Hubbell Incorporated (HUBB) Q3 2018 Earnings Report, Transcript and Summary

Good morning. My name is Ella, and I will be your conference operator today. At this time, I would like to welcome everyone to the Hubbell Third Quarter 2018 Results Call. [Operator Instructions] Thank you. Maria Lee, you may begin your conference.

Thank you, Ella. Good morning, everyone, and thanks for joining us. I'm joined today by our Chairman, President and CEO, Dave Nord; and our Senior Vice President and Chief Financial Officer, Bill Sperry. Hubbell announced its third quarter results for 2018 this morning. The press release and the earnings slide materials have been posted to the investor section of our website at www.hubbell.com. Please note that our comments this morning may include statements related to the expected future results of our company and our forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995. Therefore please note that discussion of forward-looking statements in our press release and consider it 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 earnings slide materials. Now let me turn the call over to Dave.

All right. Thanks, Maria. Thanks, everybody, for joining us today. I could just touch on a few highlights from the quarter and then let Bill get into the details. You can see from our press release, it was another quarter of strong performance for us, obviously, growth in sales, growth in earnings, and importantly, very strong cash flow generation. We think that - we feel very confident about our market position and confident in their ability to deliver differentiated results for investors over the long term. I think if I start on Page 3, just a couple of highlights within the quarter. First, obviously, as we’ve been saying all year, our end markets are all growing or all have green arrows, and really at the high end. We saw a 24% sales growth in the quarter, 5% organic, 19% acquisitions. That's obviously principally Aclara. And the end market outlook continues to be good. We did have a benefit in the quarter from the tax rate under U.S., the U.S. tax reform adjustment which had us with a little lower rate than we had been running for the year. That's certainly good news. You know if we can generate earnings from any source and particularly from lower tax rates making us more competitive. I think the key element is around our pricing actions. We've been talking about that all year certainly since the first quarter and I think our pricing actions are gaining traction, and they continue to gain traction. Bill will go through that a little later. But our pricing through the third quarter is a little better than we actually had anticipated a quarter ago. So that’s the good news. On the flip side, there’s some - obviously our objective is to try and address the tariffs but also there’s some inflationary pressures that we’re seeing and we’re not unique I know in that situation, particularly in areas that are attributable to the positive market growth activity specifically around wage inflation just because of labor shortages and transportation costs. I mean that, you can’t talk to anybody - I don't talk to anybody in the market who's not struggling with the shortage of drivers, the shortage of trucks to actually deliver and that's all generating higher cost. And we're working to continue to try and recover those costs. The tariff headwinds to-date are in line with our expectations. Obviously, that puts pressure on our margins because even if we recover our tariff dollar-for-dollar, you're not getting any more profit from that, so that has some drag on our margins, which is frustrating. But if we can at least cover those costs, that's the minimum objective. An important result in the quarter, Aclara’s performance, less than nine months post acquisition, the results were accretive to our earnings. And for such a significant acquisition in our - for us and to be implementing that and having that kind of outcome is truly a highlight. And again, the free cash flow, very strong free cash flow. We've talked about that throughout the year, and we're delivering on that, focus on the core operations, as well as working capital management, particularly around inventory. So, the result of all of that gives us the ability to raise and narrow our guidance for the year. The second time we've done that, we did that after the second quarter. We're doing it again, modest increases. But at least moving up from what we predicted and forecast at the beginning of the year. Certainly different composition of that, but that's the nature of our job is to try and navigate things that come up. The good news is you have some tax benefits. We’re working on pricing, we’re working on - take advantage of the strong markets and I think all of that leads to positive results, not without challenges, but we're working - and we're overcoming those challenges. So, let me turn it over to Bill to go through the results in a little more detail, and then I'll come back and we'll talk about the outlook a bit. Bill?

Okay. Thanks, Dave. Good morning, everybody. Thanks for joining. I think Dave just highlighted a nice list of items there. Strong demands, managing price cost, strong cash flow, and constructive capital allocation. I'm going to start on the first point there, which is strong demand, and I'm on Page 5 of the slides, that hopefully everybody has. And again, a very constructive backdrop from our end markets that we’re exposed to, similar to what we've had for the last couple of quarters now. You can see the sales, up 24% but supported by a very good end markets that we think are growing through the quarter in the 3% to 4% range. Starting with non-res, we’re seeing - still seeing healthy start data in architectural billing information. So, through the quarter, non-res still strong. Electrical T&D, the transmission is stronger than distribution. But the distribution was facing tough comps with a lot of storm volume last year and it still grew through that. So, we're viewing that T&D as very healthy and very healthy condition. The industrial, both in light and heavy, feels good to us. You've got industrial production up it’s a manufacturing index, good support there for industrial. On the oil and gas side, we certainly see both halves as positive. I think the gas for us in the quarter is stronger than what we saw in oil. But the upstream CapEx for oil is still favorable, the gas dynamics strong for sure. The revenue side getting a lot of attention here lately, we had a strong performance in the quarter on resi. Obviously, the rising rates in the stock markets used to be repricing the builders. But for what we saw in the quarter, still constructive. So, you simplify that altogether, you see GDP in kind of a 3% range for the year expected in and our end markets are outgrowing GDP, so quite constructive backdrop. Starting on 6, I want to switch to our profitability. And we just disaggregate operating profit into two components here. The gross profit increase of 16% to $355 million. Margins being dragged by price cost, and we'll talk more detail about price cost in a minute. The F&A line being more efficient, down about 90 basis points to 15.7% but the dollar's up about 15%. So we're benefiting from higher volume there as we're getting more efficient and leveraging our scale. On Page 7, we put those together to show operating profit. You see here an increase to $174 million, 15% improvement over last year. The margin similar to what you saw on the gross, down driven by price cost, essentially. The earnings per share side, you see a 41% increase, $2.22. Got two big drivers, one is higher income and, as Dave commented, lower tax rates. Last year, we were in the low-30s. And this quarter, we're just under 20%. There were - we expect in the full year to be in the 22% range. So, the quarter was particularly low and benefited from some discrete items inside the quarter. So now, we'll talk about the two segments and their performance, and I'll start on Page 8, with Electrical segment. Sales up 5%, $687 million. We saw some contributors to that, a strong growth, including the gas business, including various of our product lines that are exposed to industrial growing quite well at the lower end of the spectrum. Our lighting business grew low single-digits that was skewed by the resi piece, contributing more to that than the C&I. I think the good news for lighting for us, they continue to expand margins. And that's a good sign here as we contribute to our operating income story where you see an improvement of 6% growth, $94 million. And the margin expansion there of 20 basis points, where the lifts coming from higher volumes more than offsets the drags still coming from price and material cost and tariffs. Power segment is on Page 9, and you'll see growth in sales up to $492 million, a 66% increase. Obviously, most of that coming from Aclara, a recent acquisition, but it shouldn't be lost that the organic business growing at 5% which is nice healthy spending in that area by our utility customers. And you see the transmission fees being quite strong. And again, distribution growing, we're impressed to see growth because we had some tough comps with a lot of extra storm volume last year resulting from the storms we had in Puerto Rico and Texas. But on the performance side, you see operating income growing 30% to $80 million of OP, the margins there impacted by Aclara coming on and performing in the low teens. So, that's as expected but just drags down the margin versus prior year, and you see the price material cost headwind continuing to drag for power systems. But still, good growth obviously there for Power. We wanted to talk about price material cost. We felt for years and has been a very important topic in terms of our margin performance. And so, starting at EPG and then again in July during our second quarter, we shared analysis discussing price cost, and there were essentially two takeaways from that analysis. So, the first was to show how our business model has a lag effect between when we experience inflation and how we price and recover that inflation. It’s different than a model where someone might use derivatives and get immediate offset. We have a lag and we illustrated that lag. The second is we show that in the third quarter, our price cost caught up to the inflation we were experiencing. And we realized on that message that we has share with you all. So, in our third quarter, the price cost had matched. In that analysis, we had specifically excluded lighting and tariffs. Tariffs were too uncertain for us to predict that then - and the lighting business was different than the rest of our lines where they were actually given away price still despite experiencing inflation. So, what we've done now, because we kind of hit that mission, we've done now is we've included lighting and tariffs to the picture and shown that that still – and we did that because we think this gives you a better insight into the impact on our overall margin performance. So, you can see that the third quarter still had some drag from those two effects and that we catch up in the fourth quarter. So, the price story for us is across all of our businesses. Some of the questions that we get from you all are trying to net tariffs against price and inflation against price. And we're using our whole portfolio of products to battle inflation and we're thinking about it that way. Many of our lines of business have increased price multiple time during the year. Some of those increases have been very significant. For example, if you're exposed to significant amounts of steel. So there's a story that continues. We think our business model is exceeding. Dave described traction on the price, and you can see those blue bars continuing to accelerate through the end of this year to get us back in balance as the costs start to moderate by year-end, so that to us is an important picture driving margins. Want to touch on free cash flow that Dave highlighted as a strength on Page 11. You can see in the quarter, over a doubling of the free cash flow amount, and for the year-to-date period an increase of over 50% to $269 million. The cash flow performance driven by higher income, but it’s well working capital efficiency, most notably in the area of inventory where we've been very effective at managing those levels. I think importantly we've increased our CapEx spending during this time. So we've not been sacrificing our investing to achieve free cash flow. We've continued to invest in automation and other forms of productivity that we think are quite important. And I was going to show you also on Page 12. We've taken to showing you EBITDA. We think that we've got quite a bit of fluctuation in non-cash amortization charges as a result of our acquisition which has also caused us to incur more interest expense and taxes are going the other way. So, with all that variety, we feel that showing you EBITDA just growing at nice 16% rate is important to keep that in front of you. But I wanted to ask Maria to comment on the balance sheet given some of those cash flow dynamics.

Sure. So, I’m on the capital structure, Page 13. We typically show this page with two columns, current period and prior year-end. And this time, you can see we added a third column from March 2018 to highlight how much activity happened during the year with respect to the Aclara acquisition and repatriation of international cash. We paid off $160 million in total debt since March 31st and now have $1.9 billion of total debt outstanding. The strong cash generation that we just heard Bill talk about, but moving back some overseas cash has enabled this delivery and we expect to do more in the fourth quarter. More broadly, our capital allocation priorities remain the same, investing in high return capital projects, paying our dividends, which you may have seen our board increased last week, buying back shares. We repurchased $20 million of stock so far in 2018 and expect to do more and investing in acquisitions to complement our portfolio. Our balance sheet supports this capital allocation strategy. We ended the third quarter with $229 million of cash, approximately 94% of which was held outside of the United States. We also had about $100 million of commercial paper outstanding. Our four tranches of long-term senior notes all have attracted rates in the low to mid 3s. And we have a $750 million credit facility that backs our commercial paper program and is fully available. So, to summarize, we have a strong and a healthy balance sheet, capable of supporting our capital deployment priorities. With that, I will hand it to Dave to talk about the outlook.

Okay. Thanks. So, let’s just talk a little bit about the rest of this year. First, on our end-markets on Page 14. No change this year versus our prior outlook. Markets continue to grow consistently with what we've seen all year. Overall market growth of 3% to 4%. We're running a little bit above that year-to-date. I think we'll might settle back a little bit as we finish the year. But still, compared to a number of prior years, leading up to it a very nice finish to the year. From an overall performance for us, turning to Page 15, we think that translates into, for the full year, sales growth of 21% to 23% range. That's a little higher than our prior sales growth internally, largely on higher Aclara sales. As I mentioned earlier, we're going to - we’re raising the - and tightening our EPS range, a new midpoint of $7.25 versus $7.20 prior. We essentially had $0.15 of tax favorability in the quarter. And we're dialing the impact of less grade, which we see now as $0.10 of headwind in the fourth quarter, obviously, actively mitigating where price have increases in place, escalator set for January. But as Bill mentioned, you've seen in the charts, we've talked about it, it takes quarter or so to work through those. We certainly fully intent to pass along the increased cost through tariffs and we think the rest of the industry will as well. I've spent time recently with half of our top channel partners and that the conversation is all around tariffs and price, and secondarily some of the other inflationary pressures that I’ve talked about. And the concern is always with the 10% tariffs, you could probably navigate that when you start to put 25% tariffs scenario that becomes more challenging. Now at the same time, we have a very aggressive action that we're taking. Because at 25% tariffs in certain products, you're not making money at it, we're not going to sell it. So, you've got to recover it. And I know we're not alone. So I know that there is going to be a recovery of that to some degree. Whether it affects – ultimately affects demand is a wildcard. But we are - and the theme here is aggressively focused on getting price and pushing price where we can. I think we have found situations even - to help our channel partners get some of those prices through. In some cases, it requires a joint sell to the customer particularly around the value proposition. And when we've done that, we've been more successful in getting those prices realized, so. And that really is the nature of our products, our service levels, the quality that really helps in getting some of that price through. But it takes effort. It’s not automatic. And lastly for the - we expect our free cash flow strength to continue and end up being greater than net income. Page 16 is just the waterfall chart, regular update. The biggest changes here, as I mentioned, are on the benefit of tax with the lower third quarter tax rate, and then putting in some of the headwind from tariffs in base operation column. So, let's turn a little bit now to 2019. And obviously, it's early. We don't provide earnings guidance at this point. But certainly we start with at least our market view as of this point. Overall, we see 2% to 4% versus 3% to 4% this year. Base case has slight moderation in the residential, oil and gas and industrial. That's moderation after a strong growth this year. But once again, we still see all end-markets growing at this point. Note that Aclara is now included into the pie chart, which is why you see the Electrical T&D has a bigger slice of the pie right now. So if we turn the page, and you’ll - we talk about our EPS considerations for next year. And so, we don't give annual guidance until we release earnings in January. But just a broad framework of how we're looking at it. As I said, end-markets are going to grow solidly again, maybe more in the low to mid-single-digit range. But it should provide a nice for volume tailwind for us. Price should be a real nice tailwind for us next year with the actions we've already implemented and with more to come. We typically hang on to price as long as we can, even if commodity cost fall out or turn downward. And next year shouldn't be any different, whether it's on the commodity side or the tariff side, but we’re pushing to get them on the basis that those costs will continue. We continue to execute on productivity initiatives, benefiting from prior restructuring actions. And I know that some of you had the opportunity to meet with Susan Huppertz, our new VP of Global Operations and got a sense of some of the things that are being put on the board as part of our ongoing restructuring action. So, we have a lot of confidence that we're going to be driving more productivity, continue to drive productivity in areas that we have yet to be able to realize. Inflation, general cost increases for things like labor and transportation is likely to continue into next year. Typically, we try to offset those costs with productivity. Done a little better than that in recent years but it may end up being more neutral next year. But we're certainly driving to exceed the cost increases particularly if all of the tariff and other costs can't be realized on the price side. Obviously, tariffs continue to be a wildcard. And on tax, as Bill mentioned, we saw onetime benefit this year in the third quarter, but we expect to normalize more in the 22% to 24% range. Obviously, still some moving parts there, so we'll work through that. So, with all these said, we got a good path toward attractive earnings growth next year. I’m not going to give a range, but we've previously laid out a target of $8.50 in GAAP EPS by 2020. And we're comfortable reiterating that commitment now. Certainly, a lot of work to do to get there, a lot of actions to take, a lot of price, a lot of cost management, a lot of productivity but that's what we do. That's what we have done. That's where we're going to continue to do. And so I think 2019 results will put us solidly on the path to getting to our 2020 objectives. So, just to wrap up, we're pleased with the results. We certainly would like them – to always like them to be better. We would rather not be having to deal with the tariff situation, making a pricing environment that much tougher. It's never easy, but hoping that a magnitude of what everyone is dealing with will provide a little bit of flexibility and acceptance, at least in the near term. So, confident in our ability to navigate this stuff. We've got the challenges we will work through them and look forward to better results going forward. And welcome the questions. So, if we could open up to Q&A.

[Operator Instructions] Our first question comes from the line of Christopher Glynn. Your line is open.

So, you guys called out the C&I lighting pricing pressures again. There are broad announced price increases in the industry among the majors. How do you expect the rubber hits the road here in terms of this dynamic of the existing price pressures but much broader price increases announced seemingly in tandem in cooperation?

Well, I think - first, Chris, I think I would say that the price pressures have lessened as a starting point. And I think it's starting to turn to more of a positive. We’ve seen some elements, and certainly, we've seen some benefits in pockets where we've been more disciplined, as I mentioned, we're not going to sell it for, and we're not going to give up the margin. And we've actually been able to realize that. It’s just having that discipline. And I think that's reflective of the broader industry things that you've seen in broader price increases I think starting to stick certainly in pockets. So, I hope that's a positive sign going forward. It's still early, but I think we've seen some positive signs.

And then as we look at implied fourth quarter guidance, and obviously there's all your penal line items to triangulate, but I'm kind of gathering that your column for the fourth quarter electrical margins would probably be down a little bit year-over-year. Just wondering why that might be if you have your kind of best price cost relationship of the year in the fourth quarter.

Sure, yes. So, I think you're right to identify that there could potentially be some pressure on the electrical margins. I think it will have less of the price material headwind. However, I think on some of the cost inflation dynamics, you know, Dave mentioned some freight, labor, things of that nature. We expect that to be a bit higher due to those trends. So, that would be offsetting the benefit that we would get from lower price material drag.

Is freight and labor not part of the bars on Slide 10?

No. They’re outside of it. So the bars are specifically material cost, so commodities and price. And so the - what we go into our productivity cost increases or cost inflation bucket that the cost side would have that wage increases and freight and that stuff.

And then Aclara, so for 2019 with your orders and your project pipeline starting to get really good support for another strong organic year, how would you characterize the incremental margin profile for Aclara? Or if it's more mix driven, how otherwise should we think about the EBIT profile bridge into year two of ownership?

Yes. I think what we've seen so far in our first year of ownership is the Aclara suite of smart grid products and service is in high demand. Our customers need it and we're pleased to see that there is a very, very good growth within that. We've seen the margins improved during our ownership. And I think it's - again, as Dave kind of said, as we give guidance in January, I think we'll be more explicit about answering your question. But the first part of your question I think is very important that the demand for the smart grid product is very good right now, so that should help us in 2019.

Our next question comes from the line of Rich Kwas. Your line is open.

Can you guys just level set us on the tariffs? So, is it $0.10 explicit negative impact in Q4 on a quarterly basis? And then if the rate assuming the rate goes to 25%, January 1, then we take some multiple of that as an impact. But then you’re going to get price in Q1. So, net-net, there's maybe still behind the curve in Q1 with the increase in the rate. I mean, how do we - how are we trying to model this as we think about the impact?

And so, we had talked about, if we just back up, List 1 and 2 being a net $0.05 or nickel of headwind in each of Q3 and Q4. So, that's still true, the gross number is larger than that, but we offset it with price and other productivity and cost initiatives. So, that's for that List 1 and 2. When you add in List 3, which is what the current guide now contemplates, that is where you get another dime in the fourth quarter, and that's the result of a 10% tariff. When it bumps up to 25% as of January 1, that will increase the cost for next year. So, the $0.10 is up for a 10%. So, it would be a higher cost next year based on List 3. You'd also, obviously, have the wrap around impact of List 1 and 2 that we didn't have in the first half of this year. So, to your point, I think we're going after price, we're going after it now. We're putting productivity measures in place, so that we'll start to see the benefits. But I would expect that the compares on the tariffs get easier as we go through the year. But there will be a bit of a step up in Q1 that we are already starting to mitigate now.

I mean, with the knowledge that you know what's going to go into effect on 1/1, so it’s pretty explicit our there obviously. So, it would seem like you’d be able to push their price pretty quickly with - I mean, I know there’s a concern around demand impact. But everybody knows about it, right? So, I mean, within Q1, sometime during Q1, you should be able to start matching up, right? Is that the right way to think about it?

That's the right way to think about it. There's no question. I mean, it's important to recognize that it's a big number. And so as I've been saying, we can all do the academic math of 25% and what that is. Trying to get that through in pricing, it’s a new normal for the market. And particularly when you've been coming off years of very modest low inflation 2% and all of sudden you're coming in with big increases. And even when it's relative to the material content, you still end up with 10%, 15% increases in a product cost. That’s not insignificant. We're all hopeful that at some point there's a little bit of moderation, but we all are working as if there's not going to be because to-date, it hasn't been. And we don't want to be surprised. We can always back up, but we don't want to be playing catch up. So, that's an important element so.

And then just within the segments, I mean, it would seem like electrical is more impacted. I mean, I know you have 232 on power from earlier in the air. But is there a way to think about impact on each of the segments as relates to strictly tariffs?

I think the way - and you're right. I think 232, Rich, had an indirect impact very heavily on Power where they're using a lot of steel. As you think about List 3 I think the biggest impact on us will be on residential lighting. But there's also impacts on plugs and receptacles and some of the basic hardware parts from Power Systems. So it'll affect other areas as well.

And then last one on price cost is relates to Legacy Power. It still seems like you're a bit behind the curve on that. What's the latest on getting to parity within legacy Power? Is that – because I understand within this guide that fourth quarter you get there, and then by the time we get in the first quarter, your price cost positive.

Yes. So Legacy Power, you're right. They continue to get price and they continue to have inflation. So the way it's progressing they're squeezing, they're squeezing it down very impressively from being behind it. And so, we're probably starting next year being able to catch up. But as we end the year, they’ll still just be a little bit behind.

Our next question comes from the line of Steve Tusa. Your line is open.

The kind of 2020 commentary on free cash flow and kind of the guidance there, I mean, is that now just much less relevant given what we've seen from these tariffs?

I’m not sure what you mean by less relevant that - it’s certainly more challenging with the tariffs. I think that’s still our objective to work and have a path to get there. It certainly will be a different path than when we spoke earlier in the year pre-tariffs. So, does that mean it's still in the cards? It's a question about how we're going to get there. And the one wildcard will certainly be the entire pricing environment. We’re obviously not alone in there. But as I said, we're working to develop other paths to offset any price shortfall that will exist including more productivity and changing sourcing strategies and the likes. So, I wouldn't say it's – it’s still relevant in our mind and in our objectives.

I think Steve it's just it comes in different ways, right? So, as you price to get the tariffs, once that flattens out, then as that wraps around, you get the benefit of having price for it even though you're catching up. So, it comes in not as smoothly, I would say. That’s how we're looking at it.

And then one other one. Just on kind of your visibility in your dashboard and kind of operating the business. It just seems like every time the market has or the macro has certain issues whether it was the harsh and hazardous stuff that came with the oil downturn or the tariffs coming through, it just seems like the stock and investors are a little more blindsided by this stuff. And I'm not sure whether that's a communications thing or what you guys can see in your dashboard. I mean, have you kind of taken any step back and kind of looked at the process that you guys have and try and improve that? Or am I just being too harsh on that front?

Well, I think if you're talking about, did we see the oil downturn any better than the rest of the market, I’d say I don't think we did. But I think the other stocks that were exposed to oil had the same degree of surprise. I think the way we've managed tariffs as we've been trying to be transparent with you about how we price for it and it takes this quarter or so to catch up. So, we think that those processes are seeing that stuff. We are reacting - we reacted to the oil downturn with a big $120 million restructuring plan. And I think we feel good about kind of the cost that we've taken out of that. Some of the lighting business challenges we've used to restructuring to take cost out of that. And it got to the point, Steve, where that business is now expanding margin and much more stabilized. And so now tariffs, I agree with you in managing price and inflation is the new normal, as Dave was saying. And we think we're tracking that well. We're trying to communicate with you all. We've been doing that since, I think, the first quarter. And so hopefully the communication you guys feel is transparent enough.

I think - Steve, I would add to that. I mean, obviously, we’re always looking and evaluating our own operations as well as our communication. And certainly, that's one of the things we're continually trying to evaluate market reaction against true performance or against the price. Or is there something that’s not understood? And so we’re constantly trying to make sure that we are being as transparent as we can be on the things that matter so as a better understanding, and we minimize the surprises that can be avoided. As Bill mentioned, my crystal ball wasn’t any better than anybody else's in oil and gas, and it's not any better on tariffs. But yet, we’ve put stuff out and we're very conscious of you know working hard to do what we say. And that's the challenge of managing the things that we say, that we know. And if there's something that comes up that surprises us, we hope it's only because it has surprised the entire market, and that it’s unique to us. But we can always get better at that, and we're constantly working on it and welcome your input on those things and…

I guess, just they are coming off of the first half of this year as well where there were some confusion around CapEx levels, and the stock went down dramatically on kind of price cost which people weren't calibrating appropriately. So, it's a little more than just kind of the oil and gas related thing. But it's totally fair point just the volatility for your specific portfolio and its construct. The stock just seems to be a lot more volatile than perhaps it has to be. But I'll leave it at that. Thanks for the color.

Our next question comes from the line of Jeffrey Sprague. Your line is open.

I want to do move to kind of productivity question and you mentioned Susan Huppertz joining the firm, should we expect or why shouldn't we expect kind of a greater sense of urgency to move more swiftly on some of what she's talking about? It would seem the opportunity is quite large even in a healthy market, you might want to seize it more rapidly. But in an environment like this where you've got some very clear headwinds, I don't know why it isn't much more kind of rapid take on some of these kind of footprint and other issues that you might have at your disposal here?

Right. It's a fair comment, and there is. And you're absolutely right. I mean, it always comes back to the ability to effectively execute to make sure that we can continue to provide the level of service to the market that they expect. As you know, Jeff, and you've followed us for a long time, that hasn't always been the case, and the price of that misstep is meaningful and more long term. So, we just want to make sure that we are disciplined in those things. But there's no doubt that that's one of the things and presumably that's what you heard in your discussions with her that she’s identifying these things. We're rallying around to make sure that we can do that sooner than later.

And then, just back to the tariffs, List 3 in particular, it does sound like maybe the impact there is a little bit more severe than you were first thinking. I don’t know that you’re ever actually explicit about List 3. Perhaps there was a bigger impact than lighting there than you thought. Is there any additional color on that dime that you could provide for us?

No. I just think that when we talked about the nickel impact in the third and fourth quarter, we were really only talking about List 1 and 2. So the dime is now just the quantification of that. I think, importantly for the regulating business, the industry is basically structured with similar supply chain, right. So there's not competitive advantages or disadvantages in terms of costing due to tariffs. And so I think part of underlying while we're saying that we believe the industry will react to the same way. But there's not new things Jeff, popping up at all.

And then just finally for me. Just on the demand picture. It’s a little unclear to me what you're saying about Q4. Are you expecting some measurable slowdown in some parts of your business in Q4? And where…

No measurable. I think the thing that will create a little bit of potential volatility is any order activity in advance of tariffs or in advance of price increases for next year. We've seen some pockets of that. But that's - we haven't seen any - we haven't seen any indications of underlying weakness in demand at this point.

I would assume you’re not going to let people take order six months in advance or something on old price when you’re going to get jammed with tariffs. How are you planning that?

No. I mean, that’s - we have mechanisms in place, Jeff, that - because that’s a fairly common thing even with the minimal price increases that sometimes are put through on an annual basis on blankets and on catalog. So, there's gates around that. No, we're not going to allow that.

Our next question comes from the line of Joseph Osha. Your line is open.

Jeff just might have asked my question on supply chain. I did want to talk a little bit about passive components and discreets which had been very, very tight. And I'm curious about how that's impacting you on the Aclara business and also on your lighting business.

Yes. I mean, I think we've observed that tightness, and we've been trying to manage our ordering of components in our relationships with the supply chain accordingly. So, I think that you can see it potentially affecting lead times and whatnot, Joe. But it's something that we're navigating.

Do you feel at this point that there's maybe some ability there to find some additional margin there if that loosens up? Are you paying to expedite and to air freight and so forth?

Yes, I'm not sure that there is extra margin that comes from that. But as I said, it's - you're right to point out that that’s - there is a constraint in the supply chain there.

Okay. And just the final part of that question and have you seen any signs of loosening there or does it continue to be very, very tight? Thank you.

Yes, I think it’s persisting and just part of the backdrop of what we're navigating.

Our next question comes from the line of Josh Pokrzywinski. Your line is open.

Just a question on distributor inventory because I think we've seen evidence of both restock and destocking kind of depending on how you approach the market. Dave, what have you seen on that front and what is your sense of kind of where the channel is right now for kind of the typical large scale distributor?

I think they're overall, they're pretty balanced. I think they have been running lean. You’re right. They've had their ups and downs. But as I mentioned before, we are monitoring closely any loading up that might be occurring at lower prices. We haven't seen any big examples of that but that's one that we're monitoring. I mean, I think we're - there were certainly a rundown early in the year. I think there was some restocking midyear. I'd say from what we've seen, it's pretty balanced right now.

And just to be clear, there's no pre-buy element in your 4Q guidance? If that were to happen, that would be kind of volume upside.

That's correct. There's nothing - they’re certainly pre-buy volume that's in there, but not meaningfully because we won't look - that’s where - we manage that. If it did occur more than we would anticipate, and I'm not expecting that, that would obviously be upside to it.

Understanding it might be a zero-sum game over time. That’s helpful. And then on tariffs more broadly, have you been able to size what percentage of your business that could be tariff at some point in the future List 4 plus that is not being tariff today? So relative to where you stand today, what is kind of the total pie that you could in the future be eligible for a tariff if we kind of escalate this further?

We've not attempted to quantify List 4 plus, Josh.

I guess maybe to put it in like bigger than a breadbox term, is it bigger or smaller than what you think you're currently going through today?

Yes. I mean, it's impossible for us to get in the minds of how policy could change going forward. I think what we feel confident in is our ability to manage what's put in front of us and, as Steve was kind of asking, to be prepared for that. So whether that’s moving supply chain around and getting in to more favorable country locations, which we're doing, we're spending an awful lot of time on the price lever. There's productivity lever. So we're going to relentlessly attack whatever inflation we get. And - but, no, we haven't tried to quantify the bigger what if that you're talking about.

And then just one last one for me. It seems like Aclara continues to show some upside here. You talked about the record September. Is there an opportunity to maybe be a little bit stickier and force price a little bit more on that? It doesn’t seem like quite as raw material heavier business. So, obviously, you're not as pass-through on that front, but just in a stronger demand environment, is there room to maybe offset some of the price challenges elsewhere in the portfolio at Aclara?

I mean, I think you're right to point out that the demand for their smart grid products is very strong. That's a good thing. Their business tends to be built off of pipeline and kind of lumpier longer-term contracts. And so, the price lever tends to be out a little bit more rather than what you're talking about which is offsetting next quarters' implications. So, I'd say that - it probably doesn't work as a price offset the way you're discussing it.

Yes. So, Steve, Dan and I will be available all day. So, if - any follow-up questions, just reach out. Thanks for joining us today.

Appreciate the time and look forward to getting your feedbacks. Thanks.

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