Belden Inc. (BDC) Q3 2020 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by. Welcome to this morning’s Belden Incorporated Conference Call. Just as a reminder, today’s call is being recorded. At this time, you are in a listen-only mode. Later, we will conduct a question-and-answer session. [Operator Instructions] I would now like to turn the conference over to Kevin Maczka. Please go ahead, sir.

Thank you, Mary. Good morning, everyone, and thank you for joining us today for Belden’s third quarter 2020 earnings conference call. My name is Kevin Maczka, I’m Belden’s Vice President of Investor Relations and Treasurer. With me this morning are Belden’s President and CEO Roel Vestjens and CFO Henk Derksen. Roel will provide a strategic overview of our business, and then Henk will provide a detailed review of our financial and operating results, followed by Q&A. We issued our earnings release earlier this morning, and we have prepared a Slide presentation that we will reference on this call. The press release, presentation, and transcript of these prepared remarks are currently available online at investor.belden.com. Turning to Slide 2 in the presentation. During this call management will make certain forward looking statements in reliance upon the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. For more information, please review today’s press release and our annual report on Form 10-K. Additionally, during today’s call management will reference adjusted or non-GAAP financial information. In accordance with Regulation G, the appendix to our presentation and the investor relations section of our website contain a reconciliation of the most closely associated GAAP financial information to the non-GAAP financial information we communicate. I will now turn the call over to our President and CEO Roel Vestjens. Roel.

Thank you, Kevin, and good morning, everyone. As a reminder, I’ll be referring to adjusted results today. Please turn to Slide 3 in our presentation for a review of our third quarter highlights. Business conditions improved during the third quarter, and I am pleased to report solid double-digit sequential increases in revenue, EPS, and free cash flow. Third quarter revenues increased 12% sequentially to $475.8 million, with both of our segments delivering organic growth on a sequential basis in the quarter. EPS increased 57% sequentially to $0.72, and free cash flow increased 78% sequentially to $35.7 million. I’m extremely proud of the way our global workforce has responded to the unprecedented challenges this year. The teams remain highly engaged and committed to supporting our valued customers while maintaining the safest possible working conditions. These significantly improved results demonstrate the continued dedication of our associates around the world. During the quarter, we made further significant progress with our $60 million SG&A cost reduction program. We expect to deliver $40 million of these savings in 2020 and the full $60 million in 2021. Our teams delivered $12 million in savings in the third quarter as expected, and we intend to deliver the full $15 million quarterly run rate savings in the fourth quarter. When fully realized, this represents approximately 300 basis points of incremental EBITDA margin expansion on an annual basis. As a reminder, these are permanent cost reductions that will not return as conditions normalize. As we successfully execute our cost reduction plans, we continue to make strategic investments to accelerate growth and capitalize on the opportunities in our key markets. To that end, R&D spending increased 26% year-over-year in the quarter, with over 60% of this investment now dedicated to software development. This includes standalone software and embedded software within various hardware products. We are making targeted investments in compelling growth opportunities across the portfolio to drive further innovation in Industrial Automation and enhance our best-in-class Cybersecurity cloud platform. Innovations are important to our customers and our shareholders, as they will further strengthen our product offering, enhance our competitive advantage, and drive growth. We are seeing a return on prior investments in broadband fiber in the form of outsized growth in those products. Similarly, we expect our current investments in Industrial Automation and Cybersecurity to drive accelerating growth in those solutions going forward. Our strong balance sheet and ample liquidity provide the financial flexibility to make these important investments as we successfully navigate this economic downturn and position the Company to fully participate in the recovery. We exited the quarter with cash on hand of $391 million after repaying all remaining short-term revolver borrowings. We are comfortable with our liquidity position at this point. Finally, demand trends and visibility in our business are improving. As a result, we are resuming our traditional guidance practices. We expect modest sequential improvement in underlying demand during the fourth quarter. However, we expect our channel partners to pursue incremental reductions in channel inventory levels during the fourth quarter after only modest reductions in the third quarter. This will partially offset the sequential growth in underlying demand that we expect, and it is contemplated in our guidance. Please turn now to Slide 4 in the presentation. Looking out beyond the quarter, we remain very excited about the opportunities for Belden as we continue our transformation. We are aligning our business around markets with favorable secular trends, and our key strategic priorities are Industrial Automation, Cybersecurity, Broadband & 5G, and Smart Buildings. We believe that each of these markets offers compelling growth opportunities over the cycle. I would like to briefly review each of them now. First, the global pandemic clearly impacted demand for Industrial Automation on a temporary basis, but we remain extremely optimistic longer-term, due in large part to increasing labor costs and enhanced productivity and quality needs. The secular tailwinds remain fully intact, and social distancing and other new health and safety practices represent yet another incremental demand driver for automation on the factory floor and elsewhere. In Cybersecurity, increasingly sophisticated and costly attacks are driving the need for advanced cyber solutions. We are especially excited about the Industrial markets, where we are particularly well positioned. Belden’s truly unique offering provides critical Cybersecurity protection, and this remains an important area of investment for our customers during this pandemic. We are clearly gaining traction with our new cloud-based and other products, and we are encouraged by robust recent orders for our Industrial Cybersecurity and software-as-a-service offerings. In Broadband & 5G, demand for more bandwidth and faster speeds is ever-increasing, and the COVID-19 pandemic is only accelerating the demand for our fiber optic and other products. We continue to expand our fiber product portfolio and capacity through organic and inorganic investments, including five bolt-on broadband fiber acquisitions completed in the last few years. We are extremely well-positioned to support our MSO customers as they upgrade existing networks in response to record demand levels and new competitive threats from 5G. We also support Telco customers as they build out new 5G infrastructure. Finally, in Smart Buildings, the increasing use of integrated networks drives increasing demand for our connectivity solutions. The outlook for some Smart Buildings markets clearly changed due to COVID-19, but we continue to see growth opportunities in certain market verticals, such as government, healthcare, and data centers. As the economy recovers, we would expect healthy demand from these customers to partially offset the headwinds in other verticals within Smart Buildings. I will now ask Henk to provide additional insight into our third quarter financial performance. Henk.

Thank you Roel. Please turn to Slide 5 for a detailed consolidated review. I will start my comments with results for the quarter, followed by a review of our segment results and a discussion of the balance sheet and cash flow performance. As a reminder, I will be referencing adjusted results today. Revenues were $475.8 million dollars in the quarter, compared to $533.1 million in the third quarter of 2019. Revenues decreased 10.7% on a year-over-year basis and increased 12.0% sequentially. After adjusting for a $4.9 million favorable impact from acquisitions and a $5.2 million favorable impact from currency translation and higher copper prices, revenues declined 12.6% organically on a year-over-year basis. After adjusting for a $12.3 million favorable impact from currency translation and higher copper prices, revenues increased 9.1% organically on a sequential basis. Recall that we entered the third quarter with a planning assumption that our channel partners would pursue a reduction in channel inventory levels of $25 million during the second half of the year and $70 million for the full-year 2020. Our expectation for the full-year is unchanged, but we now expect most of the second half reduction to occur in the fourth quarter after experiencing only modest reductions of approximately $3 million in the third quarter. Gross profit margins in the quarter were 35.3%, declining 210 basis points compared to 37.4% in the year-ago period. This decline was primarily due to lower volumes. EBITDA was $65.3 million dollars, compared to $49.1 million in the prior quarter and $90.0 million in the prior-year period. EBITDA margins were 13.7%, compared to 11.6% in the prior quarter and 16.9% in the prior-year period. As Roel mentioned, we made further significant progress with our $60 million SG&A cost reduction program. Consistent with our commitment, we delivered savings of $12 million in the third quarter, representing $48 million on an annualized basis. We expect to deliver the full $15 million quarterly run rate savings in the fourth quarter. As we streamline our cost structure, we remain committed to our important growth initiatives. During the quarter, we increased our R&D investment by $6 million, or 26%, from the prior year. Net interest expense increased by approximately $1 million dollars sequentially in the quarter due to changing foreign exchange rates. At current foreign exchange rates, we expect interest expense in 2020 to be approximately $58 million dollars. Our effective tax rate was 17.7% in the third quarter, as we benefitted from incremental discrete tax planning initiatives. We expect an effective tax rate of approximately 19% for the fourth quarter and 18% for the full-year 2020. Net income in the quarter was $32.2 million dollars, compared to $20.3 million in the prior quarter and $54.4 million in the prior-year period. Earnings per share was $0.72 in the third quarter, compared to and $1.19 in the year-ago period. Earnings per share increased 57% sequentially from $0.46 in the second quarter. Turning now to Slide 6 in the presentation for a review of our business segment results. I will begin with our Industrial Solutions segment. As a reminder, our Industrial solutions allow customers to transmit and secure audio, video and data in harsh industrial environments. Our key markets include discrete manufacturing, process facilities, energy, and mass transit. The Industrial Solutions segment generated revenues of $246.7 million dollars in the quarter. Currency translation and copper prices had a favorable impact of $3.3 million dollars year-over-year and $8.1 million dollars sequentially. After adjusting for these factors, revenues decreased 15% organically on a year-over-year basis and increased 8% sequentially. Within this segment, Industrial Automation revenues declined 16% year-over-year and increased 8% sequentially. Not surprisingly, the trends were consistent across our market verticals in the quarter. Cybersecurity revenues declined 8% in the third quarter on a year-over-year basis, and increased 6% sequentially. We continue to secure large strategic orders with new customers, and significantly expand our engagements with existing customers. As a result, non-renewal bookings, our best leading indicator of future revenues, increased 18% year-over-year overall and 42% in the Industrial vertical. Further, we continue to gain significant traction with our software-as-a-service offerings. SAAS offerings represented nearly 20% of non-renewal bookings in the quarter, compared to only 5% a year ago. Industrial Solutions segment EBITDA margins were 15.6% in the quarter, compared to 11.9% in the prior quarter and 19.2% in the year-ago period. The year-over-year decline primarily reflects lower volumes and increased R&D investments in Industrial Automation and Cybersecurity. Turning now to our Enterprise segment. As a reminder, our Enterprise solutions allow customers to transmit and secure audio, video and data across complex enterprise networks. Our key markets include broadband, 5G and Smart Buildings. Our Enterprise Solutions segment generated revenues of $229.1 million dollars during the quarter. After adjusting for a $4.9 million favorable impact from acquisitions and a $1.9 million favorable impact from currency translation and higher copper prices, revenues declined 10% organically on a year-over-year basis. After adjusting for a $3.9 million favorable impact from currency translation and higher copper prices, revenues increased 11% sequentially. Revenues in Broadband and 5G increased 4% organically on a year-over-year basis and 7% sequentially. The ever-increasing demand for more bandwidth and faster speeds is driving increasing investments in network infrastructure by our customers. This supports continued robust growth in our fiber optic products, which increased 17% year-to-date on an organic basis. Revenues in the Smart Buildings market declined 21% organically on a year-over-year basis and increased 16% sequentially. Enterprise Solutions EBITDA margins were 11.5% in the quarter, compared to 10.9% in the prior quarter and 14.5% in the prior year period. The year-over-year decline primarily reflects lower volumes. If you will please turn to Slide 7, I will begin with our balance sheet highlights. Our cash and cash equivalents balance at the end of the third quarter was $391 million dollars compared to $393 million in the prior quarter and $297 million in the prior year period. Recall that we proactively drew down $190 million under our $400 million revolving credit facility early in the second quarter. This was done out of an abundance of caution at the outbreak of the global pandemic. We are comfortable with our current liquidity position, and as a result we repaid all remaining revolver borrowings during the third quarter. Working capital turns were 7.5 turns, compared to 6.6 turns in the prior quarter and 6.9 turns in the prior year period. Days sales outstanding of 63-days was consistent with the prior quarter and prior year. Inventory turns were 5.0 turns, compared to 4.5 turns in the prior quarter and 5.4 turns in the prior year. Our total debt principal at the end of the third quarter was $1.52 billion, compared to $1.56 billion in the second quarter. This reflects the repayment of the borrowing under the revolving credit facility and current foreign exchange rates. Net leverage was 3.8 times net debt to EBITDA at the end of the quarter. This is temporarily above our targeted range of 2.0 to 3.0 times, and we expect to trend back to the targeted range as conditions normalize. Turning now to Slide 8. I will now discuss our debt maturities and covenants. As a reminder, our debt is entirely fixed at an attractive average interest rate of 3.5% with no maturities until 2025 to 2028. We have no maintenance covenants on this debt, so we are not at risk of an event of default caused by worsening economic conditions. As I mentioned previously, we are comfortable with our liquidity position and the quality of our balance sheet. Please turn to Slide 9 for a few cash flow highlights. Cash flow from operations in the third quarter was $50.8 million dollars, compared to $67.9 million in the prior year period. Net capital expenditures were $15.1 million for the quarter, compared to $23.3 million in the prior-year period. The year-over-year difference is primarily related to the Grass Valley divestiture, which we completed in July 2020. Free cash flow in the quarter was $35.7 million dollars, compared to $44.6 million in the prior-year period. Free cash flow increased 78% sequentially from $20.1 million in the second quarter. We are encouraged by the robust sequential improvement during a period of continued economic disruption related to the global pandemic. On a trailing twelve months basis at the end of the third quarter 2020, free cash flow was $136.4 million dollars. Consistent with our typical seasonality, we expect the fourth quarter to be the strongest quarter of the year for free cash flow generation. We expect to remain solidly free cash flow positive for the full-year 2020. That completes my prepared remarks. I would now like to turn this call back to our President and CEO, Roel Vestjens, for the outlook. Roel.

Thank you, Henk. Please turn to Slide 12 for our outlook. As I mentioned previously, demand trends and visibility in our business are improving. As a result, we are resuming our traditional guidance practices. Assuming no further material disruptions related to COVID-19, we expect modest sequential improvement in underlying demand in the fourth quarter, partially offset by the incremental reduction in channel inventory levels that we discussed. We anticipate fourth quarter 2020 revenues to be between $460 million and $485 million, and EPS of $0.63 to $0.78. For the full-year 2020, we expect revenues to be between $1.824 billion and $1.849 billion, and EPS of $2.47 to $2.62. Before we conclude, I would like to reiterate our investment thesis. We view Belden as a very compelling investment opportunity, as we are significantly improving our portfolio and aligning around the favorable secular trends in Industrial Automation, Cybersecurity, Broadband & 5G, and Smart Buildings. Throughout this challenging period, we continue to invest in our business to position the Company for improving growth and robust margin expansion. As we successfully execute our strategic plans and deliver on our goals, we would expect this to drive superior returns for our shareholders. Finally, I would like to inform everyone that we will be hosting Belden’s 2020 Investor Day event virtually on Tuesday, December 15th. At this event, we will provide a detailed update on the Company’s strategy for creating shareholder value. We hope you will be able to join us for the live webcast. That concludes our prepared remarks, Mary, please open the call to questions.

Thank you. [Operator instructions] Your first question comes from Reuben Garner of Benchmark Company. Please go ahead.

Thank you. Good morning everybody. So, maybe we can start, this is your - I guess you have been here for three or four - have been in this role for three or four months now. Can you just maybe give us some observations, update us on how things have been progressing in your new role. And as anything, I guess, changed in your mind since you took the seat earlier this year?

Sure. Thank you. So, obviously, it’s not an easy year to continue Belden’s transformation. But we are very excited about our strategic priorities. We highlighted the $60 million cost reduction, we highlight the strength of the balance sheet the Belden has. But probably even more importantly, we feel very good about the investments that we are making. Even in this time, where it’s offline is a little bit challenging. Of course, we continue to invest. And I think we highlighted about the 26% improvement of R&D investments. And we highlighted some of the areas where R&D investments are already yielding good returns. So, for example, our fiber and fiber related revenue and broadband in 5G year-to-date is up 70%. We feel good about the investments that we are making in the industrial Cybersecurity solutions, where we were able to record robust growth. So, I’m very excited. And we feel good about the investments that we are making.

And so I guess you have got several different businesses, obviously with different macro items that are impacting them. Can you I mean, a lot of flipping takes going into next year. Can you just talk about maybe, you have got some short cycle business of sound comebacks and longer cycle visits that might, might take a while for return. Can you just kind of crystal ball, how you see the world today talk about what 2021 might look like with all the puts and takes from a market growth opportunity. And then obviously, you have made some investments to try to grow, grow and excellent to that. So can you just kind of give us the label in?

Yes, sure. So, we will guide 2021, either during our Investor Day that we just announced or when we report out Q4 results, but I think it is important to remind us of two things. So, first of all, we feel very good about three out of the four businesses. We leave mentioned that smart buildings, also in 2021 will probably be a little bit more challenging. There are verticals within the smart building segment that we see growth potential. But we have to be realistic, that the business will probably be challenged in 2021 as well. The other three businesses we feel good about. And a second thing, we should take into account is that, the $70 million of channel inventory draw that we expect in 2020 will obviously not return in 2021. So, that in it by itself will create a significant revenue growth. That is kind of how we see 2021.

Perfect. Thank you, and good luck getting through the rest of the year. Stay safe everybody.

Thank you so much.

We will now take our next question from Noelle Dilts with Stifel. Please go ahead.

Thanks. Good morning. Hi, gentlemen. And congrats on a good performance in the challenging environment.

Thank you Noelle.

Sure. So, my first question is around the channel partner inventory reduction. Given that they have sort of been running below your expectations, I’m just curious, why you are still expecting them to occur in the fourth quarter. I guess my question is, is there a chance it might be a little bit less than the $25 million you have been talking about.

Yes. Thanks for the question. So I think, the [Admixture Westco] (Ph) combination, the integration from what we can tell is going very, very well and we are very happy with the progress that they are making. But as a result of that, they didn’t draw as much inventory as we thought they would draw. And secondly, I think the balance that, our general partners are constantly trying to find is outweighing optimizing their working capital versus serving our customer needs. So, as they continue to improve and as they continue to update their revenue expectations, they will make the appropriate draws that they feel are appropriate at their inventory levels. So in Q2, we had a significant draw, in Q1 we had a significant draw, not so much in Q3. But we expect that they will draw the full $70 million before the end of the year.

Okay. And then on the increased investments in R&D, how should we think about that moving forward? It looks like R&D was running about 6.4% of sales in the quarter, is that a reasonable run rate as we think about this moving forward? Just kind of curious how you are thinking about those investments as we move into 2021.

Yes. It is. Yes, it is, that is a level that we feel comfortable with. We recognize that is an increase. But, we do expect that with the changing landscape within Industrial Automation, the further investments required for our Cybersecurity offering on the industrial floor, and as well as remaining very innovative on the Broadband and 5G segment that we have to increase that level of investments. But like I said, that should be approximately the run rate that we should expect and we feel comfortable with.

Okay, great. And then last, I’m hoping you could just dig a little bit deeper into the trends you are seeing in Broadband. Clearly, a lot of nice moments on outside the home, and I think that inside the home business has benefited a bit this year from social distancing, with some you are - Just could you give us some thoughts on how you see that developing into next year? Do you expect declines on inside the home business, given the tough comp and do you think that can be offset by growth on the outside the home piece?

Yes. Thank you. We continue to expect mid single-digits growth in that segment, that remains unchanged and we feel that the largest growth opportunity consistent with what we have learned in the past that consistent with our strategic investments will be outside of the home and driven by fiber. So, in this quarter, for example in Q3, our outside of the home revenue increased by 9%. So, we do expect that that trend to continue into 2021.

Great. Thank you.

Your are welcome.

We can now take our next question from Mark Delaney of Goldman Sachs. Please go ahead.

Yes, I was hoping you could speak a little bit more about the improvements the company has been seeing within fiber. And I think the company said that specific business is up and growing, maybe if you can update us on what percentage of Broadband & 5G business when you think about both outside and inside the home internality is now made up of fiber? And then how much is copper. And if you could also dough tale how do you see that evolving overtime. You know the company had talked about trying to access some of the mature copper portfolios or just trying to think through that evolution?

Yes, for sure. So, at the end of the third quarter Mark, there are fiber business for Broadband & 5G, the unit was approximately 30% of total revenues. And that compared to - let me say 2018, for example, where it was 5%. So, we made substantial improvements in the facility on the fiber side. Outside of the home and inside of the home is primarily a focus. And we expect to exit the year with more than 60% of our business geared or focused towards outside of the home.

And on a mature copper portfolio, some of that business I think something was looking to back away from overtime. Can you talk a little bit about the latest thoughts on that?

Yes, sure. So, we are encouraged by the engagement that we are seeing from strategic as well as financial buyers.

Okay, and then finally on margins in the fourth quarter. I was hoping to better understand gross margins in the December quarter. I think consensus EPS was a bit higher on similar revenue to what the company had guided to, so I’m not sure if maybe the company is thinking there is a little bit lower gross margin. Maybe something is kind of flattish quarter-on-quarter like 35%, or maybe that there is some increase in OpEx. So, I’m just trying to better understand gross margins in OpEx trends and better understand where maybe that disconnect is - EPS the industries as versus what the company like additive?

Yes, so gross profit margins in the fourth quarter, we expect to be about 36%. As I mentioned, we continue to focus on making investments in R&D. So, total OpEx approximately 24.5% to 25% in the fourth quarter.

Understood. Thank you very much.

Your are welcome Mark.

Kevin Maczka there are no further questions at this time, please continue.

Okay, thank you, Mary. And thank you everyone for joining today’s call. As Roel mentioned, we will be hosting Belden’s 2020 Investor Day event virtually on Tuesday, December 15th. Please be on the lookout for registration details. For those of you that would like to join us for the live webcast, which will be accessible via Belden Investor Relations website. If you have any questions, please reach out to our IR team at Belden our email address is investor.relations@belden.com. Thank you.

Thank you. Ladies and gentlemen, this concludes our call for today. You may now disconnect from call and thank you for participation.