Belden Inc. (BDC) Q2 2013 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by. Welcome to this morning's Belden Inc. Conference Call. Just a reminder, this call is being recorded. [Operator Instructions] I would now like to turn the call over to Matt Tractenberg. Please go ahead, sir.

Thank you, Andrea. Good morning, everyone, and thank you for joining us today for Belden's second quarter 2013 earnings conference call. My name is Matt Tractenberg, and I'm Belden's Director of Investor Relations. With me here this morning are John Stroup, President and CEO; and Henk Derksen, Belden's CFO. John will provide a strategic overview of our business, and then Henk will provide a detailed review of our financial and operating results, followed by question-and-answer. We issued our earnings release earlier this morning. And we have prepared a slide presentation that we'll reference on this call. The press release and the presentation are available online at investor.belden.com. Please note, there's no www in that web address. On Slide 2 of the presentation, you'll see that during this call, management will make certain forward-looking statements. I would like to remind you that any forward-looking information we provide is given in reliance upon the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. The comments we will make today are management's best judgment based on information currently available. Actual results could differ materially from any forward-looking statements that we make, and the company disclaims any obligation to update this information to reflect future developments after this call. For a more complete discussion of factors that could have an impact on the company's actual results, please review today's press release and our annual report on Form 10-K. Additionally, during today's call, management will reference adjusted, or non-GAAP, financial information. In accordance with Regulation G, we have provided a reconciliation of the most closely associated GAAP financial information to the non-GAAP financial information we communicate. This reconciliation is in the appendix of the presentation, and has been posted separately to the Investor Relations section of our website. I would now like to turn the call over to our President and Chief Executive Officer, John Stroup. John?

Thank you, Matt, and good morning, everyone. I'm pleased with our second quarter results. And I would like to thank our associates for their hard work during the period. The formation of our 4 global segments announced in April was a considerable endeavor and a necessary element to achieving our long-term strategic goals. So our ability to deliver solid second quarter results is especially gratifying. While Belden, like its peers, finds revenue growth challenging in the current environment, our consistent results highlight the balance across platforms and geographies. Most notably, our strong performance in emerging markets offset soft demand in developed markets. As a result, I'm proud to report record profitability measures this quarter, best-in-class gross profit margins of 35.2% and operating profit margins of 14.2%, which is already within the range of our newly stated goal. This is a direct result of our continued focus on portfolio enhancement and business system improvements. And finally, our share capture programs continue to show progress, proving the value of our Market Delivery System. Following the formation of Belden's 4 global business segments this quarter, our commercial strategies are easier to execute and our performance in emerging markets is significantly enhanced. Belden's portfolio now provides the most attractive growth and profitability profile in the company's history. We continue to benefit from diversification across markets and geographies. We saw solid results in our Enterprise Connectivity and Broadcast platforms, while softer demand within industrial markets was partially offset by share capture initiatives. Our performance from a geographic perspective illustrates this balance as well, with strong growth in emerging markets offsetting continued softness in the developed markets. Revenue growth in geographies such as Brazil, Mexico, China, India, the Middle East and Africa and Indonesia was at a combined rate of 13.5% year-over-year after adjusting for acquisitions,…

Thank you, John. I will start my comments with results for the quarter, followed by a review of our operations and segment results, discussion of the balance sheet and close with our cash flow performance. As a reminder, I will be referencing adjusted results today. Please turn to Slide 6 for a detailed consolidated review. Second quarter consolidated revenues were $532.6 million. Revenues for the quarter grew 16.2% from $458.2 million in the prior year. We benefited from the addition of Miranda and PPC during the quarter as compared to the year-ago period, with an impact of $103.5 million. Additionally, the revenue from our consumer electronics business is no longer included in our results, with an unfavorable impact of $24.5 million year-over-year. Organic growth, when adjusted for changes in copper prices, declined 40 basis points year-over-year. As highlighted by John, year-over-year revenues were unfavorably impacted by continued softness in North America and Europe, offset by solid results within emerging markets. Performance for the first half year is in line with our expectations. And I'm pleased with our ability to deliver consistent results in a challenging macroeconomic environment. On a sequential basis, revenues increased by 4.4% to $532.6 million from $510.4 million last quarter. Organic growth, after adjusting for change in copper and currency, was 5.1%. Record gross profit margins at 35.2% increased 360 basis points year-over-year and 70 basis points sequentially. The year-over-year improvement was largely a result of inorganic activities. Sequentially, we benefited from operating leverage on sales calls. Second quarter SG&A expenses were $93.8 million, or 17.6% of revenue. R&D expenses for the quarter were $20 million, or 4% of revenue. SG&A and R&D expenses increased year-over-year as a result of the inorganic activities, with a combined impact of $23.8 million. After adjusting for the impact of currency…

Thank you, Henk. Please turn to Slide 10 for our outlook regarding the third quarter and full year results. Belden's outstanding business portfolio and an improved organizational structure provide us with the opportunity to perform well in a variety of economic environments. We continue to emphasize our strategic initiatives, including our Market Delivery System and Lean Enterprise. The global macroeconomic environment in 2013 is generally as we anticipated, and we remain confident in our ability to deliver consistent operating results in the second half of the year. Therefore, we are increasing the midpoint of both our revenue and earnings outlook for the full year. We expect our third quarter 2013 revenues to be between $525 million and $535 million, and adjusted income from continuing operations per diluted share to be between $0.90 and $0.95. For the full year 2013, the company now expects revenues of $2.09 billion to $2.12 billion, and adjusted income from continuing operations per diluted share of $3.54 to $3.69. That concludes our prepared remarks. I now ask the operator to please open the call for questions.

[Operator Instructions] Mr. Tractenberg, your first question is from Shawn Harrison with Longbow Research.

Just on the industrial markets, I guess if you could maybe speak to both Connectivity and IT in terms of whether you saw improving trends throughout the quarter, kind of what are your expectations in terms of if you expect better momentum in the second half of the year?

Shawn, I would say that the order pattern was relatively linear throughout the quarter. There wasn't any real significant change or difference. I think our view on the second half is that the business from an industrial point of view will perform similarly in the second half to kind of how it performed in the second quarter. In terms of momentum, I would say we saw more momentum in the second quarter and also in July in the Enterprise and Broadcast businesses than we saw in the Industrial. But we also had a fabulous first quarter Industrial IT. So the sequential comparison for Industrial IT in Q2 was quite difficult.

That momentum you mentioned in Enterprise and Broadcast, John, is that seasonal or is that something beyond that, where you see maybe the markets picking up?

I'd say in the case of Enterprise, it's something more than seasonal. And it's hard for me to differentiate how much of it is just really good work by our team, which I think is meaningful, and how much of that might be, dare I say, some improvement in in-market conditions. From a Broadcast point of view, I'd say that's more cyclical, not seasonable, but more cyclical. As you know, 2012 had a lot of demand as a result of the Olympic Games as well as the U.S. presidential election. And as a result, I think the first half was a little tepid. And I think we'll see improvement in the second half.

Okay. And then as a follow-up, just on the M&A environment, I saw some e-mails in my inbox this morning about some private equity firms looking to buy or buying some connector companies. But maybe could you just talk about valuation out there, whether it's similar to the environment that you saw in the back half of last year when you completed a few deals or whether just the ability to buy things have gotten a little bit tighter?

I think it's similar to maybe slightly improved compared to where we were a year ago, at least as I comment on our situation. I would say the actionability of our funnel right now is as good as it has been in some time.

Okay. And then the focus of that funnel, John, is still more Industrial now maybe because you have more bandwidth? Or is it still kind of across the Enterprise?

Across the Enterprise. We have activity in all 4 segments.

We'll go next to John Quealy with Canaccord Genuity.

Back to Enterprise, we've seen Emerson and Eaton both talk up something more than what seems to be a temporary move up in European data center activity. John, can you comment a little bit, I know in the previous caller touched on this, but can you comment a little bit on that trend? Do you think that's a sustainable trend? Or what do you see from that side?

Well, our data center business in total globally is still a relatively small percentage of our Enterprise business, although it's growing quickly. And of course, our share of position in North America is significantly greater than it is in Europe. So my comments about Europe are going to be a little bit detached perhaps. But I would say that our Enterprise team is feeling much more confident about demand conditions today in both the data center, as well as the land environment than they have in some time. I'm always cautious when I say that. But they had good performance in the quarter. And they've come out of the gate pretty nice in July from an orders point of view. So it does feel anyways as though there might be some secular tailwind in that business. And of course, we haven't seen that in some time.

Okay. Shifting gears back to Industrial IT for a minute, can you talk about end market and perhaps geography? I think last quarter you outperformed on share gains across the end markets. But can you talk about transport and energy or utility across Industrial IT, how that's shaping up for you folks?

Yes. So let me start with geography, because I think that's kind of interesting. So on a year-over-year basis, somewhat ironically, our strongest performer in Industrial IT was Europe. So they kind of bucked the trend of our other businesses, as we commented earlier about Europe being a little bit soft. And that was, I think, directly a result of some of the work our team has done in Europe on infrastructure projects, as well as perhaps some of the good news we've gotten out of Germany recently, which I think is pretty encouraging. From a vertical market point of view, I would say the mix of verticals has not really changed very much. It's been a fairly broad-based recovery. I think that if you look at our first half performance, the 8% growth is exactly what we would've expected. We had a couple of really nice projects in Q1. The timing just kind of fell in, particularly within Asia with regard to that project in Q1. So I think our view on the end markets is really unchanged. As you know, this is a substitution play of people using this technology instead of legacy products. And we see that continuing. The only vertical really that's weak, and this isn't new information, we talked about this last quarter, was the investment in alternative energy, particularly wind, is obviously weak right now. We don't really have the benefit of that particular market. The other verticals are performing well.

Okay. And then lastly, Broadcast, can you help quantify for us in terms of pipeline opportunities, when we think about Miranda, for example, is that pipeline still staying robust? Are you seeing investment trends and conversations still track the way you want? It sounds like the business performed on plan, but what about that pipeline? How is that developing for you?

Yes. The pipeline's in good shape in all segments, including Broadcasting, including the area of Broadcasting, will be relevant to Miranda. All areas are, I think, in good shape.

We'll go next to Brent Thielman with D.A. Davidson. Brent Thielman - D.A. Davidson & Co., Research Division: I guess, on the Industrial businesses, obviously a little flat to lower on a sequential basis in terms of sales. Is the improvement in adjusted margins more execution or help from mix? Maybe parse that out a little bit more for me?

Yes. So I would say it is execution. So our Industrial IT business saw some benefits sequentially in the area of productivity, both from a gross margin and an operating -- OpEx point of view sequentially, as you comment, despite their revenue being flat sequentially. So I think that's a big part of the margin expansion. Industrial Connectivity on a sequential basis had a little bit of headwind actually as it related to mix. But they were able to overcome most of that with productivity improvements. So I thought all 4 businesses managed the productivity side really well. And as we talked about, we think that the industry-leading, category-leading gross margin that we have today is a significant source of value-creation as we continue to grow top line in the 4% to 6% range and leverage our cost structure. I think that was really, really evident sequentially in the Enterprise business, where we saw the fall-through that you would expect. And then, of course, the expanding operating margins. Brent Thielman - D.A. Davidson & Co., Research Division: Okay. And it sounds like the guidance implies maybe more market share gains versus expectations for growth in Industrial. Is that fair?

So we always have an expectation of market share capture, of course. As you know, we have a goal to achieve a market share on a year-over-year basis of 2%. And of course, to do so, you have to get 0.5% sequentially every quarter of your life. And that's our goal. And that's our expectation. I thought we did a nice job in the first half. I think that'll continue. I see a little bit of momentum actually in our share capture initiatives. And I think that all of our segments will see that improvement from first to second half. And then on a consolidated basis, of course, our organic growth is a little bit, I'd say, less challenging from a comparison point of view compared to the first half being stronger than the prior year. Brent Thielman - D.A. Davidson & Co., Research Division: Okay. And then, Henk, I think you mentioned something along the lines of sort of some product rationalization in the Broadcast business. I didn't quite catch that. Could you elaborate a little bit more on what you're talking about there?

Sure. So we see our customers adopting the PPC products over our legacy products. And that impacts our organic growth, right? And that would have an impact of roughly $2 million to $3 million. So it's about 50 to 60 basis points on a consolidated basis. Brent Thielman - D.A. Davidson & Co., Research Division: Got it. And then just lastly, I mean it sounds like the M&A pipeline is busy. Can you just kind of remind me in terms of the balance sheet what you're comfortable with in terms of ratios, debt to EBITDA, debt to equity?

Yes. So as Henk properly pointed out, our optimal leverage in our view is 2.5x EBITDA. We're there currently on a net basis. And we have, absolutely, capacity to go outside that range in the short run, which we'd be willing to do for a short amount of time to bring the leverage back in place. So dry powder roughly $450 million to $500 million today. And we think that gives us the capacity to go do many of the transactions that we're active in.

[Operator Instructions] We'll go next to Noelle Dilts with Stifel. Noelle C. Dilts - Stifel, Nicolaus & Co., Inc., Research Division: And I hopped on a little bit late, so sorry if I missed any of these things. But first, could you comment on just the levels of inventory in the channel? And if you think you're comfortable right now with levels of inventory at distributors?

Yes. So the inventory situation at our channel partners is very stable. My comments would be similar to what I said last quarter, which is on a historic basis, they're carrying less inventory than they typically would as a percentage of revenue. So they're running at pretty high turns. I don't view that as a bad thing. I think many of our channel partners are becoming more efficient with their inventory management, which is positive. I think they're also relying on us to deliver product in shorter lead times, which of course is an essential ingredient of our Lean Enterprise techniques. And so I feel like they're at appropriate levels. And I think that if demand patterns remain as they are today, we shouldn't really see any meaningful changes in the inventory levels at our channel partners, other than perhaps sort of the year-end window dressing that companies can do just to kind of get their balance sheet the way they want. Noelle C. Dilts - Stifel, Nicolaus & Co., Inc., Research Division: Okay, great. And then on the Enterprise market, you talked a little bit about what you're seeing in data center. But could you just comment on -- give us a little bit more detail on what you're seeing on the non-res side in terms of project activity? Are you seeing small-to-medium projects? Are you seeing any sort of activity that's higher from a geographic standpoint?

So we had a really good quarter in China in Enterprise. That was a real standout. Our business in Canada on a year-over-year basis has been a little challenged. We had a lot of really nice, big projects a year ago in Canada, so our comps are difficult. We had good activity in the U.S. I would say that for our particular business, small- and medium-sized projects sort of carry the day. There was nothing in the quarter that was unusually large that would create a comp problem for us sequentially or year-over-year. And I think the strong performance we had in Enterprise from a revenue point of view was probably a blend of execution, as well as market demand. And the improvement in profitability was as you would expect in terms of the leverage on the growth. Noelle C. Dilts - Stifel, Nicolaus & Co., Inc., Research Division: Okay, great. And then if I could just squeeze in one more. I really support this new change in terms of the new organizational structure. But do you think as you've worked through that, there's been any sort of pickup or slowdown? Or do you think it's been pretty seamless?

Well, I think any time you make a change like this, you have to manage it very closely and carefully. And I think that our team did a very good job in the second quarter. There are always complications, however. And those complications can include the things you have to do from a reporting point of view and from an operating point of view. But I feel really good about the fact that we executed the new structure in the quarter. We delivered, I think, very good results, particularly compared to others in our category that didn't have to go through an organizational change. And I think most importantly, the changes that we made are exactly the changes we need to make for us to grow our business in that 4% to 6% range. And I think you see that in our second quarter results already where our emerging market business was up 13.5%.

And Mr. Tractenberg, there are no further questions at this time. I would like to turn the call back over to you for any final and closing remarks.

Thank you very much, Andrea, and thank you, everyone, for joining today's call. If you have questions, please reach out to the IR team here at Belden. Our email address is investor.relations@belden.com. And we're here and happy to help. Have a great day, everyone.

Thank you, ladies and gentlemen. This concludes our call for today. You may now disconnect from the call, and thank you for participating.