Belden Inc (BDC) 2020 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to this morning's Belden Inc. conference call. Just as a reminder, this call is being recorded. (Operator Instructions)

I would now like to turn the call 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'm 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 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 a full $50 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 these investments now dedicated to software development. This includes stand-alone 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 and underlying demand that we expect and that 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 and 5G, and smart buildings. We believe that each of these markets offers compelling growth opportunities over the cycle. I'd 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 effects 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 industrial cybersecurity and software-as-a-service offerings.

In broadband and 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 5 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 our telco customers as they build out new 5G infrastructure.

Finally, in smart buildings, the increasing use of integrated networks drives increasing demand for our productivity solutions. The outlook for some smart building markets is clearly changed due to COVID-19, while we continue to see growth opportunities in certain market verticals such as government, health care 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 announcing adjusted results today.

Revenues were $475.8 million 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% 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 internal inventory levels of $25 million during the second half of the year and $17 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, compared to $49.1 million in the prior quarter and $90 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 pit.

As we 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 a $48 million annualized run rate. 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 important growth initiatives. During the quarter, we increased our R&D investment by [$6 million] or 26% in the prior year. Net interest expense increased by approximately $1 million 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.

Our effective tax rate was 17.7% in the third quarter, as we benefited 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, 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 $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 in the quarter. Currency translation and copper prices had a favorable impact of $3.3 million year-over-year and $8.1 million 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, nonrenewal 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 nonrenewal 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 to 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, 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 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 increased investments in network infrastructure by our customers. This supports continued robust both 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, 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're comfortable with our current liquidity position, and as a result, we repaid all remaining revolving 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 the prior year. EBITDA 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 3.8x net debt-to-EBITDA at the end of the quarter. This is temporarily above our targeted range of 2.0 to 3.0x, and we expect to turn back to the target range as conditions normalize.

Turning now to Slide 8, I'll 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 governance on this debt, so we are not at risk of an event of default caused by worsening economic conditions. As I mentioned previously, we're 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, 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 that we completed in July 2020.

Free cash flow in the quarter was $35.7 million, 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 12-month basis at the end of the third quarter 2020, free cash flow was $136.4 million. 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 and 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 15. 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 for the live event.

That concludes our prepared remarks. Mary, please open the call to questions.

(Operator Instructions) Your first question comes from Reuben Garner of Benchmark Company.

So Roel, maybe we could start -- this is your -- I guess, you've been there for 3 or 4 --have been in this role for 3 or 4 months now. Can you just maybe give us some observations, update us on how things have been progressing in your new role? And has 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're very excited about our strategic priorities. We highlighted the $60 million cost reduction. We highlight the strength of the balance sheet that Belden has. But probably even more importantly, we feel very good about the investments that we're making.

Even in this time where top line 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 our R&D investments are already yielding good returns. So for example, our fiber-related revenue and broadband and 5G, year-to-date, is up 17%. We feel good about the investments that we're making in the industrial cybersecurity solutions, where we were able to report robust growth. So I'm very excited, and we feel good about the investments that we're making.

And so I guess you've got several different businesses, obviously, with different macro items that are impacting them. Can you -- I mean, a lot of puts and takes going into next year. Can you just talk about maybe you've got some short-cycle business that's bouncing back, some longer-cycle business that might take a while for a return? Can you just kind of, in your 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've made some investments to try to grow in excess of that, so can you just kind of give us the lay of the land?

Yes, sure. So we will guide 2021 either during our Investment Day -- Investor Day that we just announced or when we report out our Q4 results. But I think it's important to remind us of 2 things.

So first of all, we feel very good about 3 out of the 4 businesses. We've 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 business will probably be challenged in 2021 as well. The other 3 businesses, we feel good about.

And the second thing we should take into account is that the $70 million, $7-0 million of channel inventory draw that we expect in 2020 will obviously not return in 2021. So that, in and by itself, will create significant revenue growth. That's kind of how we see 2021.

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

We can now take our next question from Noelle Dilts of Stifel.

Good morning, gentlemen, and congrats on a good performance in the challenging environment. So my first question is around the channel partner inventory reduction. Given that they've sort of been running below your expectations, I'm just curious why you're 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 $25 million you've been talking about?

Yes, thanks for the question. So I think the has been to the Anixter WESCO combination, the integration, from what we can tell, is going very, very well, and we're 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 to balance that our channel 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 have significant draw, in Q1 we had a significant draw, not so much in Q3, but we expect indeed 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're thinking about those investments as we move into 2021.

Yes, it is. Yes, it is. That's a level that we feel comfortable with. We recognize that's an increase, but we do expect that with the changing landscape within industrial automation, the further investments require for our cybersecurity offering on the industrial floor, and as well as remaining very innovative in the broadband and 5G segment, that we have to increase that level of investment. 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 was hoping you could just dig a little bit deeper into the trends you're seeing in broadband. Clearly, a lot of nice momentum on outside the home, and I think that inside-the-home business has benefited a bit this year from social distancing with some of your [kidding]. Just could you give us some thoughts on how you see that developing into next year? Do you expect declines on the inside-the-home business, given the tough comp? And do you think those can be offset by growth on the outside-the-home piece?

Yes. Thank you. We continue to expect mid-single-digit growth in that segment. That remains unchanged. And we feel that the largest growth opportunity, consistent with what we've outlined in the past and 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 trend to continue into 2021.

We can now take our next question from Matt Delaney of Goldman Sachs.

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 that specific business is up and growing. Maybe you can update us on what percentage of the broadband 5G business, when you think about both outside and inside the home in totality is now made up of fiber? And then how much is copper? And if you could also dovetail that, how do you see that evolving over time? The company talked about trying to access some of the mature copper portfolio, so just trying to think through that evolution.

Yes, for sure. So at the end of the third quarter, Mark, our fiber business for our broadband 5G unit was approximately 30% of total revenues. And that compares extremely favorable to 2018, for example, where it was 5%, so we made substantial improvements in the portfolio here on the fiber side. Outside of the home and inside of the home has been area of focus, and we expect to exit the year with more than 50% of our business geared or focused towards outside of the home.

Got it. That's helpful. And then just on a mature copper portfolio, there'd been some of that business I think the company was looking to back away from over time. Can you talk a little bit about the latest thoughts on that?

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

Okay. And then just finally, on margins in the fourth quarter, I was just 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's a little bit lower gross margin, maybe something kind of flattish quarter-on-quarter, like 35% or maybe there's some increase in OpEx? I'm just trying to better understand gross margins and OpEx trends and better understand where we that disconnect is, EPS where the Street is versus what the company had guided to.

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

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 15. 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 the Belden Investor Relations website.

If you have any questions, please reach out to the IR team here at Belden. Our e-mail address is investor.relations@belden.com. Thank you.

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