Belden Inc. (NYSE:BDC) Q3 2023 Earnings Call Transcript

Belden Inc. (NYSE:BDC) Q3 2023 Earnings Call Transcript November 3, 2023

Operator: Ladies and gentlemen, thank you for standing by. Welcome to this morning’s Belden reports Third Quarter 2023 Results Call. Just a reminder, this call is being recorded. At this time, you’re in a listen-only mode. Later, we will conduct a question-and-answer session. [Operator Instructions] I would now like to turn the call over to Aaron Reddington, Vice President of Investor Relations. Please go ahead, sir.

Aaron Reddington: Thank you. Good morning everyone, and thank you for joining us for Belden’s Third Quarter 2023 Earnings Conference Call. With me today are Belden’s President and CEO, Ashish Chand; and Senior Vice President and CFO, Jeremy Parks. Ashish will provide a strategic overview of our business, and then Jeremy will provide a detailed review of our financial and operating results, followed by Q&A. We issued our earnings release earlier this morning and have prepared a slide presentation that we will reference on this call. The press release, presentation and transcript of these prepared remarks are currently available online at investor.belden.com. Turning to slide two in the presentation. During this call, management will make certain forward-looking statements.

For more information, please review today’s press release and our most recent 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, the appendix to our presentation and the investor relations section of our website contains a reconciliation of the most closely associated GAAP financial information to the non-GAAP financial information we communicate. I will now turn the call over to our President and CEO, Ashish Chand.

Ashish Chand: Thank you, Aaron, and good morning everyone. We appreciate you joining us today. As highlighted in our communication three weeks ago, third quarter results were below our expectations, as demand unexpectedly weakened within our industrial and broadband markets adding to ongoing pressure from channel destocking. Despite a softening in demand, our expanding solutions-driven mix drove gross margin outperformance, resulting in Belden achieving the lower end of our initial adjusted EPS outlook. Our proactive efforts towards becoming a premier solutions provider continue, even amid the current market weakness. We believe this approach will drive incremental growth and margin expansion over the long term. In the meantime, we are evaluating opportunities to protect margin where appropriate and have already taken cost saving measures in response to the market weakness.

Furthermore, we remain confident in the resilience of our portfolio, which stands well-positioned to benefit from significant secular trends with lengthy investment cycles. Now, let’s review the quarter. Please turn to slide four for a summary of the third quarter of 2023. As a reminder, I’ll be referring to adjusted results today. Our team performed admirably, considering the difficult operating backdrop. Unfortunately, industry demand weakness came about unexpectedly and we experienced a marked change in orders in our Industrial and Broadband markets during the quarter. After growing orders 4% sequentially in the second quarter, total orders were down 19% sequentially in the third quarter. As such, we achieved quarterly revenue of $627 million, down 7% year over year.

Despite end demand softness, our shift to solution sales continues, which led to favorable margins during the period. Gross margins were up 280 basis points to 39% and EBITDA margins were up 80 basis points to 18.4%. Organic growth was down 4% in our Industrial Automation Segment with EBITDA margins up 230 basis points to 22.5%. In Enterprise Solutions, organic growth was down 14% with EBITDA margins down 110 basis points. As we adjust to this temporary weakness, we expect to continue to follow our previously outlined capital allocation priorities with organic growth as our top priority, followed by M&A, and finally returning capital to shareholders. Our balance sheet is strong with ample liquidity, and leverage at Belden remains low at 1.3 times, down from 1.4 times in the prior quarter.

We have significant financial flexibility to execute upon our strategic plans, whilst staying around our targeted net leverage ratio of 1.5 times, even if the outlook becomes more challenging. Free cash flow for the quarter was robust, and we continued to deploy capital to grow the business. I am pleased to report that year-to-date we have invested nearly $110 million in M&A, with our most recent acquisition of CloudRail, an edge software provider that helps connect and manage devices in industrial environments. Welcome to the team CloudRail. Further, year-to-date, we have returned over $150 million to shareholders. In summary, the unexpected shifts in market demand in industrial and broadband during the third quarter impacted orders. That being said, our team executed well and we are proud to have sustained these healthy levels of profitability with such a strong balance sheet and cash flow position.

Now please turn to slide 5 for a summary of our market performance in the third quarter and where we see things trending over the short-term. Taking a step back, during the third quarter orders changed considerably in our industrial and broadband markets. Smart Buildings performed as expected, but was more than offset by the sequential change in orders in our other markets. Starting with the Industrial Automation market. The first half of the year our business performed well with orders roughly flat sequentially in the second quarter and point-of-sale data confirming our order trends. As the third quarter progressed, industrial customers became increasingly cautious and we saw a material change in our orders and point-of-sale data. On a sequential basis, our industrial orders for the third quarter were down 21%.

The softness in the industrial market has many contributing factors, but at a high level the weakness in orders has two major drivers. First, we experienced a pause in end customer demand due to broad weakness in discrete manufacturing. Second, both OEMs and distributors took action to further reduce inventory levels during the quarter. The smart change in demand for industrial automation products and solutions is a temporary reaction coming into the back half of 2023 amid overall macro uncertainties. Looking forward, we expect to see reduced demand for a few quarters as end users adjust to challenges in the marketplace. However, we expect them to emerge with continued investments in automation. Longer term our secular trends remain intact led by reshoring, labor shortages and investments in Industrial Automation.

I’m confident that we are well-positioned to grow market share once we get past this temporary slowdown. In the Smart Buildings market, we saw revenue and orders more or less in line with our guidance. Within smart buildings, we experienced weakness in commercial real estate with more stability in our targeted verticals such as hospitality and government. The smart building market continues to face challenges with higher interest rates creating uncertainty and distributors continuing to destock as they adjust to lower demand and work to improve cash flow. Similar to our industrial market point-of-sales data declined in the third quarter which points to further weakness into the fourth quarter and 2024. Longer term, we expect to see demand growth from increasing digitization and expanding connectivity needs.

Our customers have increasingly complex challenges including hybrid networks that combine disparate data and network protocols onto a single backbone. Belden is well-positioned to address these challenges with our product breadth and technical expertise. Finally in the Broadband Solutions market, we had a good first half of the year with meaningful order growth in the second quarter. However, in the third quarter we experienced a sharp reversal with orders down 28% sequentially. This change in the third quarter is the result of MSOs adjusting their procurement processes to reduce inventory and rely on shorter lead times to meet demand. Planned network upgrades remain intact. However, we anticipate a soft fourth quarter as customers further adjust inventory into year end.

We expect a pick up in orders as we move through the first half of 2024 with further momentum as government funding increases throughout next year. I will now request Jeremy to provide additional insight into our third quarter financial performance.

Jeremy Parks: Thank you, Ashish. I will start my comments with results for the third quarter followed by a review of our segment results, a discussion of the balance sheet and cash flow performance, and finally our outlook. As a reminder, I will be referencing adjusted results today. Now please turn to slide 6 in our presentation for a review of our third quarter results. Third quarter revenue decreased 7% year-over-year and was down 9% organically to $627 million exceeding our preliminary view of $625 million. We experienced softness in Industrial Automation with revenues decreasing 4% organically. Longer term, we continue to see compelling secular demand drivers for automation solutions as industrial customers respond to labor shortages, capacity requirements and the reshoring of production.

Enterprise Solutions revenue decreased 14% organically with increased weakness in our Broadband Solutions market. As Ashish mentioned earlier, orders for the third quarter were down 19% sequentially with weakness in both segments. We ended the quarter with a book-to-bill of 0.81. Gross profit margins were a robust 39% expanding 280 basis points compared to the prior year. The quarter benefited from a better than typical product mix, driven by our Solutions business. EBITDA was down 2% year-over-year to $115 million, while EBITDA margins expanded 80 basis points to 18.4%. Margins for the quarter benefited by approximately 100 basis points due to an adjustment to lower year-to-date incentive compensation. Net income in the quarter was $76 million, down 3% from $78 million in the prior year period.

EPS increased 1% year-over-year to $1.78 compared to $1.77 in the year ago period which was slightly above our updated guidance range of $1.75 to $1.77. Turning now to slide 7 in the presentation for a review of our business segment results. I will begin with our Industrial Automation Solutions segment, which helps customers transmit and secure audio, video, and data in harsh industrial environments. Key markets include discrete manufacturing, process facilities, energy, and mass transit. The Industrial Automation Solutions segment represented 55% of our sales in the quarter, with revenue totaling $343 million. For the quarter, revenue decreased 2% year-over-year and decreased 4% organically. On a sequential basis revenue declined 10%. During the quarter, we experienced broad declines in discrete manufacturing, partially offset by stability in process automation.

Industrial Automation segment EBITDA margins were 22.5% for the quarter, compared to 20.2% in the prior year, with margins expanding by 230 basis points. Turning now to our Enterprise segment, which enables customers to transmit and secure audio, video and data across complex enterprise networks. Our key markets include smart buildings, and broadband solutions. The Enterprise Solutions segment represented 45% of our sales in the quarter, with revenue totaling $284 million. For the quarter revenue decreased 11% year-over-year and declined 14% organically. On a sequential basis, revenue decreased 9%. Enterprise Solutions segment EBITDA margins were 13.3% for the quarter, compared to 14.4% in the prior year. In the Smart Buildings market, revenues were down 14% organically.

In the Broadband Solutions market, revenues were down 15% organically. Fibre revenue was up slightly year-over-year due to the benefit of recent acquisitions. If you will please turn to slide 8 for our balance sheet, and cash flow highlights. Our cash and cash equivalents balance at the end of the third quarter was $531 million, compared to $688 million in the fourth quarter of 2022, and $547 million in the third quarter of 2022. Our financial leverage was 1.3 times, net debt to EBITDA at the end of the third quarter down from 1.4 times last quarter. As we communicated before, we intend to maintain net leverage of approximately 1.5 times going forward. We have a reasonable level of debt much lower than in the past with no maturities until 2027.

In addition, all our debt is fixed with an average interest rate of approximately 3.5%. Looking ahead, we expect to generate meaningful free cash flow in the fourth quarter, and achieve full year free cash flow slightly lower than 2022 levels. We expect to have ample liquidity to deploy, towards high-return opportunities, even as we manage through a dynamic environment. Year-to-date, we invested nearly $110 million in new and complementary businesses and $150 million towards share repurchases. So far in 2023, we have repurchased 1.7 million shares, which is 4% of shares outstanding. Please turn to slide 9 for our updated outlook. Looking forward to the fourth quarter, we expect weakness to continue in line with levels experienced in the second half of the third quarter.

This weakness is in contrast to our performance in the first half of the year. For the fourth quarter assuming the current market environment does not deteriorate further, we expect sales in the range of $510 million to $530 million, and adjusted EPS in the range of $1.05 to $1.20. This outlook implies full year revenue will decrease between 4% and 5% and full year EPS will be flat to up 3%. Further, this outlook would imply that full year 2023 organic growth will be down mid-single digits overall with Enterprise down high-single digits and Industrial Automation down low-single digits. That concludes my prepared remarks. I would like to turn the call back to, Ashish.

Ashish Chand: Thank you, Jeremy. While it is hard to estimate the continued impact of the challenges and uncertainties facing our customers, as we see it the fourth quarter is likely to be the most challenging. However, we believe that demand will start to return as the longer-term secular drivers of our business prevail over the coming year. Regarding our investment philosophy over the next few quarters, I assure you, we will act accordingly to balance two key priorities. First, we will further adjust the cost structure as necessary to help offset the overall impact on the bottom-line and we will strive to achieve decremental EBITDA margins between 20% and 30% for the cycle. Second, I want to emphasize that the current uncertainty provides our Solutions Business with an opportunity to further differentiate ourselves from competitors.

My goal is to come out of the cycle with increased solution sales, market share gains and higher margins. I would like to take a step back and highlight the progress we’ve made over the last few years, growing and transforming Belden. A key objective of our pivot to solutions was to build differentiated capabilities, whilst the business environment was positive so that, we would enter inevitable periods of increased uncertainty as a stronger company. We proactively invested in go-to-market and technical capabilities that have driven higher margins and will provide a significant leverage, as we get past this temporary downturn and return to growth based on secular trends. We have developed a unique approach of offering network and data backbone solutions, customized by market vertical that help our customers tackle multiple use cases and justify investments in smart infrastructure and digitization, much needed as customers strive to increase capital productivity and improve customer experience.

Through the combination of organic growth, targeted M&A and share repurchases, we have a clear and reasonable path forward towards future revenue and EPS growth beyond prior run rates. Our portfolio is well positioned and our balance sheet is strong. We will continue to execute operationally through these challenges look, to deploy capital towards tuck-in acquisitions that make sense and finally we will continue to return capital to shareholders. To close, I would like to take a moment and recognize the contributions of our associates including our newest CloudRail team members. I appreciate your efforts this past quarter and would like to thank you for your support, as we continue to transform Belden through a challenging environment. Thank you for your hard work.

That concludes our prepared remarks. Operator, please open the call to questions.

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Q&A Session

Operator: [Operator Instructions] Our first question comes from the line of William Stein with Truist Securities. Please go ahead.

William Stein: Great. Thanks for taking my questions. I’m hoping you can contextualize margins in the guidance. It’s clear that in Q3 margins did better than one would expect in the revenue shortfall. As you said the solutions business performed a bit stronger. That’s not clear to me that that continues in Q4 and I’m hoping you can again contextualize it and provide some comments on that. Thank you.

Ashish Chand: Sure, Will. So for 2023 as a whole, we expect margins to be in the 38% range gross margins and that’s what we’ve previously spoken of. There’s no change in that perspective. By the way this is over 5% better than what we had in 2020 and that process has continued based on, how we’ve worked on solutions and new products that we’ve talked about at different points in time. Indeed, Q3 benefited from better mix given some push-out from the broadband customers which are relatively lower margin because they are less solutions more components. But yeah, we expect it to be in the 38% range in Q4 and for the full year slightly better than 38%.

William Stein: Perhaps the follow-up is just a clarification on this. Do you expect that in Q4 solution selling will continue at a somewhat more protected pace than the rest of the business? Or is it seeing similar trends or even worse than the overall revenue growth?

Ashish Chand: I think we’re seeing very similar trends. It will be the same kind of growth somewhere in the low double-digit range. We look at our active and software portfolio, that’s a good proxy for solutions and that was low double-digit for Q3. So we don’t see a change in that given our backlog and also given the kind of projects in our pipeline right now that are closing.

William Stein: Thank you.

Operator: Next we go to the line of Rob Jamieson with UBS. Please go ahead.

Rob Jamieson: Hey, good morning. Thanks for taking my questions. I guess, just wanted to start off first with the prelim. And then just kind of a – when did the weakness start to show up in the quarter? I mean you guys have a significant amount of business that goes through distribution and a couple of large customers – it’s like 40% plus. So I feel like you’d have a pretty good pulse on what’s happening through the quarter. So just trying to understand when this showed up in the quarter? And then also what you’ve learned through this and how you intend to maybe change something internally in terms of getting a better pulse on demand intra-quarter? Just because destock headwinds have been something that we’ve seen in industrial more broadly. So just any color there would be super helpful.

Ashish Chand: Sure, Rob. So I think if I look back there have been so many things going on in the markets right? Because of interest rates, geopolitics, changes in how people think about where they manufacture, changes in commercial real estate, et cetera. So it’s been difficult for most people to read, right? What we saw in Q2 was our orders were up sequentially 4%. Our POS was strong. The point-of-sale data we were getting from our channel partners is strong. And frankly at that point, as we were entering Q3, we did not see in the early part of the quarter any clear indicator. However, as we were working through the quarter, we saw two things change. The first was there was a lot of tightness with OEMs and end users who started adjusting inventories on the industrial side and that just accelerated how our channel partners were reacting.