Jim Farrell - Director, IR
Tim Powers - Chairman, President and CEO
Dave Nord - SVP and CFO
Bill Sperry - VP, Corporate Strategy and Development
Christopher Glynn – Oppenheimer
Rich Kwas – Wells Fargo
Hubbell Inc. (HUB.B) F3Q11 Earnings Call October 20, 2011 10:00 AM ET
Good day, everyone and welcome to the Hubbell Incorporated Third Quarter Results Conference Call. As a reminder, today’s call is being recorded. Now for opening remarks and introductions, I would like to turn the call over to Mr. Jim Farrell. Please go ahead, sir.
Good morning, everyone and thank you for joining us. I am here today with Tim Powers, our Chairman, President and Chief Executive Officer; Dave Nord, our Senior Vice President and Chief Financial Officer and Bill Sperry, our Vice President of Corporate Strategy and Development.
Hubbell announced the third quarter results for 2011 this morning. The press release and earnings slide materials have been posted to the investor site of our website at www.hubbell.com.
Please note that our comments this morning may include statements related to the expected future results of our company and are therefore forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995. Therefore, please note that the discussion of forward-looking statements in our press release and consider it incorporated by reference into this call.
In addition, comments made here also may include some non-GAAP financial measures. Those measures are reconciled to comparable GAAP measures and are included in the press release and the earnings slides materials.
Now, let me turn the call over to Tim.
Thank you. Welcome everyone and thank you for joining us this morning. As we typically do on these calls, I will provide you with some overview commentary on the results we announced this morning and then, Dave will provide you with a more detailed discussion of our financial performance. I will then share some early thoughts 2012 and then we will open up the call for your questions.
We will refer to presentation materials that you can find on our website, I will start on page 3. We are very pleased to report that the positive momentum from the first half of the year continued into the third quarter. Our sales increased by 12% with growth being realized and virtually all of our businesses.
We reported operating margins of 16.4% which represented an impressive improvement from the second quarter was as expected was below the prior year due to a less favorable product mix and higher commodity costs. I am very proud of our results in the quarter as half of our markets remain at trot levels and working through a challenging pricing and commodity cost environment.
Looking at our end markets, we continue to experience strong demand on incoming orders during the quarter. The utility market strength was broad with higher demand in distribution products and increase in spending on larger transmission projects as well as improved international demand.
The industrial market continued to improve with most of our businesses including those tied to the energy markets realizing higher sales in the quarter. The new construction spending in the US non-residential market remains quite challenging, but we continue to benefit from higher demand for renovation and relight projects. On the residential side demand remains weak. I will share an early view of our 2012 end markets towards the end of my comments.
So, the volume story was quite favorable, but the commodity cost pricing dynamic has been a challenge while price increases added to sales in the quarter, they were somewhat below our expectations. Price realization proved to be more difficult in certain pockets of our business most notably the construction markets.
Also materials remain above last year’s levels and did not moderate quite as much as we anticipated. We will continue to adjust pricing to recover commodity cost increases and have raised prices in certain businesses in September.
In summary, I’m extremely pleased with the organization’s ability to produce these impressive results in both the third quarter and for the year.
Let me hand it over to Dave to provide more details on the results, Dave.
Okay. Thanks, Tim. Good morning, everybody. Let me jump into the results, I’ll start on page 4, you know, first on the sales side, we’re reporting sales of $764.3 million up 12%. As Tim mentioned really broad based improvement through all of our businesses particularly strong, we’ll talk more about our utility business. In that 12%, there is some price and currency that combined are about 4%, so our core volume grew up 8%. I think price and FX in that 4% are about equally split. So, good results there.
On the gross margin side, 33% gross margin in the quarter, now that’s down from last year’s third quarter, for a couple of reasons. One, our commodity cost still in excess of price realization, we had forecasted and we’ve been working toward getting the parity in the third and maybe some improvement in the fourth. But, as Tim mentioned, the pricing environment turned out to be unfortunately a little more challenging than we expected.
The other big driver to that decline is this less favorable mix and you recall we talked about that in the third quarter of last year, some very strong project business coming out of our industrial sector, particularly our high voltage in telecom. I think that had a significant, we would estimate that’s close to almost 1.5 of margin impact last year.
So, we are very pleased actually with our 33% because when we look at that 33% it wasn’t that long ago when we were talking about 28% gross margin. Good improvement and I think that adjusted for last year’s unusual items, I think that’s probably the highest level gross margin we’ve seen in the last three years on a quarterly basis. So overall very good performance in a trend we continue to work to improve.
Turning the page to our other expenses, other costs, selling and administrative cost of $127 million up only 8% despite 12% volume growth. So, good performance there, we’re continuing to maintain discipline even in a strong growth environment for the quarter.
So well, that led us to operating profit of $125.3 million in the quarter, operating profit margin of 16.4%. Again, pretty much due to the impact of the mixed strength that we had in the third quarter of last year, but in absolute terms, we are very pleased with operating profit margins of 16.4%.
Turning to Page 6, some of the other items are other income and expense, net down $7.3 million in the quarter down little over a $1 million from the third quarter of last year. Last year we had some foreign currency losses on transactions that we are recognizing and as well this year, we have a little less lower net interest expense. We have a slightly higher interest expense from our higher outstanding borrowings from the debt issuance last year, but certainly at lower rates, but with our cash balances on hand, little bit better investment income that we are generating there to the tune of about $0.50 million.
That leads to one of the bigger items in the quarter from a competitive standpoint and that’s on our tax rate. The tax rate in the third quarter was 29.4%, certainly lower than we had been tracking for the first six months and much lower than last year and I think that nearly 5 point difference from last year is really attributable to two things.
First, this year in the third quarter, we had some true-ups of some items as we got to the point of filing our tax return, I had better information and that contributed about 2 points to a lower rate in the quarter. You’ll also recall that last year’s third quarter was actually higher than normal because we had almost a similar amount of expense associated with settling some prior year audits. And so, that’s about 4 points to the Delta and the last item is the R&D tax credit, which we have been talking about throughout this year because it wasn’t reenacted until the fourth quarter of last year. So, it’s benefited us in the each of the comparative quarters this year by a point. So, all of those things, you know, basically what’s causing the 5 point reduction in our tax rate. No other real changes, in fact, we would expect that our tax rate for the fourth quarter will be, likely be closer to what we experienced through the first half and that was 31.5%.
Turning now to the page 7, net income of $82.4 million up 16% certainly due to the increased operating profit and the lower tax rate and earnings per diluted share of $1.37 up 16% from last year’s $1.18.
Let me now turn to the segment results on page 8. First on the electrical segment, reporting sales of $526.6 million up $36 million or 7% from last year’s third quarter. And really with broad based increases in all of our businesses other than the impact of the project business from last year and the underlying industrial businesses showing growth excluding some of those large project businesses. And in that 7% we had foreign currency and price contributing 3% to that volume growth.
On the operating profit side, $81.5 million down 3% from last year’s third quarter, big driver being the less favorable mix this year than last year being the most significant impact.
On the price cost front with the higher commodity costs not yet fully recovered by pricing that cost us so a couple of million dollars in the quarter so that’s costing us nearly a point on the margin all of that being somewhat offset by the incremental margins on the higher sales. So, very good performance certainly we are pleased with the absolute performance in the electrical segment being in excess of 15%, and we expect that to continue to improve as the cost price dynamic continues to improve.
Let’s turn now to the power segment on page 9, where we were reporting very solid results, sales of $237.7 million in the quarter, up 22% a very nice market performance. The drivers to that 22% about half of it is due to the higher distribution and transmission spending. We think that the distribution side of the business is up mid-to-high single digits and the transmission side of that business being of low-to-mid teens business.
Also, we had some very good results in our international demand in particular as you know, one of our bigger international operations is in Brazil. So, we’ve had some good market demand and growth in Brazil. We’ve had good price recovery at 3%, and then there are some other items that would be in there and particularly one of note, which isn’t as significant in terms of dollars. But certainly, one that you might expect is that some storm impact. There was some benefit year-over-year from the significant storms that we experienced in the third quarter particularly on the East Coast and that contributed probably about 2% to the top line growth.
So a lot of factors impacting the power business growth, but very good performance and performance that we expect to continue. All that contributing to operating profit in the quarter of $43.8 million, up 30%, and improved margins to 18.4%, up from the 17.3% in the third quarter last year. Obviously a big driver to that is the significant increase in volume, still a little bit despite 3 points of price, still a little bit of headwind just under $2 million of price cost headwind in the quarter. And then, some keen focus on productivity to offset the other cost inflations and some of the spending on growth initiatives, engineering, new product development and the like. So, all in all very good performance in that segment, we’re very pleased.
Now, let me turn to cash flow on page 10. Free cash flow which we define as operating cash flow after CapEx was $90.6 million, little bit better than net income with $8 million more than net income, certainly better than last year. And a lot of that being driven by the focus on working capital, despite working capital being a use of cash in the quarter of just under $10 million that’s a pretty good number considering the growth that we’re navigating through and I think a lot of that is attributable to the focus of our working capital, we focused on our receivable, our quality of receivables is good, our aging is good with no slippage in our days upstanding. Our inventory focus, we got to pick up a day in inventory outstanding, so we got one day improvement there, and we’ve got four days improvement in our outstanding payables. We’ve talked in the past the scenario of focus for us to move closer to industry standard in our payable cycle.
So all that leading to good cash flow generation in the quarter and I think a lot of that cash flow generation help support the investments that we make in capital, in dividends and as you will see, in our share repurchase in the quarter where we bought back just over a million shares in the quarter, spending about $55 million and in fact that share repurchase level exhausted or pre-existing authorization and so we announced last month that the board approved a new authorization for an additional $200 million to give us the flexibility to consider share repurchase in all of our capital allocation decisions.
Let me get to the year-to-date results and I will go through these more quickly because a lot of it is consistent with the first half and the third quarter. Sales year-to-date of just over $2.1 billion, up 12% for the year-to-date comparable to where we were in June on a year-over-year, operating profit of $314 million, up 13% and operating margin up 14.7%, up 10 basis points.
The tax rate of 30.6%, a little bit lower as I mentioned because of the third quarter changes in estimates from our year-to-date 31.5 and I expect the fourth quarter to be closer to our first half rate of 31.5 and that will give us a rate for the year when you take into account the third quarter of just under 31%. That also gives us net income year-to-date of $197.9, up 18% and earnings per share through September of $3.25, up 17% and cash flow of $175.9, up 24% as a percent of net income not quite at our objective of equal to or exceeding net income quite actually improved from the relationship last year and we always have some seasonal pick up in the fourth quarter following a very strong sales levels in the third quarter. So, we are tracking to our objective.
Turning to the segments, just year-to-date at a high level of the electrical segment reporting sales year-to-date just under $1.5 billion, up 10%. Some of the benefits in the first half start to moderate in the third quarter and that’s the strong industrial because of some of the dynamics around the high voltage in telecom. The renovation and relight activity continues and that impact is one of the contributing factors to our full year expectations relative to volume.
The lower residential, underlying residential demand for the first half of the year is there, but we see that starting to level off and maybe some very early signs of improvement or at least improvement at our performance.
And then, currency in that 10%, we had currency and price adding 4%. On the profit side year-to-date $208.3 million, up 13% again higher sales certainly a big contributor still navigating through the higher commodity cost and with productivity the offsetting focused against other inflation.
The power segment year-to-date on page 13 with the year-to-date sales of 641 million up 18% even improved from year-to-date, which was only 15% and offer the similar reasons that we have experienced in the third quarter, but with the improved level of activity in both distribution and transmission spending.
And on the operating profit side, operating profit year-to-date of $105.7 million, up 15%, nice performance there with the higher sales helping to offset some of the commodity headwinds that we’re navigating through. So all in all, we are very pleased with where we are sitting through nine months of the year. And similarly, on cash flow, free cash flow year-to-date of $171.9 million, a little bit short as I mentioned of year-to-date net income, but certainly not unusual. And increased spending will mode on CapEx with $41 million, up from last year’s $33.8 and we tend to target about 2% of sales and I think the third quarter was a little bit low, we expect the fourth quarter – we expect it to be a little bit higher to meet our full year target of about 2% of sales.
A lot of that attributable as I mentioned turning to page 15 to trade working capital and our focus on trade working capital a while – our trade working capital as a percent of sales will bounce around in a similar fashion to the seasonality of our business. The objective that we are always targeting is to be better and comparable periods year-over-year and I think we see that with an improvement from the third quarter of last year, which was in excess of 19% to the third quarter of this year, which is 18.5%. So, a lot of focus on the area of trade working capital and cash flow generation.
Turning to page 16 that will lead us to a very strong capital structure, we finish the quarter with $512 million of cash, little bit less than we started the year, but a lot of things that we are investing in and particularly are spending around share repurchase. The other item of note is what we announced this morning in a separate filing, we replaced our existing $350 million revolving credit agreement with a new five year agreement for $500 million, expansion capability of another $250 million. So, we think we are very well positioned with very good terms for the next five years. All of that being very important in support of our growth activities both internally generated and more importantly acquisitions, and I think the acquisition pipeline has been very active.
We closed on a small transaction last week, our first transaction since Burndy acquisition and most interestingly it was an acquisition that came out of the Burndy, it was a (Bello brand) little connector business for the Burndy acquisition.
We have signed another transaction this week that if it goes well, we would expect to close within 30 days. Now these are smaller transactions, I think the combined both transactions would be about a $30 million investment in the quarter, but there is 3 or 4 letter stacked up behind that not yet in the stage of signing an agreement. So, not likely to occur in the fourth quarter, but certainly it could be something that we would hope to be looking at early next year. So, all in all, lot of good activity, lot of good things happening.
So, where does that leave us for the rest of the year. I think, the sales we’re projecting based on third quarter performance and some current run rates, we think, we will finish the year with sales up above 12% that’s up from our last expectation, which I think was 7% to 9% and I think there is a number of factors that are contributing that, not the least of which is the strength that we have seen in the power segment. A lot of transmission orders, being pulled in, being released, maybe a little earlier then we expected, we are little more cautious early on, but now we are starting see some of that flow and some of that is in backlog sort of, it’ll run through the fourth quarter.
I think, we have also seen, we have always been cautious on the relight and retrofit and the sustainability of that in any quarter. I think we have seen that to be stabilized and we expect that to continue at a reasonable level to give us, you know, growth in the commercial and industrial lighting business. And I think, the other markets industrial and Harsh & Hazardous are both held up extremely well. But, if I had to order them I would power first in – we are better, I think we are going to finish better. The relight and retrofit and then just a broad based improvement we have seen through the third quarter.
Margin expectations for the year are more likely to be an increase of only 20 to 30 basis points that’s down from our prior guidance of 50 basis points. And the big issue there is that the commodity cost price parity that we expected to have for the year based on the third quarter dynamics in pricing, a concern that that dynamic will continue into the fourth and that’s going to give us some headwind and that we weren’t anticipating. Now commodity costs underneath have shown some signs of moderating and so we could see some benefit coming from that, but unfortunately because of some of our buying practices, we don’t experience any declines in commodity costs real time, it takes some time for that to flow through even though we are a reliable company.
So, certainly an improvement year-over-year, not at the level that we would have expected, but an area that we continue to focus on. Free cash flow expected at this point to equal net income and again our balance sheet allowing a lot of flexibility for acquisitions. So, when we are all done, we are expecting sales and earnings per share to finish this year at above prior peak levels.
So with that let me turn it over to Tim to give a little bit further view of the future.
Thanks Dave. Now, let’s turn to page 18 for discussion of our early view of the 2012 outlook. We usually provide next year’s outlook in our January call. But given recent volatility, we thought it appropriate to provide some early comments.
Looking in the 2012, we remain cautious, but optimistic about our end markets. There certainly continuous to be numerous macro concerns going into the comp up coming year. The general health of the global economy is unclear and the remains a high level of political uncertainty in Washington combined with stubbornly high levels of unemployment.
As you are aware, our visibility in the future demand is less than two months for most parts of our business. What we continue to like, what we are seeing in our incoming order patterns as well as conversations with our customers.
We are expecting modest single digit growth in our markets in 2012. The third party forecast for US non-residential new construction is for a modest decline and put in place spending in 2012 with a more meaningful recovery shifted into 2013. This decline is expected to be primarily due to weakness on the public side as stimulus dollars get exhausted. However, as we experienced in 2011, we believe the demand for renovation, relight and lighting controls will remain strong and more than offset the declines in new construction, allowing for modest growth overall in this end market.
Our lighting business has been participating in this growth, as our products helped customers become more energy efficient or providing compelling paybacks and cost savings.
The adoption rates for LED product continues at a very strong pace with sales doubling in both the third quarter and year-to-date and now represents just below 10% of our total lighting sales. We expect this strong growth demand to continue as LED costs are likely to continue declining while performance improves.
Our utility market has been quite strong during 2011 with growth and distribution, transmission, project activity as well as higher international demand. On the transmission side we are encouraged by the increasing activity in large project spending that has occurred in the current year and fully expect that growth to continue into next year and beyond.
The distribution side of the business should grow with higher maintenance spending in the key driver of growth, well housing starts are unlikely to benefit spending. On the industrial side of our business, we expect modest growth for next year. The strong rebound and spending that has occurred is likely to moderate somewhat, but still expanding its 2012 would only be the third year of the industrial cycle recovery. We also expect continued growth in our industrial business that are tied to the energy market which includes our Harsh and Hazardous products.
We are not expecting any meaningful recovery in the residential market, although slow modest growth is likely, high levels of unemployment, slow wage growth and home foreclosures continue to impede new single family housing construction.
In summary, we are pleased that we are on track to exceed our prior peek earnings in 2011. When you consider that half of our markets are at trot or near trot levels and that the cost price headwinds anticipated for the year, these are impressive result. Despite the success significant opportunities remain in front of us. We have excellent positioning on the long term secular growth opportunities in the energy efficient products and then in nations grid infrastructure, that is in the midst of a strong project activity for transmission related projects.
These are areas where Hubbell’s products continue to add value to our customers. The entire organization remains energized and engaged in productivity initiatives, they will be needed to offset inflationary pressures. We continue to seek outweighs to become more efficient through our lean programs, sourcing efforts and rationalizing our manufacturing footprint. So, we remain very optimistic about our full ability to generate attractive returns for our shareholders into the future.
With that this concludes our prepared remarks and now we like to open up the call to your questions.
(Operator Instruction) And we will take our first question from the line of Christopher Glynn with Oppenheimer.
Christopher Glynn – Oppenheimer
Thanks, good morning.
Good morning, Chris.
Christopher Glynn – Oppenheimer
Couple of questions on the lighting, you commented on the overall growth entered in the quarter and then with LED nearly 10%, if you could talk about what the margin impact on that kind of mixed transition is in, you know, how it’s evolving?
Okay, let me start with the LED discussion and the margin. For us, our LED sales margin is about the same as or the average product category. So, if we are talking about down light it’s the same as the average down light or we don’t experience a relative premium but we are not experiencing any margin degradation in the sale of a combined unit. And we are doing a extremely well but I think overall in the penetration of LED lighting when you consider that how much of anybody’s business when you have a Conglomerate as fluorescent so to say that the number is approximately 10%, when about a 30 business as fluorescent means that the adoption rate for LED is higher on the rest of the business. So, I think we’re doing extremely well there and we would expect that rate to continue, the rate of increased adoption.
And Chris, what was the nature of the first part of the question?
Christopher Glynn – Oppenheimer
Just the overall lighting growth in the quarter?
I think, the question was lighting overall was about 8%, little more on the C&I side, but actually some positive results even on the residential side as you know, we’ve tried to expand our reach beyond home building and I think some of that’s coming out of the DIY side and other channels.
Christopher Glynn – Oppenheimer
Okay. And then, if the construction markets don’t look like the traditional serve markets will improve next year at this point which is in your outlook, is there any reason to think the price cost relationship would be any different than it is this year?
Well, there is all kinds of reason to believe that it would be different by mean with the fluctuating metals and energy cost, it’s quite difficult for us to predict, you know, the overall relationship there. It’s just one that we have to adapt to as we see changes. We don’t even know we believe that or see that metals costs have declined, we don’t foresee any dramatic decline as we saw back in 2008. We think the economy is at some a little bit of a pause. But, as you can see that every time there is any news towards anything positive in Europe, you can watch oil prices jump up several dollars and copper and others are following. So, we think that the prices have come up there high is a little bit, but we would expect if the economy goes forward and gets a little better worldwide that these commodity costs would continue to raise back to levels that we previously seen.
Christopher Glynn – Oppenheimer
Okay, thank you.
Our next question comes from the line of Rich Kwas with Wells Fargo.
Rich Kwas – Wells Fargo
Hi, all. How are you?
Good morning, Rich.
Rich Kwas – Wells Fargo
Dave on price cost, if we look at the, I guess, when you look at the 50 basis point target for operating margin that was previously communicated. Now it’s 20 to 30. How much of that is price cost versus mix adverse mix versus expectation?
It’s almost oil price cost.
Rich Kwas – Wells Fargo
Okay, okay. And then, Tim on the (LFL12), the organic growth, does that include assumption for market outgrowth. So, you’re saying the market, you expect your market to grow low single digits, would you expect that you get a couple points on top of that based on just product penetration, new product launches that sort of thing?
Yes, so we’re just talking, to make it clear. We’re talking about the fact that our markets as we see them will grow in a low single digits modestly. So, we are in a condition, I would say that’s very similar to this year with the exception that I would say, the rate of growth in the industrial market will be somewhat less, but still growing and we can’t predict that we are going to see the kind of growth rate on the power side that we are seeing this year. I mean, everything is going so well this year and every level of the market that we are confident that we are going to see growth in the utility business, but at what rate you know, remains to be discussed or remains to be seen as we get closer to it.
Rich Kwas – Wells Fargo
And then, just a follow-up on that too. I think for the revenue guidance ’07 and ’09 assumed something like two to three points of market outgrowth with new products, product penetration etcetera. Is that coming in ahead of expectations with the new 12% revenue growth the two to three points of you know, market outgrowth, is that better?
I think its pretty comparable.
Rich Kwas – Wells Fargo
Okay. And then, so is the way – a good way to think about for next year is that right now low single-digit growth for ’12 and then maybe a couple of points of market outgrowth for the new products?
Rich Kwas – Wells Fargo
Okay. And then, just Tim last question on transmission spending you know, it certainly seems like you are more positive on the outlook relative to the March Investor Day, could you just give us more color on what’s really driving it, it seems like a lot of these projects are or some of these projects are getting released and more or so than what you had originally thought then what’s driving and is there any what’s the risk that this growth doesn’t really play out to the degree that you currently think and what’s the major risk there?
All right. Well, I think what’s different between when we spoke earlier in the year and now is we were – I would say piling up awards, we were notified that we were winning and now these projects are being released with pretty short notice, not the usual kind of get ready, get set. Suddenly, we were getting these several months earlier than we thought, which is all good news.
Some of these orders will not be shippable until next year and some of them, we are trying hard to get shipped by the end of this year. So, we have visibility into many, many of these projects and the state at which they are at and right now unless there is a change of pace to the industry there is plenty of projects on the drawing board in an advanced stages of bidding that would lead us to believe that there is going to be a decent growth in the transmission side for 2012.
Rich Kwas – Wells Fargo
And then, it sounds like the book of business that’s being quoted is expanding as well, out to the future?
Yes it is. And you know, so we are working on projects that we don’t believe will come to bid until 2013. So, there is just a lot of activity going on and we are pretty much on top of every single job. So, we are very pleased with the development on this and its been sometime coming what I think, we are at, you know, a wave of increased level of business that should last into at least ’13 perhaps even ’14.
Rich Kwas – Wells Fargo
Okay. Great, that’s helpful thanks so much.
You are welcome.
It appears there are no further questions at this time. I would now like to turn the conference back to our speakers for any additional or closing remarks.
Okay. Well, this concludes today’s call and Bill Sperry and I are available if there are any follow-up questions. And once again thank you all for joining us this morning.
Ladies and gentlemen this does conclude today’s conference. We thank you for your participation.
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