Hubbell Inc (HUBB) 2003 Q2 法說會逐字稿

Good afternoon. My name is Tracy and I will be your conference facilitator today. At this time I would like to welcome everyone to the second quarter earnings release conference call. All lines have been place on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer period. If you would like to ask a question during this time, simply press star, then the number 1 on your telephone keypad. If you would like to withdraw your question, press the pound key. Thank you. Mr. Conlin, you may begin your conference.

Good afternoon, everyone. Before we start, three preliminary comments.

First, this call is being simultaneously webcast on the Hubbell website at Hubbell.com and is available there. Secondly, this call will be archived on the website under the Investor Relations tab and the sub-tab of audio archive so you can reaccess it there if you choose to.

And finally, the call will also be available by telephone in a replay two hours following the conclusion of the call and it will be available through July 30th. The replay access number is 706-645-9291, and you'll need the access pass code, which is 1756354.

Let me also refer everyone this afternoon to the paragraph in the press release regarding forward-looking statements and incorporate that paragraph by reference into today's conference call. As most of you know, these forward-looking statements involve assumptions, known and unknown risks and other factors which may cause actual and future results to differ from the expectations that may be expressed here today.

With me as usual is Tim Powers, Chief Executive Officer of company and Bill Tolly, Chief Financial Officer. We're going to turn the call over first to Bill Tolly to give us a rundown on second quarter events. And with that, Bill, go ahead.

Thanks, Tom. Good afternoon, everyone.

I'd like to start today with an overview of our markets and a summary of the quarter's results, including the unusual items that affected the numbers, and then I'll add a few more details on the segment results and the balance sheet.

The quarter was pretty much as we expected. Earnings per share about 5 cents a share below the expectations we had coming into the year, all due to lower than planned volume, which in turn was driven by continued weakness in commercial, industrial and utility markets.

Cash flow on the other hand was exceptionally strong. Second quarter free cash flow generated from operations, that's after capital spending of $47 million, almost twice the level of net income.

Overall second quarter market conditions were consistent with what we said during our last call. Second quarter sales grew sequentially by 7% due to normal seasonal strengthening and what we think was a modest post-war bounce in activity.

But in general terms, our markets were unchanged from our last report. Continued strong residential and DIY markets more than offset by continued weakness in industrial activity, MRO spending and capital spending, a continued slowdown in commercial construction activity and cutbacks in utility, maintenance and capital spending.

These market conditions drove our second quarter sales comparisons on a comparable basis. That is, if we had owned the LCA-acquired businesses for all of 2002, our consolidated net sales were down 1% year-over-year in the second quarter after having been down 3% in the first quarter.

For the first six months favorable foreign exchange reduced the size of our sales decline by about half a point.

As the press release said, we continue to see no catalyst for a strong recovery in the markets we serve.

And although the rates of commercial, industrial and utility markets decline are slower than they were in 2002, the markets we serve are nevertheless still down, and they're down substantially year-over-year. Commercial construction markets still have to work through the bubble of overbuilding that occurred in the late nineties.

Utilities are delaying or not investing in major projects, and in many cases are delaying maintenance spending. We believe it will take time for the utility industry to heal and increase the rate of investment.

And finally, industrial capacity utilization is stuck around 73%, suggesting that a major recovery in capital spending is still a ways away. With that all said, we do believe that we are at or close to a bottoming in these markets and the overall economy does seem to be showing signs of recovery.

But we remain very cautious, and in our projections we're assuming a very slow recovery in commercial, industrial and utility markets.

Our reported earnings of 40 cents a share included $6.6 million of pretax charges, 7 cents a share for lighting integration and restructuring expenses.

The single largest action included in the quarter's restructuring expense was $4.6 million to discontinue our entertainment lighting product line. An additional $2 million was expensed during the second quarter for costs that under the accounting rules couldn't be recognized in the lighting integration charge we recorded at the end of last year.

Of the $4.6 million provision we provided for exiting the entertainment lighting product line, $1.8 million was recorded in cost of goods sold within the electrical segment. The other 2.8 was recorded in special charges. Most of the charge, $3.1 million, provides for non-cash write-downs of inventory tooling and intangible assets.

The remainder, that is, $1.5 million, provides for cash costs for severance and closeout of contract commitments. Excluding the lighting integration costs for the quarter, our second quarter earnings were 47 cents a share.

And as we talked about in the earnings release, last year's diluted earnings per share of 51 cents included an 8 cent a share benefit from a non-recurring tax settlement yielding comparable earnings last year of 44 cents a share and a year-over-year earnings increase of 7%.

The overall pretax operating margin again, excluding the lighting integration costs was 9.5% up 6/10ths of a point from last year and up 1.2 points sequentially from the first quarter.

We're continuing to fight the headwinds that we talked about in our last call, higher pension, higher insurance and higher benefit costs which for the full year translates to an equivalent 15 to 20 cents per share of additional costs.

The highlight of the quarter was cash flow. During the second quarter our net debt dropped from $153 million to $118 million, a drop of $35 million after payment of the quarterly dividend. The net debt to capital ratio dropped to 13% from 17% at the end of the first quarter.

In the last 12 months, in the last year Hubbell has generated over $100 million of free cash flow after dividend payments. That free cash flow has been used to pay down just under half of the debt that was taken on during 2002 to fund the LCA acquisition.

One other note before we get to the segment results. During the second quarter we substantially reduced our employment. Just under 600 people or a 5% reduction, and that is after an additional 2% reduction during the first quarter.

These reductions resulted from a combination of productivity gains, a substantial reduction in inventories and to a lesser extent commercial and industrial market conditions and outsourcing of product to lower cost countries. The net of all this is that our factories are nicely positioned to benefit from a market upturn when it comes while we continue to reduce our inventories.

On now to the segment results. Electrical segment sales, $331 million for the quarter, up 10% due to the acquisition of LCA at the end of April last year.

Comparable sales, again that's including the sales of acquired businesses in both periods, were down 3% year-over-year after being down 4% year-over-year in the first quarter. Sequentially sales were up 6% from the first.

Like the first quarter, strength in Canadian markets was offset by continued weakness in Mexico.

The as reported segment operating margin for the quarter was 7.8%, that was down a point and a half from last year. But as I mentioned earlier, the as reported results included the $6.6 million of lighting integration costs, of which $1.8 million was included in cost of goods sold.

Excluding those items, second quarter operating margin was 9.8%, flat with last year and up 1.2% for points sequentially from the first quarter. Within the segment, wiring system sales were up about 2 points year-over-year, a little bit higher rate of increase than the first quarter.

The second quarter wiring system operating margins were lower than last year but up sequentially from the first quarter. Likewise, rough-in electrical and harsh and hazardous sales were up about 5% year-over-year, and up 6% sequentially

Tougher pricing conditions and higher steel costs in that market. Operating margins in those businesses were down both year-over-year and compared to the first quarter.

Lighting sales on a comparable basis were down 6% year-over-year but up 4% sequentially with margins up substantially year-over-year and sequentially from the first quarter.

All of these businesses have substantial sales to commercial and industrial markets where demand has been weak and excess supplier capacity continues to create price pressure. And although our residential and do-it-yourself businesses continue to enjoy strong demand, that positive impact hasn't offset the impact of lower commercial and industrial sales.

Power systems segment sales for the quarter, $85 million, up 1% year-over-year. That includes the benefit of the Pole Line hardware business we acquired late last year. Sales were also up 7% sequentially from the first quarter.

Now, the turmoil in the utility industry combined with what I mentioned earlier, slowdowns in maintenance spending, transmission and distribution projects, continue to have a negative impact.

Operating margins for the quarter, 8.7%, down two full points versus last year, but were up 6/10ths of a point compared to the first quarter.

As we mentioned last quarter, there were no major storms in the first half of this year as there was in the first half of last year, which made for a tough comparison, and pricing continues to be under pressure again here from suppliers with excess capacity.

Finally, the industrial technology segment's second quarter sales up 12% year-over-year and up 18% sequentially from the first quarter, seeing continued strengths in Gytronics, which makes security-oriented communications products, as well as higher shipments of high-voltage test units.

Operating margins also improved, moving from a loss in last year's second quarter to an 8% profit this year. Improved results at the same two units that drove the sales increase. The other businesses in this segment were more or less flat year-over-year in both sales and operating margin.

As I mentioned earlier, net inventories dropped substantially during the quarter, $26 million for the second quarter. Our days supply of inventory also dropped from 100 days at the end of last year to 87 days at the end of June. We are well ahead of our plan to reduce inventories by $40 million this year.

One other note on inventory reduction. When inventories drop to the extent that they have, it has a substantial negative effect on current earnings in the form of lower absorption of factory fixed costs.

As you heard earlier, we made substantial progress during the quarter in reducing our headcount to levels that are consistent with current demand. But the staffing cuts were also consistent with our expectation of productivity gains and continuing inventory reduction.

Our accounts receivable balance grew by $18 million from the end of the first quarter. About half of this increase was due to normal seasonal increases in sales. The other half was due to two large customer payments that weren't received until the first week of July.

As a result, we made less progress on our quarter end DSO than we would have, 50 and a half days in the second quarter, one day better than 51 and a half days last year.

Our capital spending continues to run well below the level of depreciation expense. The first half we used $12 million of cash for capital expenditures compared to first half depreciation of $26 million.

As we've said in the past, we have no need for bricks and mortar and have plenty of factory capacity, so our capital spending continues to be focused on new products and maintenance of existing facilities.

Our effective tax rate for the quarter remained at 26%, same rate as the first quarter. That's about 3 points higher than last year's rate from operations due to a higher mix of U.S. taxable income.

We paid about $19 million in quarterly cash dividends during the quarter, about $38 million year to date. Our dividend policy remains a critical component of providing a return to our shareholders so we're very pleased that tax incentives for investors who receive dividends are in place.

In summary, we're fairly happy with the second quarter earnings especially given the rate of progress we made on inventory reduction and continuing softness in our served markets. And with the headcount actions that we put in place during the second quarter, we think we're nicely positioned for a better second half.

With those opening remarks, we'll now turn it back to the operator for questions.

At this time I would like to remind everyone in order to ask a question, please press star and then the number 1 on your telephone keypad. We'll pause for just a moment to compile the Q&A roster. Your first question comes from Michael Regan.

Hi, Bill. I was wondering if you could give some perspective. When you talked about wiring systems margins being down year-over-year despite sales up a little and your other electrical business ex-lighting, basically if we look at electrical ex-lighting, it sounds like margins were down year-over-year despite volume that was flat to up a little. Could you break out how much of that you think was continued difficult price in the end market and how much was your own underabsorption because of underproducing to take inventory out?

Hi. This is Tim.

Tim, I was asking Bill.

I know. Certainly the -- there's significant pricing pressure in the market as the markets are softer than probably we all expected going into the year, but we're off close to $10 million of increased underabsorption from where we thought we would be.

And that was despite the inventory --

And really that's a function of at what rate you run your factories and what your productivity is. So, it has had that kind of an effect on us at this point in the year.

So, just to be clear --

Mike, this is Bill. That kind of coincides with my opening remark that said our earnings per share were about 5 cents a share below our expectations we had coming into the year. If you do some quick math, a $10 million underabsorption in the first half is almost equivalent to that 5 cent per share miss.

Right. But some of the $10 million underabsorption was markets that were weaker, and some is purposeful lower production to take out inventory. Is that fair?

That's correct, sure.

Okay. And so, you've got $10 million from underabsorption. I don't know what that is in terms of margin, but -- so, then, did price -- did continued tough pricing in the end markets impact your margin or not?

I would say it has.

Beyond the 10 million of underabsorption.

Yes, it has, also. But, you know, we always expect tough price situations in a flat market, and I would say it's every bit as tough. It's a price fight in some markets right now.

Yeah, I mean, I think Tim, what I'm just trying to get a sense of is, I thought you guys overall had pretty good margins in a tough environment and I'm just trying to differentiate between your base business that seems like it continues to be tough because of the two things you mentioned. But doing a little better or continued to do well with the integration of the lighting business, which is helping margins. But you know, I think there is some concern at some point, you kind of lap those benefits and all the good things you can do there, and then we're kind of left with the end markets that are tough and price that is tough. And I guess we'll start to lap the underabsorption at some point because you can't go down to zero inventory.

Well there, you know, there's two things we're working on. Certainly you could see in the second quarter that we've adjusted our employment levels to get back in line with the business we see for the second half of the year. And in total we've reduced our employment by 7% for the whole year.

And as you remember from the first quarter, we said that it was kind of a surprise the degree of which business dropped as the war in Iraq approached. And it took us, you know, a couple months to realize that business wasn't going to bounce right back to our expected level. So, during this quarter we made those adjustments.

But I think we have made those corrections pretty quickly and we're just determined that we're gonna continue to take our inventories down. And that is equal priority for us in terms of generating that cash flow as earnings would be.

And so, it's pretty hard for us to distinguish at this point how much is related to market and how much is related to our own desire to lower inventory.

Well, Tim, to that point on inventory, you can see real benefits of taking inventory out when sales are weak, because obviously there's no clamoring for service delivery times. But I mean, this is, I mean, Hubbell's second quarter inventory to sales ratio has traditionally been somewhere in the 19.5 to 20% range. So I think you ended on a trailing four quarter basis, I think you ended this quarter at 13%. I mean, what's the right inventory level that you can go down to before you start to impact your ability to serve your customers?

I can tell you that I'm determined to make it a lot less than it currently is on a permanent basis. Our objective is to get our company's inventory turns in the 6 to 8 range on a permanent basis with the highest level of service in the industry.

And we're in the middle of that transition right now, and we do believe we've come a long way. But there's a long way to go yet. And we're just insistent that we're gonna make that change.

Well, the other part of that equation is the distribution and logistics capability to serve the customer's needs despite lower inventory. And I guess -- can you give us some update on where you stand on that? This all doesn't get tested until volumes start to come back, but -- so how do you get comfortable with that?

Well, that's absolutely true, but, you know, I don't think anybody's predicting an upturn that would be out of the range that any of our -- either ourselves or our competitors can handle. I mean, if you're talking about more than a 10 to 15% volume jump in a year, then you might start to stretch our ability to maintain the highest levels of service. But within that relevant range, we certainly will be able to maintain very high service levels.

And our inventory should not -- should be measured in terms of days relative to that -- inventory days relative to that volume. But we're looking to still take a substantial amount of dollars out of inventory on a permanent basis. And as we approach the fall, I'll be prepared to say a lot more about that plan.

Great stuff. Thank you.

Sure.

Your next question comes from Jeff Sprague.

Thanks. Good afternoon.

Good afternoon.

Just a couple things. I guess, first, you know, the additional headcount reductions that you talked about, are those imbedded in these charges we're talking about in the quarter, or was that some additional pay as you go thing that you dealt with?

Those are pay as you go. The lighting integration restructuring cost is really part of the program that we established in December of last year when we merged the LCA business with our lighting business. The headcount reductions during the first and second quarter that were work-force related, or that were volume demand related are being expensed into the P&Ls as they occur.

Can you give us some sense of the magnitude of that headwind you've dealt with in the first half in dollars?

Round about $2 million pretax.

Thanks.

Second quarter.

Okay. And just to make sure I understand how you feel about where the business is at. Bill, in your opening remarks you kind of gave a pretty depressing litany of tough end markets and everything, but then you kind of ended it with but it looks like we're at the bottom and we're seeing hopeful signs that things are getting better. Could you just maybe underscore once more, maybe they were interspersed with what you said, but where you see a few things that are making you feel a little bit better?

Sure. Residential is still strong, and we expect that to continue so long as it's not disrupted by any significant rise in mortgage rates. And we are encouraged by our small but growing position in that market.

The commercial construction market, I don't have a very positive view toward, and I think that the decline in that market will continue the rest of this year and will not bottom out, will not bottom out during 2003. We are participating in certain parts of that market, which are doing much better.

Schools and institutions are some of the strong market segments that Hubbell participates in. But still we're talking about a commercial construction market that could shrink 7 to 10% this year and will not have bottomed out by the end of 2003.

The industrial market, though, the new construction in industrial is virtually nothing. So, it's not got much farther to go down. And we do believe that MRO spending, which is a key indicator, is slowly coming back. There are signs of that. But again, the keyword here is slow.

And we're not expecting any big pop in the second half. So, it's gonna be one of those maybe a couple of percent, you know, here and there. Not a lot in the second half.

And the utility market is very disrupted right now, very disrupted by the refinancings and balance sheet problems and structural issues of a good portion of the key customers in that market. So, and you can see by some of the reports of our competitors how they have also seen declines.

You add that up and you can see the restriction in spending by the utilities. That will continue for the rest of this year and slowly begin to get better.

But I would say we're talking about through 2004 before utilities have gotten their refinancings certainly straightened up and begin to put more money back into their business. And they are building up some need to do a better job of maintaining.

So, we're kind of predicting a second half that looks like the first half except for the seasonality of the construction cycle, meaning you got more good days to, you know, build new buildings in, so there's a little bit more sales in the second half. And that's our viewpoint as to what the rest of the year looks like.

And should we anticipate any other restructuring items in the second half like we've seen here in the second quarter?

As you remember, last year we announced a restructuring program. By the rules we were only able to expense part of it during last year, and we told you that there would be between -- what is the number -- 10 and -- 12 and $15 million that would be expensed this year. And I think we're up to 9 or something like that.

So, we're -- this is exactly what we said would happen. We're right on schedule with that restructuring. Everything is going very well in terms of us accomplishing our objectives, but there will be more costs up to $15 million or so by the end of this year.

So, Jeff, it would be an incremental on top of what's already been booked in the first half, an incremental 4 to 8 that would put the full year number somewhere in the range of 12 to $16 million of restructuring expense for the full year.

But that's just exactly what we said --

Right.

Last year.

Right. Can you give us -- you made a comment about the pension in your opening remarks, I think. I don't know if you hit '04. Can you give us any early read on what to expect for '04 on pension, and also maybe on tax rate? Is there any geographic or other issues that could impact the tax rate one way other the other in '04?

Very difficult to predict pension expense for next year until we get close to the end of the year and we see what the financial markets will do. If I were to give you any directional guidance for your models, I'd say use a similar figure to the figure for this year, which was, as we told you in the past, about a nickel per share higher year-over-year this year than last.

So, another nickel incremental on top of that?

No, same. Same level of expense at this early point in the year. But it very much depends on what the financial markets do between now and year-end and, frankly, what the regulators do in terms of providing guidance to companies on what kind of discount rates they'll use.

Okay. And tax rate?

Tax rate, likewise, difficult to predict because it depends on our mix of offshore profitability and U.S. profitability. This year's rate would be -- is going to be, we think at this point halfway through the year about 26%. And I see no reason why you'd build anything different into your models at this early stage.

Great. Thanks a lot.

Your next question comes from Bob Cornell.

Hi, guys. The question that hasn't been asked yet is a strategic one. You've gotten LCA pretty well digested, you've been through the lessons learned in that integration. What about the next step? I mean, is there something that might happen? You have previously talked about some pretty big strategic goals in terms of increasing the size of the company. How does that toll program stand at this point?

Our program remains in place. We have the ambitions that we said previously, which is to grow our company to between 3 and $5 billion.

We have our targets of opportunity, and I can tell you we're working hard but there is no deal imminent right at this moment. But I can tell you our objectives are not any different than they have been.

But I would say that we're in a position, we feel, that we could take on another large acquisition at this time because we do feel that the lighting integration is well in hand and is in the, you know, the last stages. So, we think we've handled that one about as well as it can be done and we think it's coming along and we're pleased with how far we've come at this point in time.

What about pricing expectations, Tim? Have you seen any changes in that regard up or down?

They're too high right now, or otherwise we would have done something.

Right. But I mean, are though moving away from you?

No, they're not moving away from us, but, you know, in order to have them work in a way that's beneficial to our shareholders in the short run, right now they're pricing expectations are higher than we're willing to pay. That's best I can say.

Okay. Thanks.

Your next question comes from Martin Sankey.

I'd like to follow-on on the subject of underabsorption and inventories. You mentioned that you've already reached your $40 million inventory goal for this year and at the same time you feel that there's a long way to go. Are we going to still see a fair amount of underabsorption in the third and fourth quarter?

Martin, we've reached $30 million of our $40 million, and we feel that we're, you know, we're well within range of meeting or exceeding our $40 million targets. So, you will continue to see inventory reductions in the second half of this year.

And yes, we will have continued but hopefully now that we've trimmed our employment levels, less underabsorption in the second half than the first. But part of the underabsorption you know is related to fixed costs like depreciation and things like that that you can't really control. So, we've tried to address that portion of factory and overhead costs that's related to people and variable spending. And we think we've done a pretty good job there.

The other thing that hurts you is certainly the productivity levels in plants when they're running at lower levels are not as -- not able to be maintained quite as high as they are when they're running at higher levels. And that hurts you in terms of the cost in versus the inventory out. But we expect to be better. But we will still have more.

Okay. Now, I recognize that part of the way you get to a 6 to 8 inventory turnover is through improved revenues. But given that, how long do you think it would take to get to a 6 to 8 times kind of turnover, and I guess would we be seeing underabsorption until we hit that time?

Martin, just let me say this, that as we approach the fall, we need to do some work on this before we lay it out for you. But we've at this point, since we have begun to reduce inventory, we've taken about $150 million out of our inventories.

You know, part of that was an adjustment to lower sales and part of it is that we're doing better on an inventory turn, our days in inventory, we've actually changed the way we work And we have another big set of ambition in front of us on this, and I'd just like the opportunity to get it a little more organized before I roll it out for you guys.

Okay. Thanks.

Yep.

At this time there are no further questions.

Okay, Tracy. Thank you for your help. And thank everyone for joining us today.

Thank you, sir. That concludes today's conference call. You may now disconnect.