CommScope Holding Company Inc (COMM) 2006 Q1 法說會逐字稿

Welcome to the CommScope first quarter 2006 earnings conference call. (OPERATOR INSTRUCTIONS). As a reminder, this conference is being recorded Thursday, April 27, 2006. 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 the 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 are joining me on the call.

During this conference call we may make forward-looking statements regarding our financial position, plans and outlook that are 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 could cause the actual results to differ materially from those currently expected. For a more detailed description of factors that could cause such a 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 does not undertake 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 we review first-quarter results and Frank makes some closing comments, we will open the lines. Jearld?

Thank you, Phil. Today CommScope announced first-quarter results for the period ended March 31, 2006. The Company reported first-quarter sales of $352 million and net income of 13 million, or $0.19 per diluted share. Reported net income includes after-tax charges of $2 million related to restructuring costs. Excluding restructuring costs, adjusted earnings were $15 million, or $0.22 per diluted share.

Sales of orders for the first quarter of '06 were stronger than we expected. Sales increased 14% year-over-year, driven by sales increases in each of our segments. First-quarter enterprise segment sales rose 9% year-over-year to 172 million, mainly due to higher sales prices for most products, as well as higher sales volumes in most regions. Enterprise sales increased in all regions except the Europe, Middle East, Africa, or EMEA, region, which experienced weaker market conditions than in the first quarter of 2005.

Regarding enterprise pricing, we continue to be disciplined and are working diligently to recover costs. We have announced further price increases for selected cable products in the enterprise market as a result of a substantial cost increase for certain key commodities. In addition, we are implementing a new price adjustment mechanism due to the increased volatility in the cost of copper. This mechanism will adjust pricing as often as every 30 days, based on the movement in copper prices.

Broadband segment sales rose to $126 million, up 16% year-over-year, as a result of both higher prices for coaxial cable products and increased global sales volumes. Broadband sales increased in all regions of the world. We are also implementing further price increases for selected broadband cable products.

Carrier segment sales rose 24% year-over-year to $55 million, due to an increased demand for Integrated Cabinet Solutions, or ICS, products. First-quarter ICS sales reflected ongoing deployment of cabinets in support of DSL and fiber-to-the-node deployments. While we continue to expect quarterly volatility and demand for our highly-engineered cabinets, we are optimistic about ongoing robust growth, as AT&T, BellSouth and Qwest upgrade their infrastructure for high-speed video and data services.

(indiscernible) wireless sales were flat for the last year -- or were flat with last year, mainly due to wireless customers spending patterns. Wireless sales started slowly but increased as we moved through the first quarter. So, while we believe wireless customers began spending a little slower this year than last year, we do expect wireless growth in 2006.

Sales of ExchangeMAX products declined, reflecting lower sales of twisted pair telephone central office cables as a result of our decision to exit this product line.

In the first quarter, international sales rose 4% year-over-year to $107 million, or approximately 30% of total company sales. The Asia Pacific Rim and Latin American regions showed strong growth, but were substantially offset by lower sales in Europe.

Overall, external orders booked in the first quarter of 2006 were a record 444 million, for an overall book-to-bill of 1.3 times. Book-to-bill ratios were positive in all segments, with particular strength in the cabinet and enterprise segments.

Gross margin for the first quarter rose to 24.1%, that's 24.1%, up 70 basis points from the year-ago level. Gross margin improved year-over-year, primarily due to higher sales volumes. The positive impact of higher sales prices was essentially offset by higher raw material costs.

SG&A expense was $54 million for the quarter and was essentially stable year-over-year. However, SG&A declined as a percentage of sales, mainly due to higher revenue levels, ongoing cost management, and lower bad debt expense.

Also note that first quarter 2006 results include pre-tax charges of $1 million for equity-based compensation expense, related to the implementation of FAS 123R, which was recorded primarily in SG&A in the first quarter.

Research and development was down slightly year-over-year to $7 million for the quarter.

In the first quarter we incurred pre-tax restructuring charges of $4 million, $2 million after-tax, for employee-related and equipment relocation costs associated with the Company's global manufacturing initiatives, which were announced in September of 2005. As you may recall, these initiatives are designed to improve service, reduce cost and improve factory utilization. We have begun the redistribution of production among our global manufacturing facilities, and expect improvements in the efficiency of certain manufacturing processes.

As a 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 are also re-sourcing Systemax cable production from the Omaha, Nebraska facility to other, lower-cost CommScope facilities globally.

We've been working diligently during the past eight months to implement these initiatives, and believe that we are on schedule. Once the initiatives are completed in early '07, we anticipate annualized pre-tax savings of 35 to $40 million. We expect to realize about half of these annualized pre-tax savings during 2006, primarily in the second half of the year.

Operating income for the first quarter of 2006 more than doubled year-over-year to $19 million, or 5.5% of sales. Excluding restructuring cost, operating income was $23 million, or 6.6% of sales.

The effective tax rate for the first quarter of '06 was 36.5%, compared to 24.7% in the year-ago quarter. The increase in the effective tax rate was due primarily to changes in the mix of international and domestic income. While we may experience some quarterly volatility, we continue to believe that an overall effective tax rate around 30% is reasonable for calendar year 2006.

Now I will turn to cash flow and balance sheet items. Net cash used in operating activities in the first quarter was $18 million. Use of cash primarily reflects increased accounts receivable, payments related to year-end incentive programs, and severance payments related to implementation of the global manufacturing initiatives. The first quarter is typically our weakest quarter for cash flow generation.

Total depreciation and amortization expense was $14 million and included $4 million of intangibles amortization. Capital spending in the quarter was 7 million.

During the first quarter, CommScope also acquired the MC2 broadband cable product line and certain other assets from Trilogy Communications, Inc. for $14 million. The manufacturing assets for the production of the MC2 product line are currently being relocated to CommScope facilities and should be complete around midyear.

CommScope also received proceeds from the exercise of stock options of $28 million during the quarter. Now, at March 31, 2006, long-term debt including current maturities declined to $294 million and was 34% of booked capital structure. CommScope ended the quarter with $242 million in cash, cash equivalents and short-term investments.

We have started 2006 with solid financial results that were better than we expected. The strong order input in the quarter confirms our belief that our end markets are improving. At the same time, we are facing substantial increases in the cost of key commodities such as copper. While we continue to raise prices, we have not been able to keep up with increases in the cost of copper.

Considering this environment, and as we look ahead to the second quarter of 2006, we anticipate sales of 390 to $410 million and operating margin of 7% to 8% of sales, excluding special items. We expect the benefit of higher sales to be substantially offset by higher material costs. We've also updated our guidance for calendar year 2006 to reflect our expectation of improving enterprise sales volume and higher sales prices in response to a more challenging raw material environment. We now expect 2006 sales in the 1.475 to $1.525 billion range.

Despite challenges, we believe that we can still achieve a '06 operating margin around the 8.5% level, excluding special items. We expect stronger operating margins in the second half of 2006 for the following reasons. First, the expected benefits of higher prices; two, the global manufacturing initiatives, which should help reduce costs by 15 to $20 million; thirdly, the new agreement with represented employees at the Omaha facility, which comes effective June 1, 2006; and four, the MC2 product line acquisition. For modeling purposes, you should also expect to see about [72] million shares outstanding on a fully diluted basis for calendar year 2006.

[When] we say short-term challenges of rising commodities cost, we're bullish about our long-term prospects as a global leader in cable and connectivity solutions.

That ends our prepared comments. I will turn it over to Frank for a few comments.

Thank you, Jearld. First of all I'd really like to thank all the CommScope employees who put such an effort forth in this quarter. Considering that we achieved record sales, record orders and record price increases, the team did an outstanding job in the most volatile commodities market I have seen in the 30 years as the founder of this company. It is clear to me now that the market recognizes our position in the world in the last (inaudible). Given the demand for our products and increasing competition that is taking place between telco, CATV, and wireless operators for the last (indiscernible), we are uniquely positioned to continue to benefit from this. We will continue to watch the commodities, work the price increases, and I assure you that the management team behind Brian and Jearld and myself, and all of our employees, recognize this performance and want to continue it for our shareholders.

And with that, we'll open it up for your questions.

(OPERATOR INSTRUCTIONS). Jeff Beach.

Would you repeat -- the book-to-bill, I thought you said, was 1.3; but it's 1.03?

(indiscernible)

Pretty strong order intake then. I wasn't wrong on that. Can you talk about the significant improvement in your operating profits in your broadband sector? I know you raised prices in the fourth quarter; volume helped. Have you already started to get benefits from restructuring and other things? Just give us some discussion to that. Thanks.

A big part of it would largely be volume. It was a -- it was a strong quarter for us, year-over-year perspective. I would say in terms of our restructuring activities, the benefit substantially was not derived over the course of the first quarter for broadband, and much of that benefit is really in the second half of the year.

We did start -- started the year off with some price increases as well, and that's certainly helped somewhat on a sequential basis.

And on the pricing front, on your cabling business, looking ahead at the second quarter, you are the market leaders -- or the market leader in your segments. Are you taking steps to raise your pricing enough in broadband to cover your cost of aluminum and plastics? And on the enterprise side, you see some pretty aggressive moves being made by Belden. You're the industry leader, but are you basically almost following the course of the strong pricing that they're taking here that's going to allow you to benefit from that? I'd like some flavor on that.

I would tell you over the last six quarters, no one has kept our pace in price leadership. So, I wouldn't acknowledge that we're following anyone. In the broadband space, we announced new pricing effective March 13, all shipments after March 13, that we've already seen, in terms of a response to in our order input.

In the enterprise space, we announced major price increases, effective shipments January 1. We are seeing a response to that. And of course the latest announcement, which I think is very important is the one for effective shipments May 1. And the significance of the May 1 announcement is based upon the further announcement that we would be making these adjustments every 30 days.

And you look at what we've done historically in the Company, think back a few years ago, we think in terms of annual price adjustments. Over the last two years, I would say typically we're thinking in terms of adjustments two possibly three times a year. But in the current environment, the most important changes are announcement and ability to adjust pricing monthly, so that in these escalating markets, we're not following the cost increases with such duration. So, all of that begins for us effective May 1 in the enterprise market.

Ken Muth, Robert W. Baird.

On the carrier market side, could you just give a little bit of an explanation of what you're seeing in that environment?

Clearly, the regulatory environment is very beneficial to what's happening in the carrier market. Although the bills are not through Congress yet, it appears that the regulatory relief will be given to the telco industry to allow them to go ahead with their national (indiscernible) franchising opportunities. Obviously, competition with that makes everybody upgrade and continue to fix their systems, so we're seeing benefit from the potential (indiscernible) if not this Congressional year, certainly the beginning of next year. So, obviously, the merger of AT&T and SBC has made an aggressive pact to go forward with (indiscernible) deployment.

Specifically on project (indiscernible) in Q4 you had a very good quarter with them and saw a little bit of a kind of a rolloff to that project. Any color you can add for this quarter?

I'll turn it over to Brian for a little more (indiscernible) detail, but we continue to see very strong action in project bidding for those Lightspeed opportunities. So, we haven't seen anything that tells us that they're not going forward, if that's where you're headed.

It was, as we discussed last quarter, a very, very strong Q4, largely filling the pipeline and meeting any number of contractual commitments in that period. The front part of Q1, particularly January, was slow, as expected. But our intelligence or insight says that construction has been robust. And over the course of the first quarter, we've seen progressively accelerating orders. So, there's nothing that suggests that there is any slowdown by AT&T. We created a very strong book-to-bill in our cabinet business in the quarter, and so the outlook is very promising.

And on the pricing front in general, on the copper-based products here, any thoughts of market shift as maybe not all the vendors follow, or some vendors try to use this as an opportunity to take market share and stay below it? How do you combat that or what are your thoughts in that regards?

[Brian and I will] work on this with you. We have two views of that. One, clearly, we believe (indiscernible) we should be able to continue our price leadership and recover as best as possible the volatility of the copper. What has really started to happen that is unique to CommScope is that we are one of the very few people in the world to have the ability to manufacture our own (indiscernible), which is copper aluminum (indiscernible). And we're seeing a lot of interest in substituting copper for [aluminum] or low-cost products, especially in the heavy poundage metal usages. So, we're very actively engaged in putting a program forward that will look to substitute aluminum for copper in some of these products and give us even a leading market advantage in these products. We have patented products out in the marketplace, in the wireless marketplace, against the incumbent competition that use aluminum and are effective and as good or better (indiscernible) performance.

As it relates to the competition, I would say that there will always be people who are selling at a price below CommScope. That is a given. But that being said, these cost increases are so dramatic, everyone in the market has to respond. Even, I will say, in our Asia-Pacific markets, where we would compete with a lot of Asian producers, we're seeing large double-digit price increases being announced. So, there will broadly be a following for anyone who wants to stay viable in the cable market.

Marcus Kupferschmidt, Lehman Brothers

I just want to clarify first just the new revenue guidance for the full year. If I just take the midpoint of the June quarter revenue guidance and the midpoint of the full year, it seems as though the June quarter would be the highest sales level for the year. And then -- are you expecting a lot of lumpiness over the course of the year? I'm assuming that's tied to the cabinets within the midpoints of your guidance here?

Look at the guidance. The pricing environment that we're in now is part of the reason we're raising our guidance to that, and the strong outlook that we're seeing, particularly in the enterprise area. We provided a range; in both instances you've chosen the midpoint. But that midpoint -- it is possible that the second quarter this year could be our highest level quarter of the year. The second and third quarter have often been very close. So -- and the fourth quarter, as you know, typically gets some seasonal fall-off. Estimating how quickly that falls off is always a challenge. We will update the second half as we get a little closer to it.

Kevin Sarsany, Foresight Research.

Just a couple of bookkeeping. The restructuring charge -- how can I break that out between carrier and enterprise?

Hold on a second, and we will check to see if we have that.

I'm trying to get a feel for if carrier was (multiple speakers)

It's about 1.2 million for -- excuse me. It's about 3 million for enterprise and about 700,000 for Broadband.

So, that would -- okay. And the tax rate -- do you expect that at that level to continue?

We do expect to have a lower tax rate on a full-year basis. As we mentioned in our guidance, it could be around 30% for the full year, is still our current estimate. But we are seeing quarter-to-quarter volatility in that rate, and so it could be bumpy from quarter-to-quarter. But 30%, we think, is still a good working number.

Then on the business, in the broadband business, what was the growth, if you could break it out, domestically versus international? Is international still the growth engine; you're seeing maintenance domestically?

(indiscernible) was growth across the board, but you've got to remember we (indiscernible) have revenue growth. But the (indiscernible) international. We are seeing a pickup domestically, given those areas of competition where Verizon and SBC are activating (indiscernible)

Daryl Armstrong, Citigroup.

In terms of the copper-based pricing mechanism that is being put into place in the enterprise, you're getting more frequent price adjustments. Are there any (indiscernible) of the amount that you can increase pricing on a month-to-month basis (indiscernible) there?

We've applied no caps to the formula.

Second of all, I noticed on the balance sheet there was a nice pickup of inventory in the quarter. Is this primarily raw materials?

Yes, the higher raw material cost is being reflected somewhat in our balance sheet. And there is good uptick in our business requirements going on. So, our inventory turns for the quarter stayed pretty consistent with where we've been.

They're up year-over-year. But out of about 14 million, 4 of it was related to the acquisition of the MC2 product line. The other part of it is, as we're relocating the cable business out of Omaha, obviously during that process there is some capacity that you've got to take out in order to relocate it. And so we've built inventory in the advance of that process to service demand. So, pretty much where we had hoped or had planned inventory would be in the quarter.

That makes sense. In terms of the commentary about the EMEA region, you mentioned that that was a little bit sluggish. Could you give me some sense in terms of what you think caused that? And as you've moved into this quarter, has the momentum in that marketplace rebounded at all?

I would tell you just broadly, if you looked at our year-over-year growth in EMEA for both our broadband business and our enterprise business, the response has been slow, or among the lowest. So it's largely a broad-based -- I would interpret that as a broad-based economic environment to the region. And there is no immediate change visible to us as it relates to that environment.

One last housekeeping question. If you guys have it, do you know what the volume growth is in the enterprise and in the broadband segments on a sequential basis?

Not on a sequential basis. I can tell you in the broadband business, it's a pretty even mix between volume and price. And without having the number in front of me, for the enterprise business, I would say it's more price than volume, because we had more price increases in the enterprise business through '04 and -- through '05 and early '06.

And we're also seeing a shift to higher 10G product lines that we have a major market position in. So, you'll get price volume adjustments there because it's substantially more expensive.

That's a good point, Frank. Because as this market has tightened with the higher costs, we've talked -- we've spoken before about our willingness to compete in the commodity segment. So, we give up volume at the low-end because we insist upon our price increases. And in turn we've seen much higher growth rates in our category 6 or our 10G product, category 6E.

(OPERATOR INSTRUCTIONS). Jeff (indiscernible)

What was the amount of the raw material increase year-over-year, and what amount was recovered through price increases?

You're saying the raw material cost increase generally, Jeff? Is that the question?

Correct.

Substantial depends on your commodity. And in copper we're seeing increases of more than 100% on a year-over-year basis. (multiple speakers) aluminum as much as 30, 40, as Frank is pointing out. Plastics, we've seen increases -- 20% sort of numbers at times, certainly, or more. So, they have been substantial. I don't think I have a number that would equate them overall, but they have been substantial.

Maybe you could quantify in terms of the margin impact.

I think if you're asking have we recovered (indiscernible) prices (indiscernible) raw materials, I would say no. I would say that we're still chasing that price material cost curve. The increase in our margin is coming from Brian's team and managing the businesses, managing the volume, managing the market position, and working the pricing as fast and as rapidly as we can given the volatility. I think if you stand back, we've probably done as good a job as any of our competitors in managing that process, and we will continue to manage through that until we have parity and then hopefully (indiscernible). But the true margin (indiscernible) comes through volume, and (indiscernible) productivity increases, our restructuring of the Company (indiscernible) the ability to run these plants at the kind of capacity levels we're running at has really helped (indiscernible)

Also, I was wondering the percentage of volumes in the enterprise business coming from cat 6 and 10 gig.

10 gig would still be relatively small, certainly single digit. We had an excellent start, I will say, from a sales and marketing perspective, in the quarter. I suspect we will have announcements in the second half of the year, if not at the tail-end of this -- as early as the tail-end of this quarter regarding 10 gig chips for routers. So, I think our expectations remain high-growth towards the second half of the year in 10G.

As it relates to category 6, I just looked in one of our product lines; on a year-over-year basis, growth was north of 30%. So, that's part of this environment that we talked about before, where CommScope will exit category 5 or 5E space, where we may not be able to recover all the price we would like to. And we're placing our focus on the value proposition we have at these higher technology spaces.

There's a model taking place out there, if you expand (indiscernible) even though we're raising prices, and raising prices across the board in the 10G and higher category, is these raw materials force everyone to a higher [router] level. The IT managers begin to say, well, why not go with the latest state-of-the-art. Because what happens is (indiscernible) beginning to think this through, it may be a better time to install this product at this time then face something coming forward.

I'll also say, again, picking up on Frank's thought process, we've had very high gains in the fiber aspects of our enterprise business; had a very solid gain in orders -- I would say record orders, clearly, in our fiber offering in the enterprise space.

(OPERATOR INSTRUCTIONS). I see no further questions at this time. I will turn the call back to you.

I want to thank all of you for joining us today. Obviously, we're very pleased with the performance. We recognize the challenges going forward with these commodities. I do thank all the employees and all the other managers in the Company who put out such a [workman-like] effort to achieve these results in the face of all the dynamics that were taking place this year. And we thank all of you that follow us and all of our shareholders for your continuing support, and hopefully we'll have another good quarter to report to you next month. Thank you for joining us.

That does conclude the conference call for today.