Hubbell Inc Q2 FY2021 Earnings Call

Good day and thank you for standing by and welcome to the Hubbell Second Quarter Earnings Call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question-and-answer session. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today Dan Innamorato. Please go ahead.

Thanks, operator. Good morning, everyone, and thank you for joining us. Earlier this morning, we issued a press release announcing our results for the second quarter 2021. The press release and slides are posted to the Investors section of our website at hubbell.com. I'm joined today by our Chairman, President and CEO, Gerben Bakker; and our Executive Vice President and CFO, Bill Sperry. 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. Additionally, 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 slides. Now, let me turn the call over to Gerben.

Great. Thanks, Dan, and good morning, everyone. Thank you for joining us on this busy day to discuss Hubbell's second quarter results. I'm going to start my comments on page three with some key takeaways for the quarter. It was a quarter of strong growth for Hubbell, with revenues and earnings each up over 20%. We are seeing broad-based growth across both our electrical and utility segments and within each of our major end markets. As anticipated, our operating margins declined year-over-year in the second quarter due to the lapping of prior year cost actions, as well as inflationary headwinds, which we are actively mitigating through price and productivity. Operationally our second quarter results are consistent with our prior guidance, but we are now raising our full year adjusted earnings per share expectations at the halfway point. We see stronger market growth and a modestly lower full year tax rate, relative to our prior guidance. And while inflationary headwinds are greater than initially anticipated, we are proactively driving incremental price and productivity to offset. We'll give you more context around each of these dynamics throughout this morning's presentation. Turning to page four, to provide some more details on the results. Second quarter sales were up 26% and organic growth was up 21% year-over-year, as markets and customer demand were strong across both segments. In Electrical Solutions, we saw broad-based inflection across end markets, with light industrial continuing to lead the recovery and heavy industrial and non-residential markets beginning to improve as well. We noted coming out of the first quarter that electrical orders have turned positive and this trend accelerated in the second quarter, as demand remained strong and electrical orders continued to exceed shipments. Looking ahead, we expect our electrical markets to benefit from these recoveries in industrial and non-residential markets as well as longer-term trends toward increased electrification. In Utility Solutions, we continue to see strong demand for T&D components, driven by aging infrastructure and grid modernization trends. Recall, that despite the economic impact of the COVID-19 pandemic, our Power Systems business remained very resilient and grew revenues in 2020 as our electric utility customers are actively investing to upgrade and modernize the grid. These investments are driving attractive growth over the near and long term, including in our gas distribution business, which is effectively serving the growing need from gas utilities to harden and upgrade critical infrastructure. As anticipated, communications and controls markets returned to growth in the quarter as project deployments, which faced pandemic-related delays, have steadily returned. As previously communicated, we took a series of temporary cost actions and salary reductions in the second quarter of 2020, which resulted in a one-time benefit of approximately $20 million, and we lapped that benefit this quarter. We also continue to face significant inflation from materials, freight and labor as the impact of tight supply chains across the industrial economy drives higher input costs. However, we are being aggressive in our response. We continue to utilize the strength of our brands to lead most of our markets in frequency, pace and magnitude of price increases. And we achieved strong price realization in the quarter of 3.5% with increasing traction into the second half. We also continue to realize significant savings from our prior investments in restructuring actions, particularly within the Electrical Solutions segment, where you're already seeing the productivity benefits of unifying that segment under a common leadership structure come through in our results. We will give you some more granular color on our outlook section at the end of this presentation and our expectations for the second half, but we are managing through a dynamic environment aggressively and proactively and we now expect to deliver stronger full year results than from where we said a few months ago. Let me now turn it over to Bill to give you some more context around our financial results starting on page 5.

Good morning, everybody. I know how busy you all are so appreciate you taking time with us. Page 5 has got some graphical representations of what Gerben walked through. So you see the 26% sales growth to $1.192 billion. That's got four points of acquisition in it, and it's got about 3.5 points of price. It unpacks to electrical growing at about 28% and utility at about 23%. So quite a broad-based and I think fair to describe, this as a V-shaped inflection for us comparing against the second quarter last year, where we were down just a little over 20% in total, a little more skewed towards electrical as Gerben highlighted. Utility was a little more resilient last year. So I think the other thing to comment on about the sales growth and about the $1.192 billion is sequentially the pickup from the first quarter is better than typical Hubbell seasonality. So not just does the V-shape feel like it's rebounding from last year's dip, but it also feels like building some momentum and some improvement from first quarter to second quarter. The OP line $173 million is an increase of 15% year-over-year. Gerben highlighted the fact that this V-shaped recovery is bringing with it a significant amount of inflation. And so we're working hard to get our pricing up to that level and we're making quite good progress on that. And we'll talk about that a little bit more in our segment discussions. And as you look at earnings per share on the lower left of page 5, you see an increase of 26% to $2.36, a nice increase that's in line with the sales level. To get there, we had some help from the non-op areas, most notably from tax. Some discrete items allowed us to have an effective tax rate in the quarter in the mid-18s, which would cause our full year tax rate to come down to that 21%, 22% range from what we started to expect of 22% to 23%. Second contributor to the non-op side is interest expense, a little bit lower this quarter. We mentioned last quarter, we had refinanced $300 million of bonds at about 130 basis points lower interest rates. So we're getting the benefit of that lower interest rate here in the second quarter. The free cash flow of $131 million, it's important to think about what the right comparison and context for that $131 million is. Last year is a strange compare. In the second quarter of 2020, we were certainly reacting to the sharp contraction in demand and were harvesting the working capital section of the balance sheet collecting receivables, not building or investing in inventories. And this quarter, this year is a 180 to that. You basically have gone from the contraction to the expansion. And so, we're investing heavily in receivables and inventories. So, I think looking back to 2019 is actually pretty instructive. We've got a full year target this year of getting to $500 million of free cash flow which is around the level we achieved in 2019 and at the halfway point of 2021. This $131 million plus the first quarter gets us to about $170 million of first half cash flow which compares favorably to where we were in 2019. So feels on track and I think you got a story of quite strong revenues and continuing to navigate the inflationary environment, as we work to get our margins up to where they were last year. I think it's instructive though to unpack the enterprise results into the two segments because they are performing a little bit differently. We'll start with the electrical segment. On page 6 you see a 28% growth rate to $603 million of sales. That includes 1% from acquisitions. You'll remember us talking about the AccelTex acquisition, a really good investment made by the segment in the 5G antenna space. There's about four points of price in that organic growth of 26%. And so, you'll note that that's a little bit ahead of the average for the company at 3.5%. We're finding that the ED channel is quite receptive to these price increases. We find that they're passing that along the channel to the end user and installers. And most of what we're selling, we're finding selling through and not any kind of pre-buy situation that we're noticing in the channel. The broad-based nature of this recovery is certainly notable. The electrical segment was down about 26% a full year ago. The next quarter it was down about 14%; the next quarter about 10%; and then flat and now up. So quite a noteworthy inflection and quite broad-based. I'd say if anything leaning to the industrial side as kind of leading us in the V-shape rebound. Certainly, light industrial has been our strongest end market. We're selling connectors, grounding wiring device-type products into that end market and experiencing attractive growth. But the heavy side is showing positive signs as well. Our Harsh & Hazardous business, which has been quite oil and gas based, we've worked hard to diversify the end markets they serve with explosion-proof devices. And they've returned to growth which is quite welcome, as well as heavy industrial components which are serving factories, steel mills, rail transportation and the like also showing good signs. On the non-res side, we had started the year a little bit cautious on non-res. We're anticipating some contraction there. We've been experiencing growth and interesting I think to be led at this point by the reno and retrofit side of the business. I think new construction the early indicators the leading indicators are looking positive there as well. So certainly we have a brighter outlook for non-res than we started the year. Inside of there we've got not only wiring devices, but our commercial and industrial lighting which grew over 20% in the quarter. And the residential business continues to be strong. They will have harder comps to lap in the second half, but still showing some decent resilience there. The team did a great job of getting margins to expand to 13.4%, 41% growth in operating profit to $81 million. The higher volumes are important. The restructuring work that Gerben mentioned at the beginning is quite important. We've been investing money as you followed us here. A couple of years ago, we spent about $37 million on restructuring, last year about $31 million, anticipating to spend about $20 million this year. And so that you're getting both a tapering effect of that spending, but also the benefits from the projects we did last year creating some good lift. And those were substantial enough to help us overcome the headwinds from the inflation that we're facing. And I think it may be worth just a comment and pulling the lens back on restructuring. We continue to feel quite good about the program. We've taken out by our analysis about 1.5 million square feet from our manufacturing footprint. That's over 15%. And we continue to see opportunity both on the manufacturing side ultimately on the warehouse side as well. And as Gerben described in his opening comments, the ability to take the segment and compete collectively under unified leadership rather than have three different vertical businesses we think is opening up good opportunities to share warehouses, to share factories and become more efficient. And we see continued runway there. I would comment that in the first half of the year, we didn't spend half of the $20 million we anticipated. I'd say a lot of our engineering focus was on capacity and making sure we had production to service our customers' needs. And so, the back half outlook for electrical will contain an increase in R&R spending compared to the first half. But we anticipate the demand to be strong. They start the second half with a big backlog and the pricing actions continue to increase as commodities continue to increase most notably steel. We've seen copper and aluminum starting to show signs of maybe flattening out. Steel is still showing signs through the third quarter of increasing until hopefully it looks like some rollover in ultimately in the fourth quarter. So we continue to price for that. I think we've also had to expand our definition. I think those of you who followed us know we try to maintain a parity between price and commodity costs and then use productivity to offset inflation in non-commodity areas. We're finding that the inflation in areas like transportation and some labor costs are such that natural productivity levels are insufficient. So we're starting to sweep those other items into the bucket that need to be covered by price. And again, we've been encouraged by the channel's reaction. We'll continue to offset those and to get back our margins. The utility side on page 7, you see 23% growth to $589 million. There are six points of acquisition inside that utility growth number and three points of price compares to the four points of price in electrical. So, utility customers moving a little bit more deliberately than the ED channel serving the electrical side. Those acquisitions to remind you included in the enclosure area for electric utilities, water utilities and telecoms. That business is high growth high margin. We also bought a company called Armorcast. We – Beckwith is wrapping around here, which is controlling the infrastructure, and maybe also of note, we sold a very small line of business from within Aclara, the customer engagement business that didn't fit well with our set of solutions and was worth more to someone else than it was to us. So it has no material impact on our sales or OP going forward, but we feel we can use the proceeds from that to invest in areas with a better fit. We've unpacked the sales here in Utility Solutions between the components and the communications. The components is both electrical T&D, the old legacy Hubbell Power Systems continuing though resilient last year continuing to grow very, very nicely this year. The grid modernization trend and renewables trends continue to push spending there. We've noted a little better strength in distribution and transmission this quarter. That can go back and forth. And the gas distribution components that go into the last mile of natural gas distribution had been you'll recall slightly held back by some site access issues. And happy to see those conditions improving seeing nice growth and nice margins out of the gas distribution business. On the comms business and Aclara, we had also had site access issues there, and as those have improved we see that returning to growth. So, again, a broad-based situation of healthy demand inside of Utility Solutions. $93 million of operating profit is comparable to last year and at lower margin than last year. The price cost area continues to be a source of drag here in the second quarter. Our three points of price is up from about one point in the first quarter. We've had our fourth increase already announced, which will influence the second half. So I think an unprecedented number of increases. And we feel we're certainly leading the market as we announce those price increases, but we continue to be very confident that we'll catch up as this inflation from the commodity starts to level out that we'll catch up and restore our margins. There's two other factors worth mentioning here in the margin profile. First is the Armorcast acquisition that I mentioned. It's located in Southern California and we closed on it very early in January, so we've had it for about six months. And I'd say they've endured significant labor turnover and having a hard time staffing the facilities in that geography. So it's not been contributing much though it's on the bottom line. And so we're working hard and we're very excited about the acquisition. And we're confident we'll have a better second half and set up well for a better 2022. I think the third driver I'd mention to you is inside of Aclara, recall, there's three lines of business there – the communications, the meters and the install. The install business is at the lower end of profitability of the three lines of business. That's where the access had been constrained. As that was loosened, we saw the install area be the largest level of growth and therefore, being mix unfriendly. And so those pieces conspired to result in flat OP for utility. And I think that describes the two segments and where they are. As we think about the outlook for utility, we feel great about the backlog that's starting in the second half. The demand feels broad-based and solid. Perhaps of note the chip shortage that we're all reading so much about, the place that would affect Hubbell is more in the Aclara on the communications side. And we're sort of watching those supply chain situations closely. But our guidance is contemplating some of those risks. So I'd turn it back Gerben, to you to talk through the outlook in general.

Great. Thanks, Bill. Let's turn to our 2021 outlook then on Page 8 and starting with our end market pie chart on the left. With the first half behind us and increasing visibility into the unfolding economic recovery, our markets overall are trending above expectations that we had at the beginning of the year. Most notably, as Bill indicated, industrial markets have strengthened throughout the year and we now expect this market to be up high single digits on average with light industrial verticals leading the way, and heavier industries expected to continue recovering in the second half. We're also more optimistic on non-residential markets, where we were expecting a modest decline a quarter ago and now see modest growth. While new construction activity remains mostly soft for now, we expect to see recovery here heading into 2022 as major leading indicators have rebounded strongly in recent months. Near-term, our incremental optimism in non-residential is driven by reno and retrofit markets, which have been solid as the economy has reopened. On the utility half of our business, we are sticking with our prior end-market guidance for approximately mid-single-digit growth for the full year, with communications and controls outgrowing components primarily, due to prior year comparison dynamics. This all adds up to mid-single-digit market growth for the full year and we are now anticipating high single-digit organic growth as we drive approximately four points of price realization. Then when we layer on the contributions from acquisitions we now anticipate total sales growth of 11% to 13% for the full year. We've also tightened and raised our adjusted earnings per share guidance by $0.25 at the midpoint versus our prior range, and continue to expect approximately $500 million of free cash flow for the full year. I'll give some more context on the drivers of this guidance raise at the next page but with half the year behind us we are confident in our ability to deliver on these raised expectations. Now turning to Page 9 for our year-over-year EPS bridge. We've shown this earnings bridge throughout the year and we think it's a helpful way to summarize the various moving parts of our guidance. At a high level, what has changed relative to our prior guidance is that we now expect stronger volume growth, stronger incremental price realization and some non-operating tailwinds from a lower tax rate, all of which is more than offsetting inflationary headwinds, which have also turned out to be more significant than contemplated in our initial guidance. The net impact of these dynamics allows us to raise the full-year guidance to now reflect mid-teens adjusted earnings per share growth. A couple of other points of note on this page before we turn it over to Q&A. Restructuring continues to be a key driver of our financial model with ongoing investments generating strong savings throughout this year. We continue to include restructuring investment in our adjusted earnings framework and are still targeting investments consistent with our prior guidance of approximately $0.30 though we now expect this investment to be more weighted to the second half, as Bill highlighted as our operational efforts over the first half has focused more on increasing our production capacity to meet the strong demand from our customers. We still have a multi-year pipeline of footprint optimization projects to drive incremental savings well into the future. On price/material, as we've reiterated consistently throughout the first half we are highly confident in our ability to manage this equation to net favorability over the course of a cycle. Although inflation in material, as well as freight and labor have persisted throughout the second quarter, we have taken aggressive pricing and productivity actions that will accelerate in the second half and generate wraparound tailwinds going into 2022. As is typical, our financial model tends to operate with a one-to-two quarter lag between commodity cost and price capture. So while we anticipate catching up the net positive on price/material across the enterprise by the fourth quarter, this will continue to be a headwind on a full year basis. To conclude, we are raising our full year adjusted earnings per share guidance to a range of $8.50 to $8.80. We remain confident in our ability to deliver on these commitments, and we are focused on serving the critical infrastructure needs of our customers, while continuing to actively manage our costs and deliver value for our shareholders. With that, let me now turn it over to the Q&A section.

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

Thank you. Good morning, everyone.

Good morning, Jeff.

Good morning, Jeff.

Hey. Good morning. A couple for me, first just on maybe where you closed Gerben with kind of getting net neutral on price cost. I assume that comment was just on the raw materials, or are you talking relative to the broader scope that Bill was talking about, trying to get the labor and the logistics inside that construct also?

We are focused on addressing the material aspect. We believe we have the necessary actions in place and have already made our requests. However, during our reviews, we've been discussing additional factors, Jeff. Therefore, we need to continue our effort and ensure we consider other types of inflation beyond commodities that should be reflected in our pricing.

Yes. And then, Jeff, maybe I'll add a comment on that. In much lower inflationary periods, we've generally adopted the strategy of price for commodities. And then, we're driving productivity in our business to offset more general inflation in this environment, where we're seeing this steep inflationary pressure. We're definitely thinking around our pricing strategy more than just commodities, but thinking inflation more broadly. So, a lot of our actions are with broader cost inflation in mind.

Understood. And then, the comment on restoring the power margins, could you just clarify kind of, when and to kind of what level you're talking about restoring?

I think Jeff, if you look at the utility segment's performance from March 2018-2019 into 2020, you saw a healthy margin expansion of a couple of hundred basis points. We're definitely seeing the utility segment coming off a strong peak. It's also interesting to note the rebound in the third quarter last year after a tough second quarter due to COVID-related factory closures. They still managed to maintain favorable price costs, resulting in solid margins. We face some challenging comparisons, not only in the second half of 2021 but also historically. However, as we continue to grow and manage price costs, we're hopeful that 2022 will help us recover much of the margin that we encountered headwinds on this year.

And what you should expect to see is sequential improvement on that margin as we go through the balance of this year.

Okay, great. And then just one last one for me, just on Aclara, obviously the comp was super easy. The growth in the quarter doesn't really stand out relative to that comp. But I assume there was still access and other issues. But could you just give a little more specific color on how you see things playing out there over the balance of the year?

Yes. I believe that access is improving even with the presence of some variants. In terms of demand, the backlog along with the blanket orders remains healthy and is higher than last year. The unpredictable nature of the business makes it challenging to provide narrow predictions. However, we expect the communications and meters sectors to drive our growth, rather than the installation side, which needs to stabilize. Overall, the pipeline and backlog look promising. If we disregard minor quarter-to-quarter fluctuations, we anticipate a medium-term outlook of mid-single-digit growth with margin expansion.

Great. Thanks a lot guys.

Your next question is from Steve Tusa from JPMorgan. Your line is open.

Hi Steve. If you're talking, we can't hear you. I don't know if you're on mute or maybe got dropped.

Operator, can we move to the next question? There is a problem with Steve’s line.

Your next question is from Tommy Moll from Stephens. Your line is open.

Good morning and thanks for taking my question.

Good morning.

So in terms of your end market strength, you've talked about a V-shaped inflection versus last year also pointed out some momentum in the quarter-over-quarter comparisons. And then obviously raised your full year outlook. As you look across the business and as we start to think about next year, I know we're not going to get guidance today. But do you have any sense of the duration of this momentum? I mean any pockets of your business where you can start to see a more normalized rate of change, or is it just...

Yes. It's challenging to compare this quarter to last year's second quarter, which was down 21%. It's not easy to describe this as a normal situation. However, we observed some positive movement in the sequential comparison from Q1 to Q2, showing a better-than-usual seasonal pattern, albeit modest. We noticed a significant improvement in orders, indicating that demand is picking up. One concern we have is if customers are preparing for price increases and an inconsistent supply chain, which might cause them to buy earlier than necessary. We're closely monitoring sales through the distribution channel. So far this year, everything seems to be moving. It's difficult to determine if end users are stockpiling. Looking ahead, we expect to move beyond the fluctuations we saw and enter a more typical second half, especially when comparing year-over-year on the top line. The relationship between units and price will be crucial to observe. We're anticipating a notable price increase in the second half, aiming for an overall increase of four points for the full year. After seeing one point in Q1 and about 3.5 in Q2, we anticipate the second half will exceed five points. This will be in addition to the units, so we need to keep an eye on both organic growth and unit tracking.

I would like to add a couple of comments. What gives us confidence in our guidance for the second half is the backlog we built in the first half. Additionally, we have not observed significant restocking in the first half, which reinforces our confidence in delivering results in the second half. Looking further ahead to 2020 and beyond, we believe the secular growth trends in our industries, such as renewables and grid reliability, position us well for continued growth in the long term. Although the comparisons may become more challenging with such a rapid increase, we remain very optimistic about our future growth.

And as we think about Tommy, stimulus and any kind of infrastructure package that government policy maybe behind, it's certainly too early for us to see any impact of that obviously. And it's not even clear where 2022 might be impacted there. So, we think the demand we're seeing is solid and we're pretty confident in that.

Thank you, both. That's very helpful. I wanted to follow-up on capital allocation. You've taken care of your near-term maturity. Your leverage appears to be well under control. So, what would you offer to help frame up priorities in terms of M&A shareholder returns any areas of increased investment internally that you've got in mind?

I would say, if you consider our potential of generating around $600 million in operating cash flow, I expect there to be a couple of hundred million in dividends and $100 million for capital expenditures. The dividend is aimed to be around 45% of the net income payout ratio. As our net income improves structurally, you can expect an increase in dividend payouts accordingly. The $100 million in capital expenditures is roughly a couple of points of our sales, which we find sufficient for capacity and productivity needs. Our share repurchases are typically in the $40 million to $50 million range each year, which we view more as a way to offset dilution rather than to reduce the number of shares outstanding. This leaves about $250 million for acquisitions, which we believe is a suitable amount to invest in new opportunities each year. Armorcast has just begun, and we are eager to move forward with acquisitions, having a good pipeline of prospects. The market does seem to be a bit competitive on the buyer side, with rising valuations and faster processes. Therefore, we must be cautious as we look to buy, ensuring we find valuable opportunities at reasonable prices. We are confident that we will continue to achieve that.

Thanks Bill. That’s helpful, and I’ll turn it back.

Your next question is from Christopher Glynn from Oppenheimer. Your line is open.

Thank you. Good morning.

Good morning.

Good morning, Chris.

Good morning. So more good numbers top line from utility and you broke out the 19% for T&D, 9% for Aclara organic. Curious how you'd peg the market growth there because I think you have a legacy of doing a little bit better?

Yeah. Inside of T&D, I think our perception is that we maybe have been share gaining a little bit of share. But it's may be hard for me to prove that to you, but it feels to us like we are Chris.

Okay. And is there any way you benchmark the Aclara side of the house?

Yeah. I mean certainly there are a couple of public comps who report sales growth from the meters and comms side. And as we looked at them quarter in quarter out over our ownership period, I would say it feels like we've outpaced them a little bit probably on the meter side. But again we continue to see that as a good mid-single-digit long-term grower. And couple of decent public comps that we can track ourselves to, to make sure we're growing with the market.

Yeah, it's truthfully easier on that side on the communication side where you have some public companies to compare than on the legacy power side where there's less or they're within larger companies. So it's very hard to get to that in exact numbers.

Okay. And then on electrical curious too, do any deeper dive on the book-to-bill, and then within non-res the particulars of what's improving there. If it's, kind of, bifurcated in your product categories or not?

The book-to-bill ratio was over 1.15, indicating solid bookings. In the non-residential segment, we experienced better performance on the renovation and retrofit side compared to new construction. C&I lighting has become increasingly reliant on renovation and retrofit, which benefited from growth of over 20% in the quarter. Additionally, the leading indicators for new construction in the non-residential sector are also showing favorable trends. Although we began the year with some caution regarding non-residential, the actual performance has turned out to be stronger than our predictions from January.

All right. Just to clarify, I think you mentioned a lower tax rate. I'm not sure if you provided a specific level for modeling, but could you comment on that? Additionally, what is driving this change? Should we anticipate a return to the normalized tax rate that we saw in 2022?

Yeah. So I would say our normal tax run rate has been in that 22% to 23% range. In the second quarter it was down around 18.5-ish percent. And so that will cause a one point reduction in the full year to 21%, 22% rather than 22%, 23%. So the discrete items in the quarter don't repeat and don't reverse. They just help create a little bit of tailwind in the second quarter and that gets smoothed out over the full year.

Understood. Thank you.

Your next question is from Josh Pokrzywinski from Morgan Stanley. Your line is open.

Hi, good morning guys.

Hey Josh.

Good morning Josh.

Bill just to follow-up on some of the price cost commentary and kind of that broader definition that you're using. What would be expectation as maybe some of the material side of the equation starts to level off but maybe things like freight or labor or other logistics costs remain high. Like is that something that you feel like you can go to the market with price with, or do customers really want to be able to circle a chart with steel prices and tie back to that a little bit better?

Yes, I believe we are aiming to frame that discussion more broadly, and you've identified the two primary factors that we need to consider: transportation costs and labor costs. We are definitely committed to maximizing productivity for our customers. I would say it's realistic to expect that productivity improvements could reduce our cost base by a few percentage points. However, in a situation like this with rising inflation, the costs associated with transportation and labor are likely to exceed any gains we can achieve through productivity. We believe that focusing solely on the surcharge aspect, like simply presenting a graph of the prices of steel, copper, and aluminum, misses a key part of the conversation, which is addressing inflation. This is an important new initiative for us. Gerben and I spent last week in operations reviews, meeting with all our key business unit and profit and loss managers. They are all advocating for a clear understanding of what our pricing needs to cover. We will continue to push this effort in the second half of the year.

Yes, I would like to add that we have definitely evolved in our pricing strategies for the businesses, both in how we organize them and in our approaches. We are being more aggressive and utilizing more analytics and organization in this area. I completely agree with Bill's comments. Our focus is on evaluating pricing across our entire portfolio, identifying where we can adjust prices and where we need to. I believe we are managing both of these aspects better than ever before, which is reflected in our price realization. Commodities have continued to go up throughout this year, right? And it's now – I mean steel as an example, it's one of our highest uses. A year ago that was sitting at about $600, $700 a ton. We're at $2,000 a ton and so – and it's sitting at a high right now. So will that eventually level off? Will that come down? Who knows? The thing that we can control is the actions we take, which is pricing and we're going after that really aggressively.

Got it. That's helpful. And then just on the utility side for you Gerben. Obviously, a lot, especially on the legacy Power Systems business going on in the marketplace, whether it's some of the like energy transition stuff or on renewables or grid modernization. But I also know that there's some heightened kind of near-term activity with places like Texas and California. What's your sense of kind of what is going on there that you would say is a bit more kind of secular and forward thinking on the part of your customers versus stuff that's more reactionary in the here and now? And my guess would be it's all of the above but can you take that a little further?

Yes, I'm smiling as I respond to your question because it aligns with our previous communications. There are indeed some long-term trends in this market that will continue to support our position. The infrastructure is aging, and the current push for renewables is significant and adding more stress to the system. There is a clear motivation to replace less efficient assets with more efficient renewable sources, and we stand to benefit from this trend. Moreover, there is an increased awareness of the grid's fragility, especially highlighted by storms and fires, which drives the need for grid upgrades. These two factors are interconnected, and we maintain a positive outlook for the next two years. As you noted, it's not solely about one aspect, but it is advantageous for us. Additionally, there is strong regulatory support for these types of investments, with Public Utility Commissions recognizing the necessity for such changes. Overall, there is considerable momentum in this area.

Great. Appreciate the color. Thanks, guys.

Your next question is from Chris Snyder from UBS. Your line is open.

Thank you. I wanted to follow-up on some of the commentary around raw material inflation. Could you remind us how significant raw material consumption is as a percentage of cost of goods sold in a normal year? Just so we can put some math around the Q4 price cost neutral comments, which it sounds like is reflecting price up in the 5% kind of plus range?

Yeah, Chris. Your math, I like the way you're doing the math. I would put our raws in the order of magnitude of the low 40% of sales and a little bit more than half of COGS. And so there is a mathematical equation between what you need on the top line and price versus the inflation you're getting in the raws. So I think about it exactly the way you are.

Okay. I appreciate that. And then for the second one, I wanted to follow-up and particularly on the non-res business. And then within that specifically the new construction side, which feels like it's beginning to turn. Could you just remind us where you sell into the new construction life cycle? And I know lighting is quite late stage, but maybe more on the electrical side just so we can kind of feel for how you realize that recovery?

Yeah. I would say the rough-in electrical is fairly mid-cycle to the construction. So think of boxes that would be inside of the wall. But then some of the receptacles and lighting and poke throughs in the floors those would all be quite late cycle. So we're kind of mid to late and skewed towards the late in the timing of that.

Appreciate that. Thank you.

Okay.

Your last question is from Justin Bergner from G.research. Your line is open.

Good morning, Gerben. Good morning, Bill.

Good morning.

Good morning.

Two quick questions. On the grid side, the T&D side, what is the potential upside from burying electrical or burying power lines for example in California? And then on the utility infrastructure bill, if the bipartisan bill passes looking out to the medium term do you see that as sort of extending this 5% to 6% organic growth rate environment for your T&D business or actually increasing that growth rate?

So, Justin, let me take the first part, and I'll give Bill the second part. So the first one on the grid, T&D the particular question was around underground. I think you probably saw recently a large IOU utility talking about perhaps doing this. I'd say, our portfolio leans more to the overhead side, but if you think about transmission infrastructure and the distribution grid, most of the US actually is overhead except when you go into neighborhoods. We do have a presence in the underground. I would also say that, when – and as you look at the investments required to bury this, it's humongous. So it's generally at least 10x or more the cost. So I think many utilities don't find the economics to be able to do this. So I don't see it as a threat to our franchise truthfully. But it's something that in certain situations can happen and we can serve materials for it as well.

Yeah. I think the second half on the infrastructure. I think areas like renewables can really be quite favorable to where Hubbell is exposed solar and wind components both on both sides of our segments. We would have utility benefits, as well as some of the grounding and component elements inside of electrical. Anything on grid reliability certainly would be favorable. There's talk on telecom reliability, just making buildings more energy efficient for our behind-the-meter piece of our business. So, there's a lot inside of that that ultimately, I think could contribute to maybe what I'd call a stimulated period of demand that would be a little bit more than sort of our normal level, if that comes to pass and gets spent over who knows a period of five years or so. So, it would be certainly on the topline, it would have bullish implications I would say.

Thank you. I'll take my other questions offline. I appreciate the color.

Okay. Great. Thank you.

There are no questions over the phone. I'm going to turn the call back to Dan Innamorato.

All right. Thanks, operator. Thanks everyone for joining us. I'll be around all day for questions. Thanks.

This concludes today's conference call. Thank you for participating. You may now disconnect.