CommScope Holding Company, Inc. — Q2 2019 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2019. The filing identifies the registrant as CommScope Holding Company, Inc. (NASDAQ: COMM). ARRIS results are included from its April 4, 2019 acquisition, so reported year-over-year comparisons are not like-for-like.
Business context and financial performance
CommScope provides wired and wireless communications-network infrastructure and related products and services. Following its acquisition of ARRIS, it reported five segments: Connectivity, Mobility, Customer Premises Equipment (CPE), Network & Cloud (N&C), and Ruckus.
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Net sales | $2,566.7m | $1,239.9m | $3,666.3m | $2,360.4m |
| Gross profit / margin | $660.0m / 25.7% | $457.2m / 36.9% | $1,058.1m / 28.9% | $855.0m / 36.2% |
| Operating income (loss) | ($209.2m) | $164.7m | ($118.5m) | $268.4m |
| Net income (loss) | ($334.0m) | $65.9m | ($336.3m) | $99.7m |
| Diluted EPS | ($1.81) | $0.34 | ($1.82) | $0.51 |
| Adjusted EBITDA (non-GAAP) | $395.6m | $271.1m | $604.1m | $479.2m |
ARRIS contributed $1.4 billion of Q2 sales and $0.4 billion of operating loss for the quarter and six-month period. The reported sales increase therefore largely reflects the acquisition; excluding ARRIS, CommScope said legacy sales declined, primarily from pricing pressure and foreign-exchange effects. Legacy gross profit was broadly unchanged, with margin improving on lower material costs and favorable mix.
- Q2 gross profit included $164.1 million of ARRIS purchase-accounting charges, primarily the step-up in acquired inventory. Excluding this charge, reported gross margin would have been 32.1% for Q2 and 33.3% for the first half.
- Q2 SG&A included $167.0 million of transaction and integration costs; first-half costs were $187.7 million. Amortization and restructuring costs also rose substantially after the acquisition.
- Interest expense was $165.3 million in Q2 and $262.8 million for the first half, reflecting acquisition financing. The first-half effective tax rate was 9.6%; the company recorded a $35.9 million tax benefit on its pretax loss.
Cash flow, debt and liquidity
- First-half operating cash flow was negative $261.6 million, versus positive $135.1 million a year earlier. Management cited $195.2 million of transaction and integration payments, slower collections, higher interest payments and restructuring cash costs.
- Investing cash outflow was $5.10 billion, including $5.05 billion paid for acquisitions, net of cash acquired. Financing cash inflow was $5.25 billion, including debt proceeds and $1.0 billion from preferred stock issuance.
- Cash was $348.0 million at June 30, down from $458.2 million at year-end. Current assets were $4.30 billion and current liabilities $2.29 billion.
- Debt principal totaled $10.50 billion ($10.33 billion carrying value including current portion), versus $4.04 billion principal at year-end. Long-term debt was 87.9% of total capitalization. The weighted-average effective borrowing rate was 6.26%.
- The new asset-based revolver had $971.9 million available and no borrowings outstanding at quarter-end. The company reported compliance with applicable covenants and said it expected cash, operating cash flow and revolver availability to meet anticipated needs.
- ARRIS was acquired for approximately $7.7 billion including assumed debt, funded with new debt, cash and $1.0 billion of Series A convertible preferred stock. The preferred stock carries a 5.5% cumulative annual dividend and is convertible at an initial $27.50 per common share, subject to stated limits.
Changes, outlook, risks and unusual items
- ARRIS reporting units faced lower cable-operator spending and departures of key leaders. Management expected these challenges to persist through 2019 and said the cable-spending recovery might be delayed; it anticipated better N&C performance in 2020. Its goodwill test found no impairment, but management warned impairment could occur if forecasts are missed. A 0.5 percentage-point reduction in annual revenue growth would produce estimated fair-value deficits for all three ARRIS reporting units.
- Management expected near-term Connectivity sales to decline modestly, Mobility sales to remain flat or decline modestly, CPE sales to remain flat or decline modestly, N&C sales to improve modestly but below prior expectations, and Ruckus sales to remain flat. These are qualitative expectations, not formal numerical guidance.
- Additional ARRIS integration restructuring actions and related charges and cash needs were expected to be material. The company had recorded $58.8 million of restructuring costs in the first half and expected $27.5 million of payments by year-end for initiated actions.
- On July 26 and August 7, 2019, the company announced redemptions of $100 million each of its 5.00% notes due 2021, scheduled for August 7 and August 17, respectively; $450 million would remain outstanding afterward.
- A patent-infringement case brought by Fractus was set for trial beginning September 9, 2019. The company said it could not reasonably estimate a potential loss and did not expect a material adverse effect based on then-current information.
- Other risks include substantial debt service and refinancing needs, integration execution, customer capital-spending trends, pricing and competition, foreign exchange, working-capital demands, and potential future goodwill impairment. The company also disclosed ongoing changes to financial-reporting controls as ARRIS is integrated; management concluded disclosure controls were effective.
Key facts investors should verify
- How much of post-acquisition revenue and adjusted EBITDA is recurring, and how legacy business trends compare with ARRIS contributions.
- Whether cable-operator spending and the ARRIS businesses recover on management’s revised timeline, and whether goodwill assumptions remain supportable.
- Integration costs, restructuring charges, purchase-accounting impacts, and the timing and amount of expected synergies.
- Cash conversion, receivables collection, inventory levels, and the company’s ability to fund interest, maturities and preferred dividends.
- Debt covenant headroom, variable-rate exposure, future note redemptions, and the terms and dilution implications of the convertible preferred stock.
- The outcome of the Fractus litigation and any material developments in ARRIS integration or financial-reporting controls.