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

Welcome. I'm Ana Goshko from Bank of America, and this is our 2022 Leveraged Finance Conference. We're thrilled to be back in person in Boca Raton, and we're also thrilled to have CommScope with us today, Kyle Lorentzen, the company's CFO. So Kyle, thank you so much for joining us.

Thanks for having us.

Great. So just to recap, Kyle, you joined CommScope as Chief Transformation Officer in December 2020 and then transition to becoming the CFO in November 2021. So 2 years with the company, 1 year in the CFO role. And just about a year ago at your Analyst Day, you laid out key components of your CommScope next in your financial targets, which is $500 million of incremental EBITDA and then 4 to 5x leverage target for 2024. . But since then, there's been, I think, a lot of unwelcome developments and surprises exogenous factors out of your control, including supply chain issues, fuel, commodity cost pipes and some macro softening that we're hoping doesn't get a lot worse. But I think we've seen some headwinds so far. So with all of that, are you on track today with what you plan to accomplish a year ago?

Yes. So I think the short answer to that is yes, we are on track. When we think about the guidance that we provided back at the end of '21 for '22 and '23. ''22, we remain within the guidepost that we provided for '22 EBITDA. And in our Q3 earnings call, we reconfirmed that same guidance for '23. So when we step back and think about CommScope Next, and what we've accomplished over the last couple of years, we feel very good about the things that we can control and the fact that with all of those things that have hit us. We continue to be on track to deliver what we talked about at the end of '21. I think with that said, it doesn't come without challenges. We definitely have seen a lot of things outside of our control hit us. So when you think about coming out of the pandemic than we saw significant input cost increases. We saw a lot of supply chain challenges and constraints. Now we're heading into a little bit of uncertainty around what's going to happen with the macro environment. But when we step up, I think we're very proud of the fact that we put a plan together. We're implementing against the plan, and we're delivering the '22 guidepost and then we've reconfirmed the '23 guideposts.

Okay. So pricing has been a hot topic, I'd say, for you guys in particular. So even before the extreme supply chain crisis and the commodity cost spikes we saw in the '21, '22 time frame, pricing really always had been an issue for CommScope because historically, there's a lag on the company's ability to pass through cost increases, especially with your service providers who tend to be pretty big in terms of the revenue concentration. What progress have you made in your ability to push through price increases? Are there mechanisms that you have in place, contract structures? Or is it really sort of a salesperson to customer kind of negotiating it?

I think the biggest change that we've made as an organization is working on our internal processes. So first of all, understanding what our input costs are and how they're moving and then quickly reacting to that with the right price conversations with our customers. I mean we haven't made a lot of fundamental changes to our contracts. But we definitely internally are much more aware of the balance between the cost increases and pricing. Examples of that are we've installed pricing teams within our organizations that historically haven't existed. So I think as we think about how we manage pricing moving forward, I think it's more around our internal processes and procedures that we have put in place to deal with that. I think we're pretty proud of in an environment where, historically, this is a business that hasn't gotten price. And we were sitting in Q4 of last year and staring down significant input cost increases, and we started to talk about the magnitude that we have to go after from a pricing standpoint. I think that there was a lot of skeptics about our ability to do that. And I think our performance in Q3 where we're now starting to see the price actions that we took in Q4 and earlier in '22 as they come into effect, we're starting to get back to those historical levels on margin, which was our goal from the beginning. So we haven't really done a lot of changes to our contracts themselves, but we put a lot of tools in place that have allowed us to take a big chunk out of the input cost increases.

Okay. On the 3Q call, the company noted that you began to see project delays and some inventory adjustments that were slowing demand. So if we start with the inventory adjustments, is this because the supply chain situation has improved? Lead times have come down, or do you think there's a bigger macro factor kind of behind that?

Yes. I think the first piece is, I think as we indicated in our Q2 and Q3 call, we expected backlog to start declining. So as we put capacity on, particularly in our CCS business and the supply chain situation has gotten better. Our lead times are improving. So as our lead times improve and customers don't have to go out and put orders on the books so far out into the future, we just expect -- we expect, just by that lead time reduction that we would ultimately see a decline in our backlog. So I think that's one thing that's happening to us as we start improving our lead times is just that just is going to generate, by nature, a reduction in the backlog. I think on the inventory adjustment side, we saw this at the end of Q3. I think we've seen that into Q4. And we -- I think we're monitoring that situation closely. And I'd say primarily in our CCS and our OWN business. We have lots of conversations with our customers. Our customers are very bullish in our CCS business around medium- and long-term growth. With that said, we're definitely seeing some adjustment in Q4, and I think we're -- we'll continue to monitor to see how that impacts going into '23.

Okay. You maintained 2023 guidance, EBITDA guidance, which includes a level of moderate recessionary headwinds. I think that's how you put it. Did you have this level of macro weakness baked in maybe as cushion when you first issued the guidance last year? Or have you had to work harder to find ways to offset these potential recessionary headwinds. So basically, have you overdelivered and...

Yes, I'll address the overdelivering. So I mean I think the best way to answer that question is if we were seeing sort of more normal market growth and we're staring a recession recession potential in '23, I think we definitely would be in a position where we would be over delivering. So when we think about moderate recession, I mean, in that in that case that we've provided and the guidepost that we provided within that range. We have flat top line growth on a net basis for our core business to a little bit within the range with a little bit of modest growth. I think if we weren't in a situation where we were building in that moderate recession, we would definitely be in a situation where we would be over-delivering against the original guideposts for '23.

Okay. Where are you still facing supply chain constraints?

Yes. So I mean went earlier in the year, I think, in late last year, I think we were dealing with much broader supply chain issues all the way from some of the logistical challenges that we had with freight, not just from a cost perspective but also just from from availability and timing perspective. . We were seeing large input cost increases in some of our metals that we use with some of the commodities. I think for the most part, as we're moving into the second half of the year, we've seen those moderate. And I think our supply chain challenges as we move into Q4 are primarily focused around semiconductor chips. So our semiconductor chips are used primarily in our A&S business, our NIC business and our home business. And although we've seen a little bit of improvement from the first half of the year, the semiconductor situation and supply still remains pretty challenging for us. We've done some things internally, think we're building better relationships with the chip suppliers. We're looking at places where we can redesign product to design chips that are more readily available. So I think those actions that we've taken have improved the situation a little bit. With that said, we're still faced with challenges to find ships. We have decommits still and that technically impacts us in 2 areas that impacts us on our revenue line because customers want product that we can't ship. Because we can't build the products because we don't have chips. The other issue we have, it's also resulted in a little bit higher inventory levels of chips. So the way that I try to explain it is think of 1 of our products having 50 chips required to make the product. We get 48 of those chips, and we get decommitted on 2 chips. So what happens there is, number one, I can't build the product to ship. The other challenge that we have is now I'm sitting there with 48 chips in inventory waiting for the other 2 chips. And sometimes you can get that resolved relatively quickly in a few weeks. And then there's other situations where it takes a lot longer time for us to resolve that ship issue. So that continues to be a challenge for us. So it's impacting our top line, plus it's also impacting our inventory levels. I think our view on the chip situation is although it may get gradually better over the next few quarters. I mean we don't see this going away in '23. We think '23 is going to continue to be relatively challenging from a chip from a chip constraint issue. And I think we don't necessarily see resolution on this until '24 when chip capacity starts coming online, and we see a much fuller recovery on the capacity side for chips.

Okay. So shifting into the company segment. So let's start with CCS. So a multiyear industry fiber build-out and being in the early innings. So obviously, that's on the carrier side. Is that pretty immune to macro trends, do you think it's just a freight train that's going to keep on coming?

I think we're definitely very bullish on the CCS business and particularly on the fiber build-out. The government programs just in the U.S. between Ardo, [ bead ], ARPA, those funds are coming, and we will be a beneficiary of that. I think we're also starting to see programs in other countries relative to fiber build-out, U.K., Canada, Australia, being a couple. So -- yes, I think we feel very bullish about the medium- and long-term growth of the CCS business. I think with that said, we'll have to continue to monitor the situation as as recessionary impact plays out because, hey, at the end of the day, depending on the depth and the length of a potential recession, that could have some short-term impact on the CCS business. But everything we talk to from the government side through our customers, people continue to be very bullish on the fiber build-out.

Okay. And what about on the enterprise side of that segment?

I think on the enterprise side, it's probably a little bit more sensitive to the macro environment. But again, in that segment, we're seeing a lot of data center and building fiber buildouts. So I mean we're seeing the fiber growth in those markets as well. So probably a little bit more sensitive on the enterprise side to the macro environment. But again, I think there's a lot of momentum there. Our customers are telling us that they feel good about the segments that we're in, on the enterprise side. .

Okay. On the NEXT business, so 3Q Q2 was a breakthrough quarter for NEXT. It was percent sequential and year-over-year revenue growth and EBITDA, I'd say, catapulted to being solidly positive, so it's $25 million. So what really took you pass a tipping point?

I mean I think when we were in Q2, I think we had indicated that we saw that type of improvement in mix to go from a negative EBITDA to a positive EBITDA from Q2 to Q3. I think as -- I think we've been indicating on our calls and giving some specific examples of -- we have a lot of initiatives in that business. We feel good about our position and our technology in that business, and we feel like that as a business that we can grow, and we've been investing in that business. And I think what you're seeing in the results as we move into Q3, is we're definitely seeing improved revenue, one from our initiatives, but also two, as we talked about some of the things that we're doing on the chip side, this is a business that's definitely chip constrained. We have $800 million of backlog in that segment. So as our initiatives come through as we're doing a better job of managing chip supply, that's driving top line growth. in that business. It's one of our higher-margin segments and there's a lot of fixed cost. So as you grow your revenue, it's very accretive to the bottom line. So I think we saw, as we move from Q2 to Q3, you can see the revenue growth that revenue growth at the type of margins that we have in mix drops to the bottom line pretty quickly. So I think as we move forward, what you're seeing in Q3 is more indicative of what we're going to see in that business moving forward. Clearly, we're still going to have to manage through some of the chip challenges that we have in that business. But I think where we feel good about how we've positioned that business, where we've invested and the fact that I think we're on a nice trajectory in that business. And again, I think we see pretty strong demand in that segment. Plus we're also dealing with significantly higher backlog. So I mean, the backlogs of $800 million in that business is at record levels.

Okay. What are the kind of 1 or 2 kind of key products or solutions that's really driving the momentum in that segment?

I mean we're looking at services, software, software businesses. We're doing Wi-Fi 6. I mean it's a lot of -- there's not one large home run project there. It's a bunch of smaller initiatives, which quite honestly, are the outcome of the CommScope NEXT work that we did at the beginning of last year that we've been investing in that are now sort of turning into commercialized revenue for us. .

Okay. So with the outside wireless segment, are -- has the 5G momentum more or less peaked? And I know you've kind of position that business as being a slow but steady grower kind of over the long term? Are you sort of kind of approaching those rates right now?

Yes, I think we -- as going back to last year, I mean, we've been positioning that business as over a several year period, it's probably a low single-digit growth. I mean there's some technology changes that are happening in that business on the antenna side that probably work against us a little bit. But to offset that, that's a business that, again, we're making some investments in new product development in order to offset some of the decline that we may be seeing in the near term. I think when we look at in the North America, we look at the service provider spend, we would expect that business just on a base business standpoint being down 22% to 23%. But what we're also looking at is as we develop the new products and introduce those to the market, we feel like those new products can go a long way in offsetting some of the declines. So we talk about some of those products we talked about on our call, so our Mosaic antenna, which is our antenna where you got the active and passive together on the antenna. That's now in being commercialized and being sold, and we feel like there's a nice market for that. So even though we think short term, there's some downside in that business from a market standpoint. I think we feel there's a lot of momentum that we have on the new product side that should, at a minimum, offset some of those declines.

Okay. And then sort of same question on the A&S business. So there's change in mix. Some of your customers there have kind of shifting architectures, what's the kind of realistic outlook for that segment?

Yes. I think as we've talked about in the A&S segment, there's a technology shift going on, but then there's also a significant move in that market to go to the edge, right, to go from head out to the edge. We continue to have a very large installed base with our legacy technology. . We have a lot of knowledge about the networks and really real strategy for us in that segment is to have a portfolio of products that allow us to deal with any technology that customers want as they upgrade or build out their networks. And it's not only the technology toward the head end, but it's also to have products that go all the way to the edge. So our ability to have a CMTS through the mode and into the amplifier, we're sort of the 1 company that can actually do all of that and offer all of the products. But that's a business that as we move from the head end to the edge, the margin profile is a lot different. We've taken a lot of that hit in '22. And I think we would expect our EBITDA performance in that business moving forward to be more in line with what you're seeing in '22 than what we've seen historically.

Okay. And then Home Networks. Obviously, the issues have been the chip constraints demand, foreign exchange. What needs to happen -- what needs to happen to be able to get this business to breakeven and then to cash positive?

Yes. So I think on the home side, there's been some challenges in that business. It's the business probably the most affected by some of the chip constraint issues that we have. It's been hit with some FX challenges this year. But what we have recently implemented in that business is a more holistic transformation plan to figure out how we can transform that business away from just some of the core CPE hardware business to be a little bit more differentiated either on services or software as a service. We've made some announcements about some product offering or our home site product range. So in the home business. What we're trying to do is we're trying to fix the things that we can control on the legacy business, but we're also trying to transform that business with new products and services that can allow us to be a little bit more differentiated than a pretty cut throat business on the CPE hardware side and that type of a transformation it's not quarters away. It's going to take a few years for us to work through that. So it's really about how do we protect our position in the core business and then take advantage of the transformation opportunities we have in that business. But that's definitely a business that, as we announced last year, it's not core to CommScope. We feel like it's better positioned elsewhere. And when the time is right for us to have that business at the level that we want it to be, and having the right future, we'll continue to think -- we'll continue to figure out what is the right time to go separate that business from our core CommScope business.

Okay. So shifting to some of the financial items. So free cash flow. So inventory at of a lot of free cash flow in the last 12 months, but you guided to somewhat of an unwind in the fourth quarter. And at least $275 million of free cash flow in 4Q is the math, I think. So Assuming your core adjusted EBITDA guidance of $1.35 billion to $1.5 billion for next year is unchanged. What should free cash flow look like in 2023? Is there more unwind coming or it's going to be normal year?

Yes. Let me sort of explain '22 has been a little bit of an unusual year. We've invested in working capital in the business. We've grown our business 9% and that in itself has consumed working capital. The other item that we've dealt with in '22 is what I had talked about on the chip side. So we're definitely holding more chip inventory than we would like to hold because of some of the constraints that we have and some of the decommits. So I think '22 has been challenged and there's probably on the chip side, there's probably a couple of hundred million dollars of excess inventory that we have on the chip side. It's going to take a little bit of time to work through as the chip supply becomes a little bit more predictable. As we move into '23, I think we think of '23 as being a more normalized year from a cash flow perspective. So modeling out EBITDA minus CapEx, minus interest expense, minus cash taxes, a little bit of restructuring. That sort of is how we think about the answer for '23 as it equates to some cash flow guidepost for '23. So I don't -- I think we feel like we're probably at the peak of the chip challenges that we've had from an inventory standpoint. And some of that will unwind not all of it in '23. So I think the outlook on cash is to get back to a much more normalized cash flow generation.

Okay. I mean, at the midpoint of your guidance, what would that be for -- in 2023?

I mean I think it's a plus or minus $500 million as we think about -- we don't think we'll spend more CapEx than we'll spend this year. Cash taxes are about the same. I have a little bit of increase in interest expense with the $3 billion that we have in floating rate. And then obviously, with the EBITDA at the midpoint of what we've given you, that number is probably somewhere in the $500 million range.

Okay. And then what do you do with that cash?

Definitely try to delever. We will delever.

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So I mean, at the end of the day, our story is pretty straightforward. We have to drive EBITDA, and EBITDA will drive the cash performance and the cash performance will allow us to delever the company. And that's our objective. We live it every day in the equity market as dealing with the leverage situation that we're at is just not sustainable. And clearly, is something that we are very focused on dealing with. But at all, from our standpoint, it all comes from EBITDA generation and then turning that into the cash, which allows us to deleverage. So we're definitely committed to that. It's a daily conversation, and I think we're well positioned to do that in '23.

If you didn't say repay debt, I think we would have been melted with fruit from the audience. Okay. And then a final question. So the $1.3 billion bond maturity that's your -- obviously, your first maturity in 2025 are the big tower. Do you have a game plan by a target date by which you want to address that? Or kind of what's the strategy with that?

I mean I think the way that we think about it is -- there's still time. Market conditions will dictate sort of timing of that. I think we want to do that. We want to do that probably within the next 18 months deal with that. We'll look for options to deal with that as we go through '23. But since we don't necessarily have a gun to our head on that as we sit here today, I think we will look at opportunistic availability for us to go and start dealing with the '25. I mean in addition to that, we'll be generating some cash, and we'll have to figure out what to do with the cash from a deleverage standpoint. As we have a few options that we can do to start deleveraging. So I mean that will also be part of the equation where delivering our plan is going to generate a fair amount of cash between now and the end of '24. So we're focused on it. It's something that I think we feel we'll deal with over the next 18 months. And I don't think it's something that we lose a lot of sleep over, but we're pretty focused on it.

Okay. Okay. Well, we're out of time. Kyle, thank you so much for being with us.

Thank you.