Hubbell Inc Q1 FY2020 Earnings Call

Thank you for joining us for the First Quarter 2020 Results Call. I will now turn the conference over to Mr. Dan Innamorato. Please proceed.

Thanks, operator. Good morning, everyone, and thank you for joining us. I'm joined today by our Chairman and CEO, Dave Nord; our President and Chief Operating Officer, Gerben Bakker; and our Executive Vice President and CFO, Bill Sperry. Hubbell announced its first quarter results for 2020 this morning. The press release and slides are posted to the Investors section of our website. Please note that our comments this morning may include statements related to the expected future results of our company and are forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995. Therefore, please note the discussion of forward-looking statements in our press release and considered incorporated by reference into this call. In addition, comments may also include non-GAAP financial measures. Those measures are reconciled to the comparable GAAP measures and are included in the press release and the slides. Now, let me turn the call over to Dave.

Okay. Thanks, Dan. Good morning, everyone, and thanks for joining us. A lot going on. We appreciate everyone taking the time to join us today in the midst of all that's going on. Most importantly, we hope that you and your families are staying safe and healthy. So I'm going to start my comments on slide three with a brief summary of the quarter. You can see from our press release, it was another solid quarter of operating results and free cash flow generation for Hubbell. We met with you less than two months ago now. At our Investor Day, we laid out our investment thesis based on our operational transformation, our unique and differentiated utility solutions platform and importantly, our ability to generate and deploy free cash flow. A lot has obviously changed across the world and the economy over these two short months. But fundamentally, those pillars are still intact. They each drove performance in the first quarter, and we believe they will help sustain us through what we expect to be a very challenging, certainly near-term environment but importantly, allow us to emerge out of this period as a fundamentally stronger company. Before we get into the details of the quarter and our forward look, I want to provide you all with a comprehensive update on how we currently view the impact of the COVID-19 pandemic, and importantly, our action plans and countermeasures. So if you turn to page four, we've tried to break out for you the major categories or ways in which the situation has impacted us as well as our strategic approach to each issue and the specific actions we're taking. Starting on the left, first and foremost, is the health and safety of our employees. Protecting our people and ensuring the health and safety of them and their families continues to be our number one priority during these difficult times. For our office workers, we've implemented mandatory work-from-home programs for all employees with the ability to do so. We're extremely proud of our employees who have proven to be very flexible and adaptable through this process, maintaining high levels of productivity while juggling other life priorities. In our factories, importantly, unfortunately, we don't always have the same levels of flexibility as we manufacture essential products, which are necessary for the safety and reliability of critical infrastructure. Now continuing to provide our customers with these critical products is more important now than ever and underscores Hubbell's value to our customers and communities. However, we need to ensure that we continue to manufacture these products in a way that minimizes risk to our manufacturing employees. As such, we implemented a series of safety protocols in our plants and warehouses to enhance cleaning and sanitizing processes, staggering our shifts, and introducing social distancing measures. We can't emphasize enough how proud we are of our manufacturing workers for the way they've responded to these challenges and continue to come in to work every day to produce these essential products. To that end, we're providing our hourly employees with additional appreciation pay for the second quarter. Second is the impact on our customers, and we're focused on continuing to serve our customers with the same level of quality and service they've come to expect over decades from Hubbell. However, this pandemic does create some disruptions in our ability to do so as we saw several temporary facility closures in the first quarter and expect to see continuing impacts going forward. It's been a challenging area for us to navigate as there are often different local orders or site-specific challenges to work our way through. While we've had a thorough review process for any site closures and continue to develop contingency plans that optimize our production capacity across Hubbell under a wide range of scenarios. Certainly, we anticipate the economic impacts of this pandemic will have a significant impact on our end markets, and we'll talk you through that a bit later. Aside from the facility impacts, we also see operational challenges from the lower productivity and absorption headwinds from what we anticipate will be significantly lower volumes running through our factories, at least in the second quarter. To that end, we've announced some specific actions around compensation to help offset, including significant reductions across our Board, our executive team and our salaried workforce. We're aggressively cutting discretionary spending across the enterprise. At this stage, while it's difficult to accurately forecast the magnitude and duration of the downturn in our end markets, we do think the second quarter will be the worst, and we think these actions will allow us to mitigate some of that near-term downside while maintaining our flexibility long-term when markets start to recover. We'll continue to evaluate our cost structure to determine what actions we may need to take in the future. Finally, in times like these, cash and liquidity are paramount. As you know, and as Bill will walk you through later, free cash flow performance has been a highlight of Hubbell's performance recently, and this cash generation capability puts us in a strong liquidity position. We've also taken various cash preservation actions, including cutting discretionary CapEx and significantly reducing our raw material spend in anticipation of lower volumes. We made the decision with an abundance of caution to draw down $225 million from our revolving credit facilities as a proactive measure to further boost our liquidity position. While the impact of this pandemic is significant, I'm confident the strength of Hubbell's people, products, and brands, along with the aggressive actions we are taking to preserve long-term value will continue to position us for success well into the future.

Good. Thank you, Dave, and good morning, everyone. Turning to Page seven and the Electrical segment first quarter results. We see that the end markets continue to be soft in the quarter, with organic down 3% and the net impact of M&A subtracting another point as our recent acquisition of Connector Products was more than offset by the divestiture of our Haefely high-voltage test business, which you recall we sold last August. C&I Lighting and heavy industrial remained weak as both declined double digits, and this is really a continuation of what we saw and communicated last quarter. This was partially offset, however, by pockets of strength in our residential and light industrial verticals, particularly data centers and renewable markets in our connectors and grounding business. Margins were down 120 basis points compared to last year, and as Dave mentioned earlier, we absorbed the impact of a shift in timing of our long-term incentive compensation grant, which cost us $0.10 in the quarter split across both segments. We also faced headwinds in the quarter from operational disruptions related to COVID-19 with temporary closures of several manufacturing facilities. Most of our closures were as a result of regulatory mandates and were temporary in nature, with about two-thirds of IT international. Our largest manufacturing base, which is in the U.S., has seen more minor operational disruptions mostly related to proactive pauses for suspected or confirmed COVID cases and generally higher absenteeism that we have seen in our factories. While we've been able to continue to serve our customers' need during these times, these disruptions cost us $0.10 in the quarter across Hubbell, and the majority of that impact was in our Electrical segment in the first quarter. Offsetting these headwinds was continued tailwind from price cost particularly from lower commodity cost as we started to see a lap of the impact of price from prior year increases. We also saw the benefits of the investment we've been making in footprint optimization with nice savings coming through in the quarter. Later in the presentation, we will walk you through how we are managing our decremental margins in the 30% range through this challenging environment.

Thanks, Gerb. Good morning, everybody. I hope you're being safe and well. On page nine, we're talking about cash flow. Dave highlighted in his remarks, you all remember over the last couple of years, the high degree of focus we've been placing on cash flow. We had set the $0.5 billion target that we reached a year early. And so it's gratifying in 2020, during the first quarter to get off to a very good start. You can see an increase of 65% to $91 million in free cash flow. The drivers of the improvement in performance start with income but got important contributions from working capital management, most notably with inventories. Also CapEx later than last year as we're preserving cash. Notably, net income is burdened by some noncash charges, including the stock-based comp that Dave mentioned that was put in the first quarter of this year, not in last year. So very strong cash flow, a topic that we're managing on a daily basis with tools and working capital management. But the good cash flow really helps drive a strong liquidity position, which you see on the right-hand of the page. We finished the quarter with $300 million of cash. We typically rely for our short-term floating rate debt on commercial paper markets to fund ourselves. During this quarter, we essentially switched our reliance on that market and went to our revolver instead where we've got a really strong bank group, very supportive bank group. We tapped our $750 million revolver for $225 million, which leaves us $525 million available to complement the $300 million of cash. I think interestingly, of note, the CP market is improving. We have access to it. We've been able to tap it. We anticipate reverting back to that market and paying off the revolver and leaving that fully loaded at $750 million. I also wanted to comment on the long-term debt portion of the capital structure from our bonds. Next maturity is 2022, so really nothing urgent about that in terms of refinancing although it is interesting to note that the bond market has been quite supportive of industrial issuers with attractive rates. Ultimately, this cash flow and our liquidity position drives and informs our capital allocation strategy. I wanted to touch on our capital allocation priorities. A lot of you will have noticed last week, we announced the maintenance of our dividend for the second quarter of 2020. On the CapEx front, we're anticipating a 20% reduction this year. We started that already in the first quarter, very similar to how we approached 2009, focusing only on really mandatory CapEx. Those marginal projects that won't get done still have a nice IRR, so we want to get to them. We'll just make sure liquidity is in good shape before we do. On the share repurchase front, we would typically buy $40 million of shares to offset dilution. We typically would spread that over four quarters, and we effectively did all of that in the first quarter given the attractive prices to buy stock in. That leaves acquisitions as the fourth lever within capital allocation. It's worth noting Gerben talked about Cantega and reminded everybody that we sold the high-voltage business. There was some good portfolio management that you saw acting in the quarter where the low-growth, low-margin, high-voltage business was sold off. We took those proceeds that allowed us to buy the connectors business in the Electrical segment and Cantega, a fireproof components business for the Power Utility segment. So we added high-growth and high margin. That was positive changes to the portfolio that we saw in the quarter. As far as new investments, we did have a couple of acquisition candidates that we may have been closing on in the near-term that through COVID, I think, get pushed out. At the same time, I think it's a little bit difficult to get buyers and sellers to see eye to eye on value right now. But as we did in '09, at the time of some distress by many, we were able to buy Burndy, which at that time in '09 was Hubbell's largest investment. We also think that in the coming months and quarters, there will be other attractive opportunities for us as well. It's important to us to have this balance sheet in great shape to be able to be an active investor.

Just a couple from me. First, on the utility side, not surprised, but, of course, pleased to see that hanging in. Although we are hearing some rumblings of pressure on rate cases and the like in the Utility sector. Regulators, obviously, sensitive to electricity bills in a time of recession. Are you seeing or feeling that in any way in your business? And you did mention a natural lag anyhow. So, obviously, the business will slow down. But just how do you see that kind of playing out over the balance of the year?

Thanks, Jeff. This is Gerb, and I hope you're doing well. Just a couple of comments on the utility side of the business and starting with what we've talked about, which is the need to invest in this critical infrastructure and in this aged infrastructure. There is still an underlying need to invest here. That certainly is imbalanced or in the reality of rate cases; I think, to a certain extent, utility companies are seeing their demand down as well. So they too are challenged during this time like many others. We haven't seen it in our business. Our order rates have continued to hold up nicely in the first quarter and have continued in the first quarter here in April with double-digit growth. So, we haven't seen it. It tends to lag for us. So, certainly, as we look later into the year, we do expect and plan for that to decline a little bit. What we've also seen in past downturns is that there may be stimulus to continue to invest in this infrastructure. Particularly, we saw that, and we expect to perhaps see that again on the renewable side. And as you know, when there is investment there, we benefit there well with our whole transmission portfolio. We see strength there as well right now. So we are optimistic about this long term, certainly. We expect on the second half of this year a slowdown from what we're currently seeing. But as Dave said, it's one that will probably go through this period better than our Electrical segment.

Yes. Jeff, as we're looking at the point-of-sale data and talking to our customers, it feels like they have been during the very late part of March and April managing to a couple of months' worth of inventory. And so I think that does feel in line rather than we're subject to some big swing coming up either way.

Hey guys, good morning.

Good morning.

Thanks for all the detail on the outlook. It's very helpful. Some companies aren't giving a lot. You guys are, I think, doing a good job there. So I appreciate that. On the free cash, looking back at '08, '09, I mean, you guys generated just on the cash flow statement, something in the range of like 5% to 6% of sales and kind of working capital benefits, something in that range, I think, depending on how you define working capital. Is this different than that? Or do you feel like you can kind of really press hard on that and then generate that type of benefit?

Yes, there are two elements, Steve. I think as we looked at our conversion on net income, it got very high in '09 compared to historic levels. There were a couple of important drivers to that. One of which was the fact that price/cost was quite favorable. So that was being supportive. As you point out, there was a quick reaction on the part of the buying side and operational planning to not buy raw materials that you don't need and don't turn raw into whip or whip into finished goods that you don't need. As Dave made reference to, we do think that's the same this time. It was hard as Gerb and I sat down with the operating teams and say stop buying when they saw order rates still growing. But we stepped on that right away. I think that element, Steve, is the same. It's an important part of how we manage cash flow. I think the other part was we didn't experience in '09 any deterioration of the receivable quality that was extraordinary or material. And thus far, through April, that's proceeding similar, but that also was important to buttressing that cash flow profile was as a customer base that paid its bills.

Hey, good morning.

Hey.

If the economy opens up near time here, like it's planned, are there any businesses we can expect that could come back to growth by end of the year like Aclara, perhaps one flight access is granted. Can that come back to growth? And the flip side of the question, I guess, is should there be any lost sales that may not come back in any of your businesses? And can you give us examples of those?

Yes, Deepa. Certainly, the portion of the Aclara business that's related to project delays, as we talked about, that are difficult to do. We would expect those to come back because these are projects that are not canceled, but more pushed to the right. So we would expect a partial recovery. Now of course though, it's hard to make up for lost ground because we have limited amount of crews and resources and so do utility companies. So certainly sequentially, I would expect that to improve as those crews get back to work. The nature of the projects makes executing on these projects more challenging during this pandemic. So, we expect to see some project delays on certain of these deployments going into the second quarter.

Looks like we've had a lot of really good questions. Let me try to break the rhythm then or break the stretch. I guess the first is following up on some of the questions that I think Deepa and Nigel talked about. I think what's implicit in withdrawing guidance is that you just don't have a lot of visibility overall. But given the nature of your businesses that they're more, I suppose, I would think, more mid to long cycle and short cycle or at least not extremely short cycle, that you could credibly think that this run rate we're looking at for 2Q could extend for quite some time for this year. In other words, the year could be short from that perspective. Is that the right way to think about it? And as part of that, do you think you'll be able to give us a sense of annual guide when you report second quarter earnings? In other words, are you going to have enough information then to provide some kind of algorithm or range?

Yes. I think, Rob, the first thing I would say is I actually would characterize us as primarily short cycle. So as really a book and bill type business. Aclara is a good exception where they would have pretty long pipeline and fulfilling off of orders taken for a while. But outside of that, there's generally pretty short cycle. So that's the first point. I think the second point is, I think we've got the visibility to the second quarter that's reasonably credible based on April orders and customer feedback. As you start talking about the second half, I do think it becomes harder for us. If you ask me, is it possible that those volumes continue into the third? I think it is possible. I was happy that our observation in April is reasonably stable through the weeks of April. We didn't see any kind of deceleration of any kind. So if you like shapes of letters, I would just argue, we think we're at the bottom part of that U right now, and it's just hard for us to give you insight as to when the uptick happens, although when it does happen, I think we'll be well-positioned with book and bill to get our fair share. It's just hard to comment on how long that could bleed into the third quarter or what the implications are for the fourth.

Yes, Rob, you're right. And I'm glad you're absolutely right on the timing of that. You had your dates right. I think that wasn't everyone wasn't totally comfortable at that time. I would expect the same thing. I think my friend, Bill Sperry, would be a little bit more of more reservation as he's focusing on our liquidity position. The operating guys and certainly, Gerben would be in that position as well to be looking opportunistically. You can be sure that our guys are having contacts on some properties that they have been looking at for some time. That's a little bit how the Burndy came along. If you recall, that was something that we had been approaching many times, and we're able to take advantage of an owner who had some distress in another part of their business. It became an opportune time to free that property. There're no guarantees, but we certainly are looking at those kind of things.

Yes, thanks. Good morning. On the orders, transit power persisting in April versus kind of a low single-digit 2Q outlook. Are you making a call on demand coming off as the quarter goes on? Or are you factoring in the divergence driven by your supply issues that can't meet demand?

Yes. The latter, Chris, right? We think demand persists and that we'll be satisfying that demand with some disruption. Some of that demand will be satisfied ultimately in the third quarter. But so the second quarter is informed by the supply side more.

Got it. My follow-up is on Power Systems, double-digit growth. Was there any accelerated backlog conversion that happened in the quarter? Or should we think about backlog being pretty steady at this point in time? So we should see some continued growth for the rest of the year in that business?

Yes. Actually, during the first quarter, we built backlog. So the orders were slightly stronger than our shipments. As I stated before, we saw that continuing in April here with the orders continuing strong. We do expect, as we talk, that in prior cycles like this, we've seen a slight delay of a couple of quarters. So we do expect that to come down. So I think we will probably get to certainly, the second half, where we'll be working off some backlog. But so far, we've actually seen the opposite.

Got it. Sorry. Let me just wrap up here with some thoughts on why we have confidence in getting through this successfully. We refer to it as a recession playbook, but it's probably broader than that. It's managing through uncertainty. There are three key issues here that I would talk to. One is the less cyclical nature of our Power business. We are selling critical components to utilities. Back in the '08, '09 recession, this business took longer to experience weakness and spent a shorter period of time at the trough relative to the shorter-cycle Electrical business. From a market perspective, we think we're certainly in a similar position currently with the visibility to continue strong customer demand in the utility space. Based on the ongoing recognition among our Utility customers of the need to upgrade the grid, although capacity challenges for us are something that we will work through. The second is our margins, which historically tended to correlate with price/cost performance given our significant raw material buy. Recessionary environments tend to lead to deflation in commodities. In the '08, '09 period, we were able to hold margins relatively steady while absorbing significant volume declines due to the big drop-off in commodity prices. Currently, we see some potential for commodity tailwind, but not at this point at the level seen back then. That's something we're monitoring closely, but we also have other margin drivers within our control, particularly around our footprint optimization savings and our discretionary cost actions. Finally, our free cash flow performance tends to significantly outperform net income as we aggressively manage inventories and CapEx. We note that during the last recession, our strong liquidity supported the acquisition of Burndy, which those of you who were here know that that was completed at the depth of the recession and was at that time, at $360 million, the largest acquisition in our history. It also turned out to be one of the most successful in our history. We feel well-positioned currently under a wide range of scenarios. While we're certainly not contemplating anything of that magnitude near-term, we think we can manage through this period successfully and eventually take advantage of some of the opportunities that may emerge down the line. At the end of the day, what has gotten us to where we are even in the early stages of navigating through this is the experienced team. Most of our senior team and even levels down have been through this before. While this has some differences, some of the issues are the same. Some of the key issues are being conservative in your outlook and getting ahead of the actions necessary. That's why even in the first quarter, that was really pretty much humming along for most of the first quarter. We had to say, we think the second quarter is going to be down, and we need to take the actions and plan for those actions and put those in place to start the second quarter.

Your first question comes from Jeff Sprague of Vertical Research. Your line is open.