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

Good morning. Again, welcome to JPMorgan's High Yield & Leverage Finance Conference. As most of you know, I'm Tom Egan. I cover technology and telecommunications for the company. Today, it's my pleasure to have a conversation with the folks from CommScope. To my right, Kyle Lorentzen, Executive Vice President and Chief Financial Officer. And hiding down here in the front row, if you want to tackle them later, Chuck Gilstrap, SVP, Tax and Treasury; and Mick McCloskey, Head of IR.

I guess, when you have a lot of debt, you get a lot of people in the room.

All right. My mic live. Everybody hear me? Good. All right. So, there's -- one of the things I hear a lot about, or I certainly did this quarter, was a lot of investor concerns about slower capital spending, mainly among the large telecom carriers. So they're watching Verizon, say, we're trending down. We're watching AT&T, say, we're trending down. Can you tell us what you're seeing there from those companies, and if that's something that people should be concerned about?

Yes. I think -- I mean, when we look at that, it's really dependent on the segment and the carrier. I'll talk about the CCS business, which is obviously our largest segment. I think we're definitely seeing a fair amount of inventory adjustments in that business. As we talked about on our calls, we started to see some order softness in Q4. That's continued into Q1. Some of that's being driven by some of the large carriers. But in our discussions with our customers and the carriers, there's still a fair amount of medium- and long-term bullishness when it comes to the CCS business. So, I think, as we think about it, definitely seeing some impact, but a lot of that impact as we talk to the carriers is being driven by people just having too much inventory in the system. I think the other business that gets impacted is in our Outdoor Wireless Networks business, so the antenna business, we're definitely seeing an impact in that business as a result of the carrier -- the lower carrier spend in North America. And I think, as we talked about on our Q4 call, we expect the OWN business to be down year-over-year as a result of that spending. So, I think, we're seeing it here a little bit in the first quarter, the first half in the OWN business, I think that's going to continue. We think in the CCS business, there's a much stronger second half for us as we talk to those customers.

And then, how about on the cable side? Are you seeing the move to the edge increase? And how are you faring in that business compared to the traditional head-end equipment that you normally provide?

Yes. So, I mean, you're referring to the ANS segment. So, I think, as we have seen through 2022, we've seen the product mix shift from the head-end to the edge. And we saw a lot of that happen in 2022. So, we've seen what we believe is to be the major adjustment from that mix happened in 2022. And as a result of that, again, as we've communicated, margins are lower on the products that are at the edge than they are at the head-end. So, as our legacy products sort of decline and we're picking up on the edge, we're definitely seeing a mix change in the margins. How we're faring in that business? Clearly, we're a big player in the space. We have technology that supports many different technology path that our customers may choose. So, I think we feel like we're well positioned along the chain, particularly as we go to the edge. And I also would comment that just like every piece of our business, there's things that -- I mean, we're involved in most bids doesn't mean we win everything. I mean, we win some and we lose some. But we're a significant player with our products that are on the edge, and we're selling those products to all of the big cable companies, and we would expect to continue to do that. And we continue to bid on the jobs, and we'll win some and lose some.

And then, one of the other things that comes up quite a bit is your ability to pass through pricing. So, can you talk a little bit about the products and segments where you've been able to pass through the higher cost, and then in segments where it's been more difficult?

Yes. I think, in general, and I'll sort of go back to our narrative is, when we were facing an inflation, the second half of 2021, when it was really hitting our financial statements, we went out with fairly aggressive price increases across all of our segments. And we even talked about the fact that since we had pretty large backlogs, it was going to take a while for us to work that through the P&L. And I think, if you look at our progress with our Q4 results, I think that demonstrates, I think, the fact that we have been able to get the price and sort of do what we said we were going to do when we went down the journey of getting the price increases across the board. And I think the teams have done a really nice job not just working our internal processes, but also working with the customers. I mean, customers understand the inflationary environment, and they work with us and our teams to get those price increases implemented. I think just like anything, there's segments that it's easier to get the price than others. But I think, in general, we feel good about how we've come out of the inflationary environment with the price increases. And I think that's reflective in our Q4 results, where our profitability levels on a percent basis got back to levels that were more in line with historicals than they were the last several quarters.

And that's maybe a nice little segue into supply chain because that's 1 of the reasons why you had to pass through higher prices. You've mentioned a couple of times that even though we hear bits and pieces about how things might be easing up a little bit, but you've been pretty clear that it's not over yet and that it's probably going to continue into at least the balance of this year. What's sort of your early thoughts? Where are we March, and how that's playing out?

Yes. I think just -- I think from a supply chain standpoint, I would say that other than semiconductor chips, I think we've seen availability of supply, get better. So let me talk a little bit about semiconductor chips. So, we put a lot of work into semiconductor availability. So, changing parts out to -- change parts out to chips where we can actually get product. We've tried to build better relationships with the chip manufacturers. So, we've been doing a lot of work to try and help us with some of these chip constraints. With that said, although it's gotten a little bit better, I mean, we're still in an environment where we're seeing de-commits and the availability isn't what we would like it to be. That definitely impacts us in the NICS business. It impacts us in the Home business, and it hits us in the ANS business. So, our comments around what we're seeing in 2023, a lot of that has to do with this whole chip supply issue that we continue to believe that this is going to still be a challenging environment to get everything we need in 2023. What I would say about the other products? When we look at inflationary levels, there are things that have actually moved down in price, but there's still a lot of things that are at either elevated levels or, in some cases, we're still seeing price increases. So, a raw material like our glass that we buy for our fiber optic cable, I mean, we're seeing price increases on those products. I think, even on the chip side, we continue to see increases on the chip components as well. So, I think, when we think about the inflationary environment, I think other than chips, we have availability, but these prices are still high. And in some cases, we're actually seeing additional increases.

And are there other aspects of the inflationary environment like, for example, transportation and some of the things that we saw early on in the pandemic that were a problem? Or do you see those things easing up? And then, maybe in addition to that, the thing that comes up almost on a continual basis is labor. How are you faring with labor in your business?

Yes. So, as I mentioned, we're definitely seeing some things move down from a pricing standpoint. I think, freight is one of those that we've definitely seen a move down in freight costs, and that sort of allows us to offset increases that we see in some of the other components. What was the second part of the question?

Labor.

Labor. I mean, for us, we really haven't had a major problem with labor, where we spend most of our time thinking about labor and talking about labors with our customers. So, as the build-outs trying to understand what their labor constraints would be, but as we think about our business and our manufacturing facilities and our R&D organizations and selling organizations, I don't think that, that -- I wouldn't consider that to be a major challenge for us right now.

And then, you came out of 2022 with a pretty solid backlog. $2.9 billion is what I wrote down here. So, given where the business these days is, how do you -- how should we think about what the normal level of backlog is? How do you -- I know that you guys have been pretty bullish on being able to convert all of that into ultimate business and convert your bookings in the business. So, maybe you can talk a little bit about how you think about what a normal level of backlog would be and how you think that supports the business in 2023.

Yes. So, I think, the best way to think about the backlog, and we've been -- I think we've been talking about this on the last few calls, is we expect our backlog to go down, right? So, as supply chain availability eases and we're able to get more parts, it's what it allows us to do is, it allows us with our capacity increases to dramatically change lead times, right? So, as we've gone through the supply chain constraints, our lead times have clearly gotten pushed out. We've been able to bring a lot of those lead times in, particularly in our CCS business. Just that alone is going to result in a backlog decline. And I think we've seen that backlog decline over the last quarter or so. And we probably would expect that to continue. I think, when we think about what would be normalized backlog, I think if we go back and we look at before all of these constraints hit us the end of 2020, we had a backlog that was significantly lower. I think we even mentioned on our call, our backlog is up 110% versus the end of 2020. And we think that the 2020 ending is an area that, hey, we feel comfortable that, that would be a nice balance between giving our manufacturing teams the visibility to drive what we need to do from an operation standpoint, but also allow us to give the type of service levels that we would want with our customers. So, having $2.9 billion worth of backlog, I think, is not really the issue. It's more around the lead times and where we want to be with our customers. And there's still a fair amount of room that we need to do to take that backlog down in order to get to a service level that we feel good about with our customers.

And then, we have a debt audience here, and then debt guys tend to be a little bit more cautious than equity guys because they never have this much upside. But 1 of the things that you did this year was you had told us that the back half of the year of 2022 was going to be pretty good compared to the first half. You've kind of done the same thing for 2023, and you've got some folks who are a little nervous about it that say, "Well, that's always like the concern when you have a back half loaded year." So why don't -- could you just maybe give us a few comments on why you feel comfortable with the second half of the year being pretty strong compared to the first half of 2023?

Yes. I think the first thing I'd respond to on that is having conversations with our customers, right? So, I mean, clearly, as we've indicated, we've seen a slowing order rate in Q4 and into Q1. And it's something that we're spending a lot of time looking at. And we're in constant dialogue with our customers around what's going on, and 1 of those order rates going to come back up. So that's -- the first answer to that is, we're talking to our customers, and that's what our customers are seeing. Our customers remain very bullish on the medium and long-term growth and particularly in the CCS business, where I think we've probably seen a little bit more of the adjustment on order rates than we have in the other businesses. I think the other piece that just sort of drives a little bit of the back half is just how some of our segments operate. So, for instance, in the ANS business, which is a very project-driven business, hey, the reality of it is, we see more project work in the second half of the year than we do in the first half of the year, which is pretty similar to what we saw last year. So if you go back and look at the performance of our ANS business, the second half was much stronger than the first half, which was really driven not so much from some normalized demand. It just happened that the projects fell in the second half of the year. So, I think we feel good because we see the customers, but then also as we look at the business, we see just the timing of projects and, in some cases like in our NICS business, just the availability that we have on chips. We feel, as we're talking to our suppliers, we're seeing a little bit better situation in the second half than we are in the first half. So, all those things together is what gives us confidence that we're going to see the better second half. I think, with that said, yes, we're spending a lot of time looking at our order rates and having conversations with our customers because, yes, as these things adjust, then people are adjusting inventory and you see your order rates decline, which we talked about our book-to-bill in Q4 being 0.63. Yes, I mean, it's definitely something that we're looking at and having conversations with. And what we're hearing is a lot of positives for the second half.

And then, you folks -- and I forgot it was you or Chuck that was talking about it a little bit on the last earnings call. You talked about a couple of things. First was, some of the initiatives that were put in place in 2022 that will still carry into 2023 to provide some cost savings. And then, you mentioned also some new initiatives that we're going to put in place in 2023 that not only help 2023, but would help 2024 and down the road. Could you talk a little bit about what those initiatives are for cost savings, and maybe give us a bigger than a breadbox kind of an idea about what you think they could do for your bottom line?

Yes. I mean I'm not going to go into specifics. But if we think about when we put on...

I tried.

When we put CommScope next in place at the beginning of '21, it's a pretty comprehensive program, which, for all intents and purposes, is focused on growth, and it's focused on the cost side. And I think, we feel good about where we are, and there is definitely still some opportunity in that program. With that said, that's a pretty iterative process where new projects are coming on, old projects are falling off. So, I think, just like sort of any business, there's opportunities for us to drive improvement, and we're doing that through CommScope NEXT. I guess, how I would answer your question about the cost side is, we clearly are looking at our situation in the macro environment. And I mean, we are going to react to that. I mean, I think that there are costs to come out, and we will manage to that. With that said, as we think about our businesses and particularly in the CCS and NICS business where we feel like there's growth on the medium and long term, I mean we still have to balance the, hey, we need to invest for the future versus the cost savings. So, I think that's a balance that we're always trying to walk, particularly in those 2 businesses. But what I would say is, there is cost to come out, and we're clearly looking at that in the first quarter as we watch what the market environment looks like.

And let me just switch up a little bit to the segments. You touched a little bit on the NICS segment and how you think that, that could make some headway in the second half of the year. Can you just walk us through how you think about that segment longer term? And why you think that it can sustain profitability down the road?

Yes. So, I think that's a segment that I would say that Chuck and I have taken a personal interest in to really work on that with that team on how do you grow that business and how do you drive profitability in that business. So, it's a business that we invest a lot in R&D. We invest a lot in sales and marketing. And we want to turn that investment into profitability because that business clearly has underperformed, I think, from a profitability standpoint. So, as we work through '21 and '22, I think sort of the fruits of our labor were recognized in the second half of the year, where we were able to drive some strong improvement in the NICS business. So, our Q4 number of $56 million of EBITDA, there's about $10 million of onetime EBITDA in there. So, on a normalized basis, call it, $45 million to $50 million. What we would like to see is, once we are able to get the chips, we think that, that is more indicative of the NICS business than what you saw in the first half of the year. So, I think it's a long journey there. And I think we started that journey in '22. I think the 1 other piece of that business that we're continuing to invest in, and we feel that has a lot of value creation opportunity is on the software side of the business. Turning more of that business from a hardware business to a software business is definitely 1 of our major focuses there.

And then, over on the CCS side, which has been just booming lately, can you talk about where we are in that cycle? Do you see that staying stronger longer term? Are there -- at some point, could there be some near-term digestion of what people have been buying lately?

Yes. I mean, I think as we've talked about, we're dealing with some near-term impacts of people buying a lot of material in 2022 and now adjusting their inventory levels. With that said, I think we feel bullish on a medium and long-term basis in that business as we continue to talk to the customers. We're still early in the government funding initiatives. We're starting to see some funding outside of North America from a government standpoint to build out networks. So, I think, we're definitely dealing with some short-term digestion, but I think we feel very good about the long-term trajectory of that business. Now, how fast it happens? There's a lot of factors that go into that. But I think we feel very good about the CCS business and our positioning there as we move forward. And again, just the amount of money that's going to come in from government funding, we feel that alone has a lot of tailwind to it.

And then, switching up again to the balance sheet. Here's a question I probably get every time I talk to an investor. My guess is you get it every time you talk to an investor, and that is, your nearest maturity is 2025, the unsecured bond. So, how do you think about your refinancing options? If the market improves, do you do something proactive perhaps with secured debt or do you wait until your business improves so that you can get better rates? How are you sort of thinking about that and your options today?

Yes. So -- I guess how I'd answer that is, I think we have options. Our maturity on the '25 is still a couple of years away, more than 2 years away. And it's not -- it's something that we're talking about on a very regular basis. We're talking to all the banks. I think, as we think about that, I think where we are today with rates, we feel like we're going to look at it over the next several quarters and figure out what's the right thing to do. We clearly have some secured capacity. But I think at this point in time, I don't think we see anything imminent. We're watching the markets and watching the rates to see what will be the best time to go ahead and do that. I think, in addition to that, as we talked about, I mean, we expect to generate some cash here in 2023 and 2024, which will help us as we at least deal with that '25 maturity.

And then, 1 of the things that probably for the past 3, 4 quarters that I jumped to when your earnings come out is the inventory line. Because it's been a use of cash as you come out of the pandemic and you've had to scramble to get parts. And as a result, you said this year, you don't expect an inventory unwind to be a significant source of cash flow. But how do you see that playing out through the year? Is it sort of a use in the beginning of the year? Or is it a declining use and maybe sourced by the time we get to the end of the year? And when do you think that, that -- because it's a big balance sheet item and could be a really big source of free cash flow, when do you sort of see that beginning to become a source of cash flow for you?

Yes. I mean, I think, as we think about inventory, the first thing that I would say about inventory, which has been a use of cash, we have grown the business, which definitely requires an investment in working capital. I think, on the inventory side, we've talked about the fact that we definitely are holding more inventory than we would like to hold. A lot of that excess inventory is sitting in our chips. So, the challenge that we have is, as people de-commit on chips or we can't get chips, we'll go out, I use the example of we'll have a product that uses 50 different chips, you can get 49 chips. If you don't get the last chip to make your product, you're now sitting with 49 ships and you're scrambling around trying to find that last chip. I think the other just reality of it is, with chip lead times going from months to -- 12 to 18 months over the period of time, it just requires us to be a little bit better at forecasting our business. So, you're now having to forecast your business 18 months in advance in some cases versus before this issue hit us, we were thinking 3 and 4 months in advance. So, I think that's resulted in some inventory. So, I think the way that we think about it is, as I mentioned before, on the chip side, we don't see a significant improvement in that in '23. Therefore, that's why we're signaling that we're going to continue to deal with this inventory issue on the chip side through 2023. I think the way to think about the business a little bit is, with our first half being a little bit -- were being lower than the second half, I think there may be some opportunities for us on the inventory side in the first half, and there may be a little bit of use in the second half as the business comes back. But I think as we think about '23, we're not layering in big inventory movements. I think that's probably more of a '24 issue as hopefully the chip situation gets a little bit better.

Got it. Let me pause for a minute and just see if we have any questions from the audience. If you have any questions? Here in the front.

Just in terms of trading prices for companies again, just some opportunities out there [indiscernible] free cash flow for this year, debt buybacks, basically taking advantage of some of [indiscernible].

Yes. I mean, as I mentioned before, when it comes to the debt and the leverage, I mean, I think we have a fair amount of opportunities. And I think we're balancing dealing with the maturity stacks -- the near-term maturity stacks versus potentially taking advantage of opportunities that are in the market from a pricing standpoint.

Anyone else? Any other questions? Oh, in the back, yes. Hi, John.

There's more software in the business. Is that -- how are you thinking about software as part of that business going...

Yes. I mean, in the ANS business, we obviously sell software, and we also have service agreements. So that is a part of the business. I think, we definitely -- as some of our legacy products decline, we're probably going to see some softening of our software business. But as we balance that against growing our edge business, as we talked about, I mean, there's definitely a mix change that goes on in that business as you move from some of our legacy products, which would include software to the edge products. But I mean, it's -- I think we've been talking about the fact that, that transition is going to happen and we have to manage our way through that.

So let me just follow up on that point on edge products. So, when you make this transition, because I think most folks expect there to be some sort of a transition, it becomes another build cycle, so to speak, where somebody says, all right, we're going to begin to make this transition from head-end to push some stuff out to the edge, and then you come into the bidding process. How are you viewing that -- I'll call it an opportunity because it almost sounds like there's another build phase in addition to the 1 we saw during the pandemic, which mostly was focused on the head-end. So, when you talk to your customers, how are they talking to you about an opportunity which could potentially be another build cycle for the cable guys?

Yes. I mean, I think we have some communication that's come out. As people like Comcast are upgrading their network, I mean, their architecture is different than what it was before. And I think we've talked about how much we've grown in amplifier business. So, 5 years ago, we weren't selling amplifiers. Now, we're selling 1 million amplifiers. So, I think that's just the transition that happens as the customers go through upgrade cycles. There's clearly different technology paths that they can take. And we feel like we're in a good position to service each one of those different paths, and it's just now a matter of working with the customers to see what you win and what you lose. So, I mean, we've had margin degradation in that business in 2022. I mean we've seen a pretty big hit in the ANS business as we've gone from the head-end to the edge. And a lot of that, quite honestly, has to do with the fact that we're getting the volume on the edge, right? You're getting the amplifier business, you're getting the node business. So, I think -- again, I think that transition, a lot of it took place in '22. I think it will sort of continue to move on. And I think that we feel pretty good about being able to provide products in some of these new architectures that allow us to continue to maintain that business. I mean, I think we've talked about that business that that's a business that -- that business is probably not getting back to a $400 million EBITDA business. I mean that's a business that is going to be sort of a slower growth business for us as we go through this transition from the head-end to the edge.

Okay. Well, that brings us to the end of the time. Thank you for coming. Appreciate everybody coming today.

Thank you.