CommScope Holding Company Inc (COMM) 2004 Q2 法說會逐字稿

Welcome to the CommScope 2nd quarter 204 earnings conference call. [Operator Instructions] As a reminder, this conference is being recorded Tuesday, July 27, 2004.

I'd would now like to turn the conference over to Vice President of Investor Relations, Phil Armstrong. Please go ahead sir.

Thank you.

Good afternoon and thank you for joining us on this call. Frank Drendel, CommScope's Chairman and Chief Executive Officer; Brian Garrett, CommScope's President and Chief Operating Officer; and Jearld Leonhardt, CommScope's Chief Financial Officer join me on the call.

During this conference call, we may make forward-looking statements regarding CommScope, our new Connectivity Solutions business and our financial position, plans and outlook that based on information currently available to management, management's beliefs and a number of assumptions concerning future events. Forward-looking statements are not a guarantee of performance and are subject to -- number of uncertainties and other factors which could cause the actual results to differ materially from those currently expected. For a more detailed description of factors that could cause this difference, please see the press release we issued today and CommScope's filings with the Securities and Exchange Commission. In providing forward-looking statements, the company does not intend and is not undertaking any duty or obligation to update these statements as a result of new information, future events or otherwise.

After Jearld Leonhardt reviews 2nd quarter results, we'll open it up for questions. Gerald?

Thank you Phil.

Today CommScope announced 2nd quarter results for the period ended June 30, 2004, which included a full quarter results for the Connectivity Solutions business. The company reported sales of $313 million and earnings of 84 million, or $1.37 per diluted share for the 2nd quarter. Second earnings include an after tax net gain on the OFS BrightWave transaction of $76 million or $1.24 per diluted share. We reported sales in two segments, the cable segment which is CommScope's legacy business and the Connectivity Solutions segment, which is our recent acquisition. In the press release we issued today we included a sales summary that provides actual and pro forma sales by segment and major product category .

[inaudible] year over year sequential sales discussions that follow will be made on a pro forma as if we had acquired Connectivity Solutions on January 1, 2004.

For the 2nd quarter, sales rose about 20% sequentially and 12% year-over-year to $313 million. CommScope's cable segment sales rose approximately 25% sequentially and 20% year-over-year to $170 million and increased in all major product categories. The 6% year-over-year increase in Connectivity Solutions segment sales was primarily due to higher integrated cabinet solutions sales, while the 16 sequential increase was mainly driven by higher sales of SYSTIMAX' product. Total international sales rose 16% year-over-year to 96 million and reflected a more constructive global business environment.

For the quarter, cable segment orders were 158 million and Connectivity Solutions segment orders were 169 million. Overall, the external orders booked in the 2nd quarter of 2004 were $327 million for a consolidated book to bill ratio of 1.0 five times.

We continue to make progress as the global leader in cable and connectivity solutions for the enterprise market. We serve this market with two bands. The industry leading SYSTIMAX Solutions from our Connectivity Solutions segment, continues to offer premium cutting-edge solutions to its global customers. Uniprise brands from a land product group in our cable segment provides customers with competitive performance and value oriented solutions -- excuse me -- based on established technology.

Year over year sales comparison of SYSTIMAX was difficult primarily because of unusually strong sales in the prior year. More importantly we are pleased with the 25% sequential growth. Our overall enterprise sales performance resulted from improved project business and the positive impact of previously announced price increases of our products. Enterprise sales were strong during this quarter as we had a book to bill of more than 1.1 times, we expect 3rd quarter enterprise sells to be high both year over year and sequentially.

Our broad band video performance was also strong during the quarter. The year-over-year increase in broadband video sales was primarily high to the international sales. This is the third straight quarter of strong international year over year increases and we are optimistic about this trend.

Second quarter international sales were the highest they've been in nearly 3 years. Our domestic broadband video sales rose moderately year-over-year. Despite lower sales of fiber-optic cable and lower sales to our lower -- to our largest domestic customer. Sales rose to essentially all other major domestic broadband customers year-over-year. The sequential increase in broadband video sales was primarily driven by seasonally stronger domestic sales. Sales rose sequentially to all major domestic MSOs. However, based on feedback from our domestic customers, we do expect lower broadband sales in the second half of the year.

With regards to other markets we serve, we've been pleased with our sales performance. Our integrated cabinet solutions business was strong year-over-year, but declined sequentially as a large customer neared completion of current planned projects. ExchangeMAX sales were positively affected by higher sales of our net set remote [inaudible] systems among other things.

We also made significant progress in the wireless business. We continued to outpace the industry growth year-over-year and have recently made progress with another huge leading international customer.

Our results reflect certain special gains in charges during the quarter, including first a net pretax charge of 1.3 million related to lower margins from purchase accounting adjustments on certain inventory acquired from [inaudible] and the acquisition and sold during the quarter. Next there was pretax charge of 1.2 million for acquisition related transition and start-up costs. There was a $1.4 million tax benefit related to a prior period capital loss that became deductible as a result of capital gains in the quarter. And last, a net after-tax gain of $76.4 million related to the o OFS BrightWave transaction. Excluding the special items, adjusted net income was $8.1 million or 13 cents per diluted share. Please refer to the supplementary schedule in the press release for a quantitative reconciliation.

The company's overall gross margin for the quarter was 23.1% which includes, $1.3 million in net charges related to lower margins from purchased accounting adjustments on certain inventory acquired from the [inaudible] in the acquisition and sold during the quarter. Excluding this impact, the company's adjusted gross margin for the 2nd quarter was 23-1/2%. Gross margin rose sequential primarily due to three factors. First, higher sales in manufacturing volume, second, the positive impact of a 4th quarter of results Connectivity Solutions and third the partial impact of the previously announced price increases for our products. We believe we have already incurred most of the acquisition related start-up costs associated with Connectivity Solutions.

Total SG&A for the quarter was $52 million for about 16-1/2% of sales. Research and development expense for the quarter was 8 million or about 2.5% of sales. We intend to continue to fund a strong R&D effort.

As mentioned during the quarter, we announced a significant change in our relationship with [inaudible]. On June 14th, we transferred all of our equity ownership interest in OFS BrightWave to Furukawa in exchange for 7.7 million shares of CommScope's stock owned by Furukawa . We hold these shares as treasury stock. As a result of the transaction, we no longer own any equity interest in OFS BrightWave. We also renewed our optical fiber supply arrangement by entering into a new 4-year supplier agreement expiring June 2008. We will continue to have access to a broad array of technologically advanced optical fibers as well as cross license for key intellectual property.

We recorded an after-tax gain of $76 million or $1.24, as a result of this monetary transaction and the related impairment of an outstanding loan to OFS BrightWave during the quarter. We also recorded after-tax charges of $600,000 or one cent per diluted share in the quarter for our equity method share of losses of OFS BrightWave prior to the June 14th transaction.

Now I'll turn to cash flow and balance sheet items. Net cash provided by operating activities was 36 million for the 2nd quarter and reflects higher operating income and lower inventory level sequentially. We're pleased that we have been able to continue to reduce inventories, which are down more than $40 million from the consolidated opening balance sheet level. Depreciation and amortization was approximately 16 million in the quarter, which included about $3 million of intangible amortization and deferred financing fee amortization of about $600,000. Capital expenditures were $2.7 million. During the quarter we completed the redemption of the four convertible notes of $71.8 million, which included the call premium and accrued interest. We also completed the acquisition of substantially all the remaining international operations of the Connectivity Solutions business from Avaya, who's closing were delayed until the required 3rd party approvals were received in the 2nd quarter. At June 30, 2004, long-term debt, including current maturities was $328 million, or about 43% of book capital structure. CommScope ended the 2nd quarter with 139 million in cash and cash equivalent.

Looking ahead, we expect sales to be in the 300 million to $320 million range for the 3rd quarter. We expect lower broadband video sales in the 3rd quarter, but expect overall sales to be relatively stable sequentially primarily because of the enterprise market -- because the market remains strong. However, we do expect margin expansion in the 3rd quarter. We expect expansion mainly as a result of the previously announced price increases for our product. Assuming stable long-term costs, we expect gross margin to be in the 24 to 25% range in the 3rd quarter. And we expect 3rd quarter SG&A to remain around 16 to 17% of sales and R&D to be around 2 to 3% of sales. And as I indicated earlier, we believe we have already incurred most of the acquisition related and start-up costs associated with connectivity solutions.

Thank you, and now I'll turn it over to Frank Drendel for some comments and then we'll open it up for questions.

Thank you Jearld and thank you ladies and gentlemen for joining us.

First of all, looking over the first 6 months of the year, I would like to thank all of the new Connectivity Solutions employees for the outstanding workmanship and effort they have put into bringing these two great companies together. It clearly shows in our results for the first 6 months. And then an also special thank you to all the CommScope management who put in so many hours in the last 6 months, when I looked over the highlights of what we've accomplished in the last 6 months, we've acquired and closed on ACS, we completed the recapitalization of OSF BrightWave Furukawa relationship, we refinanced $250 million with -- opportunity introduced the new product line of Uniprise, we redid our bank lines and our cash flow for the last 12 months of a 124 million is certainly outstanding enterprise operational characteristics.

And with that, I'll turn it over to questions. Susan?

Thank you.

[Operator Instructions] One moment for the first question.

Our first question comes from the line of Steve Fox from Merrill Lynch. Please proceed with your question.

Good afternoon.

Hey Steve, Steve

Could you talk a little bit more specifically about enterprise sales trends in terms of unit demand pricing as we look out into the 3rd quarter and also can you comment on sales into the channel versus sales out of the channel, do you have any information on that?

I'll let Brian pick up and help you with most of that, but let me kind of give you an over haul. First, the results from the ACS transaction are outstanding. They far exceeded our expectations this early in the franchise. Secondarily the Uniprise introduction has been well received. And both of those things are gaining a geat deal of traction. So, from a corporate point of view, the strategy we have in this acquisition and this merger of these two great companies clearly has met or exceeded our expectations for the first -- actually, five months. We didn't have it for the full month of January . And Brian's team and I have been out, we've met with the senior procurement people, the top five customers on these fields, and all of them highly regard our concept and respect how we are going to enter this channel, so Brian you want to give some more specifics?

Yes, thank you, Frank. Steve, a couple of comments.

First starting with pricing, we're pleased with the pricing environment, essentially everything we that announced over the course of the 1st quarter has been implemented and moved through the channel over the course of the 2nd quarter. In terms of how the market is performing for us, surprisingly, both business propositions or segments of our enterprise business were up 25 -- roughly 25% sequentially, both of them were, and so we finished the quarter with very strong book to bill. I think we were actually building momentum throughout the quarter, and ended up with about something north of 1.1 on a book to bill ratio. The other metric, I'll tell you, relating to just the ongoing strength for SYSTIMAX within North America, our point-of-sale or sales out was the greatest that it's been in over 3 years. So we are seeing market recovery particularly in North America, but I would say we're also getting an enormous response to our proposition.

Great and then just two other quick financial follow ups. On the inventories if we look sequentially was most of the inventory decline in finished goods, if you have that detail, Jearld, and then just wanted to confirm what kind of share count we should be using for the 3rd quarter.

Let me answer the share count one first and we'll look and be a little more precise for the inventory one. On the share count, we would expect somewhere around 55.5 million shares, we brought back in shares as you know through the OFS transaction and that did not have a particularly big impact on our actual 2nd quarter results. But we should get the full benefit of that going forward in the 3rd quarter. Right now, Steve, although I don't have the numbers in front of me, I think the substantial -- the biggest part of the increase was in finished -- or decrease was in finished goods and Phil is confirming that as we speak now, substantially in finished goods where I thought it was, but I wanted to make sure of the numbers.

[inaudible] it's Frank, Steve, clearly that was kind of the low hanging fruit, but there's still some opportunity left in that full inventory area given that we've got room to get closer to CommScope's matrix and inventory process so we have some room to go further on that one.

Our next question comes from the line of Steve Kamman from CIBC. Please proceed with your question.

Hi, folks, good quarter, appreciate that. Just wanted to ask, you'd mentioned pro forma numbers, are you guys going to provide us with some sort kind of pro forma going back, including the VIA transaction, obviously it would be very helpful if for us in terms of modeling.

Yes, Steve, we did provide in an 8 K, if you will, back in March the pro forma results of CommScope and, what we were calling ATS then, combined in a -- for 2003, if that's what you're referring to.

All right, we may have been, that's my bad. Also in terms of raw materials costs, obviously have sent oil prices up, I guess that hits you both on the trucking side and materials and then copper. Just any comments on that price wise wise? Do you think you guys are in good shape? We saw a price rise out of some other people.

We have given a price increase across all of our product lines. All of those will been fully in effect towards the latter part of June. So you will see all of it in the coming quarter. Our customers are very sophisticated, they understood the raw material cost. Clearly we're a material sensitive company. [inaudible] we've have seen those costs increase, but we feel comfortable that we've recovered most of that in pricing and have some margin improvement.

Okay. And on the margin improvement, you sort of indicated coming up a little bit in the 3rd quarter, how much of that is product mix, how much is purchase accounting, how much is sort of synergies -- additional synergies or efficiencies in the acquisition?

The vast majority of it is going to be pricing. As Frank indicated, we didn't see the full benefit over the 2nd quarter. By June ending, we had the vast majority of what was announced. The 3rd quarter will be the first full quarter of new pricing. In terms of material costs, I'll tell you sequentially, Q1 to Q2, even though material costs and commodities are very high on a year-over-year basis, material costs in the 2nd quarter were essentially flat with the prior quarter.

Pretty good. And then Uniprise, just any color on how that is rolling, where you are in the roll-out, what we should be expecting in terms of modeling that in and just any color on how it's being accepted?

We're very pleased with Uniprise. As I indicated before, the growth that we saw sequentially in Uniprise matched with what was -- what we had generated in industry leading SYSTIMAX. All of our major distributors have adopted and stocked the product for channel support. The pipeline is large and growing. We have not gone public with some of the major projects that we've won, but we are closing and shipping some large projects on Uniprise, so we're very, very happy with our progress this early on.

But haven't seen the full impact from the numbers perspective, is that is fair?

We're very happy with where we are. Where can we take Uniprise? We got the expectations. I don't think we've gone public with any guidance, though.

Okay. You asked my question better and thank you for the answer on it. One last question, just in terms of the BrightWave frame agreement, have you now -- do your results now fully reflect that new pricing and frame agreement or should we look for that to phase in over the next couple of quarters?

The BrightWaves situation is completely complete now. We have a long-term pricing agreement -- [inaudible] agreement on fiber, we have a long term relationship building on the technology with them, and we'll no longer after this quarter be reporting any of the losses if that's what you're also asking so that transaction is completely done as of the end of this quarter.

Okay, it was more on the pricing side, but we're now into that new price regime?

Thats correct.

Thanks very much.

Our next question comes from David Beglio from Boston Campaign. Please proceed with your question.

Hi gentlemen, great quarter.

Thank you.

Two questions, the first is on the adjustments due to the purchase acquisition and the effects that has. I know it's depressed your gross margin the last couple of quarters. Is that largely done or do we have a little more to go on that?

I would say that's largely done now, David . The bulk of that certainly is completed.

In round numbers, you did almost $1.00 in free cash flow the first half of the year, I know some of that came from inventory or a lot of it came from inventory. How much do you think is left and what's kind of a good run rate free cash flow as we look at this business going forward?

Again, we are still, we are only five months into the combined effort of these two operations. Having stated that as a condition, there's still probably 20 to $30 million opportunity in getting the inventory turns more closely aligned with CommScope. But in the same token, in the cash flow modeling, you now have some pricing capacity that hasn't existed before which lets the margins on these two shoulder type of opportunities, you have SYSTIMAX, who can continue to lead the technical points and the pricing points and you have the Uniprise product lines coming up underneath that an opportunity for the business growth. So, margin enhancement, pricing additional capacity, better management of the balance sheet and the working capital, should all give us an ongoing effective cash flow machine. This has always been a very positive cash flow operation and we manage that very effectively I believe, and we believe in cash flow.

Thank you.

Certainly.

[Operator Instructions]

Our next question comes from Allen Matrani, Cooper Beach Capital. Please proceed with your question.

Hi, thank you. You guys have been really capital efficient in terms of your spending. I was shocked almost when I saw the CapEx number this quarter. I was thinking for the year it would be closer to 30. You only spent about 4 million -- 4.5/5 million so in the first half. Can you give us a sense of where capital spending is in '04 and where you think '05 can look like on CapEx?

Allen, part of the reason -- you know we are, fortunately very efficient, there are several issues in that. One we're behind schedule because of weather -- er China opportunity, so that has had some effect on capital spending. We now are projecting capital spending in the 20 to $25 million range down from the 30, we still think that we will have heavier capital in the 2nd half. But I think as part of that analysis that you do correctly, you have to understand that the combined capacity, not manned, but manufacturing capacity of this company is in excess of $2 million, and so we still have plenty of growth within our own physical capacity and physical assets. So capital should not be a governing factor going forward in this company. We will spend to stay current in state-of-the-art, in machinery and equipment and we will spend to stay current in R&D, but clearly brick and mortars is not an issue for quite awhile.

Okay, and then just to be sure I saw, DNA was about 15.8 million this quarter, there was an extra 600,000 for financing costs, so I guess going forward 15.2 or run rate of close to 60 million is correct?

That's correct.

That's a correct range.

Okay, and then just to understand from SG&A perspective, I realize you're going to get your flow-through on your gross margins for the price increase for a full quarter and the extra fiber agreement which will help you, but from an SG&A perspective I was under the understand that you guys have spent a lot of time in the 2nd quarter integrating the businesses, taking charges and running them through the P&L, whatever you needed to. Can I think of it, should SG&A from a dollar perspective peak -- should it have peaked in the 2nd quarter, unless obviously sales growth really comes in or should SG&A going forward start to decline sequentially a little bit?

Let me tell you a little cut of that. First of all the SG&A at the 16% plus or minus range, bear in mind we have introduced a whole new product line that has shown very, very strong growth in the enterprise. We've combined that secondary shoulder business and put that in, we've increased our sales coverage in both these businesses, we've increased our R&D coverage to accelerate some of the programs we found in there. So I think that you're seeing top line enhancement and top line growth based on asset S7A discipline, and we have that discipline into those businesses. So my view has been that we are getting more in the -- bang for the buck in the sales dollars than we anticipated early on.

Okay, so in essence what you are saying is you're going to be able to get some of the lift as the sales grow, you're not going to need to increase the dollar amount of SG&A as much?

I think there's opportunity for further efficiency in SG&A, but as we did, but as we stated in our guidance, SG&A for the 3rd quarter would be between 16 and 17% and, you know, we gave ourselves guidance of though 300 to 320, so those sort of metrics are reasonable. And someone did ask about pro forma. I will say that on a pro forma basis, last year, I believe S&GA was in excess of 17% on a pro forma basis, closer to 17.5 -- 17.4 is what is was. So we are showing some efficiency already in that now.

Okay, I'll jump back in the queue. Thanks guys.

You bet, sir.

Our next question comes from line of Karen Seedling-Becker from Alliance. Please proceed with your question.

Hi. This is a follow-up on the previous free cash flow question, which is free cash flow has been impressive. Can you sort of talk about long-term normalized free cash flow conversion from the company, what we should thinking about and also as we look at your balance sheet and we keep sort of extrapolating out free cash flow. You look under levered going out a few quarters. Can you help us understand some of the alternatives you guys are thinking about?

Karen, very few people work cash flow models better than your firm having been dragged through it with you a couple of times. Not avoiding your question, but giving you the answer in a different cut, this will be the 1st quarter that we absolutely have everything under the tent completely. If you think about, we've gotten the changes, put all the products together, have new products out there, we got the different management people reorganized, we did all those things we listed of the seven things we did in the first 6 months. This coming quarter we will have all the price increases in, we'll have, generally speaking, all the costs that we see coming through against the products pretty much in. I can't imagine these raw materials get too much worse. So we'll be able again to see where the real true margin hangs in and where the cash flow modeling comes from. I'd hate to get hung out there and give you a number that I can't deliver on cash flow at this point, but clearly this machine has the capacity, given that there is no real capital costs in front of us to generate significant cash flow. And so I'm very bullish, I want to [inaudible], I'm not about to put out another until I kind of get a feel for how this next [ overlapping speakers ]

As Frank mentioned there are large capital capacity demands that we require capital, there could be some tweaking in that area, and there may be opportunity to improve margins and operating costs through cost reduction activity and investments and those things are high on our list of things to look at going forward is how we can expand our operating margins.

Thank you.

Next question comes from Thomas Haynes from Empirical Capital. Please proceed with your question.

Yes, congratulations. Can you give us some guidance on what tax rate we should use going forward? And then also, I think last quarter we gave you an update on the facility, the Asian facility and I think you just said that your CapEx was a little lower than expected due to weather in China, but can you give us an update on that Asian facility also ?

Yeah I'll defer the Asian comment to Brian, if you would, but I'll comment on the tax rate. First, our tax rate was a little -- was less than we expected in the 2nd -- actually, more beneficial I guess is what I'm trying to say in the 2nd quarter due to this provisioning from this capital loss that we were able to utilize as a result of the OFS transaction, essentially, we were able to recognize a deferred capital loss cure for it and that has an impact on our other operating tax rate. Ignoring the special benefits we still think we'll be in the 31 to 32% sort of tax rate for the full year, taking out all the extraordinary things related to OFS BrightWave essentially.

Thomas as it relates to the capacity expansion into [inaudible], as mentioned, weather has impacted the site, our expectations were to begin some level of production in the 1st quarter of '05. The current outlook is to move that back approximately one quarter into the 2nd quarter of '05.

Our next question comes from line of Phil Myriad from Arnold Embley Schroeder. Please proceed with your question.

Good afternoon, I have a couple of detailed ones. First I was wondering if you can give us a percentage of sales that were [inaudible] in the quarter please?

32 to 33%.

Thanks. And then secondly on your guidance for the next quarter, you mentioned a couple times that pricing will kick in From the actions you've taken. But as I look at the -- sort of, if I take the mid-point of you guidance of 310 million and 24.5% gross margins and compare that with the results we just saw this quarter, I'm not really seeing much of a kick on the gross margin dollar side. Should I interpret that as guidance being conservative or is there is a mixed issue that I'm --

I think possibly we miss spoke on the pricing. If you think about this quarter we just finished, almost all of the enterprise pricing was in that quarter. Very -- approximately -- June had most of the CATV price increase on it, so you had 60 days of 5% based on broadband sales that would be reflected non-end price list of this forward coming quarter if that helps give you a little bit better handle. We said that almost -- that it will be the first full quarter that all the pricing and all the jobs is working its way through the business.

I would add that to these things aren't necessarily steps. As you know, they do move gradually and that works on the call side as well. Say it differently, in the 3rd quarter, would be the first full quarter of all of the cost increases that we have sustained this year, seeing a full quarter's worth of impact. The same thing would be true with the selling price increase we would substantially get all the benefit, while we had partial benefit in earlier periods, substantially all the benefits should be in the 3rd quarter. And again -- from a 23.5 to somewhere between 24 and 25% gross margin is a healthy increase we think in gross margin, so thats our view.

Okay, thanks very much.

Yes, sir.

There are no further questions at this time. I will now turn the call back you, please continue with your presentation or closing remarks.

I want to thank everybody for joining us, and especially want to thank our shareholder base for sticking with us as we continue to build this company. I especially want to thank all the employees who put out this supreme effort over the last 6 months to do these outstanding results. I've very pleased and proud of the company. I look forward to visiting with you next quarter. Hopefully we'll have very exciting news. Thank you very much for joining us.

Ladies and gentlemen that does conclude the conference call for today. We tank you for your participation and ask that you please disconnect your line.