CommScope Holding Company, Inc. (NASDAQ:COMM) Q2 2023 Earnings Call Transcript

CommScope Holding Company, Inc. (NASDAQ:COMM) Q2 2023 Earnings Call Transcript August 3, 2023

CommScope Holding Company, Inc. misses on earnings expectations. Reported EPS is $0.19 EPS, expectations were $0.39.

Operator: Thank you for standing by and welcome to CommScope’s Q2 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation there will be a question-and-answer session. [Operator Instructions] Please be advised that today’s call is being recorded. I would now like to turn the call over to your host, Mr. Massimo Disabato Vice President of Investor Relations. Please go ahead.

Massimo Disabato: Good morning and thank you for joining us today to discuss CommScope’s 2023 second quarter results. I’m Massimo Disabato, Vice President of Investor Relations for CommScope and with me on today’s call are Chuck Treadway, President and CEO; and Kyle Lorentzen, Executive Vice President and CFO. You can find the slides that accompany this report on our Investor Relations website. Please note that some of our comments today will contain forward-looking statements based on our current view of our business, and actual future results may differ materially. Please see our recent SEC filings, which identify the principal risks and uncertainties that could affect future performance. Before I turn the call over to Chuck, I have a few housekeeping items to review.

Today, we will discuss certain adjusted or non-GAAP financial measures, which are described in more detail in this morning’s earnings materials. Reconciliations of non-GAAP financial measures and other associated disclosures are contained in our earnings materials and posted on our website. All references during today’s discussions will be to our adjusted results. All quarterly growth rates described during today’s presentation are on a year-over-year basis, unless otherwise noted. I’ll now turn the call over to our President and CEO, Chuck Treadway.

Charles Treadway: Thank you Massimo and good morning everyone. I’ll begin on Slide 2. CommScope delivered core net sales of $1.589 billion and core adjusted EBITDA of $263 million for the second quarter of 2023. Our second quarter CCS and OWN was impacted by larger than expected customer inventory corrections, customer CapEx productions and the macro environment. We’re consolidating CommScope, which includes our Home Networks business. We reported net sales of $1.918 billion, down 17% and Adjusted EBITDA of $260 million, down 13%. Despite the market challenges, we continued to manage what we can control, including our CommScope NEXT initiatives. Two of our most significant achievements thus far in 2023 are cost efficiencies and mixed performance.

On the cost side, we have aggressively evaluated our cost structure. This has resulted in an annualized cost savings of more than $150 million. This will position us well when demand returns to normal levels as these reductions are permanent and will not be needed as volume returns. Additionally, we continue to drive performance in our next segment where we achieved another record quarter of EBITDA of $75 million, up $90 million year-over-year. The team continues to drive substantial growth and value in our NICS segment. Before I talk about market outlook, let me talk about the progress of each of our businesses. As we indicated in previous calls, we believe CCS has strong long-term market tailwinds, including significant spending commitments to improve United States broadband infrastructure in addition to other country programs around the world.

Although our orders are down, we continue to manage what we can control in this business, including investing in new products and capacity ahead of market recovery. During this downturn in demand, we are working on our efficiencies, including debottlenecking efforts to improve throughput when volumes returned. In addition to operational improvements, we continue to invest in new product development. We continue to move forward with the launch of our notebooks [ph] product line that will offer customers the modular approach to connectivity, resulting in decreased installation costs for our customers. On some of the future investments we are working on, we are working with the State of North Carolina for funding. Recently, we announced a grant from the state to support several future growth projects.

We have aggressively invested in our internal capacity to enable CommScope to take full advantage of future carrier footprint expansion, driving fiber deeper. In addition to the state grant, I had the honor and privilege to attend President Biden’s announcement of his Internet for All initiative. This is an exciting announcement as it indicates the beginning of the $42 billion of BEAD funding. As demand for our products return we are well positioned to deliver against significantly higher demand with an improved cost structure. Turning to NICS, the business continues to perform very well. Our first half EBITDA of $133 million is up $162 million over the first half of 2022. The NICS segment is on an annualized EBITDA run rate of $266 million.

Backlog ended the quarter above $550 million. Based on current visibility, we expect second-half EBITDA to be stronger than the first half. I’m extremely proud of the NICS team as they have significantly transformed the business over the last 24 months. We are well positioned for continued growth as we invest in new services and software as part of the segment’s transformational growth strategy. Through our NICS compiled NEXT plan, we have been able to improve all areas of the business, including growth, new products and costs. The NICS segment has successfully leveraged the existing cost structure to dramatically improve profitability and cash generation. We expect continued growth in this segment, driven by new hardware and software products as well as cost management.

Recently we announced the RUCKUS One platform that is being sold with a network as a service option. RUCKUS One is an AI-driven cloud native platform delivering network assurance, service delivery and business intelligence in a unified dashboard. It simplifies converged network management across multi-access public and private networks. In addition to RUCKUS One, we are a leader in the development of Wi-Fi 7. We expect to be one of the first in the market when we launch our Wi-Fi 7 product in the fourth quarter of 2023. I’m extremely excited about the future of NEXT as the business has been a large benefactor of our CommScope NEXT program. We have created substantial value in this segment over the last few years and expect to create more moving forward.

In OWN as we mentioned in previous calls, we fully contemplated the decline in U.S. carrier capital spends. While this presents headwinds for 2023 revenue and adjusted EBITDA performance in the business, we continue to position the business for long-term growth. As we have done in the CCS segment, we’re using the slower demand to focus on new products and efficiencies. We continue to further develop the Mosaic antenna to provide a unique solution to active/passive requirements. We now expect Mosaic to make major inroads as the market demand returns. In addition to new products and positioning for growth, we are working aggressively on our cost structure, including operations. We’re implementing several projects that will improve our cost and throughput in our factories in future periods.

Finishing with ANS as we have discussed, the segment has made a very successful transition to a leading supplier of edge related products including nodes, amplifiers and RPD, RMB modules. Although we remain a strong supplier of our legacy CMTS technology, we continue to grow our edge business as we are in the early phases of the DOCSIS 4.0 upgrade. We continue to work with all of the major cable operators on edge products. As previously discussed, we announced that we are working with Comcast on a next generation FDX amplifier. FDX is a key driver for their upgrade to 10 G. In addition to our position on amplifiers, we are well positioned in RPD, RMD modules where we are selling significant quantities to large cable operators. Finally, we continue to commercialize our virtual CMTS solutions and are actively testing in cable operator labs.

Overall, I’m extremely excited about our position in ANS as DOCSIS 4.0 upgrades are in early phases. We’re the only supplier that can provide all of the products required for an upgrade, including virtual CMTS, nodes, amplifiers, and modules. We are also finding success in the conversion of our legacy E6000 CMTS technology to a virtualized system that can compete with the existing virtualized solution. We continue to invest heavily in the future and we see 2023 as an inflection point moving forward. Finally, as we’ve discussed previously, ANS is a bit more of a project based business than our other segments. Some revenue timing is driven by projects and licenses. In 2023, we would expect to see stronger second-half than the first half as project timing is weighted to the second-half and edge continues to ramp.

Now let me address the market environment and what we are hearing in our discussions with our customers. Our near-term market challenges are CCS and OWN related. Starting with OWN, we were highly exposed to the three major carriers in the U.S. going into 2023. We expected to see a decline in capital expenditures as indicated by the carriers. This decline was included in our 2023 core adjusted EBITDA guidepost of $1.35 million to $1.5 billion. During the second quarter, carriers indicated a downward shift on 2023 demand as they continued to cut CapEx and manage 2023 cash flows. Other than the demand picking up because some customers have normalized inventories in the first half, we expect these decreased demand levels to remain through the rest of 2023.

We will continue to monitor the major carrier CapEx plans for 2024 as they get developed. As it relates to CCS market conditions, there’s a significant short-term uncertainty in the market today. At this point, it is clear that there are three major items driving softness in CCS orders; inventory adjustments, capital expenditures and the macroeconomic backdrop. Let me start with market conditions. We’re seeing short-term pauses as spending on the fiber side is down. Several major customers are managing their cash after two years of significant investment in fiber build out. Our conversations with customers continue to leave us with medium and long-term optimism for substantial spending. The conversations are also pointing to the additional large BEAD government funding programs going into effect in the second-half of 2024.

In addition to lower market demand, customers clearly purchased more material than they needed in 2022. This had a significant impact on our demand in the first half as customers started to normalize inventory levels. The magnitude of these inventory builds was greater than we expected. We feel that we may have benefited more than our competition on the customer inventory builds. And speaking with our customers, we sensed that their inventory positions had improved. However, there is still too much inventory in the system and it will continue to impact demand in the second-half of 2023. We expect that we will see further improvement in 2024 as the spends picked up again. Based on the above challenges, we have revised our EBITDA guidepost down.

We now expect full year 2023 core adjusted EBITDA to be in the range of $1.15 billion to $1.25 billion. It is important to note that this downward adjustment is based purely on current depressed market conditions. We believe that we are maintaining our market share and that our view of medium and long-term demand remains unchanged. And with that, I’d like to turn things over to Kyle to talk more about our second quarter results.

Kyle Lorentzen: Thank you, Chuck, and good morning, everyone. I’ll start with an overview of our second quarter 2023 results on Slide 3. For the second quarter, consolidated CommScope reported net sales of $1.919 billion, a decrease of 17% from the prior year, driven by declines in CCS, OWN and Home, but partially offset by strong mix growth. Adjusted EBITDA of $260 million decreased by 13%. Adjusted EPS was $0.19 per share, decreasing 54% from prior year. This was below our expectations as we experienced significantly lower demand in our CCS and OWN segments as customers more aggressively normalized inventory levels and managed their capital spending. For core CommScope, net sales of $1.589 billion declined 15% from the prior year and adjusted EBITDA of $263 million decreased 8%.

The Adjusted EBITDA held up a bit better than our revenue as we continue to drive our CommScope next initiative plan including reducing our fixed costs. In addition, EBITDA performance was helped by continued improvement in our NICS segment. Driven by lower order rates, particularly in CCS and OWM, core CommScope backlog continued to decrease and ended the quarter at $1.9 billion, a decrease of 20% versus the end of Q1. The lower order rates has had an impact on our backlog. In our CCS and OWN businesses our backlogs are back to normalized levels pre-supply chain challenges. This has allowed us to significantly reduce customer lead times. Turning now to our segment highlights on Slide 4. Starting with CCS, net sales of $699 million decreased 29% from the prior year.

The decline was more attributable to our building and data center business than our network, connectivity and cabling business. This result was below our expectations as discussed earlier. Order rates remain challenged and we have seen only a modest increase in order rates in the latter part of the second quarter and early in the third quarter. As mentioned, CCS customer conversations remained bullish on medium and long-term growth. The short-term demand profile remains very uncertain as customers continue to manage inventory and cash. CCS adjusted EBITDA of $80 million was a decrease of 53% from the prior year, driven primarily by the drop in revenue. NICS net sales of $328 million increased by 59%. From a business unit perspective, RUCKUS led the way, increasing 60%.

NICS adjusted EBITDA of $75 million improved from negative $15 million from the prior year, a $90 million change primarily driven by stronger demand and operational improvements. The NICS segment LTM adjusted EBITDA is $214 million, an improvement of $245 million versus LTM a year ago. As discussed on previous calls, the team is focused on driving growth and profitability in the NICS segment. We have seen the benefits of this focus over the last several quarters. We are very excited about the growth opportunities in NICS as we continue to invest heavily in R&D. Our new product development, including RUCKUS One clearly provides a strong platform for growth. We would expect to see a stronger second half than the first half in NICS. Congratulations to the team for delivering another record quarterly performance.

OWN net sales of $229 million decreased 41% from the prior year and across most business units. Although a decline was expected as major carriers indicated lower 2023 capital spending versus 2022, the magnitude of the decline was greater than we expected. Carriers took aggressive steps to manage cash, including managing inventory down and lowering spend in general, including one carrier unexpectedly stopping all deliveries of our products for 60 days. The near-term outlook remains uncertain. OWN adjusted EBITDA a $42 million declined 45% from the prior year. In OWN, we continue to manage cost and invest in new product development. Our Mosaic antenna continues to gain traction and is well positioned when the market recovers. ANS net sales of $333 million increased 14% from the prior year due to project timing.

ANS adjusted EBITDA of $66 million increased 15% primarily driven by improved revenue. ANS continues to position itself to take advantage of the DOCSIS 4.0 upgrade cycle. We are the only supplier that can supply all the products from amplifiers, nodes, modules and CMTS, including virtual CMTS. We are winning business at all major customers and are well positioned for future growth. Based on project timing, the key driver of the ANS business quarter-over-quarter performance, we expect a stronger second half than first half. Finally, Home continues to be faced with challenging market conditions. Home net sales were $330 million, declining 22% from the prior year, essentially across all business units, driven by customer inventory adjustments and lower demand.

Home adjusted EBITDA of negative $3 million declined from $13 million versus prior year as a result of the lower revenue. Home, not unlike core businesses, is experiencing customer inventory adjustments and low recessionary demand. The home business has seen further deterioration of the market in the second quarter. Although we expect EBITDA to improve in the second-half, it will be modest and highly dependent on the market. We continue to implement our transformational initiatives and our winning new business. However, we don’t expect to see substantial top line impact of these initiatives until the second half of 2024 at the earliest and expect their full effect to hit in 2025. We will continue to manage the business as we look for prudent separation alternatives.

Turning to Slide 5 for an update on cash flow. During the quarter, we generated cash from operations of $137 million. During the quarter, we reduced inventory driven by a decline in revenue as well as improved management of inventory. As previously discussed, we are still holding excess inventory driven by the supply constraints in 2021 and 2022. We are beginning to unlock some of these values but there’s still a long way to go. Based on the revenue and EBITDA challenges, we are revising our 2023 adjusted free cash flow forecast down to $250 million to $350 million. Turning to Slide 6 for an update on our liquidity and capital structure. During the second quarter, our cash and liquidity remained strong. We ended the quarter with $418 million in global cash and total available cash and liquidity of over $1 billion.

During the quarter, we increased our cash balance by $91 million. We did not draw on our ABL revolver during the second quarter and therefore ended the quarter with no outstanding balance. In the second quarter, we continued to execute our debt buyback program and repurchased $28 million of our long-term debt for cash consideration of $25 million. To add more detail, we repurchased $10 million of the 8.25% senior notes due 2027 and $18 million of the 6% senior notes due 2025. Since the beginning of the year, we have repurchased $85 million of debt. During the quarter, we also paid the required $8 million of term loan amortization. The company ended the quarter with net leverage ratio of 6.4 times. Going forward, we intend to use cash to reduce debt including buying back securities opportunistically.

I’m now turning to Slide 7, where I will conclude my prepared remarks with some commentary around our expectations for the remainder of 2023. As discussed, the external environment remains uncertain in the near-term. The recessionary backdrop clearly is impacting our customer behaviors as they manage their near-term cash flows. As we have moved through the second quarter, our expectations for the second half have changed significantly. Order rates in CCS and OWN have not materially increased. Despite some indications from our customers that there will be a strong rebound in the second half, we are not as optimistic. Based on the above, we have reduced our 2023 core adjusted EBITDA guidance to $1.15 billion to $1.25 billion. We’re still well positioned to take advantage of the expected strong fiber demand over the medium and long-term.

However, timing of a meaningful recovery is highly uncertain. We will continue to monitor and assess. As Chuck mentioned, we have implemented additional cost actions including accelerating certain CommScope NEXT efficiency initiatives. As we have gone through this exercise, we are excited with the opportunities we have found and implemented. We feel that a significant portion of the cost actions we are taking now are permanent in nature. In total, these cost actions represent more than $150 million of impact. Upon recovery of the demand, we should be well positioned to drive strong profitable performance. Finally, I would like to address our debt position and specifically our nearest term maturity in 2025. We are evaluating our options to address this maturity proactively.

We have several options available to us and we plan to share more on this topic no later than our next earnings call. And with that, I’d like to give the floor back to Chuck for some closing remarks.

Charles Treadway: Thank you, Kyle. As I mentioned earlier, we are focused on what we can control. I feel we are making nice progress as we continue to drive improvement in the positioning of our business for success. I point to our recent focus on costs that will pay off in the short and long-term. Unfortunately, we are dealing with market demand issues that are both more severe than we anticipated and challenging to overcome in the short-term, specifically in CCS and OWN. There’s a significant near-term uncertainty in our markets, including macroeconomic challenges. Visibility over the next several quarters is limited. We continue to be bullish on medium and long-term demand as investments in broadband and wireless infrastructure will be significant and we will be in a great position when markets rebound.

I’d like to thank you for your interest and support of CommScope and belief in our ability to continue to drive transformative change, which we believe will unlock significant value for our shareholders over the long-term. And with that, we’ll now open the line for questions.

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Q&A Session

Operator: Thank you. [Operator Instructions] Our first question comes from the line of George Notter of Jefferies. Your line is open.

George Notter: Hi, guys. Thanks very much. I guess I’d like to start just by asking about the NICS business. I assume that some of the improved performance there is coming from better availability of components. I think certainly componentry in the Wi-Fi side is unlocked across the marketplace. Can you talk about what happened in backlog in NICS, are you getting some benefit from that release of componentry? And what type of EBITDA run rate would you guys be generating there if you’re only shipping against a more natural rate of end market consumption?

Charles Treadway: Yes, I’ll start off and let Kyle finish. Thanks for the question, George. When I look at CommScope NEXT initiatives, I mean focused on growth and profitability, I would say the NICS team performed very, very well. I mean we got cost leverage. We get a lot of cost leverage as we grow the business. Look we have detailed plans and initiatives to continue to grow the business especially with the launch of RUCKUS One and more software as a service. In terms of inventory and stuff our distributors are digesting a fair amount of inventory as the supply chain constraints improved and I would say we’re catching up on backlog. What I’d say is, the close and win rates continue to be strong in our business. There is still some constraints in our distributors for significant order rates because they would have the majority of the products for the customer solution but not all.

And these constraints are starting to alleviate in the second-half. And as those chips come in and we start to get flow to them, we expect order rates to improve as well and then the inventory will be taken down with the distributors to allow them to have more flexibility there. You know, one of the advantages we have is we’re a smaller player in the market and we feel we’re well positioned to grow with I’d say modest market share gains. I don’t know Kyle if you want to talk about the…

Kyle Lorentzen: Yes, I think on the chip side substantially better than where we were a year ago and then the second half of last year. To Chuck’s point, there’s a few areas where we still have constraints, but we would expect those to work their way out in the second half. And by the time we get to the end of the year, we feel like we’ll be back to a normalized position on chip supply.

George Notter: Got it. And then you said what the backlog was in NICS, but can you give us a backlog in NICS for the March quarter? Remind us on that number?

Charles Treadway: It was about 700.

George Notter: Okay, great. I’ll pass it on. Thanks very much guys.

Operator: Thank you. One moment please. Our next question comes from the line of Meta Marshall of Morgan Stanley. Your line is open.

Meta Marshall: Great, thank you. I just wanted to get kind of more detail of where kind of the additional $150 million of cost savings that you announced is kind of coming out of? And then on the ANS business, you guys have had some struggles in that business just as the market kind of converted to more lightweight edge devices. You kind of sound more optimistic there. Do you feel like you’ve kind of anniversaried some of that pain of that transition? Thanks.

Charles Treadway: Yes, I’ll hi Meta, I’ll take the first one. On the cost, on the $150 million of cost, clearly part of that cost reduction is we’re reacting to the lower demand here in the short-term. So we’ve gone back and taken a more aggressive view on cost in addition in that $150 million as part of our CommScope NEXT plan we had the cost initiatives that in some cases we hadn’t implemented them all and we’ve just accelerated those plans. So it’s sort of a combination of sort of new things that we came up and then there’s a portion of it that’s just us going more aggressively after some of the things that were still available to us as part of CommScope NEXT.

Kyle Lorentzen: And then related to your ANS question, I would say the team is performing very well. I mean, we made a shift in leadership there. We made a shift in strategic direction. We doubled down on some investments in R&D specifically on amplifiers. I would say the team is performing very well and we’re getting share in most of the upgrades that are going on right now. And as I’ve shared with you all before, we’re the only supplier that provides all the products to virtual CMTS, the CMTS nodes, modules and amplifiers. And I would say that our team is using the knowledge and the strong knowledge of our customer networks through our legacy products to win product, win across the breadth of our product line. And we’re really excited about our FDX amplifier work Comcast.

And I would also say that we’re very pleased with our virtual CMTS progress which is now in a customer lab for testing. So we feel pretty good about where we were and the changes we’ve made and the investments we’ve made in that business.