Hubbell Inc (HUBB) 2003 Q4 法說會逐字稿

Good afternoon. My name is Monica (ph) and I will be your conference facilitator today. At this time, I would like to welcome everyone to the fourth-quarter earnings release call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period. (OPERATOR INSTRUCTIONS) Thank you. I will now turn the conference over to Tom Conlin, Vice President of Public Affairs. Sir, you may begin.

Thank you Monica and good afternoon everyone. Thank you for joining us. This is Hubbell's fourth-quarter and full year 2003 earnings conference call. With me today, as usual, Tim Powers President and Chief Executive Officer of Hubbell; and Bill Tolley, Chief Financial Officer at Hubbell, both of whom will make some comments on the press release today.

This call is being simultaneously webcast on the Hubbell web site, so you can hear it there. The call will also be available for replay by telephone two hours after we conclude today. And the replay number for that method of access is 706-645-9291. The replay pass code number is 485-1577. Replays will also be available on the Internet, also on the Hubbell web site. Three clicks needed -- Hubbell.com (ph) first, then the investor relations tab, then the audio archive tab, whereupon you can access this conference call.

Our press release was issued this morning about 11:00 detailing fourth-quarter and full year results. And that press release, too, is available on the Hubbell web site. An integral part of that press release, as I've noted before, is the paragraph on forward-looking statements. In essence, that paragraph notes that future performance and results may differ from today's expectations, whether noted in the press release or on today's call. Please take note of that paragraph in the press release, and I would like to incorporate it, by reference, into today's discussions. Let me also note, speaking of the Internet, that one of the business news services had a report on our earnings this morning, and in the headline, they noted that fourth quarter profits were up 4 percent excluding items. That calculation is in error. The percentage increase excluding items is considerably higher than that. I've been in contact with the wire service and asked them to re-issues the release. But the point I wanted to make was to take some careful note if you're using that news service for the earnings release.

With that, let me turn the conference call over to Tim Powers, President and Chief Executive Officer of Hubbell. Tim.

Thanks, Tom. I'll start my remarks today with a little discussion of the market place and then the results, go through each individual market, talk a little bit about our initiatives to improve our results. Bill will discuss many of the details in the financial statement and Hubbell 2006, and I'll conclude with a discussion of the outlook for 2004.

Turning back to the markets in 2003, in July of this past year, we predicted that the second half would be modestly better than the first. The war was over, seasonal construction activity began to improve, the residential market was continuing to be strong, but the commercial market had not bottomed out. The industrial markets, while they had turned, were not turning up very fast. And in fact, the way we saw the second half of the year, it came out pretty much as we expected -- a modest increase in demand, but no major move upward in any markets we served.

Given that situation in the market place, we were very pleased with the way we finished 2003. Our operating margins had improved nicely, cash flow set a new record for the Company, and the earnings per share trend through the fourth quarters trended upward. The fourth-quarter earnings per share of 58 cents is up 18 cents from the 49 cents last year, after adjusting for gains, tax items and restructuring. Record cash flow, driven by increased income, working capital initiatives, particularly inventory, and continued lower capital spending.

Now turning to the markets individually, in terms of the overall market there were no big changes. No overall direction to drive it upward. October as a month was okay; November was pretty good; but December, while up year-over-year, was a little bit of a disappointment to us. So we continue to be cautious about any short-term gathering of strength in the market. Commercial construction awards still hit a down year-over-year and are not expected to bottom until the middle of 2004. The residential market continues to be strong and the backlog of residential construction business at the National Builders bodes well for the first half of the year. Beyond that, however, the balance of the year depends on mortgage interest rates. But we are expecting that the year could be as strong as it was in 2003.

The industrial construction demand continues to recover very slowly. Capital and MRO spending have turned up, but are also moving slowly, in line with industrial production growth of about 2 to 3 percent. But factory capacity utilization remains low and far from activity levels which support substantial construction spending increases. And finally, the utility demand is at best flat and probably down slightly in 2003. Given continued industry turmoil and uncertainty regarding energy policy, there are no signs of increased utility infrastructure investment yet. Markets are moving up slowly and will continue at this pace -- all of our markets at this slow pace into 2004.

While the markets are moving at this slow pace, we are focused on four initiatives that support better results. First, cost reduction, which consists of two elements -- our lighting integration and outsourcing of product. Working capital reductions, of course, accounts receivable and inventory reductions and increased terms for accounts payable. Third, becoming a lean Company with process improvements in our factories, offices and warehouse to improve productivity. And fourth, to implement a new enterprise-wide business system, which we refer to as Hubbell 2006. We continue to be focused on these four initiatives, all of which position us for recovery when it gets fully underway.

We are pleased to report that we have made good progress on all fronts. The lighting integration program is proceeding on target and within budgets which were established over a year ago. This involves factory closures, warehouse consolidation and the elimination of redundant product lines. We started to see the bottom-line benefit of those initiatives in the third quarter, and are continuing in the fourth. Margins are steadily improving in the lighting business. Outsourcing is growing, but remains about 10 percent of our total products.

Working capital reductions. We continue to make progress on our goals for improving our working capital efficiency. We continue to hold capital spending well below depreciation. Of all these working capital initiatives, controlled capital spending combined with net income above our expectations allowed us to generate $54 million in operating cash flow. We are now net debt free, and Bill will discuss this more in detail.

Becoming a lean company. Our lean process improvement initiatives continue to expand. We are pleased with both the level of involvement and the benefits of becoming leaner, which enable us to achieve inventory and cost reduction objectives. Using lean processes, we are just starting to see new product developments that are delivered on schedule and within budget with a design that fits the customer's need and our objectives in about half the time that we used to take. Additionally, we are employing lean principles in the administrative processes of our offices. 2003 was the next step forward in our lean journey.

Hubbell 2006 business process initiative is proceeding well and will provide strong information foundation that we need to be successful for the future. We had been preparing and doing a lot of groundwork for a year and have now began the phased 30-month implementation of this business process initiative. The initiative is on budget and on schedule. We are making good progress in each of our initiatives that support better business results. At this time now, I will turn the discussion over to Bill, who will continue with the financial details.

Thanks, Tim. Hello, everybody. We ended the year on a very strong note. Fourth-quarter sales were about, as Tim said, what we expected going into the quarter, but we exceeded our expectations for operating margin improvement, earnings per share and cash flow. Fourth-quarter sales were up 4 percent year-on-year, reflecting a slow but continuing recovery in our served markets. Favorable foreign exchange rates accounted for about one point of that 4 point year-over-year increase. Fourth-quarter sales were down 3 percent sequentially from the third quarter, and that reflects the usual seasonal fall off in activity. Two segments, electrical and power, reported year-over-year gains in sales of 5 percent each, while sales in our smallest segment, industrial technology, were essentially flat.

Fourth quarter earnings, 57 cents a share, including a penny of restructuring expenses. Last year's earnings per share of 45 cents, as the press release said, included two large items, a 13 cent per share charge for the restructuring programs and 10 cents of income related to R&D tax credits. If you exclude those items in both years, earnings per share, as Tim said, 58 cents this year versus 49 cents last year, an 18 percent increase.

For the full year 2003, sales were up 12 percent over the reported figure in 2002 and up 6/10 of a point on a comparable basis -- that is, if we had acquired the LCA lighting businesses in the 2002 results and had included those numbers for the entire year. Favorable foreign exchange accounted for all of the year-over-year increase in sales, but it's important to note that the sales comparison for the two halves of last year, 2003, were very different. First half comparable sales were down about 2 percent year-over-year, while second half sales were up 3 percent year over year.

Full-year earnings per share $1.91 compares to the $1.38 we reported last year, $1.81 adjusting for the non-cash write-down of goodwill at the end of 2002. As the release said, there were large or unusual items in both years that affected the comparison. In 2002, we had restructuring charges that reduced income by 14 cents a share, while tax credits and gains on sale of assets increased income by 21 cents per share. If you net all those favorable and unfavorable items, you generate the adjusted earnings for 2002 of $1.74. 2003's earnings per share, comparable basis, $1.99, an increase of 14 percent year-over-year.

The pretax operating margin for the fourth quarter, again excluding restructuring provisions, was 11.7 percent. That's up over one point from last year and up half a point sequentially from the third quarter. Each of the third and fourth quarters, as I think I mentioned in the last call, also included about $2 million of incremental expense associated with the Hubbell 2006 IT initiatives. As Tim said, we were very happy with the sequential improvement in the second, third and fourth quarter operating margins. We were also happy to see that the improvement in operating margins all came on the gross margin line, more evidence to us that the productivity gains are translating into improved profitability.

Cash flow from operations, again very strong for the quarter -- $50 million plus in cash flow from operations. That is after a planned $25 million cash contribution to our pension plans. We used a portion of that cash generated in the fourth quarter to pay our normal cash dividend, and we also in the quarter acquired about $5 million of Hubbell stock. Net debt reduction was 35 million in the fourth quarter, 168 million for the full year. And I think the highlight for our results this year is that we were net debt free at the end of 2003 -- that's sooner than we expected by several months.

On to the segment results. The electrical segment's fourth quarter sales, as I said, were up 5 percent year-over-year. All four businesses within this segment -- that's wiring systems, rough-in electrical, harsh and hazardous, and lighting -- all four businesses reported up quarters, with a low of up 2 percent year-over-year to a high of up 6 percent year-over-year. Operating margins for the quarter, 11.7 percent, a full point better than the fourth quarter of last year, 6/10 of a point better than the third quarter. Wiring systems margins were more or less flat, as industrial market demand continues to be very sluggish. Rough-in electrical margins were lower, as pricing continues to be very competitive and steel costs increased. Harsh and hazardous margins were up but only slightly, in a very slow market.

As was the case in the third quarter the lighting business margin improvement was above our expectations. The residential lighting business margins were flat, but on nicely higher sales, yielding a healthy year-over-year gain in operating profit, while the commercial industrial businesses reported flat sales, but several points of margin improvement. Despite the fact that there is more to do, we see increasing evidence that the restructuring activity in this business is generating results from the bottom line.

Our power systems businesses continue to struggle, with very sluggish demand for utility infrastructure products. As Tim said, this comes from a combination of industry uncertainty, lack of progress in the development of energy policy and generally weak utility balance sheets. But despite a very weak demand environment, fourth quarter segment sales grew by 5 percent, indicating to us a slow, steady gain in market share. Operating margin dropped by 1 point year-over-year, a result of very competitive pricing in the face of the weak demand and higher metals costs.

Finally, the industrial technology segment sales for the quarter were more or less flat year-over-year, as was the case all year long in 2003. The GAI-Tronics Specialty (technical difficulty) continued to perform very well, with sales up in the mid-single digits, offset by modestly lower sales in the industrial and high-voltage test equipment businesses. Operating margins were up by over 7 points in this segment in the quarter, again due to gains at GAI-Tronics and the high voltage test businesses. The other businesses in this segment reported flat margins year-over-year.

Just a couple more details on the balance sheet. Net inventories dropped by $3 million in the quarter, 50 million for the full year. More importantly, days supply of inventory in the fourth quarter was 59 days. That's down one day from the end of the third quarter and much improved from 75 days in the fourth quarter of 2002. We believe that there is still more opportunity to improve the way we manage our inventories and we fully expect to continue to improve inventory supply days in 2004. Days sales outstanding and receivables for the quarter continued to hold at 50 days, about the same as the last two quarters. For the full year of 2003, we reduced our average days sales outstanding by 1 day. Importantly, we also improved our days payables by negotiating more favorable payment terms with many of our suppliers, and that contributed to the fourth quarter cash generation.

To put the impact of working capital management in perspective, since the year 2000, Hubbell has reduced its trade working capital, that's in inventories, plus receivables less payables, as a percentage of sales from 32 percent to 19 percent. And that translates to a favorable cash impact of $225 million -- very substantial improvement that helps finance growth. For the full year 2003, capital spending was 28 million compared to about 50 million of depreciation. We do expect our capital spending for 2004 will be $10 to $15 million higher than the actual spend in 2003, primarily because a portion of our IT initiative's cost are capitalized. Our effective tax rate was 26 percent for the fourth quarter and the full year 2003. As we have discussed in the past, we expect that rate will increase by 1 to 2 points in 2004 due to a higher level of U.S. taxable income. In summary, we are very happy with the fourth quarter results, particularly the 2-point operating margin improvement and improving earnings per share trend throughout the year and continued strong cash generation.

Finally, just a couple of notes on the Hubbell 2006 business system initiative. As we discussed during the last call, SAP software will be installed across all of our businesses in a series of staged implementations over the next two years. For the next two quarters, we will be focused on preparing for the first implementation, which is scheduled for the fall of this year. We expect the total cost for Hubbell 2006 will be in a range of 40 to $50 million, spread over 30 months. The split between capital and expense is difficult to estimate, but at this time, we expect it will be about a 50-50 split. About $4 million of project cost, as I said earlier, was expensed during calendar 2003, and about $3 million was capitalized.

This year, 2004, we expect the P&L expense for Hubbell 2006 will be in a range of 8 to $12 million pretax, with another 10 to $15 million to be capitalized. As I said during the last call, we don't expect that savings will begin to benefit the bottom line related to this project until 2006, but expect full-year annualized savings of anywhere from 14 to $18 million, starting in 2007. With that, I'll turn the call back to Tim for some comments and outlook for 2004.

Good, let's talk about 2004 for a minute. First of all, I would say that we would expect the first half of 2004 to look very much like the second half of 2003. That is, a continuing slow recovery in most of our markets, which should translate into slightly higher market demand and a growth of 2 to 4 percent in overall sales. And barring any external shocks to the economy, expected second half sales would be a bit stronger than the first half, but we remain cautious.

The commercial market is still working through the over-building cycle -- excess capacity, empty space -- and we don't expect that to bottom until the mid-year and slowly begin to turn up in the second half. The utility markets remain flat waiting rules for minimal (ph) rates of return on transmission and distribution infrastructure investment, and we need to see that the energy legislation that is before Congress is passed. Even then, only with a modest impact on 2004, and more impact in the next couple of years from this legislation. Industrial new construction is virtually nonexistent. However, increases in maintenance and repair and inside-the-plant capital spending will result in an increase in the industrial market of 2 to 4 percent. The residential market is at the top, but can potentially hold at current levels of activity if mortgage rates don't escalate and the consumer sentiment remains strong. In short, a modest recovery in our markets. We expect 2 to 4 percent year-over-year growth in sales, in the range of 1.8 to 1.9 billion.

From a results point of view, internally we expect more progress on our thrust to improve the way we manage our operations -- one full percentage point in operation margin improvement, despite another year of cost inflation and increases in some commodity metals and continuing price competition. We expect earnings per share in the range of $2.05 to $2.25 before restructuring, a 5 to 15 percent growth over 2003. We also expect to continue to restructure our business as a result of productivity gains in business processes. Expect continuing factory and warehouse consolidations over the next two to three years in the range of 15 to $25 million of expense per year on a pretax basis. In other words, we still have too much plant as a result of our inventory reductions and productivity gains, and we are working step-by-step to get our footprint down to the size that we need for the future.

2004 we expect another strong year of cash generation, but not quite as strong as 2003's record-setting numbers, but more progress in inventory days supply, collection days and payable days. We expect 20 to 30 million from cash from reduced working capital. In addition, as Bill talked about earlier, capital spending will increase about 10 to 15 million because of the Hubbell 2006 initiative, but still remain below depreciation expense. With all this debt reduction in 2003 and strong cash flow continuing, we are positioned nicely to continue to grow our Company by acquisition. We still remain focused on four key areas -- wiring systems, lighting fixtures and controls, rough-in electrical products and harsh and hazardous in the utility components, and we are still looking for those acquisitions.

2004, in summary, we would expect earnings per share up nicely in a slowly improving economy, with a quarterly trend improvement. Cash flow will remain strong. More progress on internal initiatives, and a balance sheet positioned for growth. 2004 will be a better year, one of modest growth, but not one of strong economic growth for our markets. Now I think that summarizes things, Tom, and I think we are ready to take questions.

Monica, if you will open the call now to anyone who needs to ask a question.

(OPERATOR INSTRUCTIONS) Bob Cornell of Lehman Brothers.

Hi guys. Got a big picture question for you here. Tim, this is your ball park, I think. When you look at these numbers, and you clearly generate a lot of operating earnings leverage out of the modest sales, which says something about the internal efficiencies and the lean, so forth and so on. And also you have your balance sheet down to zero net debt. What this says to me is that -- you guys have previously said strategically you want to build out the Company -- I think the goal was to get to 3 to 5 billion in sales in a certain period of time. But I know you're looking for another deal that has pricing like lighting. But when you look at what you've done with the existing businesses, it suggest to me that you probably could pay more for an acquisition and integrate it add value, perhaps, than previously you might have thought. Do you see where I'm going with that question? You probably do, so what's the answer?

Let's say that we continue to look diligently for those acquisitions. We know that not all deals are priced the same. Certainly, as business conditions improve, the price of properties increase. We understand that and we are still at the same time trying to find those properties that add value to our shareholders. So in other words, we are working as hard as we can at it and we'll buy one as soon as we can come (multiple speakers) --

I understand that, Tim. But you look at what did with lighting, you look at what you have done with lean, and any of these acquisition algorithms include a certain amount of cost take-out and synergy. If you go back and look at what you might have wanted to pay for something two years ago, and the synergy and cost-take assimilation, all those things I think are better than you might have wanted to believe. So you look at where you are now, I mean, whereas you might have wanted to pay five times for something in the past, you probably now, given the way you've scaled the Company and had the lessons learned, you could probably pay a higher multiple and get the same sort of economic value added.

I would agree with that statement.

One other question then, since I got away with that one. I was little confused about the headwind issues you mentioned. You said '04 would be $2.05 versus $2.25. That's before this restructuring, this 15 to 20 million of restructuring, so that the actual reported number is going to be below $2.05 to $2.15?

That is correct. Just like when we talk about our $1.99 this year, those numbers of $2.05 to $2.25 are comparable at that level.

So all in, including all the headwinds, what does the range look like in terms of reported GAAP numbers for '04?

If we picked a midpoint of our restructuring -- we are doing some calculations here; just a second. It depends on how fast that restructuring takes place. We are moving as quickly as we can, but we will have more business units involved in restructuring in 2004 than 2003. We will have more restructuring in lighting; we will have some in a couple of the other businesses. So --

I'm just trying to make sure that the world doesn't run off with a $2.05, $2.15 expectation when you are not really talking that type of number.

If you take the middle of the range on our expected expense for restructuring in 2004, it's about 20 cents a share; tax effected at 38 cents.

So it's $1.85 to $2.05 is what should show up someplace in First Call if people believe what you say?

That's right. Using the middle of the range.

Thanks.

Jeff Sprague of Smith Barney.

Good afternoon, everybody. Tim, I was wondering if you could address the issue of the shifting manufacturing base in the U.S. Clearly, manufacturing is not going to go away, and along Bob's line of question, clearly you can add value by buying mature businesses and running them better. But just in the last two days, we have heard GE say the plastics business is tough in the U.S. but they made up for it with growth in China, and the same thing out of 3M on some of their industrial businesses. How do you see that playing out as it relates to your businesses, and do you reconsider your strategy, which is really kind of primarily aimed just at the United States?

I would say despite the loss of manufacturing jobs and a flat to slightly down perspective for the industrial market, we remain optimistic about the North American market in total, and specifically the commercial markets and the residential markets. As you see us change our portfolio, we will be thinking and emphasizing more in that direction, although we would certainly take an opportunity to buy any top name industrial brand. But we would not change our view that we need to become bigger and broader in our core market in North America before we would move into any other major international acquisitions.

Separate question. I confess to not reading the whole 1300 pages of the energy bill passed (ph). But what I saw didn't really seem to have a tremendous amount of (indiscernible) or clarity around these regulated rates of return issues. I wonder if that's your reading and I wonder if you just have any --

It certainly is not the only answer, but it's a necessary gate to go through to get to the answer. And if we don't get through that gate and have the energy legislation passed, then we are going to continue in this sideways tracking of expenditures, because the executives and utility boards just don't have the confidence to make the expenditures, although they have plenty of plans so that they can be sure they can get a return on these investments. So it is certainly as I read it, you read it, it's kind of weak, but it gets us started in the right direction and sets up the framework for final regulations that will allow a return on asset to be calculated. And that is really an important step moving forward.

Great. Thanks a lot.

(OPERATOR INSTRUCTIONS) Martin Sankey of Neuberger Berman.

Hi, Tim. I guess first a follow-on to Bob's question before I have a question of my own. You mentioned with respect to restructuring that you were still kind of trying to figure out when to take the charges or when to take the actions. Could you sort of walk us through what you're thinking with respect to how that 15 to 25 million might show up through the year?

It isn't when to take the charges; the charges get recorded when the actions are decided and the events take place by the new accounting rules. And it is a decision to reduce our footprint by about 15 percent in total over the next couple of years. The rate at which we are able to do that has a few variables in it. But we have taken probably seven or eight specific programs spread over three business units, and that is how we are proceeding. That will not completely get us to where we want to go on this 15 percent or more reduction, but it certainly is the first wave of that.

And all these plants are being emptied by the amount of inventory we've reduced, by the lean process, which probably saves about a third of the factory space, and also by outsourcing. So we just need to reduce our footprint and we are trying to do that in an orderly way, and it is just going to take more than one year. So like in the past you might have been able to take one charge and then talk about how you're doing it. This way, you have to do it on a step-by-step basis and record those costs as they occur. So we're doing the best we can to give you that information and we will update that on a quarterly basis.

But you have no clarity as to whether it's going to be first-half or second-half weighted?

Second half, I would say, if I was -- I would say second half.

The other question I had is you mentioned during the fourth quarter that you repurchased $5 million worth of stock, which I think is the first significant repurchase you've done in a while. Given where the balance sheet is, and the fact that you still have a pretty hefty authorization, will we be seeing more acceleration in repurchase activity in coming months?

I would say you would look at that as opportunistic repurchasing of shares. I don't know that you are going to see any dramatic improvement or increase in the speed at which we repurchase shares. This is more of a trimming of the effect of the dilution of stock options rather than any major attempt to rebuy shares. We are still trying to keep the majority of our cash available to expand the Company through acquisition.

Do you plan on continuing with that kind of philosophy in the near-term?

Yes.

Let's extend it out for a little bit further then. Given the rate of cash accumulation at the Company and the fact -- and to the extent that the next acquisition doesn't take place, how long do you sit on cash before changing -- before you start to consider more of a share repurchase program, or do we go back to the days when Hubbell kept a very high net cash balance?

Well, Martin, we would certainly reassess our situation if we get far into the year and our prospects for acquisitions don't look as bright as we think they might, we might speed up some of the stock repurchase. But right now, we have every reason to believe we are on the right track with the relatively low pace of share repurchases and hold the cash.

My last question is, speaking to that, how does the pipeline look?

It's a matter of price, not a matter of opportunity. There are some properties out there that are available and the expectations on those properties are very high by our view. So at the moment, we are still just looking. But there seems to be enough to look at. It's a question of coming to an agreement on price.

Thank you.

At this time, there are no further questions.

Thank you for your assistance today. And thanks to everyone who phoned in.

This concludes today's conference. You may now disconnect.