Earnings Call Transcript - HUBB Q3 2022

Operator, Operator

Good day and thank you for standing by. Welcome to the Q3 2022 Hubbell Inc. Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. Please be advised that today's conference call is being recorded. I would now like to turn the conference over to Dan Innamorato. Please go ahead.

Dan Innamorato, Presenter

Thanks, Lisa. Good morning, everyone, and thank you for joining us. Earlier this morning, we issued a press release announcing our third quarter 2022 results. 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 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 on 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. And with that, I'll turn the call over to Gerben.

Gerben Bakker, CEO

Great. Thanks, Dan, and good morning, everyone, and thank you for joining us to discuss Hubbell's third quarter results. Consistent with the first half of 2022, our third quarter result was solid. Our markets are healthy, our positions in those markets are strong, and we continue to execute effectively from an operational standpoint. Our third quarter results exceeded our initial expectations, and we are raising our full year outlook to reflect a continuation of those positive trends throughout 2022. We are well positioned in attractive markets that are supported by long-term trends in grid modernization and electrification, which continue to drive strong demand for our products. Utility customers are proactively replacing aging infrastructure while investing significantly to upgrade, harden, and modernize the grid, driving another quarter of strong orders growth and backlog build. The work we have done to streamline our portfolio and the investments we are making in strategic growth verticals are positioning Hubbell for sustainable GDP plus growth as our economy becomes more electrified. From an operational standpoint, margin expansion in the quarter was driven by volume growth and favorable price cost. We have been active in pricing to address significant material and non-material inflation over the last 18 to 24 months. While general inflation persists throughout our supply chain, we have now started to benefit from easing in the portion of our cost base that is tied directly to certain raw materials. While the operating environment remains dynamic, we are proud of the way our employees have continued to effectively navigate through supply chain uncertainty to deliver on our commitments to customers. As we look to drive continued success on this front, I'm also excited to welcome Akshay Mittal to the senior leadership team as Hubbell's new operations leader. Akshay comes to Hubbell with an extensive operation and supply chain background across various industrial manufacturing industries, and we look forward to building on the strong foundation we have established while accelerating our efforts in footprint optimization, factory automation, and supply chain resilience. Turning to Page 4, I would like to highlight a few of the key financial outputs of the themes we just talked about before letting Bill walk you through the results in more detail. In the third quarter, we achieved organic growth of 20%, adjusted operating profit growth of 37%, adjusted operating margin expansion of 190 basis points, adjusted earnings per share growth of 45%, and free cash flow of $194 million. These results were driven by strong price realization and volumes, combined with easing material costs and effective operational execution. Overall, a very strong quarter for Hubbell and attractive results for our shareholders. I also want to turn to Page 5 and take a few minutes on two recent achievements, which really highlight the strength of our franchise in the electric T&D market and the work we are doing to support critical infrastructure needs of our customers. The first is our storm restoration efforts to Hurricane Ian and Fiona with our 24/7 Hubbell Emergency Action Team. Storms like these are unfortunate due to the impact on lives and community, and they also put a lot of strain on utility customers to restore service and repair damaged lines. We are proud to support our customers in these efforts through a dedicated team that prioritizes these requirements and gets our customers the needed expedited materials to enable successful and timely restoration of service. This is a unique differentiator for Hubbell as we can fully utilize our industry-leading sales force, depth, and breadth of the product offering and operational capabilities to effectively serve our customers when they need it most. Our people truly distinguish themselves during these events, which helps us forge long-lasting customer partnerships based on quality, reliability, and service. And on the topic of long-term customer relationships, we are also pleased to have been recently awarded the Annual Supplier of Choice Award by one of the largest investor-owned utilities in the U.S. This award was given to Hubbell for our strong service, not only over the last decade, but through the more recent challenging supply chain environment as our industry-leading scale and the investment we've been able to make in our business have enabled us to effectively deliver on our commitments. While strong electric T&D market growth continues to be a key driver of our success, we also feel confident that we will continue to outperform these markets as we reinvest to bolster our position. With that, let me now turn it over to Bill.

Bill Sperry, CFO

Good morning, everyone. I appreciate you joining us today. I want to extend a warm welcome to Akshay as well. I'm looking forward to collaborating with him as we aim to enhance our operational effectiveness. My remarks will begin on Page 6, where I will highlight the robust financial performance of the Hubbell team in the third quarter of 2022. Starting with sales, we saw a 21% increase to just over $1.3 billion, made up of 20% organic growth, 2% from acquisitions, and a minor decline due to foreign exchange. The organic growth of 20% is comprised of about 13% from price increases and roughly 7% from increased volume, demonstrating impressive contributions from both fronts. Tracking sales sequentially also reveals a mid-single-digit growth from the previous quarter, with similar contributions from price and volume, indicating a potential easing in the supply chain. We operated at capacity during the second quarter due to a significant backlog and customer demand, and now we're starting to see some improvement in staffing, materials, and transportation availability. As we assess the demand driving this sales growth, it appears to be broad-based, with both Electrical and Utility segments showing remarkable performance. Orders continue to exceed sales, and we are increasing our backlog, particularly in the Utility segment, while the Electrical segment finds a more balanced book-and-bill approach. On the operating profit front, we saw a 37% increase to $224 million, accompanied by nearly two points of margin expansion, largely due to favorable pricing that has helped mitigate inflationary pressures and supply chain inefficiencies. We recorded incremental drop-through in the mid-20s, showing that the price increases have become essential to manage other inflationary challenges. In terms of earnings per share, we achieved a 45% increase to $3.08, primarily driven by improved operating profit, along with some contributions from taxes and share repurchases following the disposal of C&I Lighting, in addition to slight non-operating gains. Our free cash flow for the quarter was $194 million, significantly improved from last year. Looking at our year-to-date cash flow performance, we feel confident about meeting our full-year objectives, and we'll provide an update on our guidance soon. We're strategically investing in working capital to meet rising demand, especially in receivables and inventory. Moreover, we are focused on capital expenditures, with more investment directed toward productivity in the Electrical segment and expansion in the Utility segment. Turning to Page 7, our Utility Solutions segment had a stellar quarter, with sales increasing by 29% and operating profit dollars surging by 53%, alongside significant margin expansion. This growth is mainly organic, with a small contribution from acquisitions. Despite the strong performance of Ripley Tools, the organic growth far outpaces it. The growth in this segment is primarily in T&D Components due to aging infrastructure, the transition to renewables, and supportive infrastructure legislation that boosts customer confidence in funding their projects. On Page 8, our Electrical Solutions segment also showed strong results, with a 12% increase to $542 million in sales, propelled by low single-digit unit volume and high single-digit pricing. While residential markets faced a double-digit contraction, other verticals like data centers and renewables remained strong, contributing to the overall growth. Operating profit improved by 15% to $80 million, supported by favorable price material dynamics and volume growth, despite some headwinds from supply chain issues and non-material inflation. Regarding orders, we’ve experienced a balance between bookings and sales, with no signs of a slowdown so far. However, we remain vigilant of consumer trends, as year-end customer behaviors can be influenced by incentive plans which may distort order patterns. We continue to invest in productivity despite the drag on our margins due to these efforts. On Page 9, the performance of both segments has positively influenced our outlook for the remainder of 2022, leading us to raise our guidance. We are increasing our EPS estimate from a previous range of $940 million to $980 million, now projecting $10.25 to $10.45. This consistent outperformance reflects better-than-expected volume and pricing throughout the year. We also note our M&A activities, with successful additions that will further enhance our earnings moving forward. We aim to invest strategically in productivity, capacity, and innovation across both segments to secure long-term growth. Although our free cash flow conversion might adjust downwards due to increased investment needs, we are confident that we can manage working capital effectively while continuing to improve customer service. We look forward to finishing the year strongly, and now I'll hand it back to Gerben to discuss our outlook for next year.

Gerben Bakker, CEO

Yes, Great. Thanks, Bill. And before we turn it over to Q&A, we wanted to provide some initial thoughts on our setup into 2023, and Hubbell is planning to deliver continued attractive results for our shareholders. While the macro environment remains uncertain headed into next year, we are confident that our markets are well positioned to continue outperforming GDP. In Utility Solutions, we believe there is still plenty of runway and above average visibility to continued growth driven by long-term grid modernization trends. In Electrical Solutions, we expect residential markets to remain challenging, but we believe that the 20% of segment revenues exposed to our strategic growth verticals in T&D, renewables, data centers, and communications should prove resilient to cyclical dynamics. Operationally, while commodity prices have eased, we are planning for general inflationary and supply chain pressures to persist. We will continue to manage price and actively drive productivity to come out net neutral or better relative to our overall cost base. We also plan to continue reinvesting in our business to deliver long-term growth and productivity. In Utility Solutions, we plan to invest in capacity expansion to service a visible long-term growth profile. As we have highlighted in the past, the inflection in T&D markets, from a low single-digit growth to mid-single-digit growth over the past several years has caused us to bump against capacity constraints in certain key product lines. Looking ahead, we see a unique opportunity to further strengthen our position and better support visible customer investment plans by executing on high-return expansion and innovation projects. In Electrical Solutions, we plan to maintain elevated investment levels to support footprint optimization projects as we continue our multi-year journey as a unified operating segment with a structurally higher long-term margin profile. The net of these early considerations for next year, acknowledging that there remains a lot of uncertainty, is that we are expecting to deliver solid performance in 2023 and across a range of macroeconomic scenarios. We plan to provide a more detailed '23 outlook on our typical cadence along the release and discussion of our fourth quarter earnings results. With that, let me now turn it over to Q&A.

Operator, Operator

Coming to the stage now, we have Jeffrey Bradley of Vertical Research Partners. Please go ahead. Your line is open.

Jeffrey Sprague, Analyst

This is Jeffrey Sprague from Vertical. That introduction broke up a little bit. Maybe just start big picture, Gerben, actually, just on kind of the operational plan and people you've had some movement at the senior levels with Susan and Peter Lau moving and then Akshay in. Is there a fundamental change in your kind of operational priorities or some kind of change in what you’re kind of expecting to deliver relative to maybe some of those longer-term plans that you've put out before?

Gerben Bakker, CEO

Yes, I'd say, Jeff, the short answer to that is absolutely not. Certainly, I'm not going to comment on specific personnel matters. But as you look at the environment, generally, it's an environment in our organization, many organizations of higher turnover. And I would say that while we've lost people, we've also attracted very talented people. I think we're actually in a very good position. If you look at the strength of our business where we play the markets that we're in and the potential of this business as we look to bring on people and Akshay is a good example of that, they're very attractive to join a company like Hubbell. So, I'd say it's part of what us and many others are just dealing with, but we are continuing to be able to attract good talent to Hubbell and continue to develop talent within Hubbell. I'd say to the second question of is this somehow an indication of our strategy. The answer is no. And in Akshay's case, it's refilling, backfilling that position. There's a lot of work you heard Bill talk about particularly in the Electrical segment, what we need to do still on our footprint. But equally, in the Utility business, as we look to expand capacity, there's a lot of operational execution in those things as well. If you look specifically at the strategy on our two segments, it's something that we started to put in place if you recall when I was COO. It was a model after the Utility business where we proved that to be very successful in bringing all those brands under a common structure. So, I would say a couple of years into that. I feel really good where we stand. There's still a lot of work to be done. And even as I've spent a little more time with those GMs here, as I kind of overlook at that business, why we look for a new leader there. I'm really impressed with the talent there. And so I'm very bullish on being able to execute that strategy in unifying that segment, and that will lead to a higher margin profile for that business going forward. And I think growth that we're also seeing that we'll be able to get out of that by operating more as a unified segment. So reinforcement to my answer of no.

Jeffrey Sprague, Analyst

Okay. I appreciate that. Maybe just then on Utilities, sort of maybe a two-part question really. First, was there a measurable storm impact in the quarter on the top line? And maybe more significantly, just on comms and controls and Aclara. What is the visibility on potentially uncorking this and getting around some of these shortages and driving some growth there? Obviously, it sounds like you expect T&D Components to still be strong in the next year. But your comp is tough, right? It would be nice to see Aclara finally catch a little bit of a tailwind there and begin to kind of fill in the blanks a little bit.

Gerben Bakker, CEO

Yes, let me address the first question and then pass the second one to Bill. Clearly, the storm had an impact. I emphasized the great work of our team in responding to those challenges. The order impact was approximately $15 million due to the two storms, which affected a bit of two quarters. As you might recall, the last storm hit right at the end of the quarter. While there is an impact on our business in those situations, it's less about driving growth and more about demonstrating to our customers the value we provide. We excel at serving our clients, especially when our capacity is limited, by ensuring they have the necessary materials to restore the grid. So, while there was a slight impact on sales, more importantly, it was an opportunity to highlight our capabilities. Bill, maybe you can...

Bill Sperry, CFO

The second half of Jeff's question was around Aclara visibility. And I would say, Jeff, the first nine months were challenging for us to see the value proposition of the solution of the smart meter have great resonance with the customer base, and yet perhaps the supply chain struggle to support that has been challenging. So your question is now around visibility going forward, and there's kind of two dimensions to it. One is chip supply loosen up here as we've seen some demand for consumer electronics start to slack in, and we think that will evidence itself. And secondly, we have been spending a lot of time trying to validate alternative sources for the technology, and we're making progress on that. And so between those two avenues, we're hoping by the time we get together with you in January to talk more quantitatively about 2023. We'll be able to give you a more quantitative assessment of that visibility. But it appears to us to be improving. And I agree with your last statement that will be quite welcome to have Aclara a growth and margin contributor.

Operator, Operator

Thank you. One moment for the next question. I have the next question coming up. The next question will come from Steve Tusa of JPMorgan. Please go ahead.

Steve Tusa, Analyst

Congratulations on a fantastic year. Great execution in a challenging environment. Regarding the fourth quarter of 2023 and the basket of costs you are monitoring for inflation, could you clarify what percentage of those costs tends to be more stable and what percentage is truly variable and influenced by the metals market? Also, on the pricing side, could you remind us of any indices related to metals or any mechanical factors that fluctuate with raw material prices?

Bill Sperry, CFO

Yes, let's start with the pricing aspect, Steve. There's a relatively small percentage that is specifically indexed, and we have been focusing on collaborating with our customers to implement price increases. Regarding your question about stickiness, there may be a couple of percentage points in price that could contribute to incremental sales next year. This is supported by the price increases we saw in the third quarter, which serves as a useful indicator of price stickiness. As we approach year-end, this is typically when we discuss program pricing and related adjustments with our customers. When we provide our formal guidance for 2023 at the start of the year, we will have a clearer expectation of pricing. Based on our current indexing and actions, we anticipate a couple of percentage points from pricing. Regarding our cost structure, we generally categorize half of our costs as materials. Within materials, there's a portion that is raw, which reflects visible daily prices. Additionally, there's a part that involves some value addition. On the raw materials, we can easily track price fluctuations, and while the value-added portion plus non-material costs are experiencing an 8% inflation rate, this illustrates the challenges we are managing with pricing. Typically, we would aim for pricing to offset material costs and for productivity to counter non-material inflation. However, with non-material inflation at such a high rate, it becomes overly ambitious to achieve that level of productivity. Therefore, we are placing additional emphasis on pricing. As we look toward our plans for 2023, we are keenly aware of inflation’s significant impact, even as raw material prices decline. We are committed to maintaining the pricing discipline we established toward the end of 2021 and throughout 2022. This focus on effective pricing is crucial to managing the varying cost trends we are facing, with raw prices decreasing while other costs are rising.

Steve Tusa, Analyst

Right. So that bond on Slide 9. I mean, is that going to be like similar to this year? Or it sounds like it's going to be less year than it was this year?

Bill Sperry, CFO

Yes, I would expect it to be green, but obviously smaller, yes.

Gerben Bakker, CEO

Yes. In addition to what Bill mentioned, we are currently managing a situation where the scale of these changes is significantly larger than usual, affecting both costs and prices. Looking ahead, this poses a bit of a challenge. However, our portfolio is generally well positioned to maintain enterprise value, as we represent a low percentage of total ownership costs, with a high cost of failure, which is advantageous for us. That said, the extent to which prices have changed causes us to reconsider our ability to maintain that positioning under all circumstances. We are navigating this dynamic. If there is any price reduction, it would be accompanied by decreased costs, allowing us to still manage towards a net neutral or better outcome overall. Nonetheless, handling these factors is more complex than it would be in a low inflation scenario.

Steve Tusa, Analyst

Sorry, one last quick one. What's the fourth quarter embedded margin? And is that normal seasonality? That's my last one for the total company. Thanks.

Bill Sperry, CFO

Yes. We are expecting the top line to reflect normal seasonality, which is influenced by having fewer shipping days, typically in the mid-single digits, resulting in a similar impact on sales. Consequently, I believe this will lead to a normal seasonal effect on margins, bringing us closer to typical seasonal patterns.

Operator, Operator

Thank you. One moment for the next question. For our next question, it will come in to you today, Thomas Moll of Stephens. Please go ahead with your question.

Tommy Moll, Analyst

Gerben, the 2023 early preview is helpful and appreciated. And now, we can ask more questions on it, of course. Specifically on the Utility Solutions side, you did a good job framing some of the secular trends, the backlog trends you're seeing. We haven't yet talked about the recession sensitivity there. Can you help frame that for us, though? And is that a business or a segment rather that you can still grow top line even if GDP is down in the U.S. just given some of the positive tailwinds that you've called out?

Gerben Bakker, CEO

Yes, I think you're approaching this correctly, Tom. Let me take a moment to discuss what occurred during the last slowdown based on our business data. In the Utility sector, we observed that it lags behind the Electrical sector by a quarter or two, and the decline we experienced was less severe and recovered more quickly. At that time, the need for investment in infrastructure due to the slowdown actually benefited our business. I see this situation as similar, and I could argue that it has increased the urgency to invest in the grid regardless of macroeconomic conditions. That said, I don't believe it is completely insulated; its impact will depend on the severity and duration of the downturn, and whether it is consumer-driven or extends into commercial and industrial areas. I would expect some effect, but to a significantly lesser degree. I also see the possibility, as you suggested, that growth could continue even in a challenging environment.

Tommy Moll, Analyst

And as a follow-up, I just wanted to touch again on personnel, specifically on the Electrical segment leadership. Can you just give us an update on what kind of process you're running and potential timing for when there might be some news there?

Gerben Bakker, CEO

Yes. So as we indicated in the press release, I believe this is an area where we're looking both internally and externally. These are, of course, very important positions on my leadership team. And I'm very pleased, both with the internal and external talent that we're seeing. I think an element of it is what I described earlier of that we're an attractive company. And I would say maybe we haven't always done the best job in describing what we do both to our investors as well as our employees. And I think as we get sharper and really highlighting why it is that we matter and what it is that we do, we find people interested in coming to join us. So, we are very active in this process right now, and I would expect that here in the fourth quarter, we will backfill that position.

Operator, Operator

Thank you. One moment while we get ready for the next question. I have a next question that's coming from Nigel Coe of Wolfe Research. Please go ahead.

Nigel Coe, Analyst

Gerben, I'll send my resume. I wanted to note that the residential segment is down significantly, around 20% or perhaps 15%. Can you clarify the differences between Lighting and Components? Was the decline primarily in Lighting, or are you also seeing pressure in Components?

Bill Sperry, CFO

Yes. It is largely lighting, but there are some other components that we sell to the DIY market through big boxes. So, there is some of the other stuff, but majority is lighting.

Nigel Coe, Analyst

And then if we then looked at ex-lighting, how are the margins in natural systems?

Gerben Bakker, CEO

How are the margins on residential products you're saying?

Nigel Coe, Analyst

No, no, no. Well, yes, residential margins, but if we look at the segments and lighting, any sense on how that would look?

Bill Sperry, CFO

Yes, Lighting is a drag on the volume by a couple of points. And certainly, from a margin perspective, it is also a significant drag. So, yes, ex-lighting margins would be larger and would be growing more because the residential margins have suffered as the volumes come down.

Nigel Coe, Analyst

Okay, that's helpful. Just one more question from me. Regarding the restructuring and the increase in the loss, I believe it's $0.10 if not accounted for. Should we consider that a pull-forward from actions in '23?

Gerben Bakker, CEO

Yes, it's not necessarily a pull forward. It's related to our restructuring. We've discussed the challenges from supply chain issues, which have affected our ability to manage both our supply chain and various projects. I would say it's more of a multiyear program we've outlined, and we anticipate being able to accomplish more as some of those supply chain issues improve. They haven't disappeared, as we're still working to balance solving those problems while investing in what will position this electrical segment well for the future. Therefore, I wouldn't consider it solely as pulling from 2023; rather, it's a program we are managing to accelerate slightly as we progress through the remainder of this year.

Operator, Operator

Thank you. One moment while we prepare for the last question. Next question is coming from Christopher Glynn of Oppenheimer. Please go ahead with your question.

Christopher Glynn, Analyst

So T&D, obviously, lots and lots of good commentary and then a little more good commentary. One thing I did want to ask about I think U.S. onshore wind investments down quite a bit this year. Is that a timing benefit to T&D investment where maybe some of the upgrades or front-running revitalization and kind of wind investment? It seems more like an afterthought question given all the positive commentary, but I wanted to ask about that factor.

Bill Sperry, CFO

I believe there are timing considerations in the decision-making process for wind deployment, influenced by certain policies. This gives Chris a clearer short-term outlook for solar, while I still see positive developments for wind in the medium term. I don't think this has any special predictive power, but renewables have been a significant growth driver for us. The key question is whether wind or solar is included. For the foreseeable future, we anticipate positive trends in renewables overall, with wind possibly experiencing some additional supportive conditions in the medium term.

Christopher Glynn, Analyst

Okay. And a quick follow-up on residential lighting. I think the container costs are a big part of that, and they were super high and come down quite a bit. Are you still flowing through peak container cost in residential lighting?

Bill Sperry, CFO

No, the costs are adjusting and returning to a more normal level. They are slightly higher than before, but that will eventually stabilize within our operations. You are correct that this is a significant variable for the business.

Christopher Glynn, Analyst

Okay. So you should see some improvement on that basis on the lag, the flow-through. Okay.

Bill Sperry, CFO

There is a benefit, but I'm not sure if you're looking for a net effect because volumes are decreasing, which has a negative impact. Overall, the top line scenario is generally unfavorable, and that offset is seen in the cost of goods sold that you're referring to, but the outlook remains somewhat challenging.

Operator, Operator

Thank you. I would now like to turn the call back over to Gerben Bakker for closing remarks.

Gerben Bakker, CEO

Great. Thank you, everyone, for your support, your interest, and your questions on our third results and the discussion we just had. And we look forward to reconnecting with everyone again in the new year. So thanks again, and we will see you in January.

Operator, Operator

Thank you all for your participation in today's conference call. At this time, you may all disconnect, and everyone have a great day.