CommScope Holding Company Inc (COMM) 2005 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the third quarter 2005 earnings conference call. During the presentation, all participants will be in a listen-only mode. Afterwards, we will conduct a question-and-answer session. At that time, if you have a question, please press the 1 followed by the 4 on your telephone. As a reminder, this conference is being recorded, Thursday, October 27, 2005. I would now like to turn the conference over to Phil Armstrong, Vice President of Investor Relations.

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. Before we get started, let me give you the forward-looking cautionary statements. We may make forward-looking statements regarding our financial position. hey're 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 a number of uncertainties and other factors which can cause the actual results to differ materially from those currently expected. For a more detailed description of factors that can cause such a difference, please see the press release we issued today and CommScope's filings with the Securities and Exchange Commission, particularly the 99.1, CommScope's PRI reports and regarding 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. Also, please note that all dollar figures and percentages are approximations. After Jearld Leonhardt reviews third quarter results, we will open the line for questions. Jearld?

Thank you, Phil. Today CommScope announced third quarter results for the period ending September 30, 2005. The Company reported third quarter sales of $346 million and net income of $12 million or $0.18 per diluted share. Reported net income includes total after tax charges of $11 million, primarily for equipment impairment related to previously announced global manufacturing initiatives. Excluding these items, adjustment to earnings was $23 million or $0.34 per share. Our operating income performance exceeded the high end of our previous guidance and we are pleased with our ongoing progress. For a reconciliation of GAAP earnings to adjusted earnings, please see the table included in our press release.

Sales for the third quarter of 2005 increased almost 12% year over year, primarily driven by improved carrier and broadband segment sales, as well as price increases in response to higher raw material costs. Third quarter enterprise segment sales were essentially flat year over year at $168 million. Enterprise sales reflected increased prices for most cable products and higher year-over-year international sales which were offset by lower domestic sales. Enterprise sales declined from the second quarter of 2005, primarily due to the anticipated seasonal sequential sales in Europe.

Broadband segment sales were $122 million, up 13% year over year and up 11% sequentially. Broadband sales increased year over year primarily due to higher prices. The stronger international business and sales for construction related to hurricane damage. About $6 million of broadband sales resulted from construction related to hurricanes in the quarter. Carrier segment sales rose 71% year over year to $56 million, primarily due to strong demand for integrated cabinet solutions and wireless products. Both ITS and wireless sales were more than doubled year over year while ExchangeMAX sales were essentially flat. The ITS business strengthened due to robust sales to domestic carriers for digital subscriber line and fiber to the node applications. We expect ongoing strong sales for cabinets as customers such as SPC Communications, BellSouth and Qwest upgrade their infrastructure for high-speed video and data services.

Our wireless sales were also very strong. We have made excellent progress with some key customers and believe we have enhanced our competitive position as a result of cell reach outstanding performance, high reliability and ease of installation.

Total international sales rose 20% year over year to $112 million or about one-third of total Company sales. We saw particular strength in the Asian-Pacific Rim and Latin-American countries in the quarter. Overall, external orders booked in the third quarter of 2005 were 368 million for an overall book-to-bill of slightly above one time. Broadband and Enterprise book to bill were essentially at one time for the quarter. The Carrier group book-to-bill was well above one time for the quarter.

During the third quarter, CommScope announced new global manufacturing initiatives that are designed to improve service, reduce cost and improve factory utilization. Over the next 18 months, we plan to redistribute production among global facilities and improve the efficiencies of certainly manufacturing processes. As part of these initiatives, we plan to close the Scottsboro, Alabama facility in late 2006. Broadband cable production in Scottsboro will be consolidated into other CommScope facilities. We also plan to resource SYSTIMAX cable production from the Connectivity Solutions manufacturing site in Omaha, Nebraska to other lower-cost CommScope facilities globally. CommScope expects annualized pretax savings of 35 to $40 million once the initiatives are completed in early 2007. We expect to realize 15 to $20 million pretax savings associated with these initiatives during 2006, primarily in the second half of the year. In order to execute this strategy, we are incurring restructuring costs, including impairment charges for equipment, employer-related expenses and equipment relocation expenses.

CommScope's third quarter results reflect some of these restructuring charges along with other special items. These include first a pretax charge of $17 million or 11 million after tax, primarily for equipment impairment related to the global manufacturing initiatives. A $3 million pretax benefit, which is about $2 million after tax related to employee benefit plan changes and a special $2 million tax charge related to establishing a deferred tax valuation allowance for net operating losses as an international operation.

Gross margin for for the third quarter of 2005 rose to 27.4%, up from 26.3% in the previous quarter. Adjusted gross margin for the quarter was 26.9%, which excludes about $1.5 million of the special item related to employee benefits noted previously. Gross margin for the third quarter of 2004 was 25.2%, and adjusted gross margin improved year-over-year that is, about 170 basis points, primarily due to increased sales prices, higher sales volume, and ongoing cost reduction, but was somewhat offset by higher material costs.

As a result of these higher costs, we have informed our customers that we intend to increase prices on selected cable products. These increases are primarily due to the rising cost of petroleum-based materials as well as the increased cost of copper and other metal. Recent hurricanes in the southern United States have also affected the supply and cost of certain key products. Prices for selected broadband cable products will increase 5 to 7% with implementation generally beginning in December 2005. In addition, the Company has recently taken other pricing actions to recover the rising costs of raw materials and intends to make additional changes as necessary.

The total SG&A for the quarter was $51 million, down $3 million sequentially and essentially stable year over year. The sequential decrease is primarily due to lower general administrative spending as well as about a million dollar of pretax benefit relating to the changes in the employee benefit plan noted earlier. Our research and development expense was $7 million or about 2% of sales.

Operating income was $20 million or about 6% of sales for the third quarter of 2005. Excluding special items, operating income would have been a strong $34 million or nearly 10% of sales for the quarter, well above previous guidance.

Now I'll turn to cash flow and balance sheet items. Net cash generated by operating activities in the third quarter of 2005 was $29 million. Total depreciation and amortization expense was 15 million and included 3 million of intangible amortization and deferred financing fee amortization of less than 1 million. Capital spending for the quarter was $3 million. At September 30, 2005, long-term debt, including current maturities, declined to 300 million and was 38% of booked capital structure. CommScope ended the quarter with 214 million in cash, cash equivalents, and short-term investments.

In summary, we had another excellent quarter. We maintained price discipline and generated profitable growth and delivered on cost reduction commitment. A key driver of our improving performance is the execution of our plan to improve Carrier segment profitability, and we achieved profitability in the Carrier segment in the third quarter. For the first time nine months of 2005, the Carrier group has increased profitability by more than $20 million compared to the prior year. We believe the longer term outlook for the Carrier group is positive as SBC expands investment in Project Lightspeed and other telephone companies of greater fiber to the node infrastructure.

From an outlook standpoint, as we move into the seasonally slower fourth quarter, we anticipate sales of 325 to $340 million in the fourth quarter. We also expect higher raw material costs, so operating margin should be approximately 6 to 7% for the fourth quarter, Excluding the special items. This guidance is generally consistent with current analysts' expectations for the fourth quarter. The announced price increases, which are expected to begin in December, should have a more positive effect on results beginning in the first quarter of 2006. Special pretax charges relating to the global manufacturing initiatives are expected to be 3 to $4 million in the fourth quarter.

So overall for calendar year 2005, we expect sales to be 1.32 billion to 1.33 billion and operating margin to expand to 7%, Excluding special items. For historical perspective, this guidance is above the original guidance that we provided last year in November.

Looking ahead to calendar year 2006, we anticipate sales of 1.4 billion to $1.45 billion, primarily driven by modest volume growth and price increases. Based on this revenue outlook and the ongoing cost reduction, we believe we can expand calendar year 2006 operating margin to 8.5% or better, Excluding special items. The second half of 2006 should be stronger than the first half, primarily due to the expected benefits of global -- of the global manufacturing initiative.

For modeling purposes, other financial expectations for calendar year 2006 include an effective tax rate of approximately 30%, depreciation and amortization expense of approximately 55 to $60 million, capital spending of approximately $30 million, restructuring costs of approximately 11 to $14 million pretax to complete the previously announced global manufacturing initiatives. Through a combination of modest revenue growth and effective cost management, we believe that we can drive earnings growth, Excluding items, up to 25 to 30% in calendar year 2006. We believe that CommScope has built a solid foundation for longer term earnings growth. We have industry-leading cable and connectivity solutions, and we're executing our cost reductions plan effectively and we believe that the fundamentals of our business are sound. And now we will be glad to answer your questions. Operator?

Jearld, before the Operator comes on, I would like to take a moment to thank all of our employees for the outstanding quarter that they achieved. We had rising margins in a most difficult material environment I think any of us have ever seen. I also want to thank our Broadband team for the excellent workmanship and the emergency supplies that they've got to all of our customers in all the hurricane areas. We delivered over 10,000 gallons of water to our customers to help them through this very difficult time. To Ted Daly and his team, the Carrier turn around has been unbelievable. We've done a $30 million turnaround and has been part of our family. And then, not least, Randy and his team for the excellent execution of bringing 10G on and finally Brian's team and all of the cost reductions. Given our position in the marketplace, we are now learning that we do have pricing capability and pricing power, and we continue to believe that we can --- into the market what it takes to maintain profitability. And with that, we'll open it up for questions.

[OPERATOR INSTRUCTIONS] Our first question comes from the line of Celeste Laurenzano from Merrill Lynch

Hi. Thank you. Just wanted to know if you could elaborate on sequential trends in the Enterprise segment? Basically what did you see during the quarter by region and if you could give us an update on trends for a 10G cable.

This is Brian Garrett. Good afternoon. Sequentially, we experienced a tough comparison, and not totally unanticipated. Third quarter historically is a soft period in Europe, and we certainly experienced that. I would contrast that to a typically strong second quarter and first half in total that we experienced in Europe. So a big part of the swing in Enterprise is clearly the performance in Europe on a comparative basis. But I'll also say, Celeste, I step back and look at where we've gone with this business. On a year-to-date basis, we're still up 14, 15% year over year. We've grown one of our key objectives, of course was to grow profitability, and we've put about 300 basis points on our operating income margins. Maybe not a real strong quarterly perspective, but in the big picture, we're really happy with where we are.

On the 10G picture, a similar story. The good news is that we continue to see growth in all elements or regions of the country on 10G, or the global I should say. We started off, as you know, with a real bang in Europe. They were the early adopters. I would say right now in the third quarter, we saw a slowing of 10G activity just like we, in Europe, as we we did the whole region. Counter to that, we're seeing new strength in 10G coming out of the Asia PAC area and Calla. So on balance we're happy with where we are. Some 100 project wins to date, 100-plus project wins, and expectations, I think we said at the beginning of the year, we hoped we could do 20 million in project wins and I think we're on that target. So good news so far.

Great. And then looking at the Carrier segment, can you give us a little more detail on profitability levels, just looking at ExchangeMax and ICS separately.

We look at ExchangeMAX in two pieces right now. One of the messages that was in this release is that we're still actively looking for alternative ownership, if you will, for our cable business, the cable element of ExchangeMAX, but we've made substantial progress on the apparatus side, and as far as profitability in that piece, I'll just say so long as we're convinced that we can demonstrate double-digit earnings and double-digit growth, we're going to hang onto it and grow the business and that's where we are on the apparatus side of ExchangeMAX. On the -- what was the other part of the question?

On the ICS business.

Cabinets, same perspective. You know, tremendous year-over-year performance, doubling expectations, again, double-digit earnings and growth and certainly something that can be of a much bigger part of our business going forward.

Great. Thank you.

Yes.

Our next question comes from the line of Steve Kamman from C IBC.

Can you hear me, guys?

Yes, Steve.

Sorry. I was on a headset. So I wasn't quite sure. Number one, congratulations on the -- you know, the operating numbers are phenomenal and very happy to see that leverage coming in. Wanted to ask about incremental opportunities out of Katrina and/or hurricane-related repair? Obviously we just had another one go through Florida. Do you think this is another couple quarters or where do you think you are in that?

These are the most serious hurricanes our country has suffered through in many, many years, probably in recorded history. We had about $6 million in the current quarter, and I would say that we're not even close to 25% of what it's going to take down there. Again, there's all kinds of re-studies going on on how you rebuild this plant. We have estimates that there's as much as 80,000 miles of plant on the ground. I would say it will continue for several quarters at least.

Interesting. Then the ExchangeMAX, number one, where do you think that whole -- the Carrier business can get to? I know it's at break even, but gross marginwise and operating marginwise, where do you think we can end up at? 5, 10%? Is that doable?

I think Brian's team has got an excellent strategy. We were fortunate we caught a marketplace turn and there's a great business going on there in standard cabinets, but with the competitive process of going forward with the fiber to the node and things I think they can get close to the same operating margins as the rest of us.

Okay. And then on the -- sorry, the raw materials cost issue. Copper obviously has been going through the roof. I was trying to get a better sense on the polymer side and where you think that sort of flows through and have we seen the worst of those hits on polymers or will we see more impact next quarter? Again, I know the lag times can be a little bit long.

Brian has been on top that. I'll turn it over to Brian. It is an everyday issue.

Yes, Steve, a real tough read for right now. Typically, as you know, we've seen the escalation of materials here for the last six or eight quarters. The particular complexity at the moment, particularly as it relates to polymers, is just the impact of the hurricane. So not only are we seeing limitations in terms of volumes of material available to us, but also hopefully short-term pricing impact because of that limited supply. So a difficult picture. But for us the focus isn't really about the material costs in the month. It's really about how we manage our pricing and our whole cost structure during this period. And at least for this year, last four quarters, we've been able to demonstrate that we can grow margin in the presence of these rising commodity costs. So that's the bottom line for this management team.

I'd like to add another point, Brian. Our customers are now realizing that sometimes it's not just the price, it's the availability of raw materials. Some of our customers are coming to us now and adding to our requirements because they can't get it from their other suppliers because they can't get the raw materials, especially plastics. So far we have seen no interruptions in our ability worldwide, depending on our other plants in the world to supply materials to help us meet those customer's needs. You see this bifurcation between the little supplier and the big supplier happening in this market.

Not a bad thing. One last question. I remember last year, the former Avaya business, sort of maybe out of muscle memory, really pushed hard in the September quarter, which was their traditional year-end quarter push. Obviously, a little bit less of that here. Do you feel you kind of have them on your -- I wanted to ask about whether you feel you have them on your fiscal year and whether or not we should expect them to be coming in strong next quarter?

They aren't "them," they're "us." The team is 100% on the bandwagon and has been for six quarters, so we're very pleased with them. There were incentives, Steve, in the past, ownership to create volume at year-end, and we've spoken in the past that those incentives no longer exist with our distribution partners. So no, we should not be seeing inventory glut or channel glut as we conclude '05.

And as we get to the end of year, I mean, is there any chance of an acceleration as you go into what's now your year-end?

No. Again, there's no reason to be doing that.

Okay.

Historically, the first quarter is a very soft period for us. We don't want to be building channel inventory in advance of those periods.

Oh, come on. It's so much fun to burn them down. No problem. Thanks very much.

Our next question comes from the line of Daryl Armstrong from Smith Barney.

Thank you very much. I have a couple questions. You know that the hurricane-related revenue opportunity will likely extend over the course of the next few quarters. Could you give me a sense in terms how much revenue you're actually embedding within your guidance for your December quarter?

Again, we've disclosed immediately what we have shipped, and it was about 6 million. Right now, to give you any solid guidance, you've got to depend on what our customers are telling us and some of them haven't even gotten to the area. I would say it's not going to be a huge amount of money. It's not going to be something that will just change all the projections. But it is good incremental business and it is something that is important for us to take care of because it's a set point.

And then you gave some color in terms of the expected pricing on the Broadband side of the business. How should I think about price increases on the Enterprise front?

I think we generally keep our pricing points at the level that it keeps us in the marketplace with the margins we're projecting showing our market leadership. We will give up some market share to show that this one and margin enhancement so we don't get caught with this surprise raw material squeeze. I think we've demonstrated that to this point. I think our team has done an excellent job and will continue to do that. Our customers are becoming very educated in this and we're helping them with it. I think when you look at CommScope compared to the other people you follow, our market position is so much bigger than our competitors, we do have some leeway in working on these price points and it shows in our strength and our product and our customer base and our employees and leadership in this Company to get the margin and get the customer.

Great, and then one last question. Could you give us a sense in terms of how we should think about modeling out stock option expense over 2006, and do you anticipate when you report that item that you'll tell us how much comes out of COGS versus SG&A or R&D?

Yes, Daryl. This is Jearld. We don't have a breakdown as you suggested there between the line items, but we'd say in our guidance for 2006 that we would expect to have about $4 million of long-term incentive compensation based into that guidance.

Okay. Congratulations.

There will be SG&A. There will be be a little bit that goes to the COGS order.

Okay. Congratulations on the quarter.

Thank you, sir.

Our next question comes from the line of Jeff Beach from Stifel Nicolaus & Company.

Again, very nice quarter.

Thank you, Jeff. You're fairly accurate.

A couple of questions. You had substantial profit improvement in Broadband that seems to be more than just volume, and I'm not aware of price increases recently. How did you do such a good job there?

Well, Jeff, there was some price increases that finally worked their way through, so you have to put that in consideration in Broadband. Mostly it was mix. It had to be partially mix in there.

I think there definitely was some mix benefit, some higher distribution. But volume was up too. The volume has a lot of leverage in Broadband because we're vertically integrated. And so it's not just the impact of the cable costs through volume, but remember, you know, we internally produce our own bimetals and fine wires, so in a sense there's a double whammy on that volume leverage. And it was reflected in the quarter.

And I was referring to the profit improvement sequentially. I don't know again if that caught --

I'm sorry. The volume was --

But you have profit improvement and I'm guessing here a little bit on the charges of 8 million on a 12 million sales increase. That seems to be a pretty high contribution.

Yes. I think also, as Brian pointed out too, you're referring to the segment information, these onetime -- this employee benefit adjustment was largely in the Broadband section, not entirely but was widely related to the Broadband business.

All right. Still was a great quarter. Second, looking ahead to your sales projection for next year, where do you see the most confidence in end markets and geographic markets to believe you can get your sales up potentially above 1.4 billion?

Well, broadly I think and I'll let Brian talk about some of the specifics in building the plan. Broadly we're beginning to see our position differentiate as from the competition. I mean, when you're number one in these two markets and you have the coverage, the sales force that's twice as big as everybody else's, worldwide manufacturing capacity, you begin to get that leverage coming through. You also have the leading product group. So each time one of our products gets deeper into the channel, we get lift in the channel with the customers and the technology in the scale. For instance, the scale safe test this quarter, by being able to depend on our international plants to back us up when there was no plastic available to our competitors.

Yes. Jeff, I think what we're outlining is appropriate and modest, if you will, and, the new growth area for us, you think about our history in the Broadband area. Certainly we know that space very well as we do the Enterprise space. The growth in our Carrier space is substantial in '06, and of course, we have less experience in that Carrier market, same as wireless where we've been for some period of time. Maybe responding in part to your question, where would be the -- one of the larger variables, I'd have to go back to the Carrier space. If you share the confidence in SBC's business plan as we do, I think you'll feel good about that as well.

And how about international versus domestic? Continue to see generally international sales growth greater than domestic?

Yes. Certainly on the -- in the domestic Broadband space. When we get into the Enterprise space, I expect to see a lot of continued international growth and outpacing North America.

I think the Broadband side is finally getting most of those bankruptcies reorganized. All that should lead to improved business.

All right. Thank you.

Yes, sir. Thank you. Good analysis.

Ladies and gentlemen, as a reminder to register for a question, please press 1 followed by the 4 on your telephone. Our next question comes from the line of Marcus Kupferschmidt from Lehman Brothers.

Good afternoon, guys.

Hey, Marc.

A couple different questions I wanted to run through. First, could you give us an update on the China plant now? It sounds like you actually used it to make some materials that were shipped into the U.S. markets, so I guess it's fully up and running, everything to your satisfaction. Are you using the facility at all to try and win new market share overseas or more just still to replace the product you would have made in other markets?

It's contributing -- that is Brian Garrett. It's contributing in a lot of ways right now. It has helped us expand our regional sales activity. I think we said that was one of the -- that was the primary objective. That is helping us. The other thing that it's done is it's helped us balance demand between U.S. and South American facilities. So, yes, it's becoming with each month, it's becoming a larger part of our global formula for Broadband. You know, it is not at its rated capacity at this time frame, but it's getting very close. It's ahead of plan. If you look at the original project plan, which, of course, you can't, but it is on or ahead of schedule in terms of volume as originally announced and then of course in September, we announced that we were going to expand capacities at that site further, and that project activity is on schedule as well. So we'll see -- we'll see quarter over quarter, we'll see continual increasing output from that facility throughout '06.

Okay. And a couple other odds and ends I wanted to touch base on. In terms of the fourth quarter, just expand what Steve Kamman was asking about, should we just expect your typical kinds of trends where Broadband is normally a little bit slower in the fourth quarter, Enterprise is slower in the fourth quarter and I would guess Carrier could improve because you have a little year-end activity by some of the telcos?

That's very close to what we expect to happen. There might be a little bit of lift in the fourth quarter continuing for Broadband that you would not normally have because of the hurricanes, but other than that, you're on.

Primarily, there are the holiday seasons that particularly as we get closer to the end of the year have a big impact on shipping rate.

All right. Two other things. In terms of your third quarter, can you give us a sense of how much the rising raw material costs might have penalized you so therefore we can say if your costs would have been similar to Q2, how much better could your operating margin have been this quarter, do you think?

Rather academic, but I would --

Hard question.

I'm going to bracket and stick my neck out here and say it's probably in the 2 to $3 million range.

Okay. Then one other final question just to kind of get a little more clarity on the '06 revenue guidance. Could you give us a sense of -- if you think about the dollars of growth you expect next year, where you think the biggest dollars of growth would come from? Maybe you could rank the Carrier versus Broadband versus Enterprise just to give us a sense of what your expectations are?

Yes. It's going to be pretty simple. All the businesses are going to grow nicely next year, so if you want to reduce it to dollars, it's going to have to go to the biggest segment, which would be Enterprise. I think you have to understand there's pricing and margin left in those dollars too.

And then between Broadband and Carrier?

Same. I mean, we're looking at raising prices wherever we have to raise prices in this business, across all the segments to maintain the margins that are acceptable to our shareholders. So you're having a price and a volume lift at the same time, but obviously Carrier represents -- Enterprise represents about 30% of the company, so that would be the largest group.

Okay. Great. Thank you

Yes, sir. Thank you.

Ladies and gentlemen, as a reminder to register for a question, press the one followed by the 4. We have no further questions at this time.

Well, thank you everyone for joining us both on the Internet and on the call, and thank you to all of our employees who are listening for an outstanding quarter. Let's do it again next quarter. With that, good evening.

Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines.