Belden Inc. (BDC) Earnings Call Transcript & Summary

Okay. Great. Thank you, everybody, for joining. My name is Mark Delaney, and I lead coverage of the U.S. auto and industrial tech sector for Goldman Sachs. I'm very pleased to have with us from Belden, Ashish Chand, the President and CEO; and Jeremy Parks, the SVP of Finance and CFO. Thank you both for coming.

Thank you, Mark.

Thank you.

I thought we could start on a big objective that the management team has been focused on, and Ashish you should know, has been a big priority of yours and that's around solution sales. The company has talked about 10% of revenue coming from solutions, sales as a target for 2024. Maybe just to start, level set us on what do you consider to be a solution sale? And where do you see that mix going over the longer term?

Sure. So solutions are kind of the mainstay of our new strategy. And the whole idea is that we have a fairly diversified portfolio of best-in-class products. But when we pull them together to provide the full data infrastructure for a customer that needs to deal with increasing volume, velocity and variety of data. That is a solution because it goes end to end from all the sources to the destinations of data. And yes, so we started this process in 2020, mostly on the industrial automation side. We are now just over 10% of revenues from solutions. Our goal is to get to 20% by 2028, we stated that publicly. And within that, we see opportunities for both our Automation Solutions segment as well as what we call a Smart Infrastructure Solutions segment, which is more the enterprise-type applications of hospitality, health care, education campuses, et cetera. And of course, industrial automation would be -- or automation solutions will be a little higher than 20%. Modern infrastructure would be slightly lower, but as a blended number, that's where we think we'll get critical mass.

And for it to be defined as a solution, any time is it multiple products, does it have to have software? I mean what is it -- when does it count a solution?

Yes, it's more to do with how we engage rather than exactly what we sell because sometimes the solutions process is a bit of a journey for a customer, but when we engage with the customer right from the outset where we've figured out what KPI they want to improve. And then we've impacted their workflow and data flow design to then typically provide multiple products, including services and software, but it doesn't have to be. Sometimes it's hardware plus services, sometimes it's hardware plus software. So it's some combination of things. But it's more to do with how we engage and how we construct that solution.

Jeremy, maybe I can go to you for this one. What does it mean for Belden's financial when a solution sale occurs and as they're typically recurring revenue that comes with a solution sale?

Yes. So solutions are generally speaking, more profitable than just the typical product sale, mostly because of the fact when we sell a solution, we sell higher-margin products. So we sell more of some of our active components, switches, gateways, routers, software, things of that nature. So selling solutions is a very good strategy for us to improve profitability over time. And we've seen that progress so far in the industrial business.

Belden has talked about having an ecosystem of partnerships that is utilizing as part of this solutions approach. You talked about Accenture, you talked about cloud providers like AWS and also some of the tech platform providers like Nokia. How is that affecting your ability to sell these solutions products?

Yes. So at the outset, we said that our goal is to provide the data infrastructure solution that connects sources and destinations of data. So if you think of the sources and the destinations, they tend to be either hardware or software companies that either produce or consume or both with data. So think of AWS, for example, they want more data in the cloud, but they also recognize the fact that not all data needs to move to the cloud because it's super expensive. And it might be -- it might have too much latency -- so when we work with end customers, for example, in the manufacturing space -- smart manufacturing space, having partnerships with, for example, AWS allows us to decide what data needs to move. And then we have pre-configured protocol. So think about this. There are 2 languages, so to speak, of protocols that allow data to go to the cloud. But there are typically 260 languages spoken on an advanced manufacturing shop flow. So now we convert all of that to simple language, let's call that Google Translate, for example, that's what we do. And then we port data to the AWS cloud infrastructure. So it's very beneficial for AWS to have us to do that. It's very beneficial for the customer that AWS and Belden are working together. And then recently, we talked about an acquisition called Cloud rail that allows you to set up data to the cloud in minutes literally. So it's a kind of plug-and-play product with some firmware. And that has brought our partnership with AWS event made it even more close, because now AWS can literally tell customers that if you plug in these devices anywhere within minutes, we can have your data in the cloud. So I think that's one kind of partnership with a technology vendor. The other kind of partnership is with systems integrators like Accenture because whilst we want to do the architecture of the solutions, we don't want to do the implementation. That's not really our expertise. So the way to think about it is that we are producing fabric that needs to be tailored to a particular customer's sites. And I think we have a really good partnership with SIs, including with Accenture to do that.

Belden recently acquired Precision Optical and Voleatech to enhance its solution capabilities and offerings. Can you speak to how integrating these companies has impacted your customer engagement? And how has customer feedback has been?

Yes. So 2 different acquisition thesis. Precision Optical really is a company that supplies very high-quality, high-end optical transceivers into the broadcast -- sorry, into the broadband service providers. So what Precision Optical does is they have hardware and software going into the data center of a broadband company, but also into the equipment in the cabinets in the field. And then our legacy broadband business does everything in the middle of those 2 points, right? So now when we combine that we are able to go to the customer with a full solution saying, "Hey, we can help you reduce your loss or improve your efficiency across this entire channel and Precision plus Belden together can do that for you." Plus they have a number of customers that we get access to. So I think that's really very interesting in terms of growing our fiber footprint, growing our customer access. Voleatech, a much smaller company, they do an amazing software interface for all sorts of firewalls. And we realized at Belden that since we had a number of different brands that had come together to form Belden Solutions, we had slightly different software interfaces for each of our active products. And we decided to build a unified software platform. But now we don't need to because we acquired this company, and we can use that software. So it's kind of taken our R&D process. It's taken it 3 years ahead. So different thesis, but again, very good feedback from our customers. Even before we acquired Voleatech, we had already started working with them as partners. So our customers were exposed to that. Very exciting for us.

That's great. At your Investor Day in September, Belden highlighted a road map to increase Belden Horizon installs within its solution sales. Can you provide some color on where the company is currently with Belden Horizon and help us better understand how customer traction is progressing?

Yes. So let me take a second here to just talk about what Belden Horizon is, and then we'll talk about where we've reached with that. So we talked about the fact that there are multiple sources and destinations of data. This is a big challenge for customers across industries, whether it's in manufacturing, mass transit, health care, whatever you -- whichever vertical you go to. And there is no -- even if you buy equipment from end automation providers, there is no single orchestration platform where you can say all my data is accumulated in 1 place, and I can then hand it out to different people to process. So that's what Belden Horizon does. It's basically a data orchestration platform that sits on top of all the hardware and consumes all the data. And it could be something as simple as making sure that all the temperature data is in one unit of measure like Fahrenheit or Celsius. It could be something as simple as that, or it could be, we have vibration data, we have video data, and we have sound data, and it needs to be sent to different clouds, because there are different applications sitting in different clouds that need to process that, right? So it could be something as complex as that. So Belden Horizon does all of that orchestration. So the reason we built it was not to start selling software stand-alone. But basically, as a rubber-band around our total hardware plus software offering, because we would go to customers with a solution, and they would say, "Yes, this is great. You guys are able to bring data from all sorts of places, I don't know where to put it." Because if I put it in that data lake, then I can't serve it to another automation vendors requirements. So how do we make it really universally available. So we introduced Belden Horizon about 2, 3 years ago as a very basic data orchestration platform. And now we had a lot of interest, by the way. So in our sales pipeline, a very large proportion of customers have now started working with Belden Horizon as their data integration platform. We've seen a number of successful implementations to more recently in the last 6 to 9 months. But coming up soon is a new version that will also incorporate some AI features and that allow a lot more autonomy in terms of how customers data is orchestrated. They won't have to like have a person doing orchestration. The system will do it for them based on set parameters. So that's kind of the next version. And again, a lot of customer excitement around that.

And Horizon, would that product be applicable to both smart buildings and industrial customers? Or is it more tailored for one kind of environment?

No. It's actually the one layer we have, which is fully interoperable. So in fact, one of our recent Horizon sales was to a hospital system where in a hospital, if you think about it, every device that monitors the patient's health in a hospital speaks a different language, a different protocol. And there was a big hospital system here in the U.S. that said I want all of the data on one screen so that somebody can easily see if the patient is healthy or not, right, versus having to look at like 5 different devices. So Belden Horizon was brought into that orchestration requirement. So yes, it's applicable across all our verticals.

Really exciting to see the traction you're having there. Maybe we could pivot a little bit and speak to some of the end market trends. As of your last earnings report, the company had seen order growth sequentially for 4 consecutive quarters and discuss general stability and order patterns. Can you provide some color on what you're seeing currently in your end markets?

Maybe Jeremy can start and I can chime in.

Yes. Yes, sure. So I think in general, things have been progressing pretty well as we've moved throughout 2024. Remember, we had this destocking that was relatively widespread market-wide and across our different end markets that started in the second half of 2023. Since then, we've seen progression, like you said, every single quarter, we've improved sequentially in orders. On a year-over-year basis, I expect that will be up pretty substantially in the second half of the year 2024 versus 2023. We're not quite back to where we were in the first half of 2023 before this destocking happen. But again, I think we're making nice, steady progress every quarter. And our perspective would be that, that is mostly because we're getting through this destocking. So we're getting -- we're closer to the end than we are in the beginning. And I think the good news here also is that it's not just one business that's improving. All 3 businesses have gotten progressively better as we move throughout the year. So in general, I would say we're optimistic. There's still a little bit of uncertainty for 2025. We don't have perfect visibility, but things continue to move in the right direction. So I think in general, we're pretty happy.

Yes. And if I can just add, as Jeremy said, we are optimistic. Of course, we are also cautious. We are looking at the environment around us. But if I think of a more medium-term view, right, which is, let's say, over 2, 3, 4 years, one of the defining problems and opportunities of our time is around reshoring and reindustrialization. So everybody talks about reshoring, but we don't have enough workers to make all those products that we want to reshore. So unless we elevate the productivity of those workers with automation, edge compute, AI, it's unlikely that we can attain that capacity or capability, right? So I think a lot of companies. A lot of our customers across the spectrum whether they work in manufacturing or whether they work in hard infrastructure like mass transit or whether they work in soft infrastructure like hospitality, health care, et cetera, all of that, people are now realizing that they just don't have enough labor, whilst they're also dealing with elevated cost of capital, I know they're coming down, but it's still elevated and whilst they have this pressure to increase capacity, right? For example, we called our plant manager in Richmond and said, "Hey, we want to make much more in the U.S. And he was like, yes, but my machinery is all very old, and I don't have enough people, right?" So we had to actually do digitization in our own plants, which is a great project, by the way. But we can take -- we can see how capacity can increase by maybe 15%, 20%, 30% in existing infrastructure. So this is I think what we are seeing right now, of course, is the end of destocking, but we're also seeing the beginning of this whole reshoring reindustrialization phenomenon. And again, in the medium term, we are extremely optimistic.

Jeremy, you said you're most of the way through destocking. Maybe help us better understand how you're assessing that and to what extent the additional destocking that might be needed?

Yes. So first of all, I'll say we don't have perfect information. I think we do sell through distribution. So as it pertains to our larger distributors, we do have good information. And we have seen inventory turns go up and days of inventory come down over the past year. So that is an encouraging sign. And roughly where we were before this -- before even COVID happened. So I think we're in a good spot with respect to distribution maybe a little bit of noise could happen as we go into year-end. But I think in general, we're in good shape. Where we don't have perfect visibility is beyond distributors, right, because we're selling to a pretty complex value chain distribution, OEM customers, machine builders and so forth. And so we don't have perfect information there. But I think the trends in general, again, are pretty good. So what we're seeing is POS point-of-sale information from our distributors is improving every quarter as well, which I think is an indication that their customers are getting through the destocking as well. So again, information is not perfect, but we've calibrated multiple data points that make us believe we're getting towards the end.

Maybe remind us how much of your business goes through distribution?

So most of the business goes through distribution with the exception of our broadband business, which is mostly getting sold to MSOs and telcos. Outside of that, virtually everything else is getting sold through distribution.

And any regional differences you would call out as you think about U.S., Asia, Europe?

Yes. Me or you?

No, go ahead.

Okay. So yes, in general, I would say that the Americas is probably the best performing right now. So actually, we were up year-over-year in the Americas in the third quarter, organically. So we're in good shape in the Americas. Asia is a smaller market for us. It maybe 15% of total revenue, something like that. China, in particular, is pretty small. But I would say Europe is probably the most challenged area or region right now. So Germany has been pretty slow. PMIs are still in the low 40s in Germany. So in particular, we've seen a little bit of weakness in discrete automation, and we've seen weakness in Europe.

Ashish, you spoke a little bit around the elections and what that might mean for reshoring. Maybe you can double click on that. I mean, are you having those kinds of conversations with customers already and seen some momentum on that front? Or is this more prospective and something that might happen next year?

No, it's already visible in our pipeline. So I think even preelections, most of our customers were convinced that whatever the outcome of the elections, there's going to be a need for reshoring, whether it came through kind of an incentive-driven framework or a disincentive driven framework, tariffs, whatever, people knew that they had to invest. But there was some uncertainty. They were waiting -- I think they were also waiting for interest rates to normalize a little bit. But our pipeline for solutions at the end of September was 30% higher than at the beginning of the year, right? So it's really grown a lot. And we have a far more stringent way of measuring pipeline now that we do solutions, when we used to do products, right? So the stage gate process is far more stringent and conversion rates are actually pretty high. Especially when a customer has visited our CIC and done a validation. By the way, the CICs are our customer innovation centers, where we bring in customers to tweak some of the hardware and software elements of the solution, so we can validate that full solution for their applications. So really, pipeline has grown a lot. We see across -- so it's a little muted even now in typical discrete manufacturing, still a little muted. But across the board, if I look at power transmission and distribution, mass transit, health care, hospitality, if I look at some of the process industries, there's a lot of planning going on right now to increase capacity starting 2025. Now will some of those companies wait and see what happens to tariff policies exactly and before they kind of start digging. That is possible. There is still a little bit of speculation going on. But I think for the most part, everybody is going to go pretty hard starting '25.

I just want to make sure I heard correctly 30% increase in the pipeline for solutions that's over the last year?

That's between Jan 1 and September 30 this year.

Okay. And then you mentioned tariffs and that potentially being a challenge. For Belden specifically, help us better understand how much of your footprint is down in Mexico?

Yes. So first of all, we make within region for each region, largely, right? 90% of what we make in the region is what we consume in a region has made in the region. So we do have a footprint across the Americas. We have manufacturing in Canada, in Mexico and in the U.S. And the largest portion of that is in the U.S. And recently, I don't know whether you remember, but we built a new fiber facility in Tucson. We built a new facility for active products in North Carolina and Cornelius. We expanded our facility in Richmond in terms of the capacity. So yes, we do make products in Mexico, especially for our Smart Infrastructure Solutions business. But these are fairly -- it's fairly easy for us to move them around within our footprint because our plants are large and they have multiple product categories being built there. So for example, we could move some of that to Richmond. So we are starting the tariffs carefully. We have a team that's working on it right now. We don't obviously want to do anything knee-jerk. So we're going to let this whole thing evolve. But at this point, our assessment, our considered view is that we can manage the impact of those tariffs within our process, including with some pricing, and we are not necessarily worried about it. And we have levers to pull, like I said, in terms of moving to production.

Okay. Very helpful. Hoping to better understand the company's exposure to the federal government vertical and maybe talk about your outlook for that end market.

So very small. We have a couple of small businesses that do work with military and aerospace, those kinds of things. But generally, our exposure to federal government is very, very small, like in single digits.

On your broadband end market, the company has previously spoken about tailwinds tied to RDOF and BEAD funding maybe better help us understand what you've already seen from some of those programs, what might still be to come and how impactful some of these stimulus measures might be for Belden.

Yes. We haven't seen anything from BEAD as yet. I don't think generally, the market has seen anything. We see that more as a second half of '25 start. We've certainly seen the benefits of the RDOF funding. And if you look across the usage plans that we have discussed with our MSO customers so whilst there was a destocking phenomenon, there hasn't been really any reduction in their rollout plans, whether it's in terms of new homes passed or whether it's in terms of increasing the speeds by deploying more fiber or more technology around DOCSIS upgrade. So our usage -- our sales to them adjusted for inventory are tracking those usage plans they had. There is a big move right now to upgrade speeds and this is one of the reasons we did the acquisition of Precision so that we can be more involved in that whole electronic design process in the channel. But yes, I don't see, at least for the MSOs, any change from their longer-term plan. I know for the telco market, it's been a little more lumpy, but our exposure to telco is very small.

I know broadband in the past has been a market that's actually had some of the bigger inventory fluctuations. I know Jeremy, we've already spoken around inventory levels and you guys felt like things were pretty well calibrated. Is that also true for broadband?

Yes. Yes. I think we've made great progress. Actually, broadband is one of the businesses where we've seen the most sequential growth as we move throughout this year. So I think we're in a good spot with cable operators at this point. I don't think there's much more to do. Again, fourth quarter is always a little strange from an inventory management standpoint, but in the grand scheme of things, I don't see that there's really much to go. I think we're in good shape.

And just as a reminder, Jeremy said reminded me. So the broadband bookings growth in Q3 was sequentially 12%, excluding precision, right? And it was also positive, the quarter before that.

What do you mean by markets can be strange in the fourth quarter?

So we feel completely -- we feel great about our guidance right now for the fourth quarter. My only point is that sometimes like you see exaggerated inventory reductions in the fourth quarter as companies customers manage cash. So we'll see some inventory reductions, but that's already factored into our guidance. There's no new information here.

Okay. Yes. I just want to make sure I understood what you meant by strange. The smart building market has been affected by the remote work shift. How is that business tracking? And to what extent are you seeing strength in data center and including on-prem data center?

Yes. So to be honest, our data center business is still small, a lot of upside here. We've generally avoided the hyperscalers because those are not really high-margin opportunities for us, even though they're high growth. So we have a very focused data center team that's been put in place. Our goal is to go to data center opportunities with a full solution around. Apart from what goes inside the data center, which is called the white space, there is a whole gray space opportunity around substations, so providing the data center with electricity, security, HVAC, et cetera. So we're going to data centers and saying that by combining smart infrastructure and automation technologies, we can give you a full solution. And we've seen increasing traction with that because people that are building data centers right now are very, very concerned about how they would supply it with power, right? That's a big problem. But smart buildings as a whole -- the good thing that's happened for us over the last 2, 3 years is we've reduced our dependence dramatically on the commercial real estate piece, which is now -- so smart buildings is about half of the -- or about 40% of the Smart Infrastructure Solutions segment, which is about 45% of Belden. And within that piece of smart buildings, commercial real estate is now less than 20%. So overall, for Belden, it's like 4%, 5%. It's not a big exposure. Our bigger focus is on hospitality, health care, education campuses, warehouses, and then also getting smart building products into manufacturing, mass transit, power transmission and distribution, et cetera. And those are doing reasonably well for us in terms of growth opportunities.

You mentioned on the last earnings call as well as today and some of our conversation about the energy business being an attractive opportunity for you. And in the past, I thought of Belden as more of a data automation kind of exposed company, but we keep hearing around energy. So maybe help us better understand what you're doing there. Are you guys selling high-voltage cables? Or is this more managing the back end of the data to power smart energy.

Yes, yes. So we are not doing high voltage cable. So just to make sure that there's no misunderstanding. Our focus is on the edge compute and data management in a smart grid, so what we call the power transmission and distribution area. So in general, there is adequate energy being produced in most markets. The inefficiency is in the distribution process, right? And there are a number of reasons for that. One could be simply matching where energy is produced to where it's required. The second thing is with renewable energy, there is a kind of peak that takes place during the day and then it kind of goes down at night. So there is a curve that has to be dealt with. And then, of course, there is some kind of dynamic requirement where some places that could consume energy could also then produce energy and send it back to the grid when they have a surplus, right, because they have their own generation. So there are these dynamics that have to be managed. And this needs a lot of data integration. It's a very, very complex process. So -- and a number of the grids that we have across the world, including in the U.S. still have a lot of analog kind of products in that data integration process. So for example, we had a customer in Spain where if they had an outage in their grid, it could take them 140 minutes to find where it was because of all the analog equipment that was deployed, right? So we're going in and modernizing and digitizing all of that grid and this is a huge market opportunity for us. And we have, by far, the most comprehensive portfolio in terms of active products, passive products and software to solve that problem. A lot of these energy grids are also moving away from the old SONET/SDH communication systems to IP and as this transition is happening, that's a great market opportunity for us. So again, no high-voltage cables. I think of that sort, it's all data integration.

Okay. That's very helpful. A couple of financial questions, if I could, to close out the session. Maybe first, Jeremy, you can help us better understand the price cost trends that Belden has seen in the business. And maybe talk about how much inflationary pressures there may be that you're dealing with in areas like materials and labor?

Yes. So for sure, we have seen the rate of inflation come down over the past few years. It was pretty high in 2022, 2023. That's come down at this point. There's still price increases that we're seeing in various markets, especially on electronics. We see that to some extent. For the most part, commodities like copper and other metals and things of that nature, are -- have been coming down lately, which is a good thing. I think we've, in general, our policy or our approach has been to manage prices along with these commodity price changes or increases in our input costs, and we've been pretty successful over time passing those through. I think we have a good process in place to take action quickly. And like Ashish just mentioned, tariffs are another area where we could see cost inflation, and we'll have to evaluate price increases to manage that as well. So I think we're on top of it. Up to this point, we've had good success passing that on. I think looking forward, the opportunity for us then is to continue selling solutions and continuing to do more value-based pricing even, which I think, hopefully, will be a little bit of upside for us over time.

You've articulated an $8 earnings target for 2025. I mean that was as of a prior Investor Day, but you've maintained it at your most recent Investor Day this fall. The companies spoke about different pathways to potentially hit $8. Maybe talk about any pathways that are more or less likely? And do you still feel like $8 is achievable?

Yes. I think it's achievable. As we said, it's a path to get there. We're not guiding for 2025 at this point, because I think there's still uncertainty. We're still not back to where we were completely in the first half of 2023. But to answer your question, the bridge from where we are today to $8, I think the most likely path is that we see growth, right? Think about maybe mid-single-digit growth of where we are in the second half of 2024, probably 30% incremental EBITDA margins and then some amount of capital deployment in 2025, that is a path to get there. It requires the economy to continue to get better, it requires you to get through this destocking completely. Like I said, I think we're close to the end on that at this point. But I think that's a very realistic path. We'll just have to see how the economy evolves and what tariffs could do or other policy changes, how those could impact the economy. But in general, that's the way we're thinking.

And maybe just lastly, you mentioned capital allocation. Any specific plans for cash deployment as you think about the next 12 to 24 months. You just did a couple of acquisitions, I mean, is there appetite and room to do more?

Yes. I mean, we could certainly do more. We generate good cash flow in this business and leverage is not excessive right now. We're right around 2x net leverage. If we deployed no capital, we would be clearly under the 1.5x target by the end of next year, which means we could deploy capital. Certainly, we could deploy the free cash flow that we generate in 2025 and beyond and still be in a good spot. With respect to the priorities, we talked about them in Investor Day a couple of months ago, number one, organic opportunities, CapEx and products; number two, M&A and #3 share repurchase.

Well, great. We'll have to leave it there. But Ashish, Jeremy, thank you both for joining us.

Thank you very much.

Thank you.