Belden Inc

NYSE:BDC

Earnings Call Transcript 2020-Q1

[Operator]

Ladies and gentlemen, thank you for standing-by. Welcome to this morning's Belden, Incorporated conference call. Just a reminder, this call is being recorded. At this time, you are 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 Mr. Kevin Maczka. Please go ahead, sir.

[Kevin Maczka, VP, Treasurer and IR]

Thank you, Mark. Good morning, everyone, and thank you for joining us today for Belden’s first quarter 2020 earnings conference call. My name is Kevin Maczka, I’m Belden’s Vice President of Investor Relations and Treasurer.

With me this morning are Belden’s President, CEO, and Chairman John Stroup, Chief Operating Officer Roel Vestjens, and CFO Henk Derksen. John will provide a strategic overview of our business, Roel will provide a detailed update on our operations and review our segment results, and then Henk will provide a detailed review of our financial and operating results, followed by Q&A.

We issued our earnings release earlier this morning, and we 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 in reliance upon the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. For more information, 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, the appendix to our presentation and the investor relations section of our website contain 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, CEO, and Chairman, John Stroup. John?

[John Stroup, President, CEO and Chairman]

Thank you, Kevin, and good morning, everyone. As a reminder, I’ll be referring to adjusted results today.

Please turn to slide three in our presentation. Before we review our first quarter performance, I’d like to discuss the COVID-19 situation and how we are responding. This unprecedented pandemic is putting incredible stress on the global economy and financial markets, and our associates, customers, and suppliers are experiencing disruptions in their daily lives that were unimaginable just a short time ago.

Belden is certainly not immune from these new challenges, but we have the solid financial foundation to weather these difficult times. We are committed to protecting two our people and supporting our customers and offering our expertise and resources to assist in combating COVID-19.

The health and safety of our associates and their families remain our top priority, and we are following CDC and WHO guidelines to maintain safe working conditions. We rapidly scaled our work from home capabilities in our offices, enhanced the hygiene practices in our factories, and implemented social distancing standards across our organization.

We are also providing flexible working arrangements to help employees and their families navigate the disruption. I am extremely proud to report that our teams are rising to the occasion and finding creative ways to support local efforts to combat COVID-19. This includes donating cabling and connectivity products for ventilator production, and masks for medical centers and temporary hospitals in the United States, Wuhan and elsewhere.

In addition, we are using our 3D printers to produce components for face shields for medical workers, and rapidly developing and testing designs for N95 masks. Our valued customers are feeling the impact of this global pandemic as well, and we are focused on keeping them supplied while keeping our associates safe.

The majority of our sites have qualified for essential business status and remain operational, albeit at reduced capacity in some cases. Roel will provide more details on our operations in his remarks.

We remain committed to our capital projects and R&D investments. These investments are important to our customers and will enable us to provide a high level of product innovation in the future.

We are also taking the opportunity to further optimize our business for the current environment and the eventual recovery. As you would expect, we are managing our expenses and deploying countermeasures to protect cash flows. This includes upsizing our existing cost reduction program, harvesting working capital, and implementing compensation reductions for our senior leaders.

Specifically, for the remainder of the year we are reducing base salaries by 50% for myself and 30% for our senior leadership team. We are also reducing cash retainer fees for our Board of Directors by 50%.

However, we intend to maintain our direct labor force in anticipation of improving demand trends later in the year. During this period of softer demand, our direct labor is allocating additional time to kaizens and other continuous improvement and preventative maintenance activities. This will allow our operations to emerge even stronger.

Please turn now to slide four in the presentation. Next, I would like to update you on the three transformative actions we initiated last year following our comprehensive strategic portfolio review. These include the divestiture of Grass Valley, the $40 million cost reduction program, and the planned exit of approximately $250 million in undifferentiated copper cable product lines.

The Grass Valley divestiture remains on track. In February we announced a definitive agreement to sell 100% of Grass Valley to private equity firm Black Dragon Capital in a transaction that we expected to close in the first half of 2020.

The teams are working diligently to satisfy any remaining closing conditions, and the transaction remains on track for closing in the second quarter. As I mentioned, we are upsizing our $40 million SG&A cost reduction program.

We previously communicated an expectation of delivering $20 million of these savings in 2020 and the full $40 million run rate in 2021. We made considerable progress on achieving the planned savings, and our teams have identified a number of incremental opportunities.

Today, we announced an increase in the program to $60 million. We now expect to deliver $40 million in savings in 2020 and the full $60 million run rate in 2021.

Finally, given current market conditions, we are delaying the planned exit of $250 million in copper cable product lines. We believe that we are unlikely to maximize the value of these product lines during a global pandemic, so we will revisit this process and engage with potential buyers when conditions normalize.

Turning now to slide five in the presentation, I’d like to update you on our end markets. Recall that the strategic actions we are executing will result in an improved portfolio of businesses that is aligned with favorable secular trends in Industrial Automation, Cybersecurity, Broadband and 5G, and Smart Buildings.

We continue to believe that these are robust markets with compelling growth opportunities over the cycle. We are well-positioned to participate in that growth as we execute our strategic plans.

Turning now to slide six in the presentation, that said, the current situation is very dynamic, and visibility remains limited, making it incredibly difficult to accurately forecast near-term trends. As such, we thought it would be helpful to share our view of the potential trends in our markets once conditions normalize.

When the crisis passes and global economies reopen, we believe that many of our businesses could emerge stronger than ever. The next three slides illustrate our view of market conditions in a post-crisis environment.

Green represents markets that we believe could see an accelerated recovery.

Yellow represents markets that will likely see a typical recovery, while red represents markets that could remain depressed for an extended period before recovering.

Broadband and 5G, which represents approximately 23% of total revenue, should be a clear beneficiary of the global pandemic and the associated social distancing and work from home practices.

Broadband networks are being stressed like never before. We believe this will drive increasing investments in network infrastructure by our customers, supporting continued growth in our outside-the-home product revenues.

Further, our inside-the-home business recently secured several large orders for self-install kits as a result of social distancing and a reluctance to send technicians into consumers’ homes. We are well positioned to benefit from increasing demand for Broadband and 5G and the required investments in network infrastructure.

Turning now to Industrial Automation, which represents approximately 46% of total revenue, the global pandemic is clearly impacting end demand on a temporary basis, but we remain extremely optimistic about automation trends longer-term. We see a number of drivers of sustainable secular growth, including increasing labor costs and enhanced productivity and quality needs.

Social distancing and other new practices in the post-crisis environment could represent yet another incremental demand driver for automation. Within Industrial Automation, we serve customers in four market verticals, including discrete manufacturing, process facilities, energy, and mass transit. Our discrete products reside in machines on factory floors in a number of industries.

Not surprisingly, recent demand trends vary significantly by sub-vertical. We support customers in consumer products, material handling, medical and pharmaceutical products, and semiconductors. These are areas of relative strength that we expect to perform very well in the recovery.

The energy market is all about electric utilities, producing and distributing electricity. This vertical includes conventional electricity generation along with newer alternatives such as wind and solar and smart grid installations.

Energy is typically less cyclical than most industrial verticals, and we expect demand to remain healthy through that period. Mass Transit is also typically less sensitive to economic conditions. Projects in this market are often state funded, and infrastructure-related stimulus investments could be especially beneficial, particularly in the EMEA and Asia-Pacific regions.

Much like Industrial Automation, demand trends in Smart Buildings vary significantly by sub-vertical. We would also expect robust demand in some of our Smart Buildings markets. We serve government, health care, and data center customers. And as the economy reopens, we would expect healthy demand from these customers to partially offset the headwinds in the other verticals within Smart Buildings.

Finally, Cybersecurity is about 6% of our total revenue. We continue to see compelling secular growth opportunities in cybersecurity, especially in industrial applications. However, COVID-19 is impacting our near-term results. Our customers are temporarily shifting their IT priorities elsewhere and delaying planned projects.

Importantly, however, we are not seeing large project cancellations, and we expect the projects to proceed as the crisis passes.

Turning now to slide seven in the presentation, this slide highlights our other verticals that we would expect to see a normal recovery once the global economies reopen.

In Process Facilities, we play in the water and wastewater, oil and gas, metals and mining, and chemicals markets. Process markets like water and wastewater tend to be much more stable even in recessionary environments. We would characterize our expectations for the recoveries in these markets as relatively normal.

Turning now to slide eight, while we expect many of our markets to see accelerating demand trends as the global economies recover, some of our markets may be depressed for an extended period before recovering.

For instance, in Smart Buildings, our customers in the hospitality, retail, and commercial real estate markets are clearly facing fundamental changes in their businesses that will have implications for demand for our products.

We would expect projects currently underway to proceed to completion, but new project starts in these markets could soften going forward. Oil and gas is obviously challenged, and I would note that this market represents only approximately 5% of our total revenues.

Similarly, demand from automotive factories is increasingly pressured, and it also represents only approximately 6% of total revenues.

In summary, we see many more opportunities than risks in our markets in the post-crisis environment. Our portfolio of businesses will be impacted by COVID-19 to varying degrees, but we believe that many of our businesses, such as Broadband and 5G and Discrete Manufacturing, will emerge stronger than ever. We remain extremely excited about the opportunities for Belden going forward as we continue our transformation.

Please turn to slide nine for a brief discussion of our first quarter results and balance sheet and liquidity position. Revenues in first quarter declined 7% on a year over year basis to $463.5 million. End demand for our products exceeded our shipments in the first quarter, with incoming orders declining 2% to $489 million. EPS was $0.67, compared to $0.84 in the year-ago period.

Perhaps more importantly given the current environment, our balance sheet is strong, and we are very comfortable with our liquidity position. In recent years we strengthened our balance sheet and secured sources of additional liquidity. These decisions are proving to be especially beneficial now, providing important financial flexibility to successfully navigate this difficult economic environment.

We exited the first quarter with cash on hand of $294 million. Subsequent to the end of the quarter and out of an abundance of caution, we proactively drew down $190 million under our revolving credit facility, resulting in ample liquidity of over $450 million.

Our financial leverage at the end of the quarter was 2.8 times net debt to EBITDA. This is within our stated range of 2 to 3 times. Importantly, our fixed interest rate debt has no maintenance covenants and no maturities until 2025 to 2028.

I will now ask Roel to provide an update on our operations and review of our business segment results. Roel?

[Roel Vestjens, EVP and COO]

Thank you, John. Before I review our business segment results, I’d like to provide a more detailed update on our operations.

As John mentioned, most of our U.S. and global facilities remained operational during the outbreak while implementing enhanced safety protocols designed to protect our associates. In most cases, we received exemptions to remain open because we qualified as an essential business based on the nature of our products. However, operations in countries with government-mandated shutdowns, such as India, were suspended in the first quarter and have not yet reopened.

In addition, some facilities that were closed temporarily have reopened, albeit under capacity restrictions in some cases.

In China, our Suzhou facility was previously closed due to government mandate but is now open and operating at full capacity.

In Mexico, we are operating at limited capacity due to an agreement with the local government.

Importantly, we have effectively shifted production from closed or impaired facilities to other facilities with little or no customer disruption.

For example, in January, our customers in China were benefiting from our manufacturing capacity in Europe and the United States. In April, the opposite is true.

We are extremely thankful that across our global operations, only a few Belden associates have tested positive for COVID-19 to-date. In each case, we followed our pre-established processes for site sanitation and employee quarantines, which resulted in temporary disruptions.

We anticipate improving demand trends in the second half of the year, so we intend to maintain our direct labor force sized for normalized demand levels. During this temporary period of lower demand, our direct labor will allocate additional time to kaizens and preventative maintenance activities.

The majority of our office locations have implemented work-from-home protocols, with our remote connectivity systems functioning well. From a supply chain perspective, we did experience some disruption with various suppliers in China and elsewhere, but we have been able to manage through these situations for the most part.

We are benefiting from a decision made years ago to produce within close proximity to our demand whenever possible. And as a result, we have minimized the potential supply-chain disruptions. At this point, almost all of our suppliers have recovered to normal capacity levels.

Now please turn to slide 10 for a review of our business segment results. Beginning with our Industrial Solutions segment, I will be referring to adjusted results today. As a reminder, our Industrial Solutions allow customers to transmit and secure audio, video and data in harsh industrial environments. Our key markets include discrete manufacturing, process facilities, energy, and mass transit.

Revenues in this segment declined 9% on an organic basis after adjusting for changes in channel inventory levels to $251.3 million. Industrial Automation revenues declined 6% year-over-year in the first quarter after adjusting for changes in channel inventory levels. Not surprisingly, the declines were broad-based with demand softening as the quarter progressed and our channel partners reduced inventory levels.

Revenues in our Cybersecurity business declined in the first quarter. We typically generate a significant portion of our quarterly bookings and revenues in the last few weeks of the quarter, and the last few weeks of March were significantly impacted by COVID-related shutdowns.

As a result, many of our customers understandably delayed large IT projects, including Tripwire installations. We are not seeing project cancellations or market share loss, and we anticipate significantly improved demand trends later in the year. Industrial Solutions segment EBITDA margins were 14.1%.

Turning now to our Enterprise segment, as a reminder, our Enterprise Solutions allow customers to transmit and secure audio, video and data across complex enterprise networks. Our key markets include Smart Buildings and Broadband and 5G.

Revenue in this segment increased 2% year-over-year to $212.2 million and declined 3% on an organic basis after adjusting for the contribution of our recent broadband fiber acquisitions and changes in channel inventory levels.

Revenues in the Smart Buildings market declined 6% on an organic basis, with trends decelerating in March. Consistent with our expectations, our channel partners reduced inventory levels in this market during the quarter.

Revenues in Broadband and 5G were approximately flat in the quarter on an organic basis after adjusting for changes in customer inventory levels, with orders increasing by 4%. We experienced some disruption related to fiber suppliers in China, but these suppliers are now back to full production levels.

We continue to see robust demand for our fiber optic products. Following the successful integration of our broadband fiber acquisitions, we are significantly expanding our product offering and capturing additional share.

We are also capturing share with our inside-the-home products, as we secured a number of large orders for self-install kits. Enterprise Solutions segment EBITDA margins were 11.6%.

Finally, I would like to discuss channel inventory levels. We entered 2020 with a planning assumption for the full year that our channel partners would pursue a reduction in channel inventory levels of approximately $50 million.

Given the more challenging environment, we now expect a larger channel inventory reduction of approximately $70 million. Inventory levels declined by $20 million in the first quarter, consistent with our expectations, and most of the remaining reductions are likely to occur in the second quarter.

I will now ask Henk to provide additional insight into our first quarter financial performance. Henk?

[Henk Derksen, SVP, Finance and CFO]

Thank you, Roel. I will start my comments with results for the quarter, followed by a review of our segment results, a 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 11 for a detailed consolidated review. Revenues were $463.5 million dollars in the quarter, decreasing $36.6 million, or 7.3%, from $500.1 million in the first quarter of 2019.

Revenues decreased 9.1% organically from the prior-year period, as a $17.0 million favorable impact from acquisitions was partially offset by an $8.2 million negative impact from currency translation and lower copper prices.

After further adjusting for changes in channel inventory, revenues decreased 6.4% organically from the prior year. End demand for our products exceeded our shipments in the first quarter. Incoming orders of $489.0 million dollars resulted in a book-to-bill ratio of 1.06.

Gross profit margins in the quarter were 36.9%, declining 50 basis points compared to 37.4% in the year ago period. This decline was due to lower production volumes and unfavorable product mix. EBITDA was $60.8 million dollars, compared to $76.4 million in the prior-year period. EBITDA margins were 13.1%, decreasing 210 basis points from 15.3% in the first quarter 2019.

Our SG&A cost reduction program is ahead of schedule, as we delivered $5 million of savings in the first quarter relative to our original commitment of $2 million. We also continued to fund our growth initiatives and R&D investments, and we remain committed to these important projects.

Net interest expense was consistent with the year-ago period at $13.3 million dollars. At current foreign exchange rates, we expect interest expense in 2020 to be approximately $57 million dollars.

Our effective tax rate was 18.2% in the first quarter, as we benefitted from incremental discrete tax planning initiatives. We expect an effective tax rate of 20% for the remaining quarters in 2020 and 19% for the full year.

Net income in the quarter was $30.5 million dollars, compared to $42.0 million in the prior-year period. Earnings per share was $0.67 in the quarter, compared to $0.84 in the year-ago period.

Please turn to slide 12. I will now discuss revenues and operating results by business segment. In the first quarter 2020, we transferred certain cable businesses and product lines from the Enterprise Solutions segment to the Industrial Solutions segment.

We have recast the prior period segment information to conform to the change in the composition of reportable segments. These realignments help simplify our operating structure and enable the restructuring actions related to our cost reduction initiatives, as well as potential divestitures.

The Industrial Solutions segment generated revenues of $251.3 million dollars in the quarter, decreasing 14% from the prior-year period. Currency translation and copper prices had a negative impact of $5.4 million dollars.

After adjusting for these factors and changes in channel inventory, revenues decreased 9% organically on a year-over-year basis. EBITDA margins were 14.1% in the quarter, declining 460 basis points year-over-year, primarily due to lower production volumes, growth investments and product mix.

Our Enterprise Solutions segment generated revenues of $212.2 million dollars during the quarter, increasing 2% from the prior-year period. Revenues were favorably impacted by $17.0 million dollars from acquisitions.

After adjusting for acquisitions and changes in channel inventory in the year-ago period, revenues declined 3% organically on a year-over-year basis. EBITDA margins were 11.6% in the quarter, increasing 120 basis points from the prior year period, primarily due to improved productivity and our ongoing cost reduction programs.

If you will please turn to slide 13, I will begin with our balance sheet highlights. Our cash and cash equivalents balance at the end of the first quarter was $294 million dollars compared to $426 million in the fourth quarter and $339 million in the prior year period.

As John mentioned, subsequent to the end of the first quarter we proactively drew down $190 million under our $400 million revolving credit facility, resulting in ample liquidity of over $450 million. This was done out of an abundance of caution, and we have no immediate plans to deploy this capital.

Working capital turns were 6.8 turns, compared to 13.0 turns in the prior quarter and 5.7 turns in the prior year. Days sales outstanding of 59 days increased by two days sequentially and 6 days from the prior year. Inventory turns were 4.6 turns, compared to 6.0 turns in the prior quarter and 4.5 turns in the prior year period.

Our total debt principal at the end of the first quarter was $1.40 billion, consistent with the prior quarter. Net leverage was 2.8 times net debt to EBITDA at the end of the quarter, in-line with our target range of 2.0 to 3.0 times.

Turning now to slide 14, I will now discuss our debt maturities and covenants. As a reminder, our debt is entirely fixed at an average interest rate of 3.5% with no maturities until 2025 to 2028. We have no maintenance covenants on our debt, so we are not at risk of an event of default caused by worsening economic conditions. We are very comfortable with the quality of our balance sheet and our liquidity position at this point.

Please turn to slide 15 for a few cash flow highlights. Cash flow from operations in the first quarter was a use of $52.1 million dollars, compared to a use of $46.1 million in the prior year period. Net capital expenditures were $18.8 million for the quarter, compared to $23.6 million from the prior year period. The year-over-year difference is primarily related to project timing.

Free cash flow in the quarter was a use of $70.9 million dollars, consistent with $69.6 million in the prior year period.

On a trailing 12 months basis at the end of the first quarter, free cash flow was $165.7 million dollars, compared to $166.9 million in 2019. We are implementing countermeasures to protect cash flows, and we expect to remain solidly free cash flow positive even in a severe downside scenario, as we were during the financial crisis in 2008 and 2009. This includes upsizing our existing cost reduction program from $40 million to $60 million, other expense control including executive compensation reductions, and harvesting working capital.

Specifically, we expect to reduce working capital by approximately $75 million dollars during the remainder of the year as we reduce our inventory levels and manage accounts receivable and accounts payable. Our capital deployment plans have changed in response to the global pandemic.

We are committed to our growth capital investments, and we continue to expect CapEx of approximately $70 million dollars in 2020 for continuing operations. However, we now expect less share repurchase and M&A activity this year. We deployed $21.2 million to repurchase 592,000 shares in the first quarter.

Year-to-date, we deployed $35 million to repurchase 977,000 shares at an average price of $35.83. We are not planning to execute additional share repurchases until conditions normalize and visibility returns. Similarly, we are unlikely to complete additional M&A in this uncertain environment.

That completes my prepared remarks. I would now like to turn this call back to our President, CEO, and Chairman, John Stroup. John?

[John Stroup, President, CEO and Chairman]

Thank you, Henk.

The COVID-19 situation is very dynamic and visibility into the extent to which our global markets and manufacturing capacity will be impacted is limited. This makes it incredibly difficult to accurately forecast near-term trends. Given the wide range of potential outcomes, we are not providing specific revenue or EPS guidance for the second quarter or full year 2020 at this time.

That said, the typical seasonal patterns are unlikely to hold this year. We expect our revenues and EPS to be lower sequentially in the second quarter. We are also anticipating significant reductions in channel inventory levels.

Again, our prior planning assumption for the full year was a reduction of approximately $50 million, but we now expect approximately $70 million with the majority occurring in the second quarter.

While we are not able to accurately predict the timing and magnitude of the recovery, our current expectation is that business conditions will bottom in the second quarter and we will see sequential improvement in the second half.

We look forward to resuming our normal guidance practices once visibility returns. 11 That concludes our prepared remarks. Operator, please open the call to questions

[Operator]

[Operator Instructions] So, we will now pass to our first questionnaire, Noelle Dilts from Stifel. Please go ahead.

[Noelle Dilts, Stifel]

Hi guys, good morning and thanks for everything you guys are doing to support health care industry during the crisis.

So, my first question was just on the channel partner inventory reduction $50 million going to $70 million. Could you just clarify, how much of that inventory reduction you did -- channel partner inventory reduction you did see in the quarter. And then I know in the past we have talked about and have that the Westco Anixter merger could have on inventory reductions that hasn’t closed yet.

So, are you expecting potentially some additional inventory reduction beyond the second quarter as that closes? I just like to get -- I'm sorry, and also by segment. How you’re thinking about that inventory reduction would be helpful? Thanks.

[John Stroup, President, CEO and Chairman]

So, thanks Noelle for the question. This is John, I’ll let Roel add. So, the $20 million that came out in the first quarter was what we had expected, and we thought there’d be another $30 million, we now think it'll be 50. This is obviously not a precise calculation.

The process we use to get there is we start by forecasting what the sell-through will be at our channel partners, then we look at what their historical turns are. And then we calculate the amount of inventory that will either go up or go down.

Given that we think most of our channel partners are also going to be focused on cash flow, like we and most companies are, we thought they might want to take turns off a little bit. And as a result, we thought that the inventory reduction could be a little bit larger. This by the way, is inclusive of the planned acquisition and integration of Westco and Anixter. So, this is all in there. We're not expecting anything in addition to that.

As it relates to segments, our inventory at our channel partners is largely cable products. So, there's a few exceptions, but it's mainly cable, which means that it's going to be roughly split between our Smart Buildings business and our Industrial Automation business roughly, we do have a few customers that hold inventory.

So, for example, in our Broadband and 5G business, we have some customers like Comcast and Charter that hold inventory and we look at that as well and include that in our calculation, but it's relatively small compared to the large channel partners.

[Noelle Dilts, Stifel]

And then again, understanding that there's not all that much visibility. Anyway, you could expand upon the trends that you're seeing so far in April, and kind of how the month has trended so far?

[John Stroup, President, CEO and Chairman]

So, I think the question Noelle, it's a little hard to hear you. I'm going to let Roel answer, but I think your question was, what are we seeing in April and how is April been compared to March and where we are, so Roel do you want to give an update please?

[Roel Vestjens, EVP and COO]

Sure. April is trending according to expectations, we see APAC, our Asia Pacific region actually trending up relatively strong orders in China. BPC was off to a very strong start in April, but overall, we think the second quarter will be down sequentially from the first quarter.

[John Stroup, President, CEO and Chairman]

And I think Roel, our order run rate in April so far has been fairly similar to what we saw the last couple of weeks of March. So, although it's changed a little bit by region, and it does bounce around a little bit, I think on an average over the last three or four weeks of April, we've seen demand be pretty similar to what we saw at the end of March, which was down pretty substantially compared to February.

[Operator]

We can now pass to our next question from Sean Harrison from Luke Capital. Please go ahead.

[Unidentified Analyst]

Hi, good morning, everybody. John or Roel, wanted to just think more about the Smart Buildings business because that's typically been a bit of a laggard, as we've done our downturn or recessionary type events.

And so, is that something where maybe the pain isn't as immediate as you are seeing, particularly the industrial business right now and you would see maybe more of a downturn as we get into 2021. But just know how the cyclicality of that businesses potentially change since 2008, 2009?

[John Stroup, President, CEO and Chairman]

So, as we highlighted, our Smart Buildings business is approximately 25% of our total within that 25 apart. That is in our in our opinion the most vulnerable to a downturn would be the commercial real estate, hospitality and retail, which is about 15% of our total.

What we're seeing right now, Sean is a little unusual and I think it's a consequence of the shelter in place orders, where contractors are unable to actually do the work at the normal rate on projects that are already started.

Our expectation is that will improve, and that we would see stronger demand in the second half for our Smart Buildings products. But that demand would be a consequence of projects that would have been started probably nine to 12 months ago.

So, our belief is that most of the projects that were already started will be completed. We'll probably see softness is in a year from now, because we think it's unlikely there will be very much activity and starts in the second, third or fourth quarter within commercial hospitality and retail, so as we think about modeling, in my opinion, I would think that somewhere around the second or third quarter of 2021 we would begin to feel the negative effects of weakening starts within commercial hospitality and retail, which is about 15% of our total.

[Unidentified Analyst]

Okay, that's helpful. And then second just on free cash flow is a percentage of net income; I know you're typically targeting a hundred percent. Are there any dynamics this year other than kind of the lower profitability that would affect Belden achieving that goal?

[Henk Derksen, SVP, Finance and CFO]

Well, there's a little impact, this is a Henk, Sean. It does impact restructuring for sure as we execute our OpEx simplification programs, we expect funding here of approximately 50 million to get a 60 million annualized cost reduction.

[Operator]

We can now pass to the next question from Reuben Garner from Benchmark Company. Please go ahead.

[Reuben Garner, Benchmark Capital]

Thank you. Good morning, everybody. Maybe just start with a follow-up on the question about Smart Buildings on slide eight. I'm a little surprised to see the commercial real estate part of that. Can you just maybe elaborate on what you're expecting there? And I guess the heart of the question is we've heard a lot of, are you seeing in media a lot of expected changes particularly in the office environment and how people work and where they work.

And you'd think that there be more of a need for Smart Buildings and connectivity, if you will, in the office spaces. Is that not necessarily a big part of that 11%, or a big part of the new construction and that's why it's red, can you just kind of touch on that piece of it a little bit more?

[John Stroup, President, CEO and Chairman]

Yeah. So, first of all, this is obviously somewhat speculative. And none of us know exactly how the economy will reopen, but as you said, we think it's likely in the future that people might view their investment in commercial real estate differently. They may think about how they use space differently.

They may think about work from home differently. And so, as a consequence, we think that there's a good chance that the starts in commercial real estate in the second quarter and through the rest of the year might be down from the prior year. And if that's true, 12 months from now, we would see the impact from a square footage point of view.

We would continue to expect the secular benefit of more connected devices within the installed square footage. And I think that will continue, but it probably won't be able to completely overcome the reduction in square footage.

So, as we sit here today and we look at our portfolio, that's an area where we feel like there could be some headwinds, entering 2021 and we wanted to be clear and transparent with our investors about that possibility.

[Reuben Garner, Benchmark Capital]

Great. Thanks. That's very helpful. And then Broadband and 5G, obviously green in the slide, can you just talk about what you're seeing here recently from an order trend standpoint, I'd imagine that there's more of a need another for increased speed and worth, can you just kind of tell us what you've seen so far over the last four to six weeks?

[Roel Vestjens, EVP and COO]

This is Roel, absolutely, that's absolutely true. As we mentioned in our prepared remarks, we sold orders up 4% in that segment, we furthermore continued to see a trend of very strong performance outside the home.

So, our orders are actually up 9% in Q1 for outside the home products. So, this trend of people working more from home, spending more time in their homes and hence consuming more bandwidth, we expect to be very favorable for this business in the medium and in the longer-term.

[Reuben Garner, Benchmark Capital]

Thanks. Good luck navigating through all this guys.

[John Stroup, President, CEO and Chairman]

Thank you.

[Operator]

We'll now pass to the next question from William Stein from SunTrust. Please go ahead.

[William Stein, SunTrust]

Great. Thank you for taking my questions. First, we understand your expectation for revenue to decline in Q2, we understand you cap size it. Can you helps perhaps better understand what we should expect from a detrimental perspective on gross and operating margins please?

[Henk Derksen, SVP, Finance and CFO]

So, this is Henk. I think we should model detrimental EBITDA margins of 30% to 35% and addition as included in our prepared remarks, we should also include roughly 4 to 5 million placeholder, because we’re planning to keep the capacity in our factories intact and expectation of rebound in the third and the fourth quarter.

[William Stein, SunTrust]

So that placeholder is that sort of one-time -- in addition to that 30% to 35% detrimental or is that a comment as it relates specifically to cash flow but not EBITDA?

[Henk Derksen, SVP, Finance and CFO]

No, that's in addition to the detrimental and that’s temporary.

[William Stein, SunTrust]

Okay. Thank you for that. One other, which is you did a -- the company was already in the midst of some pretty transformative events, sometimes you look to crises to expect well-managed companies to undertake some activities to transform the business to become stronger coming out.

Belden sort of fortunate in that some of these were already underway with the Grass Valley divestiture and the $250 million of cable and wire and the restructuring. And so, one of those seems to be on contract happening Grass Valley, we have the 40 million upsize to 60, the 250 million divestitures on hold for now.

Are there any other things that we could think of that either perhaps I missed in the script or other things that you're doing or thinking about doing that could improve your competitive position coming out of the crisis,

I know you said M&A is off the table for now, but I don't know new product introductions or are you looking at the potential for smaller competitors to have a tougher time and maybe capture share. Anything like that we could point to be more optimistic about Belden's future.

[John Stroup, President, CEO and Chairman]

Yeah. Well, so first of all, I thought you summarized our actions well. I also agree with you, that we are fortunate that we had begun many of these things well in advance of this crisis and that gives us a strong head start. It's a lot easier to increase a $40 million cost reduction to $60 million than it is to start one from scratch. So that's actually perpetuals for us.

The other things I would say that we're doing that I think provide optimism is we're clearly much stronger financially than some of our competitors. That's obvious and we're already beginning to see that play out in terms of how customers think about choices that they make. And Roel and team I think are doing an excellent job of making sure our customers are aware of that and helping them make good decisions.

The other thing is that this slide that we've showed all of you with regard to the markets that we would expect to actually benefit from this crisis and some of the ones that we think would be negatively impacted,

Roel and team are already redeploying resources around this view. So, we've got in the case of, for example, commercial real estate. We know that we have a 12-month lag between when starts occurring and when we get revenue. And that means that Roel and team have a 12-month head start to figure out how we redeploy our resources towards other markets that we're much more bullish about like broadband.

So, we can redeploy commercial resources, we can redeploy engineering resources, we can redeploy manufacturing capacity. That's a huge advantage. And then the last thing I'd like to say, the Roel already pointed in his prepared remarks, is the decision we made long ago to manufacture our products near our customers is proving enormously helpful.

We're not having to deal with the kind of supply chain disruptions that people, other people have had to deal with. And I think at the end of the day, that allows us to continue to solidify the trust that we have with our customers. So those would be the things I would point out.

[William Stein, SunTrust]

Thanks.

[John Stroup, President, CEO and Chairman]

Thank you.

[Operator]

We can now pass to the next question from Jed Dorsheimer Canaccord Genuity. Please go ahead.

[Jed Dorsheimer, Canaccord Genuity Corp]

Hi, thanks. And thanks for those slides. It's helpful to kind of recognizing that that there's some variability at least shows it's helpful to understand the mindset. So, I guess my first question is around sort of that rebound slide.

And just want to make sure I'm looking at it correctly if I -- weighted average the different segments. Looks like your expectations are at some point in time and kind of holding those yellows is outliers. For 50% of the business to be up 11% and 50% of the business to be down 5% to 7%. Is that sort of the right way to look at that? And then kind of have that yellow is a wildcard for the variability.

[John Stroup, President, CEO and Chairman]

So, the green segments are all examples of vertical markets that we think will recover nicely from this business. So, if you look at our baseline, I think the math you're trying to do is we would expect that the businesses in green, which represent roughly 65% of our total.

We would expect those businesses to get back to and grow off where we were. So that's the expectation we're trying to create that we would expect to fully recover and then seek growth from there.

The reds are areas where we would not expect to recover back to where we were, at least not anytime soon. And the yellow we would expect that recovery to happen, but it would probably take a little bit longer.

So, as we shared already, we haven't -- we're not providing guidance for the second quarter for the full year. But we're certainly trying to share with everybody how we're thinking about our end markets, how we're thinking about the likely recovery, and maybe most importantly, how we're thinking about how we deploy our resources and our capital.

[Jed Dorsheimer, Canaccord Genuity Corp]

Got it. That's useful. And then, Hank, just a question with respect to the EBITDA. I want to make sure I caught this correctly in Q2. The way to think about is did you say 35% reduction in EBITDA over Q1 sequentially. And then, reserving $4 million for kind of recovery in Q3.

[Roel Vestjens, EVP and COO]

No. What we what we said is the detrimental EBITDA margins on the sequential down in revenue, needs to be a roughly 30% to 35%. And then in addition, we'd like you to model another $4 million to $5 million of temporary inefficiencies that we're holding to ensure. We can respond to a recovery, an improvement in demand in the third and fourth quarter.

[Jed Dorsheimer, Canaccord Genuity Corp]

Got it. Thank you.

[Roel Vestjens, EVP and COO]

You're welcome.

[Operator]

We will now pass to the next question from Matt Delaney, Goldman Sachs. Please go ahead.

[Matt Delaney, Goldman Sachs]

Yes, good morning. Thanks very much for taking the questions. First of all, it's something to better understand the cost reduction plan the $40 million and $60 million number. How much that is net savings?

So, in other words, is that savings going to be reinvested? Or is that the net amount that the company expects to save. And along those lines, as I think about the quarterly trajectory of SG&A, I think it was $95 million this quarter, 35 million left to go for the 2020 savings.

So, you have to take out on a quarterly basis, about 9 million or so per quarter. That will take down to mid-$80 million range but maybe could you even go lower than that because of the other temporary cost savings. So just can help us think about the quarterly trough this year.

[Henk Derksen, SVP, Finance and CFO]

Yeah. So, the cost reduction program will result into a $40 million improvement in SG&A, not in R&D. We're keeping our investments in R&D in place. And the cadence is $5 million the first quarter, $8 million in the second quarter, 12 in the third and 15 in the fourth. That's the best planning assumption.

[Matt Delaney, Goldman Sachs]

Okay, that's helpful. And then my follow up question on Cybersecurity. There was a market that I think is in the green category. But also, the company mentioned some near-term headwinds. Just trying to better understand some of the trends that you've seen in terms of orders and within cybersecurity and the customer discussions about how quickly that the business could potentially come back? Thank you.

[Roel Vestjens, EVP and COO]

Yes, as we said in our prepared remarks, we did not see any project cancellations, nor did we see share loss projects that we would lose to competition. We expect this uncertainty so our larger customers dealing with social distancing and not necessarily receiving our engineers on-site to install our Cybersecurity Solutions to continue in the second quarter. But we do expect fully in the second half of the year our demand trends to improve.

Our industrial offering, Cybersecurity offering remains robust and continues to do well. And we are certainly adjusting some of our products and actually launching some new products in the second half of the year that would help further secured networks in this environment of people working more from home.

[Matt Delaney, Goldman Sachs]

Thank you.

[Operator]

We can now pass for our next question from Paul Chung, JP Morgan. Please go ahead.

[Paul Chung, JP Morgan]

Hi, guys. Thanks, thanks for taking my questions. So just a quick follow-up on free cash flow seasonality kind of assuming even stronger second half, kind of given the Q2 headwinds on COVID. But what are kind of puts in takes on working CapEx, you can kind of benefit from?

[Henk Derksen, SVP, Finance and CFO]

Yes, so we expect instability movements throughout the year. And pretty evenly an improvement in inventory turns and slight improvement in DSO, as we think for the remainder of the year and we'll hold accounts payable.

[Paul Chung, JP Morgan]

Okay. Thanks for that. And there's just a follow up on the Cybersecurity question. Are you seeing any kind of pent up demand? No once the COVID concerns come down doing it's becoming increasingly important for your enterprise customers?

[Roel Vestjens, EVP and COO]

While we're certainly seeing -- if the projects are not being canceled, and we're not losing to the competition and we will win them at a later point in time. So that would-be pent-up demand. It's obviously the question is the projects that we're originally scheduled for late to occur later on in this year will they still occur, will they shift as well? That's a little bit hard to predict. But we certainly expect very robust demand moving forward in the medium and long-term for our Cybersecurity offerings.

[Paul Chung, JP Morgan]

Thanks, guys.

[Roel Vestjens, EVP and COO]

Thank you.

[Operator]

Kevin Maczka, there are no further questions at this time, please continue.

[Kevin Maczka, VP, Treasurer and IR]

Okay. Thank you, Mark. And thank you to everyone for joining today's call. If you have any questions, please reach out to the IR team here at Belden. Our e-mail address is [e-mail]. Thank you.

[Operator]

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