Vistance Networks, Inc. (VISN) Q1 2021 Earnings Report, Transcript and Summary

Good day. Thank you for standing by. Welcome to the CommScope First Quarter 2021 Results Call. At this time all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. I will now like to turn today's call over to Russell Johnson, Vice President, Treasurer, Investor Relations. Please go ahead, sir.

Good morning and thank you for joining us today to discuss CommScope's first quarter 2021 results. With me on today's call 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 report 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, I have 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. All quarterly growth rates described during today's presentation are on a year-over-year basis, unless otherwise noted. I'll now turn the call over to our President and CEO, Chuck Treadway. Chuck?

Thank you, Russell, and good morning, everyone. 2021 is already shaping up to be a very exciting year of progress at CommScope. We are putting in place a broad transformational agenda and are beginning to feel the impact of these efforts in our results. This morning, we released our results for the first quarter of 2021, and I'm pleased to report that our consolidated business showed strong performance, led by sustained momentum in our Broadband Networks segment. In our core business segments that will remain after the separation of Home Networks business, sales up 11% year-over-year and adjusted EBITDA was up 25%. And just one month ago, we announced two critical components of our CommScope next initiative. First, that we intend to spin-off our Home Networks business into an independent publicly traded company. And second, that we have taken initial steps to optimize our company's cost profile and free up resources to reinvest and grow. Today, I will provide you with more insights into our broader plans for transforming CommScope into a growth-oriented, profitable technology leader. And I hope that you will share our excitement about the company's future. But first, I'd like to provide more detail on our first quarter results.

Thanks, Chuck, and good morning, everyone. I'll start with a review of our consolidated financial results for the quarter on Slide 7. During the first quarter, net sales increased 2% to $2.07 billion, led by another quarter of impressive performance from our Broadband Networks segment. Orders for the quarter were very strong at $2.83 billion, yielding a book-to-bill ratio of 1.37, which represents a significant increase over the Q1 2020 ratio and demonstrates the robust demand we are seeing in many parts of our business. While this high backlog gives us confidence about our revenue prospects throughout the balance of 2021, I would caution everyone that we are experiencing many of the same supply constraints as other technology and manufacturing companies. We're also seeing relatively sharp increases for a range of important inputs and components, including copper, steel, resins, semiconductor chips and freight.

Your first question comes from the line of Meta Marshall with Morgan Stanley.

Great. Thanks, and congrats on the quarter. I guess a couple of questions for me. Can you give a sense on the supply chain shortages you're seeing and just whether it's giving you more visibility from customers for the year? And just how that frames kind of your outlook for how the year developed and then just maybe more context on ability to pass some of the cost increases that you're seeing on to customers? Does it kind of vary meaningfully by product? Just any context there would be helpful. Thanks.

Okay. In terms of supply chain shortages, the main one that we're experiencing is in the Home business with our silicon products and we actually have to work with our customers there. And obviously, there's allocations, and there's opportunities to expedite, and we're working with our customers to help pay for that, and we're communicating directly with them on those types of opportunities to make sure we get the supply there. If you think about the other businesses, it's kind of a start and stop. I mean, we seem to have a problem in the day and we get it resolved in the next day. We're able to work through it pretty well. We have a pretty large supply base. We are seeing some inflationary effects. But I would say we're not really shutdown by any component shortages other than silicon. And I wouldn't even say we're shut down. It's just – we're just not getting the supply we need. And in terms of inflationary effects on the other products, many of our customers, we have contractual relationships where there's formulaic opportunities to raise price, depending on what's going on with the inflationary components of the product.

Meta, the only other thing I'd add, Chuck obviously mentioned the semiconductor issue, I mentioned in my remarks, capacity constraints within our fiber cable and fiber connectivity. Those are internal constraints, and we're making investments in the factory that will begin to come online in the later part of the year. And that – those investments really are meeting the significant increases in demand that we're seeing. So that's the only other supply chain issue that I'd mention, but that's obviously fully within our control, and we're taking steps to unlock it.

Great. I guess I was asking more from a perspective of have your customer’s kind of shared order trajectory over the year to assure that you have supply chain?

So yes. Some of our customers have worked with us to give us a longer-range output, and in some cases, actual orders to follow for some of these more critical components. As an industry, we're all trying to project out what those things will be and manage that supply chain, appropriately. So I think it's a work in progress. But certainly, we've gotten closely with our customers on that.

Great. Thanks.

Your next question is from the line of George Notter with Jefferies.

Hi, guys. Thanks a lot. Maybe just too kind of expand upon that prior question. Is there – do you have any sense for how much cost inflation you're seeing in the business? Is there a dollar value you can kind of put on that? And then how much of that are you able to offset with price increases? It'd be interesting to kind of see what that inflation component is translating into in terms of the EBITDA of the business?

Yes. It really depends on what element you're looking at. In the semiconductor space, it's sort of in the mid-single digits. In terms of percent, freight is probably quite a bit higher than that. In ocean freight, it's close to 70% inflation, air freight, a little bit less in sort of the 14% zone. Copper, obviously, you've seen substantial increases in copper prices, which you can tell, if you just look at the LME index, similarly with steel. So it really depends. I think one of the things that is important to consider is that a number of our products have a fairly – while the commodity input is important, it's a lower percentage of the overall value-add of the – our product. So it's not – wouldn't be fair to say that the price of our product is going to increase directly in line with the price of whatever the underlying commodity is. And that's really the negotiation that Morgan was talking about is helping our customers understand what these inflationary effects are, working with them to mitigate those through a combination of productivity actions and pricing and preserving our margins. So that's sort of how we're managing the profitability picture.

Got it. Okay. I assume when you roll it up, there is a negative net impact on EBITDA. Is that fair to say?

We're going to – these impacts, George, are impacting every single player, not only in the technology space, but in the broader manufacturing space. And both our competitors know that as well as our customers. And I think we have every expectation that we'll be able to offset this pressure.

Great. Thank you very much.

Your next question is from the line of Jeff Kvaal with Wolfe Research.

Good morning. Thanks for taking the question. I would like to delve into the new constructs around the cost reduction plans and EBITDA growth forecast. I'm wondering if you could help us frame kind of where you are measuring that $500 million from over how long should we get it or sort of in what stages should we get it? And are we going to see all of it? Or should we expect that you'll reinvest some of that $500 million? And so the overall EBITDA isn't going to be $500 million higher by the end of the three years, but despite somewhat less.

Sure, Jeff. So let me kick it off and then others on the team may want to pile in. So to start with, CommScope NEXT is $500 million – what we've said is at least $500 million of EBITDA improvement. 50% of that coming from growth, 50% of that coming from cost. So to the extent we have greater cost savings than that $250 million, we may choose to reinvest those in incremental growth, or we may choose to bring those to the bottom line. Those decisions haven't been made, but we are committing to $250 million in cost-related EBITDA improvement and $250 million in growth-related EBITDA improvement. Those savings are net of headwinds. So the way to think about modeling it is if you take our TTM EBITDA, you back out the impact of the Home Networks actions that we've taken. You add your $500 million on top of that, that gets you to a new run rate. And then over and above that, we do expect some cyclical recovery in the market. So this is – these are actions that we take above and beyond just normal market recovery. So hopefully, that gets you to an EBITDA number. And then in terms of timing, what we've said is this is a three year aspiration. And obviously, the cost actions we started in April. So those are already in flight. There's more actions that Chuck referred to around procurement. Both on the indirect side and the direct side. There's actions being taken on manufacturing efficiency. And then the investments that we're making in growth, both in new markets and in verticals will likely be farther out in that three-year time horizon. So maybe I'll pause and see if Chuck would like to add anything on top of that and ask you if that answers your question.

I think you said everything.

Let me follow-up, briefly. And just to say, do you have a sense of what year one or year two might look like? Like the cost reductions might be heavily weighted to the front end of your timeline, for example.

We've not provided and we're not undertaking to provide that level of detail at this point. I think it's reasonable to expect when we get to our Investor Day at the end of the year that will give you some indication on kind of the velocity of how this materializes in the P&L, but we're not at that level right now.

Thank you all.

It's okay. Operator, I thought Jeff had a follow-up question. I didn't hear him.

Your next question is from Samik Chatterjee with JPMorgan.

This is Joe Cardoso on for Samik. The decline in metro cell or metro and macro cell solutions, which is not much – it doesn't give much surprise, given the reasons you highlighted. However, curious to hear if you can provide any additional color around how that opportunity in wireless plays out in the second half of the year and what your large customers have communicated to you in terms of the deployments there?

Yes. So, I'll let Morgan pile on. What we've said – we said this last – at the end of last year is there are two North American operators, in particular, that spend heavily on C-Band spectrum. We anticipated that, and it actually exceeded our expectations. There's a natural pause right now as those operators basically are developing their strategies for how to light up that spectrum. And again, we fully expected that. That's what they communicated to us, and that's, in fact, what we're seeing. We expect that their spending will ramp. And in fact, we're seeing a lot of their orders coming in now already in the second quarter. So that spending is ramping just as anticipated. And we do expect a stronger second half for outdoor wireless than we saw in the first half. A couple of other points that I'd make., the first is, one of the reasons that the year-over-year comp is difficult is because we saw exactly the opposite trend in 2020, where the operator spending was actually a very front-end weighted because they were trying to get their investments behind them to focus on C-Band. So you're lapping a tougher comp with 2020. And then last point I would make, last two points. The one is on the margin. The reason the margin picture looks the way it does is because of this North America mix versus some of the rest of the world where we actually did see growth. And then finally, I think it's really important for those on the call to understand within the outdoor wireless networks is much more than just base station antennas. So as the spectrum gets deployed, there's need for new power solutions, there's need for reinforcing the infrastructure with steel, there's need for new cabinet solutions. All of that is product that we provide in this space.

Yes. So I'll just add on to Alex's comments. So we do have of a EBTR strategy, everything but the radio and that applies between as to 5G as well as it did to 4G. In the rest of the world, the mid-band spectrum has been available for a longer period of time. So that the start-ups of spectrum usage, dense urban area coverage and then moving out toward less dense areas has occurred. So we have a pretty good road map of what's going to happen in the United States. And we're very comfortable with the product portfolios we have on a going-forward basis that we will be able to take advantage of that. Both by integrating the active antennas, where they are being used with passive antennas in an effort to improve the ability of putting things on towers, reduce weight, wind loading, etc, as well as for the non-active antennas, which we expect will be a significant portion of the market. So from our perspective, this is going along according to plan. In terms of the metro cell market, specifically, that was caused – there was a decrease in new site builds last year due to permitting and other events, and we expect that, that to shall – will mitigate as the years go on, and we will continue to take advantage of that market as well.

Got it. And then for my second question, you mentioned the benefits from our – of materializing in the second half of this year. But just curious to hear your thoughts around your positioning for government stimulized plans in other regions of the world, like by the U.K. or the European Commission? And what are expectations around the scale and timing around those?

Yes. So I'll take that one as well. So the RDOF funding in the United States is rather significant. It's meaningful in the rest of the world, but not of the same scale. However, we are positioned in similar position. These RDOF fundings are really, for us, based on providing fiber connectivity to the various places that they're improving. In Europe, there are places such as U.K. and Germany that are building out much more heavily than places that have already built out, say, Spain, as an example of that. And we believe we're well positioned for all the things that you need to build this network that is not the active gear. At the moment, we really don't participate in the active gear portion of this. This is a network. In terms of when this is happening, it is an ongoing piece of business, and it's more fragmented than in the United States. So you won't see an enormous burst, but you'll see a specific country or specific customer that will go on a major build. And in fact, we're seeing one of them right now.

Got it. Appreciate the color and thanks for the question.

Thank you.

Your next question is from the line of Rod Hall with Goldman Sachs.

Yes. Thanks for the question. I have two for you. One is on the cash flow and the working capital, Alex. I just – I noticed your accounts receivables up a lot. I guess that's related to the backlog. But I'm curious whether that is likely to be a drag on cash flow as we look forward? Or is this kind of a one-off adjustment to this new normal level of receivables. So I wonder if you could comment on that and then I have a follow-up.

Okay. No. So our cash flow is typically weak in the first quarter. It actually strengthens as we go through...

Just to be clear on that, just to jump in, it's quite a bit weaker than normal seasonality. That's why I asked the question.

So it's typically weak in the first quarter. And yes, there is some timing-related impacts on AR, just related to collections activity. So there's nothing unusual other than just the timing of collections. The other thing that typically happens in the first quarter is we have cash taxes. And then we also have bonus payments. So bonus payments for our annual incentive plan this year were quite a bit larger than they have been in the last couple of years, which is creating a bit of a headwind. And then the final issue is around inventory. So because of the significant backlog as well as some of the components shortages, we have much more kind of in-process inventory. And then on freight because there's been some bottlenecks in the ocean supply chain. We've got a little bit more in process inventory on the ocean. But in general, what I would say, and you actually kind of mentioned this, the fact that we're seeing working capital growth is completely reflective of a significant demand environment, which as we work through the backlog and as we deliver the product, that's going to convert into EBITDA and ultimately into cash.

So do you think – I mean, it feels like a lot of this was one-off in nature, though, and probably doesn't – I mean, we shouldn't expect continued increases? Or do you think we should be kind of anticipating a little bit of that early in the year and then it writes itself later in the year? Or how do we think about the trajectory here?

Yes. So you will see cash flow ramp fairly significantly through the remaining quarters. So we don't anticipate being a use of cash for any of the remaining quarters. That being said, we are seeing a strong demand environment, particularly in the Broadband Network segment. And as I think Chuck mentioned in his remarks, we do believe this is sustainable demand and part of the beginning of 5G-related spending as well as cable MSOs upgrading their networks. So I wouldn't say the demand environment is more of a onetime event. I think we do see that as sustained. But certainly, the bump in inventory and the collections activity is more onetime in nature.

Okay. And then I just wanted to ask on millimeter wave deployments in Europe, what you guys are seeing. Can you give us any color on just kind of what you're seeing there, how much you would expect in the next year and so on?

Sure. I'll take that. On the millimeter wave side of the world, I think the answer is not much. Most of the operators in Europe are really focused more on that mid-band spectrum than any sort of high-band spectrum, and we expect that will continue.

Okay. Great. Thank you, Morgan.

Welcome.

Your next question is from the line of Sami Badri with Credit Suisse.

Hi. Thank you. I just want to go back to the CommScope NEXT strategy and the $500 million of EBITDA, how should we be thinking about timing for this? Is this going to be following us over three years? Or is this going to be weighted upfront or even back end? Just to understand how is it going to hit the income statement?

Right. We had a similar question earlier. What I would say – I'll take this one instead of Alex. What I would say is what we're doing right now is we're building the plans. We have a clear line of sight on where we want to go and where we're going to target. Now we're building the plans to do that. And obviously, we did take some cost out in April that we shared with you in our last call. But in addition to that, we have to build all the plans up, and then we have to have execution plans to implement them. And as we're building them, by the time we get to our earnings, let's say, our Investor Day, we'll be able to share with you more details on how those will roll out in time. But right now, those plans are still being built and we're looking forward to sharing with you later in the year on that during an Investor Day.

Got it. And then one other follow-up is you called out RDOF benefits in your Broadband Networks segment, but does RDOF have benefits into other segments as well in your business?

So yes, they do. It's less direct than the broadband segment, but certainly, RDOF funding has been used, not just for providing a fixed line to rural homes, but being able to provide this via wireless. So there is an opportunity there for us as well, and that attaches in a lot of cases to the fiber. And part of RDOF funding went to satellite as well. And after those satellites get to the ground, there is some opportunity for us to take those signals and play there as well. So yes, this is a very important program for CommScope throughout and impacts all of our businesses.

Thank you.

Our next question is from the line of Simon Leopold with Raymond James.

Thanks for taking the question. First, maybe a quick one and then more of a trending one. In terms of a quick question, there were a lot of questions earlier that were qualitative around input costs. I guess, just simply put, do you expect your gross margin in the June quarter will be higher or lower than what we just reported in March when you net all these factors? And then I've got a follow-up.

Yes. Look, Simon, there are a lot of things that go into gross margin at the risk of stating the obvious. We do see improved demand in Outdoor Wireless, which will drive a favorable – in North America, which will drive favorable mix. We have substantial volume and continued Network Cable & Connectivity and Access Technologies deployment, which will drive scale in the Broadband segment to improve margins. We are seeing strong growth in RUCKUS through education, hospitality, healthcare, that has substantial gross margins in RUCKUS. So that flows through quite nicely. So the mix impact has a significant effect on margin. I tried to be as clear as I can be in a public setting that we're going to work to offset absolutely as much as of the inflationary impact as we can. So I think it's reasonable to expect that, that gross margin would be consistent with what we've seen in the past. And I think that's probably about as much detail as I can give, given our guidance strategy.

Okay. I appreciate it. I had to try. So on the trending question. I wanted to see if we could talk a little bit about how 5G wireless architectures might be different for your business, specifically. The increase in massive MIMO and integrated antennas. I certainly heard you in terms of your partnership and work with Nokia. So I'm not ignoring that. But just wondering how the mix of increased integrated antennas and massive MIMO can affect CommScope's, everything but the radio strategy? Thank you.

Yes. So I think I'll take that, Simon. So with every generation of wireless, there is a continued push to integrate. We saw this in 4G, some of the OEMs have products that did this and they participated in the early days of the market. And by mid-days of the decade, those products when kind of out of favor. We think this is different this time that active antennas are an important portion of the 5G rollout. However, it is not the only portion of the network. And many of the problems of putting an active antenna on a tower, very similar to the problems, putting a passive antenna on the tower, namely wind loading and weight and we are critical to doing that. We're critical to putting the various antennas behind the other antennas or within the other antennas that exist on the tower and so while we will participate in some portion of the actual active antenna itself, and we are trying to participate with more OEMs. We will participate with many of the operators in integrating the passive and the active solutions together, in a way that makes it possible to roll these out to all the cell sites that they're going on. In addition to the antenna itself, which we tend to focus on a lot, there are advantages to CommScope when you do go to these active antennas, and I'll just give you a very simple one. An active antenna consumes a lot more energy than its predecessor because it has many more transceivers than its predecessor. That power needs to come from somewhere. And for example, our powership technology becomes almost mandatory in an active antenna networking system versus a passive antenna and a traditional radio, where it is not required at all. So there's additional business opportunity when active antennas are used for CommScope. So we think there'll be a mix, both active and passive antennas in 5G. We think it will be different from 4G. And I think – we think we'll participate in all the phases of this.

Great. Thanks. That's very helpful. Thank you.

You're welcome.

Thanks, Simon. Operator, we probably have time for one more question if there's any more in the queue, and then we can take everything offline.

Yes, sir. Your final question comes from the line of Amit Daryanani with Evercore.

Thanks. And glad I see to the line. I guess, Chuck, I have – there are two questions, I'll ask them both to you at the same time. The $500 million cost reduction plan, I guess, post-spin. Do I assume that $120 million of that, that will be used to offset the Home Networks spend and the remaining is for core CommScope? Is that fair? Or is this entire $500 million per core CommScope? And then secondly, you touched on procurement optimization that you're starting to undertake. Is that what will result in the entire $250 million savings? Or is there more things like ERP and real estate optimization you can do to get to that number? So just more details on what is driving the $250 million piece of cost optimization.

I'll start with your cost optimization piece. Is direct and indirect material will be a significant part of it. But obviously, we also had a reduction enforced that was announced where we said we would cover the cost. We would cover the reduction of EBITDA from the Home Networks business with that, plus allow us to invest with this money. So if you think about the cost, it's direct, indirect. It's structuring. I would also think there's going to be opportunities to unlock more savings through our operations. We're working with our teams to start a grassroots effort to look at opportunities to improve productivity, to increase capacity because demand continues to grow, and we're hoping we're going to get some leverage from that. So that's also another piece of it. So, I guess, your first question was more related to – you kind of broke up a little bit in the beginning, I couldn't...

No, the $500 million EBITDA expansion plan, right? Do I think of it as $120 million will offset the Home Networks spend and $380 million flows through to core CommScope or is it all for core CommScope, I guess.

So I – so just to clarify what we said. So we said that the $500 million, $250 million and $250 million is net. And so the way to think about it and we also said that we are going to more than offset the loss in EBITDA from Home, which is what Chuck mentioned. And so the way to think about just doing the math is take our trailing 12 months, and then you can subtract the Home Networks trailing 12 months EBITDA, then you can add $250 million in cost, you can add $250 million in growth. And then you can assume some level of just cyclical market recovery above and beyond that. And that should give you a waterfall to what exactly we're saying.

Perfect. Thank you very much.

Perfect. Well, I'll let Chuck just close up with some closing remarks.

Yes. Look, we'll keep everybody. Thank you so much for your interest in CommScope. We appreciate your questions and your support. We look forward to talking to you again soon. Thank you.

This concludes today's call. Thank you for joining. You may now disconnect your lines.