Vistance Networks, Inc. (VISN) Earnings Call Transcript & Summary

All right. Great. I think we'll get started. I'm going to start with some disclosures here. Please note that all-important disclosures, including personal holdings disclosures and Morgan Stanley disclosures, appear on the Morgan Stanley public website at morganstanley.com/researchdisclosures or at the registration desk. I'm Meta Marshall. I cover the networking space here at Morgan Stanley. We're pleased to have Alex Pease, CFO of CommScope, here with us today.

And so I think we'll kind of jump right in, maybe kicking off how we kicked off most of the sessions this week of just kind of asking for any updates on the coronavirus guidance that you gave. You had noted a $60 million kind of impact of coronavirus at earnings. Any change to perspective or just how you guys are thinking about the potential impact.

Sure. So first of all, thanks, everybody, for coming, and thanks for your interest. On the specific question, what we've said when we reported the quarter was $100 million a year top line impact and a $60 million a year bottom line impact. Really comes from 2 primary sources. The first is essentially a quarantine that was in place in China. So we had our 2 manufacturing facilities in China. Basically, we couldn't start up again after the new year. When we gave that guidance, they were just beginning to come back online. They're now back about 70% to 75% capacity. So things are ramping back up on a much more normalized basis, really in line with our expectations. So we were anticipating them getting back to full production by the end of February, and we're largely in line with that. The other big area of concern was raw material that's being sourced from China and being used to feed factories outside of China. So these are things like printed circuit boards, the metal pieces and parts, all of that. And a lot of that is obviously manufactured in China. So to the extent we saw supply chain shortages feeding the factories outside of China, we had some concern there. In fact, we actually haven't seen any of that materialize. So our outside factories there are operating at about 90% capacity. We've seen no supply chain logistics issues. So on balance, it feels as though that was more of a worst-case scenario, and it was largely a timing-related issue that we expect to recoup over the balance of the year. But as everybody knows, this is a really uncertain, uncertain time, and I don't think anybody has a very good insight in terms of what the longer-term implications could be.

Got it. And then maybe we can dig into kind of where things have maybe not turned out exactly as planned. But I want to just -- how do you restate the rationale for the ARRIS acquisition and just like how you saw that acquisition as being critical to kind of part of a vision of what 5G look like?

Yes. So I think there's a handful of areas where we thought the acquisition would make a lot of sense. So probably the area that we're most excited about and continue to be very excited about is in the whole intelligent enterprise space. So as most folks are aware, with the 4G revolution, that investment cycle was a lot about mobility everywhere and giving people access to their cell phones and their data as they went around the community and the world. In 5G, it's all about basically what -- how the technology unlocks productivity in either the enterprise space or the consumer space. And about 80% of cell phone traffic happens in-building. That's going to grow to about 85%. That's going to be used to unlock all of the industrial IoT. So basically, being able to deliver on an in-building wireless intelligent enterprise solution to us is a huge revenue opportunity, revenue growth opportunity as 5G begins to be deployed. I think we are more excited now even than when we did the deal. When you think about the intersection of our licensed spectrum expertise, so all of the LTE expertise, the unlicensed spectrum, which we inherited with Ruckus, the introduction of CBRS, bringing all that together and then connecting all of that with our structured cabling and fiber products, we think creates an opportunity to really unlock this potential of the intelligent enterprise, private networking opportunity. The second really underlying thesis of the deal was that scale matters as you serve the cable operators. And the cable operators have an increasingly relevant role to play in 5G, whether it's enabling the connected home and the consumer, or providing a structured cable or wired backhaul for the MVNOs. And our view was that the combination of the active electronics that the Network & Cloud business represents, this is the CMTS or the CCAP part of the portfolio, integrating with our hardened connectivity, fiber cable, copper cable and the ability to provide an end-to-end solution, whether it's a DOCSIS network, a Full Duplex network or fiber-to-the-home architecture, our ability to play at scale across the end-to-end broadband network is extremely relevant. And again, we've heard a lot that makes us more excited about that portion of the thesis than ever. And then the -- really, the third element of the deal is all these opportunities that 5G portends as it relates to the next super cycle of investment and our ability to be kind of the world's most relevant 5G pure play. You think about -- I talked about the industrial IoT. There's the whole consumer-driven IoT, which we unlock through our broadband gateways. You talk about the battle between the telco operators and the MSOs and how the MSOs try to maintain increasing relevance versus the telcos, and the telcos try to disintermediate the MSOs. We really play in all aspects of that battle as 5G investments begin to really take shape. So those are sort of the top 3 reasons of the deal, which, despite the fact that we are off to a softer start than we would have anticipated, none of that potential that I just articulated has begun to be manifested in the marketplace. So we still feel like we're sitting at the front end of a wave of investment that could be very exciting for the company.

So customer CapEx has certainly been more constrained than expected. Simon then had AT&T, Verizon, Comcast, Charter kind of all speaking today, none kind of speaking about robust kind of CapEx spend. And so what do you think kind of triggers or becomes the catalyst to kind of restart investment or more meaningful investment? Is it mid-band auctions? Is it Sprint/T-Mo approval? Just how do you view kind of a loosening of wallets happening?

Yes. So I think it's -- there's a number of things that you can envision happening. So first, let's talk about Sprint and T-Mo because that's a huge opportunity. And so I think what they've said publicly is they're reaching a level of scale to rival the same scale of network that an AT&T or a Verizon has today. So really, for us, they go from being a distant third in terms of the amount of capital spending they have in our portfolio of products to something more like a 1 or 2 customer. You also look at the amount of spectrum that, in the mid-band, that Sprint has been under-investing in over the course of the last year and the need to light those -- to light that spectrum up. I think one of the public comments from T-Mo was an intention to climb something like 40,000 to 50,000 towers once the deal gets closed. So you think about that. You think about the fact that AT&T has largely built out its LTE network and is now in a more of an optimization stage in advance of 5G. Well, does this accelerate the introduction of the C-Band auction in the midrange? And does that then generate a next wave of investment? All of that happens on the telco space on the heels of the Sprint/T-Mo transaction. And then I think what's even more exciting is that, that creates another competitive threat to the MSOs. And so the MSO CapEx commentary has been largely consistent with the telco CapEx commentary of sort of flattish year-over-year. And a lot of that is because there was this pre-investment in capacity on the heels of Google Fiber. Well -- and there's not a competitive threat, so they can really sweat those assets, which they did in 2019, and we're anticipating them doing in 2020. Well, as Sprint/T-Mo begins to light up their new spectrum, that creates another competitive threat for the MSOs, which then generates a new wave of investment there. So I think it's very exciting for us. We think we're pretty uniquely positioned to take advantage of that. We have very strong and deep relationships with both sides, and we sort of stand ready to enable their investments once they're ready to make them after the close.

Got it. And so maybe just veering in on that. I think investor feedback that I got was, "Well, why did the tower guys sound fantastic?" And why do you guys say, "Oh, if the spending starts, we'll see it." And so what was really kind of the disconnect between being more bullish potentially kind of around Sprint/T-Mo?

Yes. I mean I think what we have been trying to do is make sure we're establishing expectations in line with what we're hearing from the customers and what we're hearing from the marketplace. And our commentary was based largely on a plan of record that T-Mo had shared with us. It's probably important to note that all of their spending in 2019 occurred in Q1 through Q3. Q4, they basically didn't spend any money, and they made this announcement publicly that they weren't going to continue to invest in the network until they got the uncertainty around the deal behind them. Q1 has looked largely similar to that, at least, Q1 to date. And so as we looked at it, we said there's going to be -- it's not a question of if, it's a matter of when. But there's going to be a certain amount of time once -- we don't even know when they're going to close the deal, but let's say they close it in April or late April or May. It's going to be a certain amount of time to just compare networks, develop a capital deployment strategy, get people mobilized, get the permits in place, all of the kind of prerequisite activity. That then takes you into the second half of the year. So we do anticipate growth in that portion of the business year-over-year. We just anticipate it to be more back-half weighted and then lead to a real catalyst in 2020. And we have the inventory, we have the manufacturing capacity to the extent they're able to mobilize more quickly. We're certainly able to capitalize on that. But I really think it's just a matter of timing as opposed to perspective on what it portends for the future.

Okay. And then maybe kind of the other, call it, bull case scenario is that this really does go forward with the point in a network. And given that it would be greenfield, are there -- are your technologies aligned with how they would potentially build the network, assuming...

Yes. So we absolutely have the relevant technologies to serve them. And I think the real hope is that they become a fourth operator and introduces some more competition in the telco space. There's also some speculation or conversation that this becomes part of a fixed wireless play. And so this creates another competitive threat to the MSOs, which would be advantageous to our business. I think, again, it's not a question of whether or not we'll serve them. We have very strong relationships with them. We talk to them about the technologies we offer. We're well positioned to take advantage of that. It's a question of timing. Building out a greenfield network, as you probably know, is much -- takes much more time than building out a brownfield network. Because in addition to all of the network design considerations that need to go through the system, there's permitting, there's site access, there's getting power to the site. There's all of the basic kind of infrastructure build that has to happen before you just put antennas out there.

Okay. So OneCell has been one of the more exciting opportunities that you guys have talked about over the last year, particularly with AT&T kind of approving that technology. What is the size that opportunity could be over the next couple of years and just explain maybe what the primary use cases?

Yes. So this connects back to the opening commentary around the intelligent enterprise. And so the big challenge that you have, as you get into shorter and shorter wavelengths inside the building and in the enterprise space, is in-building propagation. And what's really exciting about OneCell is it provides a very, very cost-effective ORAN solution for in-building wireless coverage. We layer on top of that the Ruckus unlicensed technology. And now you have a mesh network technology that can provide sort of end-to-end comprehensive in-building coverage. And it's performed much better than even anticipated in the early trials. The exciting piece of the business is that, that is one of the core growth areas as you think about private networks, you think about, again, the intelligent enterprise space. You think about in-building coverage, and we're able to do it now more cost effectively than anybody else in the industry. So that's sort of the first piece. The second piece of the equation that's exciting is if you look at our next-generation distributed antenna business. This is one of the real hotspots of growth for the company. So this allows you to cover the really big venues, think about the Super Bowl Stadium. So now you have real big venue coverage, you've got more medium-sized enterprise building coverage. You really can cover the entire enterprise space in a way, again, that nobody else in the market could. You asked how big could that business be. Our view is that it can be every bit as big as our macro cell business over time. Again, you think about how in-building is going to grow relative to macro cell over time. And then the last piece of the equation that's exciting is as you think about public safety applications, you have to be able to communicate from the in-building, where the public safety events likely to happen. The first responder has to be able to communicate from the in-building to the metro cell layer. We now have both sides of that equation. We have the metro cell, we have the in-building and we're working on ORAN-based solutions to basically provide that interface. And again, that's one of the areas that's going to be a big area of growth in 5G.

Got it. And so maybe stopping on to the kind of previously known as connectivity business with the fiber, fiber builds being kind of extensive over the last 3 to 4 years, but seems to be going through at least a little bit of a pause on the fiber-to-the-home side. What recatalyzes that spend for you? Or is it simply a matter of a large build is done and we're now kind of at a more static level?

Yes. So we continue to see strong growth in the -- and I think what you're referring to would be the business we used to call outside plant fiber. We also have referred to it as network cable and connectivity. So this is the hardened connectivity that basically connects the fiber to the neighborhood, essentially, is the way to think about it. We don't provide the long haul fiber. So we continue to see strong growth in this business, both on the fiber cable, copper cable and the hardened connectivity side, predominantly in Europe, as they continue to push fiber deeper and deeper into the network. And we also see it in a lot of the rural buildouts, where we're continuing to deploy in those networks. The primary area of softness is largely related to the communication that AT&T has made on U-verse and DIRECTV. So stopping the U-verse investments. That's been an area of some softness. And then obviously, Verizon has gone a little bit more slowly in terms of their fiber-to-the-home deployments. And so those 2 areas have been soft. But overall, we anticipate that business being up year-over-year.

Got it. And so maybe turning to the cable business, which saw a large contraction last year, and the industry is also going through some architecture decisions in addition to maybe just kind of overbuilding in 2018. Do you feel like we're coming to a decision process or kind of capacity constraint where we could see spending again? Or is it going to take a competitive threat from fixed wireless to really spur meaningful investment?

Yes. So probably a little bit of both. So what we continue to see, bandwidth demand growth in the order of 30% to 50%. So the underlying drivers of demand continue to be there, and we continue to be excited about that. Really, what drove the slowdown in '19 was, call it, 3 elements. The first was this overbuild that you mentioned related to Google Fiber. It will take us 2 to 3 years to work through that capacity at 30% to 50% growth. So that gets you to a return to more normal growth levels in kind of 2021, 2022 time frame. The second was the evolution of virtualization and a question mark on how different network operators' virtualization strategies were going to unfold. And so obviously, there's a large operator that has a partnership with one of the competitors of ours that had some early successes in virtualization. There were some question marks on how that would unfold. We're now in the market with a fully virtualized E6000 chassis. We're testing that with operators as we speak. So we think, to the extent operators are moving towards virtualizing their networks, we're very well positioned to capture that and we've gotten very positive customer feedback. Because remember, our virtualized solution builds on 20 years of feature-rich code. It builds on industry leadership. It dovetails seamlessly with the legacy investments that they've made in both their access nodes that we provide as well as the legacy E6000 chassis. So we feel as though we're building off an installed base that's going to be remarkably competitive. And so a lot of that headwind, while it continues to be a competitive dynamic, we think that sort of log jam has been removed. And then the last piece of the equation is really the role of what the next generation of capacity introduction is going to look like. Will it be a Full Duplex architecture, will it be Extended Spectrum? Will it be some hybrid between the 2? And ultimately, CableLabs has come out and just said that it will support both architectures. Full Duplex has the disadvantage of being very expensive because you have to go to a Node-Plus-Zero design. So certain operators will decide that they are willing to make those investments ahead of when they're necessary. Others will choose an extended-spectrum model. We're actually designing both. And I mean, against all that backdrop, there's been other players that have communicated they're exiting the industry and not supporting Full Duplex anymore or Access Technologies anymore. So we feel as though there's opportunity for us to come in and take an even stronger leadership position than we had in the past.

Got it. And the CPE business is another kind of area where both investors talk about as well as analysts ask you about as well of it will always kind of be a headwind to growth. You're the only kind of multi-purpose vendor left in the space. Just how do you think about the investments that you're making here? And does it always need to be a part of the combined CommScope?

Yes. So this is probably one of the areas that, when we talk about the underlying deal thesis, that has been different from what we originally intended. There's no question that the over-the-top cord-cutting trends have impacted, I think, the entire industry more dramatically than anticipated. And that has had a material impact on our video business and, as a result, our margins because video business carries a higher margin profile than the broadband business. On the other side, this is a strategic product portfolio for our customers. And it brings with it a significant pull-through of other products that have a different margin profile and are really important for the underlying growth thesis and margin and cash generation potential for the business. So we have to be very careful in terms of how we invest in the strategic choices we make because we don't want to impact the rest of the portfolio. So what we've said publicly is that we're committed to the business as long as we can make money in the business. And I think there's a review that we need to do, which is looking at every single dollar of R&D that we're spending and figuring out where those R&D dollars are not generating productive revenue and think about harvesting those and redeploying those R&D dollars to other investments that are generating higher returns. And so that work is going on. Overall, it generates good cash, and we use that cash to pay down our debt, which is one of the reasons why you've seen better-than-anticipated debt paydown trajectory over the course of last year. But that is a business that we're trying to manage quite closely because there's no question that the decline has been more dramatic than what we anticipated.

Got it. And so you mentioned, kind of bringing it back to the enterprise solutions and the unlicensed spectrum, the CBRS have been a potential driver of Ruckus for kind of multiple years now. How do you think of this being an opportunity? And when could it be more material for you?

Well, so the good news is we have our first dollar of CBRS revenue. So that's exciting. And we feel as though we have a really interesting portfolio of technologies. The real catalyst in CBRS deployment is going to be the introduction of CBRS-capable devices. So that's really going to be the leading indicator. We think that those begin to come to market about the end of this year. We're going to be in a position to deploy networks that support those devices. We're in active conversations with a number of enterprise customers around how they can use the CBRS band to introduce their own private networks and some of their infrastructure as a service strategic investments. None of those have gained the level of scale yet to be meaningful in the context of the full business, but we are excited about what that opportunity has for us in the future.

Okay. And the leverage brought on about on the ARRIS acquisition was meaningful and has become only more sizable kind of on a net leverage basis as EBITDA has contracted due to some of the things you already mentioned. How do you think about extracting synergies out of the business to pay down debt? And what flexibility do you have around that debt over the coming year?

Yes. So the good news is, I think we exceeded expectations in terms of cash generation. Certainly, in the fourth quarter, we'd given expectation of $100 million, and I think we've beat that by north of $200 million. The nearest-term maturity is the 2021 tranche. That's now down to just $50 million in that tranche. We will largely pay that off either late Q1, early Q2. So we'll have completely derisked the balance sheet at that point out until 2024. So that's, I think, the first thing that's important to point out. The next piece that's important to point out is that we don't have any maintenance covenants. So it's a very covenant-light sort of borrower-friendly package. And we continue to generate strong cash flow. So on a sort of normalized basis, it's about a $600 million a year cash flow generator. So all that's good. One thing, as I mentioned that is we guided $400 million a year this year. The reason for that is because we're anticipating ramping to growth in the back half of the year so the balance sheet becomes a use of about $155 million against that $600 million kind of normalized rate that I pointed out. So really, it comes all about driving EBITDA growth and then driving cost performance. We're on track to over-deliver on the synergy target that we've communicated. In addition to that, we're taking aggressive other cost-saving actions. Most of the over-delivery on synergy has happened within kind of the G&A lines. We're now taking a harder look at the R&D piece, making sure the R&D investments are generating the returns that we anticipated. Within cost of goods sold, we've made some moves to consolidate factories and really optimize our contract manufacturing footprint. So you'll see some improvement on the gross margin line, and all that should contribute to better earnings power for the business. In terms of the last piece of your question, what flexibility do we have on the debt. We obviously have full prepayment flexibility on the term loan. The long-dated bonds are callable, so we could refinance those if we wanted to, to take advantage of the lower interest rate environment. I think if you were to do that analysis, you'd find the rates on those bonds to be pretty attractive now. So I'm not sure that, that trade would make a lot of sense. The other earlier tranches are non-call, so there's not really any flexibility to refinance those and take advantage of this. We are looking at some opportunities more on the interest rate swap side to take advantage of some of the lower interest rate environment.

Okay. Got it. And you mentioned last quarter that you were going to increase investment on certain OpEx areas or certain R&D areas potentially capitalizing on opportunities like active antennas and Open RAN. Just how should we think about quantum of investment that needs to be done as well as when could those opportunities be more material?

Yes. So I think what we said was something like $50 million to $60 million of incremental R&D. But probably important to note that what we said on the -- when we closed the deal, was about $800 million of combined company R&D. So the total R&D spending this year is going to be, in 2020, is going to be in the order of $790 million, give or take. So we're basically at the expectation that we set when we did the deal. 2019 was a bit low. We had the softness in the Network & Cloud business, and we had the softness in the CPE business. So we moved pretty aggressively to take cost out of the system, given what was going on in the top line, and we didn't see the positive ROI. We did choose to redeploy some of that cost takeout in the growthier areas that you mentioned. So redeploying in active antennas, redeploying in open RAN, redeploying in the OneCell product offering, redeploying in the virtualized solutions, looking into Ruckus, and redeploying into the cloud and more advanced analytics and Wi-Fi 6. So all of these are investments to position us for that 5G opportunity that we talked about at the opening portion of the conversation. In terms of when they pay out, they'll pay out in the sort of middle-ish of the decade. I think it's important to say, with OneCell, we invested for 4 years before we saw our first dollar of revenue. Looking forward, we anticipate that could be a $1 billion business. So these are investments for the future. Unfortunately, they don't have in-year returns. But when you think about what we look like 2, 3 years from now, I think we'll all be happy that we chose to make them. The last piece on R&D, which is work that remains to be done, and I mentioned it earlier, is taking a look at that full $790 million spend and figuring out where is it not being as productive as we would like, harvesting those dollars and either returning those to shareholders or redeploying those into some of these growth areas that you talk about.

Got it. Well, that takes us right to time. So Alex, thank you so much for being here, and I appreciate it.

Well, thanks for your interest.