Vistance Networks, Inc. (VISN) Q4 2020 Earnings Report, Transcript and Summary

Ladies and gentlemen, hello, and welcome to the CommScope Fourth Quarter and Full Year 2020 Results Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. As a reminder, this conference call is being recorded.

Good morning, and thank you for joining us today, and welcome to our fourth quarter and full year 2020 earnings call. I’m Russell Johnson, Vice President of Treasury and Investor Relations. And joining me today are Chuck Treadway, President and CEO; Alex Pease, Executive Vice President and CFO; Morgan Kurk, Executive Vice President, CTO and Segment Leader for Broadband Networks; and Bud Watts, Chairman of the Board. You can find the slides that accompany this call on our Investor Relations website. Please note that some of our comments today will contain forward-looking statements based on our current view of our business, and actual future results may differ materially. Please see our recent SEC filings, which identify the principal risks and uncertainties that could affect future performance. Before I turn the call over to Chuck, just a few housekeeping items to review. Today, we will discuss certain adjusted or non-GAAP financial measures, which are described in more detail in this morning’s earnings materials. Reconciliations of non-GAAP financial measures and other associated disclosures are contained in our earnings materials and posted on our website. All references during today’s discussion will be to our adjusted results, unless otherwise noted. Also note, the full year 2019 results include historical ARRIS pre-acquisition results, reflecting certain classification changes to align to CommScope’s presentation. All quarterly and annual growth rates described during today’s presentation are on a year-over-year basis unless otherwise noted. I will now turn the call over to our President and CEO, Chuck Treadway. Chuck?

Thank you, Russell, and good morning, everyone. Today, I’ll start with the review of our 2020 highlights and our fourth quarter results. I’ll then provide a preview of our transformational initiatives to drive growth and value creation, which we refer to as CommScope NEXT. Let’s turn to Slide 3. As the COVID-19 pandemic was beginning to unfold, we moved aggressively to keep our people safe, continue delivering for our customers. We pivoted quickly to remote work, put in place robust health and safety system and initiated a business continuity program. Our team leveraged the diversity of our global manufacturing footprint to mitigate supply chain risk and respond to the evolving regional challenges. Within a matter of weeks, we mitigated the vast majority of our supply chain challenges and our factories were running at capacity. The management team and I are proud of CommScope’s ability to deliver on our promise to meet customer needs in such a challenging time.

Great. Thanks, Chuck, and good morning, everyone. This morning, I’ll start with a recap of 2020 before moving to our fourth quarter results, segment performance and some commentary on cash flow and our capital structure. I’ll finish with some closing thoughts on key industry and technologies trends that we expect to influence CommScope’s performance during the coming year before we open the call out for Q&A. Turning to Slide 6. The full year 2020 net sales of $8.44 billion declined about 14% from the prior year as a combined company. We saw moderate growth in our Broadband Networks segment during 2020. The sales declined across all other segments, most notably Home Networks, which was down 30%. From a geographic perspective, sales declined across all regions.

Thank you, Alex. Before turning the call over to Q&A, I want to close with some final thoughts regarding CommScope NEXT. So while we initially indicated an intention to preserve formal commentary and my plan until Q3, I’m encouraged by what I’m seeing and become increasingly comfortable that we can share certain aspects of the plan in advance of this initial timeline. We started the process today at a very high level, and I anticipate it will begin to communicate certain directional targets when we report our earnings in Q1, with more detail to follow in Q2, culminating with an Investor Day featuring the extended management team later this year. Thank you very much for your attention. And with that, I’ll turn the call over for Q&A. Operator?

Your first response is from Meta Marshall with Morgan Stanley. Please go ahead.

Hi, great. Thanks and congrats on the quarter. Just a couple of questions, just as you start formulating NEXT. You noted international opportunities as an area that you’re potentially evaluating. In the past, there has been some volatility there with kind of what the margin opportunity is there. So just kind of how you’re thinking about that? And then additionally, just how you’re thinking about the strategic makeup of the business and whether there is anything that can be separated? Thanks.

In terms of the international market expansion, I mean, when you think about Europe and the Middle East, some parts of Asia, Japan, Korea, there are actually some pretty price – pretty good price levels we can get there very similar in what we would expect to see in the United States, but we’re targeting areas there. However, we also are looking across the board. What can we do in India? We just had to think about completely different design concepts. It’s going to take a little more time there, but we have to think about bare bones things in that particular market. With that, your question about what businesses could we disconnect, whatever, we’re going to just hold our comments on that until we finish our analysis of all the different businesses and portfolio of products that we’re going to be reviewing. Obviously, we’re still in the middle of that. So I’ll hold my comments there.

Meta, let me just pile on a little bit on the international, because you’re probably remembering couple of years ago, we talked about exiting certain regions that we’re extremely margin sensitive and we felt like we just couldn’t compete. I think there’s been a bit of a pivot, that strategic pivot, which Chuck alluded to since that time around how do we design a product that are much, much lower cost for those markets where the market where the price is just so depressed. And so that is a bit of a shift from what we communicated previously. But we’re pretty excited about the work our teams done to really innovate and drive costs down for those – cost and functionality down for those more challenging markets.

Great, thanks.

Thank you. Your next response is from George Notter of Jefferies. Please go ahead.

Hi, guys, thanks very much. I guess I wanted to try to dig into the CommScope NEXT program a little bit more. Chuck, you said a lot about the different aspects of the program, including reallocating capital removal of redundant costs, systems issues, you can kind of hash through. But could you give us some more tangible examples of things you found as you’ve dug into the company and realize these opportunities to take cost out? And I guess, frankly, the company has been restructuring costs for a longer time now, and it feels like a lot of the low-hanging fruit may have been picked. But is that a view you agree with? Walk us through the picture at this point on cost restructuring. Thanks.

When you think about duplicative systems, I mean, just think about the acquisition of ARRIS, so we’ve brought two very large companies together, two $5 billion plus companies. When we put those together, you find a lot of duplicative systems. Great example is what we have in the IT side. I mean once – one company runs Oracle, one company runs SAP. As we move to one system, we’re going to have significant savings from that. We’ve really dug – we’re starting to do a pretty big deep dive with all of the business units to understand where are we spending money, where are we investing. And we’re finding things that we can frankly get on the upside without developing it on our own, so we can take that money and then double down on things that are really critical for us. That’s just a couple of examples. I would also say that when we think about discretionary spend, whether that’s indirect or, well, let’s just start with discretionary, indirect discretionary spend. There is an opportunity when we move to a general management strategy, where the general managers will be able to look at all those expenses with an eye that – have a business leader that’s saying, I don’t want to get allocated to Boston, now they don’t have to, they can really make decisions on their own. And we’re going to be really giving them a lot of opportunity there, and we can also be finding some oversight there and more details when we think those types of expenses. And then if you think about direct procurement, I mean we doubled what we buy, right? So there should be some opportunities depending on what commodities are that we can do more there. So I’d just say there is a lot, and I think as we really start to talk to the team, we got some general managers really getting excited about looking deeper, and we’re getting into the details there, and we’re finding answers to that.

Great. Thank you.

Thank you. Your next response is from Sami Badri of Credit Suisse. Please go ahead.

Great, thank you. I just wanted to flip back to the Broadband Networks slide, where you talked about CMTS licensing being strong, and we’ve seen the same exact bullet point, or this comment come up a couple of times over the last year and a half. Could you just elaborate on what your customers are doing with the CMTS license sales versus actually buying the equipment itself, which was a historic case? Can you kind of unpack this for us, what’s going on, and – customers?

Let me start and then actually, fortunately Morgan’s in here because he runs that portion of the business, so I’ll let him pile on. But effectively, what we saw at the early part of the COVID, but there was a desire by the network operators not physically intervene in the network, because there are so much pressure on the network. So the easiest way to do that would be to add capacity virtually basically by adding licenses to be existing E6000 infrastructure that they had in the head end. As we’ve gotten toward the latter part of the year, what we’re seeing is there is some license activity with some of the operators, but a number of the operators, I think, basically exhausted the capacity of the DOCSIS 3.1 investments in their head end. And so rather than invest in the head end infrastructure, they’re pushing the investments into the node. So there’s a mix shift from the CMTS piece of the business to the node piece of the business, which is where we were talking about the more physical interventions in the network, as we look out sort of this part of the year, and then into 2021. So that’s kind of the dynamic that’s been going on, but I’ll let Morgan talk in more technical level.

Yes, Alex, is exactly correct. So the network spend moves between hardware and software, depending on what you have in your network and what your needs are. The COVID has driven us to the point of a breaking, particularly in the uplink, there is so much less spectrum allocated to the uplink at this point that our operator, customers have had to split nodes and make smaller user groups that are sharing that uplink capacity that’s node splitting and that’s largely hardware. And as such, more of the capital has been pushed toward that physical equipment. In addition, there is a depth that goes on between adding more licenses, adding additional capacity to hardware that you have and buying new hardware in the head end, and so that goes on, and you’ll see this going back and forth over the years, as they continue to invest in the network. One of the things that they’re doing to invest in a network now is there they’re going to what’s called a high-split, they’re allocating more spectrum to the uplink to try to solve this problem. And of course, once they’ve upgraded the hardware, there will be software upgrades as well.

Okay. And then, maybe just so we understand some of the dynamics here as there is almost like a built-in expectation at CommScope that these same customers are going to probably come back to you guys a few times with CMTS-related licenses, right, just as they continue to densify and harmonize their infrastructure. Is that a safe assumption from an industry outlook perspective?

So, they come back to us when they need more capacity in their network. So, they buy physical cards and then they add additional capacity to those cards in effect. It’s a software-related capacity add over time and they do that until they exhaust the amount of bandwidth that’s available to them. So, it is an opportunity to continue to sell additional licenses to them until they reach a certain point and then they go back to buying hardware to increase that available capacity again. That’s the dance that’s going on. Of course, there is also the upgrade to the network, whether it is to go to DOCSIS 4.0 which expands the amount of spectrum available and thus the amount of both hardware and software that they can buy from us. And also, the change in architecture from the centralized, the CCAP to distributed access architecture, whether it’s Remote MAC or Remote PHY which puts more of this equipment out toward the edge of the network to reduce some costs in the head ends and to increase the capacity of the backhaul network and to reduce latency. So, all of those things will be going on for the next decade.

Got it. Thank you.

Thank you. Your next response is from Simon Leopold with Raymond James. Please go ahead.

Thanks for taking the question. Just want to see first if you could offer just the metrics of headcount, where it was this quarter versus last. And then the longer-term question, I wanted to see if you could maybe unpack C-Band comments a little bit. I appreciate the indication around the second half weighting. What I wanted to ask about was how you see the trajectory and timing and scope because you mentioned spending on macro towers this year, I assume, we see that expand off the towers in 2022. So, if we could you get some idea how to size this opportunity beyond second half of 2021 and maybe help us understand how it gets funded given the amount they’re paying for spectrum. Thank you.

Yes. So I’ll take a swing at that and I’ll ask Morgan to chime in as well. So, in terms of that, I think you’re asking about headcount. It’s a bit of a tough question to answer. In general, we have in the order of 30,000 employees globally. The vast majority of those are in our manufacturing facilities and it’s one of the ways we manage our cost structure as by eliminating essentially labor when demand is soft. And so, that number can move between, call it, 28,000, 29,000 and 32,000. I think really what you’re asking is what have we done on period overhead. And I think we mentioned we’ve achieved our $150 million synergy target more than a year ahead of schedule. A significant piece of that was headcount related costs. In addition in the Home Networks segment, we took out significant costs, particularly in the video side, in the video R&D side, a large portion of that was headcount related as well. So, a significant piece of the improvement you’ve seen in period overhead is headcount related. I think that total number year-over-year is something like $100 million. So, I think that’s what you’re getting to Simon, and if not, happy to clarify either in a follow-up question or after the call. As it relates to C-Band, we mentioned that two large operators bid substantially higher than at least our original expectation. I think the total award was $80 million versus the original expectation of something like $50 million. They will be using the first part of the year to – the first part of the year to basically design their networks and there’s some choices that they have to make around what type antenna configuration they want to use. And so, that will carry with it implications for wind nodding and shear on the towers that will carry with it implications for power going up the tower, all that will benefit us. But that will take through likely the first part of the year before they’re ready to move into actual physical power lines which begins in the latter part of the year and then will ramp as we get into 2022. The other piece which you mentioned, which is absolutely right, is the importance of densifying the networks. So, we talked about in the prepared remarks that the integrated solution piece of that business, the Metro Cell piece of that business has been weak in 2020, largely related to permitting delays and crew delays, largely COVID-related. So, as those densification investments return, we expect to see that business return to its normal growth trajectory. So, I think to bring all that together, 2021 feels like a modest growth opportunity with the real opportunity as to get out into 2022 and some of these competitive dynamics begin to unfold. But Morgan, what did I miss?

Yes. So, Alex, you only missed one thing which was that there was $1 billion that they spent, you said millions. And if they only spent $80 million, I think all of our carrier customers would be a lot happier. But clearly, the reason that the carriers have bought this large amount of spectrum is because it is going to make their networks a lot more efficient. So, they’re going to want to put this into play as quickly as they can. They have a competitive dynamic where one of the operators is already putting mid-band spectrum into play, but this takes time. It takes time to do the planning and it takes time with new technologies like Massive MIMO. It takes planning because it really is a big network upgrade. One of our customers that has been dealing with this in Europe said this is as big an upgrade as we’ve seen since 2G, which is a massive upgrade. It’s an upgrade to power on the tower, it’s an upgrade to potentially architecture in some places and so it takes time to do it, but we expect because there is this competitive dynamic and because this will make the network so much more efficient that the build as it starts to ramp-up will be positive for us, but it will take a little bit longer to ramp up than immediate, which is what everybody would like.

Thank you very much.

Thank you. Your next response is from Rod Hall of Goldman Sachs. Please go ahead.

Yeah, hi, thanks for taking the question. I guess I wanted to come back to the cost structure and the R&D reduction that we saw in the quarter and I know you had alluded to maybe reduce the outsourcing things and so on, but I wonder if you could dig a little bit more into how you’ve reduced that R&D number so much. I guess the color on this is, typically when we see R&D reductions like that, it’s not always a good thing, but admittedly, there could be a lot of inefficiency in there we’re unaware of. So, just wonder if you could dig into that a little bit more and then, I’ve got a follow-up.

Yes, sure. So, there has been a lot of action on cost and period overhead. A lot of that’s just natural synergy capture, which is elimination of redundancies and then a lot of that is, I would say moving to a next-generation operating model. And then the third part of that is R&D optimization. So, I think the elimination of redundancies is an obvious one. I am not going to spend any time on that. In terms of moving to a next-generation operating model, we’ve been looking very aggressively at how we leverage low-cost resourcing across both the back office as well as the R&D functions. So, we recently completed a large system conversion. We ramped our shared-services activity in Goa, India as well as in Taiwan, and Ireland and Mexico. A lot of that has allowed us to just run the finance and IT and HR functions more efficiently. So, there’s been substantial activity on there. And as Chuck talked about CommScope NEXT that will be a big unlock for us as well as we drive farther system consolidation. On the R&D side, this has been a pool of money call it $700 million or so, that historically has not been very, very actively managed. It’s been sort of a very disclosed management style. And I think as we’ve gotten into, what we found is really two things. One, we’re making investments in essentially low ROI or no ROI areas. So, there’s an opportunity to harvest those investments that aren’t yielding the returns that we want and redirect those funds to areas like cloud and analytics and virtualization technologies that we really think that as tickets to the future. We’ve also found that historically just by nature of the way these two companies have grown up, a substantial amount of the R&D spending happens in very high cost regions. And so, we’ve been deploying a playbook that really – the CommScope team had developed over years of how do we build up R&D capability in lower-cost regions like – again, like China, like India, like Ireland, places like that where we can just get a lot more bang for our buck and that work has only really just begun. So, again as we start talking about CommScope NEXT, that’s one big area of opportunity for us to begin.

I’ll just add one more thing. I want to be crystal clear that we will not be cutting anything that will hurt our future. I’m working very close with the segment leaders and Morgan to look at every single thing we’re working on in the company and anything that’s critical to our future. We’re either keeping as it is a doubling down on that. So, I don’t want you to get any impression that we are anyway looking at this in the short term. This is a long-term play. This is going to be about investing where we see it makes good sense. This is getting closer to our customers and understanding what they need, getting that information back to our R&D teams and developing exactly what we need to take us to the next level. So, I don’t want you to take anything away from this that – we’re going to be cutting anything that we don’t need. We will be doing everything we can to protect it.

And just one last point and I’m sorry to keep piling on, but it’s an important one. When you look at the year-over-year decline in R&D that is driven by home video. And so, really that was the actions that Joe Chow and the team took to scale the R&D appropriate with the size of that business which I think everybody could understand given how dramatic the top line declines were. So at that point, there was not R&D spending harvested from the growth areas.

Could you repeat that last part? You broke up when you said what drove that R&D reduction?

It came out of the Home Networks segment and in particular, the video piece of that business, which is down 30% year-over-year. Did that...

Very clear. Okay, that’s helpful. And then my follow-up with on C-BAND again maybe, Morgan, I guess, this one’s aimed at you, but do you know – I mean I know they are in the process of re-planning spectrum now, but how confident are you that that spectrum is going to be allocated to macro towers where you guys would benefit more versus smaller cells in metro densification kind of projects. And is that a wrong perception? If you go into densification in smaller cell sort of deployments for that spectrum, do you guys benefit just as much there? Maybe just talk us through that a little bit.

Sure. So, I am very confident that this will be used on the macro layer. It is an enormous both capacity add to the network and also an efficiency play and the output power in the technology is certainly available to blanket your network from a macro tower will be the most efficient way for the operators. So, they’re certainly going to do this. I believe they’re also going to do a metro layer to add additional capacity in cities because just doubling your amount of available spectrum which is roughly what C-BAND does to the operators is probably not enough to last through more than the first couple of years. So, I expect them to do a metro layer as well and we do benefit from both. There are a lot more Metro Cells and there would be macro cells per square kilometer. So, our benefit per area would likely remain very, very similar, although the types of products that we sell are different, the costs of the products are different, the margin profile would be similar regardless of where it is in the network.

Great. Okay, thank you.

Thank you. Your next response is from Samik Chatterjee with JPMorgan. Please go ahead.

Okay, great. Thanks for taking the question. I had a couple. Chuck, I just wanted to ask you one more on the strategic direction here. I think if we rewind to the time of the ARRIS acquisition, there was an argument made for a broader portfolio and more end-to-end solutions, particularly for cable and broadband customers. How are you thinking about the value in terms of that strategic direction. Do you see value in having all end-to-end solution for certain customers that was really the argument behind the ARRIS acquisition and I have a follow up.

I think we are absolutely are seeing the value of having end-to-end solutions and what we’re going to be doing as we think about our portfolio, there could be some things that will be removed, but there could be also opportunities for us to make acquisitions that are lined up with exactly where we want to play. So, I’d just say that we do feel there’s an end-to-end side here and we also think that’s there opportunities to add on where we need and we’re going to be diligent on what we think is really not creating value.

So, I’ll add in here an example just so that everybody can make it real. One of the real network challenges that will go on in this next decade, one of the ways that you measure the quality of a network will be based on latency and jitter. In other words how snappy your network feels and how reliable it is in that snappiness. And by providing a complete end-to-end solution, all the way through the network from, let’s say the core of the network, all the way through that access layer and even through and into the home through the Wi-Fi access point all the way to the edge is one of the ways that an integrated CommScope can really add value beyond that which somebody who just makes a point source could do. And we think these are the types of areas where it really benefits by having this tight integration.

A follow-up for Alex, if I may. Alex, I think you mentioned weaker 1Q. Just wanted to clarify, you mean weaker year-over-year because I think seasonally we all understand 1Q is weaker. And then just in terms of where consensus expectations are, it looks like consensus expects you grow top line for most part of the year. I know you’re not guiding here, but just based on visibility and the constraints that you talked about, do you think that’s realistic?

Yes, you kind of answered your own question. We’re not guiding, so it’s a tough question for me to answer. The commentary that I did give was sequential. I am trying to help you understand what the sequential kind of velocity looks like as we think about normal seasonality patterns as well as some of the costs that we see coming back into the business in 2021. And then, I tried to give you some commentary, some qualitative commentary on how we see the markets unfolding, particularly with some of these tailwinds related to RDOFs spending, C-BAND and the like. Beyond that, I don’t think I can really comment on consensus numbers or what our point of view is on that.

Okay. Thanks for the clarification there. Thank you.

Thank you. Your final question is from Jeff Kvaal from Wolfe Research.

Yes. Thank you, gentlemen. I have a couple. I guess, first of all, I was hoping that you could add a little bit of color to the leverage reduction story. There hasn’t been as much of a theme on the call, as it has been in others. What can you tell us about how we should expect leverage to decline through 2021 or over broader time frame.

I thought you’re going to have two questions, Jeff. Is that the question you have? Jeff?

I’m sorry, Alex?

I misunderstood. I thought you were going to have two questions. So I didn’t want to cut you off.

Okay. I’ll ask them in the same time. Okay. That’s fine. And I guess my second question would be on the broadband margins. My sense is that some of that is a little bit one-time, but if you could let us know how much is sustainable improvements and how much you expect to give back to some of the factors you mentioned before. I’d appreciate that. Thank you.

Sure. So, let me to take the leverage one first. We are absolutely committed to aggressively deleveraging the balance sheet and I think there’s obviously two ways we do that. One is by paying down the debt, which we’ve been doing and the other is by growing EBITDA which we aspire to do certainly through CommScope NEXT. And really that priority hasn’t changed. It’s again – I’m not at liberty to provide guidance so I can’t give you an outlook for what 2021 will look like, unfortunately, which is I know what you’re asking for. But that’s sort of not part of our guiding philosophy at this point. As it relates to broadband margins, I actually would say that to me margin improvement is absolutely not one side in nature, but it is transitory in nature. And what I mean by that is, as mix shift and the issues that Morgan was talking about previously, as mix shift between a software type of solution for adding capacity or upgrading the network to a hardware type of solution with physical node interventions in the high split activity that Morgan described, you will see a negative mix trend. And as we look into 2021 and we see more of the activity in the Broadband Networks segment trending toward physical nodes splitting activity, you will see the margin compression. But that’s not to say that as the cycle matures and there’s a next-level of investment in more virtualized solutions that you won’t be that time reverse, this is between whether it’s physical activity or software-based activity. And hopefully that helps you get a sense for what we see in 2021 as it relates to broadband margin.

Okay. Thank you, Alex.

You’re welcome.

Thank you. I would now like to turn the call back over to Chuck Treadway.

Well, we appreciate your support of CommScope and we hope you have a great day. Thank you very much.

Ladies and gentlemen, this concludes today’s conference. Thank you for your participation. Have a great day. And you all may disconnect.