter. Over-all profitability decreased as a result of a lower volume in residential and the commodity cost increases not yet recovered through pricing. The favorable impact of the Kurtversen acquisition and productivity improvements provided some offset.

On the electrical products side, we showed continued strong volume growth in industrial, at Harsh and Hazardous, and even on the construction side, with continued improvement on profitability as a result of the higher volume selling price increases and productivity.

On the power segment side, reported sales of $211.9 million up $55.6 million or 36% from last year’s third quarter were due to a combination of a lot of strength, acquisitions, and the impact of storms late in the third quarter. We attribute about half of that increase due to the above-mentioned and the other half due to organic volume and price increases. All that led to an operating profit of $34.6 million up $10 million or 41% from last year.

Despite and included in this performance there is still some of the negative cost-price in the quarter was experienced in the power segment as they are the biggest consumer in the business of steel, which despite near term reductions in the cost of steel as we've talked throughout the year, we're out three and six months.

So declines in prices will take time to work their way back in. They are not expected for the remainder of this year. So, all in all, a very good quarter with solid performances across all the businesses in just about every measure.

With that I'll turn it back to Tim.

Timothy Powers - Chairman, President and CEO

Thanks Dave.

Now let's turn to the outlook for the balance of the year and beyond. With the dramatic upheavals in the financial industry and the seizing up of liquidity that are shaping up this financial credit crisis, these are remarkable developments.

We applaud the efforts of the government and in fact the apparent cooperation internationally of governments and central banks to address the lack of trust that has emerged.

While we view these efforts as helpful, it is too early for us to determine their ultimate impact, and thus our outlook in these markets will continue to have an uneven impact on Hubbell.

In the near term, the residential construction market continues to be on the same weak track as even the September numbers for housing starts show continuing declines on a very low base.

With secondary home prices not yet stabilized and the limited availability of financing, we expect these declines to persist into 2009. The non-residential construction is Hubble's largest end market, and the spending there continues to hold up admirably, although we are very cautious considering the tremendous upheaval in the credit markets.

The industrial market is slowing as capacity utilization is declining.

On the other hand, we continue to see utilities spending to be above last year even adjusted for storm impacts this year. And we see the same high levels in our harsh and hazardous segments serving the energy markets and in the building automation segment of our wiring business.

And another growth opportunity exists in our lighting retrofit market of our lighting platform, where we anticipate owners of older buildings to elect to install newer, more energy efficient equipment.

Given everything we see, we expect to do better than we indicated at the beginning of the year. We expect to deliver a full year 2008 sales growth in the 6% to 7% range and earnings per share of $3.80 to $3.90 per fully diluted share.

Underpinning this forecast is the reasonably strong 4rth Quarter but some charges related to work force reductions that we believe are necessary to prepare for the softness in 2009.

To conclude, we are very pleased with the performance in this quarter and we believe we will finish the year strong.

We are confident that the discipline and the energy of the Hubble management team will continue to effectively utilize our high-quality brands, implement growth initiatives, focus relentlessly on productivity and be supported by a conservative balance sheet to manage the challenges of 2009 to deliver favorable results.

Thank you for your attention. Now let's turn it over to you with some questions.

Question-and-Answer Session

[Operator Instructions]

We'll take our first question from Bob Cornell at Barclay's Capital. Go ahead sir.

Bob Cornell

Thanks. First of all Tim and Bill… Jim could you summarize could you summarize maybe what the difference is, he said that the results would beat the early year expectations. Could you summarize a couple of reasons for that beat and wheater it's revenue, cost price, and which business really throw the beat?

Timothy Powers - Chairman, President and CEO

Are you talking about for the quarter or for the year?

Robert Cornell

The quarter and the year, really. You said you did better than expected. I'm saying what was better than expected more explicitly?

Let's go back and talk about the conditions at the beginning of the year. We said that we didn't really expect much favorable contribution from unit growth looking at 2008, and we thought that most of the year's increases were going to be caused by acquisitions and price.

Certainly we think that by and large that has been true; that there have been very limited amounts of real unit growth and certainly the utility business is one area and some sectors in lighting, and our industrial business of [harsh end hazzards] has contributed some.

But it hasn't been a year of what I would call strong unit growth. And that has really continued through the year. Certainly there's been a spike in the third quarter caused by a storm business and a strong year right through the year in the product lines servicing the oil and gas sector.

But the year is shaping up pretty much like we anticipated. But we really didn't anticipate such sharp growth in commodity costs when the year began. And as a result we've been talking all year about the battle between cost-price and productivity.

And in the third quarter in particular, an unprecedented rise in steel prices and energy prices, even though those have come off just lately, but that's been our battle all year long. So I think we've done a little bit better than we anticipated in that cost-price challenge this quarter.

Last quarter is not exactly that in itself. But if you look at the whole year it's pretty good. And acquisitions - We've had a few more lately than we anticipated at the beginning of the year.

That summarizes it.

Robert Cornell

I guess the question that all of us would like to know is again, you point out the non-res and it's holding up a little bit better than you thought it would. But maybe just give us a little more of the visibility you might have out there. What's going on with the inquiry rates, the order rates, and how much visibility do you have out there? Are projects slipping? Just expand on that point please, Tim.

Timothy Powers - Chairman, President and CEO

Sure. I would say that our order rates in October are reasonable and in line with our guidance. Our quotation rates are still good.

We hear antidotal evidence and stories of projects being delayed because of financing. They have not yet showed in any dramatic way in our order pattern.

Certainly the psychology of what's going on here in the credit markets with the stock market is having a negative effect on everyone. I would expect our distributors to finish the year with a conservative position towards their inventories. Whether they see a downturn or not, they are just going to be cautious like everyone else in the business.

So we do not have good visibility very far into the future right now just because of the magnitude of what's going on in the credit crisis and how it, undetermined at this point, it's going to effect projects going forward.

But just from all that we can see, as it has a negative effect on the general economy it certainly will not be helpful to the markets we serve either.

Robert Cornell

How locked in is the fourth quarter guidance you gave? How much of that is done and how much of that is undefined at this point?

Timothy Powers - Chairman, President and CEO

We have a backlog that's a month. About a month's worth of sales and we're halfway through the first month of the quarter. So half of it is in our hands and half of it is the rest to come.

Robert Cornell

Ok. I got it. Thanks.

Operator

We'll take our next question from Jeff Sprouge at City Investment Group

Jeff Sprouge - City Investment Group

Thank you. Good morning.

First on power, Dave. You said acquisitions and the storms were about half the growth. Can you split those two apart for us so we can understand the impact of these recent deals?

Timothy Powers - Chairman, President and CEO

Sure. Acquisitions were about 10 points of the growth. Storms was about 8.

Jeff Sprouge - City Investment Group

And what do you think about the carry on effect of the storms? I'm sure that's part of your Q4 outlook is it a two-quarter fix. Does this spill into early 09? Do you have any thoughts there, Tim or Dave, on how long this remains?

Timothy Powers - Chairman, President and CEO

Certainly there's a help in Q4. It would be too early to determine whether orders will remain. This is also across the transom day in day out orders to see whether rebuilding continues at a high level into the first quarter. I'm not sure of that at this point.

But I would say certainly our revenues will be higher because we're still fulfilling some orders in Q4.

Jeff Sprouge - City Investment Group

And your comments to Bob on orders elsewhere were straightforward. But I wonder on oil and gas. Now we've got a six handle on the barrel of oil. Some of those harsh and hazardous projects that you're seeing in the oil patch. There are really some signs that some of that stuff is slipping.

Timothy Powers - Chairman, President and CEO

Yes. I would say there are a couple of things about that. One is that the business we're seeing today was decided months ago or years ago, right, unless it's the repair from the storm.

So, it really has more to do with future decisions of those folks, developing oil and refining oil and what projects they go forward with from here. So I don't hear of any projects that are underway being stopped. But the rig-count and things like that have started to slow a bit. But it determines whether oil stays at $70 a barrel or what the future forecast of that is.

But if it's $70 a barrel there's still profit for everyone there.

Whether they continue at that rate I don't know.

Yes. What is the early dynamic, if any, on price in the channel? You obviously do have the delayed impact of costs coming through. You said it would be three or six months before you start to feel the benefit of costs going the other way.

Is the channel already pushing back on price watching these commodities drop?

What's the tone of discussion there? How do you set prices for 09? Catalog prices- that whole dynamic.

While there is certainly talk by end customers of that, and I would say it's an increasing amount of discussion and some pressure. It is because of the magnitude and the speed with witch commodities have declined. And so it would still be early for us to make any clear statements about the outcome of this.

But I would say that if commodities stayed as low as they are, certainly we would have to go back to some prior level of prices, I would say.

Jeff Sprouge - City Investment Group

Ok. Thanks a lot.

Timothy Powers - Chairman, President and CEO

Sure.

Operator

We'll take our next question form Christopher Glynn with Oppenheimer

Christopher Glynn - Oppenheimer

Thanks. Good Morning.

Timothy Powers - Chairman, President and CEO

Good morning Chris.

Christopher Glynn - Oppenheimer

On the price-cost, going back to some of your comments at the beginning of the call- I just wanted to clarify. It sounded like you were breaking out the drag from price-cost into two parts. Was there a total of 150 basis points headwind from price-cost in the quarter?

David G. Nord

The biggest part of that Chris is from the math of increasing the magnitude of increasing sales to cover costs, which just has a simple mathematical detriment to you margin sign. From an absolute standpoint, not breaking it out, it was a net negative on an absolute basis, on an absolute Dollar basis.

Timothy Powers - Chairman, President and CEO

So we, to make it clear, is when we raise prices we're just trying to recover the material content of the increase and that we really rely on our own productivity to offset our internal labor costs. So mathematically if you just get back in price that material cost, then your margins does not expand. That's what I think Dave is saying.

Christopher Glynn - Oppenheimer

Right. Did you say there was 100 basis point impact from that, and then a 50 basis point in the areas where you actually had a shortfall still?

Timothy Powers - Chairman, President and CEO

Right.

Christopher Glynn - Oppenheimer

So, 150 basis point overall drag

Timothy Powers - Chairman, President and CEO

Right.

Christopher Glynn - Oppenheimer

Ok. How would you see it playing out if it gets some of that pressure, but your costs start to flow through a little cheaper; would that gap tend to close, in that deflationary environment?

Timothy Powers - Chairman, President and CEO

Yeah, I mean, we’re still trying to get up to the break-even on what steel prices are even today, if they’re a little softer. We haven’t fully caught up with the magnitude of the price increases in steel. And certainly, we’re still paying on a delayed basis in our freight rates and things like that. Fuel charges, surcharges that are above the $70 a barrel number. So we’re still chasing costs up at this point and I think it will be some months before we talk about a rollover or anything like that. But I would say that I wouldn’t expect a decline in margins from this particular phenomenon going the other way. If we would see a decline, I would say it would more be attributable to the change in physical volume going the other way, than it would be from this cost-price phenomenon.

David G. Nord

Or, it could be competition, you know. In a weaker market, more battle over less business, that could contribute also.

Timothy Powers - Chairman, President and CEO

Hey Chris let me just clarify one thing to the hundred and fifty basis points that we are talking about was on the gross margin line. Now, you lose some of that obviously because of the higher sales value, you’ve got to give back in commissions and selling costs, so on an operating margin basis its closer to a point.

Christopher Glynn - Oppenheimer

Ok, and the acquisitions impact about half-peak or half the new ones?

Timothy Powers - Chairman, President and CEO

Yes

Christopher Glynn - Oppenheimer

Ok, just a couple on working capital and cash flow and I’m done. The fourth quarter is typically your strongest cash flow quarter. Does that stand or did you kind of get some of that a little early, it looks like, potentially. And lastly, what is the inventory opportunity for turns and inventory reduction in ’09?

David G. Nord

I’ll take the cash-flow first and then Tim may jump in on the inventory. But clearly on the cash-flow, you’re right, fourth quarter is typically our strongest, third quarter was a nice quarter and there might be some of the fourth quarter benefit that rolled in, but nothing that we’re specifically aware of. So, we think that the fourth quarter should continue to be strong absent some shock in some segment of the market, some difficulty on the customer side, none of which we are currently anticipating or we see. We’ve gone beyond, as I’ve mentioned, we’ve got a very good history on our days and our overdues, but we’re even going beyond that to try to risk assess some of our customer base to make sure, because some of these things happen without warning. So, we’re pretty much on top of that.

Timothy Powers - Chairman, President and CEO

I would say on the inventory side, really it’s trying to be prepared, but keep generally slowly reducing your inventory at a gradual pace. Its hard to judge right now what 2009 may look like, but just generally, we are trying to take inventories down in the $10-20 million range. That would be our short term objective.

Christopher Glynn - Oppenheimer

Ok, thank you, appreciate it.

Operator: [operator instructions]

We’ll take our next question from Steven Gambuzza, with Longbow Capital. Go ahead, sir.

Steven Gambuzza - Longbow Capital

Good morning, I was wondering about the acquisitions that you announced this quarter; would you expect them to be operating close to segment margins in 2009?

Christopher Glynn - Oppenheimer

Yes.

Steven Gambuzza - Longbow Capital

Great, thanks very much.

Operator

[Operator Instructions]

All right, it appears that we have no further questions at this time. We will now turn the program back over to Mr. Sperry.

Bill Sperry, Vice President of Corporate Strategy and Development

Thank you everyone for joining us this morning.

I see a lot of you are back to back to back, so thanks for joining and we are available for questions and calls, please check in with Tim and I if you have any. Thanks.

Operator

Ok, this concludes today’s conference, you may disconnect at anytime.

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Source: Hubbell Inc Q3 2008 Hubbell Inc. Earnings Conference Call
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