CommScope Company - Earnings Call - Q3 2019
November 7, 2019
Transcript
Speaker 0
Good morning, ladies and gentlemen, and welcome to CommScope Third Quarter twenty nineteen Results Conference Call. At this time, all participants are in a listen only mode. Later, we will conduct a question and answer session and instructions will follow at that time. I would now like to turn the conference over to your host, Mr. Kevin Powers, Vice President, Investor Relations.
Sir?
Speaker 1
Good morning, and thank you for joining us today to discuss CommScope's third quarter twenty nineteen results. With me on the call are Eddie Edwards, President and CEO and Alex Pease, Executive Vice President and CFO. You can find the slides that accompany this review on our Investor Relations website. Please note that some of our comments today will contain forward looking statements based on our current view of our business and actual future results may differ materially. Please see our most recent SEC filings, which identify the principal risks and uncertainties that could affect future performance.
Before I turn the call over to Eddie, just a few housekeeping items to review. Today, we will discuss certain adjusted or non GAAP financial measures, which is described in more detail in this morning's earnings materials. Reconciliations of non GAAP financial measures and other associated disclosures are contained in our earnings materials and posted on our website. All references during today's discussion will be to our adjusted results. Also note, the third quarter twenty eighteen results include historical ARRIS results reflecting certain classification changes to align to CommScope's presentation.
All quarterly growth rates described during today's presentation are on a year over year basis unless otherwise noted. I will now turn the call over to our President and CEO, Eddie Edwards. Eddie?
Speaker 2
Thanks, Kevin, and good morning, everyone. Today, we reported third quarter sales that were in line with our outlook and adjusted EBITDA and earnings per share that were at the high end of our outlook. Our results were consistent with our expectations with the exception of some networking cloud product sales that were expected to occur in the fourth quarter and mobility sales weakness due to a pause in spending related to a pending large carrier merger. Overall, our results reflect our ability to manage near term headwinds while maximizing profitability in a challenging environment. During the quarter, we made progress across several areas as we continue to execute on our strategic plan to deliver shareholder value.
From a financial standpoint, while sales were down year over year on a pro form a basis, we successfully stabilized adjusted EBITDA margins at 15.5% and generated over $500,000,000 of adjusted free cash flow. This strong cash flow performance enabled long term debt repayment of $200,000,000 during the quarter and an incremental $200,000,000 in the fourth quarter to date. As Alex will touch on later, we continue to expect strong positive cash flows through the fourth quarter. CommScope remains a strong business, and these results illustrate our ability to act with agility and meet our short term and long term financial obligations despite broader industry challenges. Examples of proactive efforts to maximize our profitability and stabilize our business include, we are evaluating all opportunities to accelerate deal related cost synergies.
As a result of our efforts, today, we're on track to deliver at least $75,000,000 in cost synergies in the first year post close and exceed our annual run rate savings of a 150,000,000 ahead of the third anniversary of the close of the ARRIS transaction. In addition to deal related synergies, we have taken decisive action to execute on our previously announced plans to deliver $30,000,000 of incremental cost action in the second half of twenty nineteen. We've implemented manufacturing footprint optimization changes and driven efficiency gains through product reengineering initiatives. As we continue to work to enhance efficiency, reduce cost, and drive integration solution in the short and long term, we are coordinating and integrating all indoor LTE work together and utilizing traditional switch ex expertise. This will enable us to service a nascent but important SIPRE and e SIPRE aggregation market among other programs.
As these broader industry headwinds abate, CommScope will be strategically positioned to capitalize and return to growth as we have experienced in the past. We continue to believe in the long term potential of the business and are committed to delivering shareholder value. Now I'll turn to specific business performance. In connectivity solutions, indoor fiber sales remain pressured in the quarter with continued shift from company owned data centers to the cloud. However, we continue to identify opportunities to ensure that we continuously improve performance at CommScope.
For example, because of the intense focus on data privacy and security, we are seeing financial services clients employing more of a hybrid approach, that being deployed in both company owned data centers and into the cloud. We have a strong history of success in company owned data centers, and we believe that investment by the financial services sector is an attractive opportunity for CommScope. In addition, hyperscale data center sales remain robust and have more than doubled in the quarter in a market expected to grow at low double digit CAGR over the next five years. Our strong performance is driven by two factors, growth in the overall market and strategically growing our position in the high fiber count connectivity product segments. One of the primary concerns of hyperscale customers is scaling up quickly on a global basis to meet customer demand.
CommScope has demonstrated superior r and d and operational capabilities to provide complex, high density solutions at global scale, keeping pace with the hyperscale demands. While indoor copper enterprise sales continued to decline in line with the industry, we are focused on maintaining and strengthening our market position and positioning our products for new applications. To ensure our continued leadership, we are investing in innovation that provides the best performance in the industry to help our customers deal with connectivity challenges of today and tomorrow. These include solutions to solve for connectivity and increased power needs from devices such as Wi Fi access points, the Internet of Things, and indoor small cells. As a result, we have seen our in building cellular sales through the enterprise channel grow substantially year over year as our enterprise sellers and channel partners collaborate to sell more CommScope products and services.
We remain well positioned with the breadth of our industry leading portfolio to address these growing needs. And over time, we expect our rate of decline to subside. Network cabling and connectivity remained soft as expected in the quarter, primarily due to headwinds from Tier one North American cable operators and carriers, but we see opportunities for growth in other areas of the market. Tier two and Tier three markets in The U. S.
Remain strong as they build out their networks to address regional markets underserved by other larger players. In addition, from the international perspective, we see fiber builds continuing across several markets. Recently, we've won fiber to the home deployments in The Philippines, Germany, Puerto Rico, and The Middle East. All told, we expect to see a modest lift in fiber cabling and connectivity from the cable operators in 2020. In mobility solutions, we continue to help operators design their cell site architecture for five g.
To that end, our base station antenna business, and we continue to help our operators continue our our customer operators to efficiently deploy more and more spectrum within even tighter space constraints at the top of poles, buildings, and towers while also continuing to improve network performance. The average port density of our antennas we are shipping this year is up nearly 50% versus two years ago. This is an investment cycle that we expect to continue over the next decade, and we are well positioned to capitalize on this opportunity. In our metro cell business, which features small cells, we now have fully integrated smart poles deployed in multiple major US markets, including Boston, Dallas, and Los Angeles. These solutions are designed to solve challenging site acquisition problems for carriers by blending complex connectivity installations with urban street furniture.
Our solutions are deployed in over 10,000 integrated metro sales across the country. Deployments are rapidly growing and we as we receive zoning and architectural approvals by growing list of municipalities. To that end, we have made investments to more than double our manufacturing capacity to provide a full breadth of solutions to meet the requirements of nearly every urban planner. Importantly, these integrated smart pole solutions pull through additional product sales that include fiber, connectivity, RF infrastructure, and power. We're incredibly excited about this business as a growth engine for CommScope in the near and long term.
In our distributed antenna systems and indoor small cell business, we're making good progress across multiple fronts. Our next generation digital DaaS solution called Era is an RF over fiber distribution system that evolves the conventional DaaS architecture by adding centralized or C WAN capabilities. Importantly, Era makes in building wireless solutions easier to install. The system has a smaller footprint saving space. It's easier to manage and less expensive to operate than other systems, all while giving operators, mutual hosts, and enterprises the room they need to grow as five g technologies and applications come to market.
I'm happy to say that we've been awarded the cellular coverage for the twenty twenty and twenty twenty one Super Bowl stadiums, further validating our fully digital era DAS platform as the industry's leading solution to pack maximum amount of spectrum and bandwidth from multiple operators into high density public venues. Next, our CRAD small cell offering called OneCell recently won formal approval from a major North American tier one carrier. The formal approval followed multiple trials across different venues, and we've already signed a contract for turnkey deployments with a significant pipeline of various buildings and venues. OneCell is our innovative innovative in building small cell solution that supports multibands and multi operators. Is built off five g architecture and dramatically reduces the cost of ownership for in building cellular coverage.
With five g relying on indoor coverage to be successful, OneCell unlocks an entirely new and very large pool of addressable market for us in small buildings and venues and a right sized solution to deliver cellular services. In addition, OneCell is built on an IT friendly architecture, which allows the solution to be deployed and operated by an IT ecosystem, which further unlocks scaling opportunities. Also, we expect OneCell sales to increase significantly in 2020 and continue to grow as the need for reliable and cost effective indoor cellular coverage increases for five g. This product will also add operating capabilities for the FirstNet footprint. Moving to CPE, we successfully introduced new video products in the third quarter, including a set top box for Altice that combines far field microphones and speakers with traditional set top capabilities.
This combination creates a new class of smart media device and enables integration of digital home services with video. During the quarter, we also launched four k set tops at several European operators. Moving to broadband. We're excited that our fixed wireless broadband gateway is in the final stages of lab approvals at two American wireless service providers. We remain heavily engaged in next generation gateway development for both PON and DOCSIS solutions with deployments expected in 2020.
We're also continuing to support the gigabit broadband service rollout with Vodafone in Germany, and we're seeing strong additional demand from this service in the newly acquired Unitymedia regions. Moreover, we launched the Mercury v two DOCSIS gateway supporting Liberty Global's Giga CD service. From a cost standpoint, tariffs on certain set tops that would be risk four eighty went into effect in September with additional tariffs going into effect in December. We felt the impact of this list four tariffs in the third quarter, which we expect to continue in the fourth quarter. However, we expect that the impact will be materially mitigated by the first quarter of twenty twenty.
Finally, we saw a sequential increase in CPE gross margin and EBITDA due to cost containment and material cost improvements. This extends gains in gross margin and EBITDA achieved in the second quarter, and we expect to see further improvements in the fourth quarter. We continue to drive positive changes in the organization to improve efficiency and are deeply focused on cost management. Turning to Network and Cloud. As expected, sales improved sequentially in the third quarter from an improvement in cable spending and some earlier than expected orders.
While the business remains softer than expected this year, we achieved several notable mines milestones in the quarter. As the market leader in installed nodes, advanced technologies, and fiber and copper connectivity, CommScope continues to be a natural choice for upgrade modules as operators look to upgrade to a distributed access architecture. To that end, we recently launched our new optics aggregator and optics termination products at a tier one North American cable operator. These new node based products are significant as they will become a key component in this operator's distributed access architecture upgrade. The first products were installed in the field last week with volume shipments coming this quarter.
In addition, we've been asked to engage jointly in a large tier one MSO and a large chip manufacturer for their next generation Remote PHY device. CommScope was awarded this project because of our industry leading capabilities and reckless scale, which are a necessity for a project of this significance, to be successful. Moving on to VCORE, our virtual CMTS platform. We are currently in trials with several operators and will be ready for commercial launch by the end of the year. We are making great progress and are very comfortable with our timelines and positioning.
According to third party projections, the market for virtual platforms is expected to be relatively small through 2020 with the majority of the DOCSIS infrastructure spending continuing to go through current traditional platforms. Although, we don't expect our commercial timeline to be impactful on our long term market positioning, and we'll continue to deploy our current generation CCAP products. And finally, we continue to add new Remote PHY device modules to our portfolio. In the first half of twenty twenty, we plan to launch our our new Remote MAC PHY module, which will be plug in compatible with our node platforms. This will give us the ability to support either a vCore plus remote PHY architecture or a fully distributed, remote Mac PHY.
And turning to Ruckus. Ruckus had an active quarter making progress across all product lines. Following the launch of the r seven fifty, the industry's first Wi Fi six certified access point, we introduced several additional products, including the r six fifty and t seven fifty, which will not only improve network throughput for up to three gigabits with new compatible clients, but also will improve the capacity for existing AC clients by up to 30%. This is proving to be incredibly valuable for our customers with high density requirements like schools who continue to be a very important segment of this business. In line with our plans, we continue to upgrade our switch portfolio.
The ramp of our high end ICX seventy eight fifty campus switch is progressing faster than we expected. We believe that, with the need of 10 gigabit per second capable switches to feed Wi Fi six access points, we will see significant growth with these products. For CBRS, during the quarter, we continued to build support for private networks with trial systems and combined engineering efforts with our OneCell product line, which will enable us to address solutions for both licensed and unlicensed spectrum. Our CBRS business kicked in high gear with SEC announcement of entering initial commercial deployment. One of the first publicly announced deployments of CBRS was in New Times New York York's Times Square and included Ruckus technology.
And just yesterday, Ruckus CBRS technology was demonstrated as part of the Microsoft Azure capabilities for private LTE networks during Microsoft Ignite. For cloud and analytics, we have released a beta, release for all of you cloud and analytics platform, which will tie both our licensed and unlicensed wired and wireless products together on a single pane of glass and help our customers manage and optimize their networks. This platform will launch in the first quarter of twenty twenty. From a market standpoint, we have made great progress in adding our wireless products to federal certification for release next year. We positioned the Internet of Things, Wi Fi six and analytics toward the hospitality markets, and we continued focusing our offerings at all levels of the education market.
Wrapping up our third quarter achievements, we continue to make progress on our ARRIS integration plans. Day 100 items have been completed, and we have finalized a new purpose, vision, and values for the combined organization to be embedded with an aligned culture. We also implemented a three into one website integration that will create a more consistent communication platform and experience, to all stakeholders as well as expose our collective customer base to our entire portfolio. We generated over 400 cross selling leads during the quarter, leveraging the breadth of the product portfolio and have that has the potential to deliver significant revenue synergies over the next few years. And I mentioned earlier, we make we remain on track to deliver at least $75,000,000 of cost synergies in the first full year post close, of which 50,000,000 will be realized in calendar year '19.
From an organizational design standpoint, we restructured our CEO reporting relationships to flatten the organization and drive accountability. I am pleased with our early results, but we have the opportunity to make further refinements to better position the organization. Now before I turn the call over to Alex, I want to reiterate how excited I am about the unique opportunity that we have to shape the future of network con connectivity. We've made a number of changes this year that are repositioning the company to achieve accelerated returns, I'm confident that we will deliver on the strategic and financial promise of the ARRIS acquisition. We have notable progress from ARRIS already and continue to believe the successful integration will position the company for long term success.
With our portfolio of industry leading products, strong customer relationships, a talented team, and long term potential to lead the transformation of communications connectivity remains as strong as ever. Now I'd like to turn the call over to Alex for a financial discussion.
Speaker 3
Alex? Thanks, Eddie, and good morning, everybody. Today, I'll begin with a review of our third quarter financial results and discuss our guidance for the fourth quarter as well as providing our preliminary view for 2020. We'll then open the line up for questions. So let's get started.
In the third quarter, net sales increased to 2,380,000,000.00, primarily driven by the benefit from the Eris acquisition, which contributed 1,340,000,000.00. Eris sales in the third quarter include a $14,000,000 reduction of revenue related to a deferred revenue purchase accounting adjustments. Pro form a net sales declined 15%, which includes a 1% impact of unfavorable foreign exchange. Third quarter sales were down across all geographic regions as we continue to be challenged by cable operator spending, geopolitical trade tensions, a temporary pause in spending due to a pending telco merger. Consolidated orders for the quarter were 2,350,000,000.00, providing a book to bill ratio of 0.99.
For the third quarter, adjusted EBITDA increased 55.5% to $369,800,000 or 15.5% of sales. Pro form a adjusted EBITDA declined 13.5% to $369,800,000, yet we were able to modestly expand margins. The adjusted EBITDA results were primarily driven by lower volumes, particularly in networking cloud CMTS software licenses. We partially offset this top line weak weakness with favorable commodity and raw material pricing as well as lower operating expense as a result of the aggressive actions we have taken to preserve profitability as we manage a difficult operating environment. Our cost synergy and cost savings actions for the year continue to track well ahead of plan and the commitments we made earlier in the year.
We also accept expect to exceed annual run rate savings of a $150,000,000 ahead of the third anniversary of the close of the transaction. Finishing up the p and l, book net interest expense was a $160,700,000. Excluding the amortization of debt issuance cost and OID of $7,400,000, interest expense was a $153,300,000. The adjusted effective tax rate in the quarter was 28.1 versus our expected range of 29 to 30%. The favorability in the third quarter was the result of lower than expected US tax cost on foreign earnings.
Adjusted net income in the quarter was a $127,000,000 or 55¢ per diluted share as compared to adjusted net income of a $115,000,000 or 59¢ per diluted share last year. As reminder, included in our third quarter twenty nineteen diluted share count is the assumed conversion of the Carlyle convertible preferred stock resulting from the $1,000,000,000 investment to help fund the ARRIS acquisition. Now moving to our segment results. I'll begin on Slide seven and discuss results for the Connectivity and Mobility Solutions. Connectivity Solutions segment sales for the second quarter decreased 13% year over year to $635,000,000 Excluding the impact of unfavorable foreign exchange, sales declined 12%.
In North America, sales decreased about 14% with weakness in the remaining geographic regions. As expected, results were negatively impacted by softness in the network, cable and connectivity business, driven by the continued trend of lower cables capital spending from certain North American cable operators and capital spending reductions on major projects by North American carriers. In addition, enterprise sales declined in both copper and fiber markets, primarily in Europe and China, with declines of 1231% respectively. Turning to profitability. Adjusted EBITDA was down about 25% year over year to a $121,000,000 with adjusted EBITDA margins of 19.1%.
Despite the impact of lower sales volumes, we were able to offset some of this pressure through continuous cost savings and efficiency programs. Moving on to mobility solutions. Segment sales for the third quarter decreased 3% to $4.00 $6,000,000 primarily impacted by a pause in spending related to a pending North American carrier merger. This order delay impacted the third quarter mobility sales by nearly 5%. Excluding the impact of unfavorable foreign exchange, sales decreased by 2%.
From a geographic perspective, results benefited from growth in North America and EMEA, which was offset by declines in CALA and APAC. While macro tower RF sales, product sales declined primarily due to the carrier merger uncertainty, our macro tower accessories and metro cell business increased about 30%. This growth was followed by our DCCS business with project wins in EMEA and North America. Operators are accelerating spend to densify their four g LTE network in preparation for five g, and we expect this momentum to continue. In the quarter, mobility adjusted EBITDA increased over 8% to $83,000,000 or 21% of sales, a 220 basis point improvement over this point last year, further demonstrating the ability of the team to manage costs and protect margins in the business.
Results were driven by a combination of favorable product mix, manufacturing footprint optimization and other cost reduction initiatives to improve profitability. Now turning to Slide eight for the ARRIS segment performance. CPE's second quarter net sales were $826,000,000 a decrease of 12% from the pro form a year prior. While revenue declined year over year, adjusted EBITDA increased 55% to $60,000,000 EBITDA margins of 7.2% of sales represent a three ten basis point improvement versus last year as the team has worked relentlessly to manage raw material costs, remove controllable overhead through headcount optimization efforts, and stabilize pricing. Lower CPE revenues were again largely the result of weakness in our broadband business as we continue to be pressured by reduced cable operator spending and weaker demand from a tier one carrier.
Over time, we continue to believe that broadband device volumes will return to more typical levels and provide an opportunity for growth as the monetization of docsis3.1 investments occur. Video shipments for the quarter declined 1% year over year, but improved more than 6% sequentially as select operators continue with the technology refresh cycles. Despite these factors, we expect the combination of ongoing tariff mitigation activities and the continued growth in North American over the top trends to be likely headwinds moving forward. For the networking cloud segment, third quarter net sales were $377,000,000, a decrease of 29% year over year. Adjusted EBITDA was $95,000,000, a decrease of 31%.
Adjusted EBITDA margins declined to 25.2% of sales. Our networking cloud segment sales were were lower driven by a combination of factors, including customer driven m and a, strong capacity additions added in late two thousand eighteen, and to a lesser extent, a temporary pause in spending as the industry aligns around the path towards virtualization. We continue to see strong growth in bandwidth demand, and we view our networking cloud business as well positioned to serve a wide range of architectures when the impact of these transitory factors abates. To that end, we're starting to see an uptick in CMTS license purchases from a major tier one North American cable operator as they begin to exhaust capacity from last year. This is a good indication for continued purchases of current CMTS products for the foreseeable future.
Moving on to the ruckus third quarter results. Third quarter net sales were $137,000,000 a decrease of 23% from the pro form a of a year ago. Adjusted EBITDA was 10,800,000 a decrease of 19%. Despite lower sales volumes and what has historically been a high fixed cost business, adjusted EBITDA margins of 7.9% improved 43 basis points from the pro form a year prior as we execute our cost savings and efficiency plans throughout the business. We remain confident in the long term potential of Ruckus and expect trends such as the introduction of Wi Fi six and cloud based architecture to provide a tailwind for the business.
While Ruckus sales remain weaker than expected, we're encouraged by the improvement of over 30% compared to the first quarter. We see an additional e rate demand ahead, recent wins in the OEM channel, the introduction of WiFi six, fast ramping of a cloud based architecture, and several recent customer wins, all as evidence for the strong, longer term growth prospects of the business. Furthermore, we remain excited about the long term growth potential in Ruckus as part of our new capability in offering licensed and unlicensed spectrum solutions to the market. We believe this combined solution is extremely relevant in five gs and has the potential to solve many of the most demanding in building and venue wireless challenges in the future. It will also serve as a critical element to unlock the full potential of private networks, which represent a substantial growth engine as five gs unfolds.
Returning to the consolidated results for CommScope, I'll address our cash flow on Slide nine. For the trailing twelve months, we generated $393,000,000 of cash flow from operations and $590,000,000 in adjusted free cash flow. During the third quarter, cash flow from operations was $522,000,000 and adjusted free cash flow was $535,000,000 These amounts exclude cash paid for the transaction, integration and restructuring costs. Cash flow in the third quarter significantly improved from the prior quarter with a meaningful improvement in the cash conversion cycle. For example, our days inventory outstanding improved to 65 through a cross functional inventory optimization program.
Through the successful implementation of this program, we delayed final configurations, drove optimistic fast transportation of low volume, high value inventory, and improved tracking and management of inventory, which resulted in a more flexible product line and lower utilization of cash. Importantly, we continue to expect to generate positive free cash flow in the fourth quarter. This reaffirms our previous expectation of a meaningful improvement in the second half of the year. So now let's discuss our capital structure on Slide 10. We closed the quarter with net leverage of 6.1 times pro form a adjusted EBITDA, which includes pre acquisition adjusted EBITDA for ARRIS for the trailing twelve months as well as $120,000,000 of anticipated cost synergies and an additional $20,000,000 of other cost savings initiatives.
Because of the significant cash flow generation during the third quarter, we redeemed $200,000,000 of aggregate principal to our five of our 5% senior secured notes due in 2021. Shortly following the end of the third quarter, we redeemed an additional $200,000,000 of the 2021 notes, which occurred on October 20. As previously mentioned, with the expectation of meaningful cash generation in the back half of the year, we expect further debt repayments to occur in the fourth quarter. Despite the temporary headwinds we experienced in the current operating environment, we continue to deploy the traditional CommScope playbook, tactfully adjusting the operating models of each segment to maximize efficiency and cash flow generation. The most recent redemptions of our two twenty twenty one notes emphasize our ability to execute in a challenged environment and our commitment to deleveraging with the utmost urgency.
Longer term, we remain committed to returning to a net leverage ratio of approximately four times and eventually to two to three times. Now moving into our fourth quarter guide on Slide 11. For the quarter, we expect revenue of $2,200,000,000 to 2,240,000,000.00 Non GAAP adjusted EBITDA of between 275,000,000 to 335,000,000, and non GAAP adjusted earnings per share between 27 and 37¢. Additional assumptions include an adjusted effective tax rate between 2728%, and a weighted average diluted share count of approximately 232,000,000 shares. Turning to slide 12 regarding our fourth quarter outlook by segment.
In our connectivity segment, we expect sales to follow our normal seasonal pattern declining sequentially for the fourth quarter. We expect the softness to be driven by weaker network cable and connectivity as well as declines in the enterprise copper and fiber. In our mobility solutions segment, we expect sales to follow our normal pattern and sequentially decline in the fourth quarter. However, in addition to the seasonal trend, we are accounting for the temporary spending uncertainty associated with a large North American carrier merger that will materially impact Mobility results. This pause in spending impacted mobility sales by about 5% in the third quarter, and we expect that impact to increase in the fourth quarter, which is largely timing related.
In our CPE segment, we see strong demand for gateways and IP setups at key North American cable operators, but we are currently experiencing supply constraints that will prevent us from achieving the full upside potential. In addition, we're seeing impacts from lower capital spending at other operators due to declining pay TV subscribers, a shift from capital spending to content acquisition, and the shift to lower ASP IPTV set tops. As such, we now expect fourth quarter revenue to be modestly down sequentially from the third quarter. For networking cloud, as a result of some expected fourth quarter customer orders that we booked in the third quarter, we now expect fourth quarter sales to be relatively flat for the third quarter. In our rocket segment, we expect net sales in the fourth quarter to modestly decline from the third quarter.
While we while we remain confident in the long term growth trajectory of this business, we're focused on optimizing the cost structure to align to current sales trends to preserve profitability. Before I open the call up for questions, I'll provide a few early thoughts on our business outlook for 2020. Given what we're hearing from around the industry and from our customer conversations, cable operator spending is anticipated to be largely unchanged from 2019, but the mix of spend is extremely important for CommScope. We see an opportunity for a modest uptick in network infrastructure spend next year, while CPE spend will continue to be constrained. While we expect CPE sales decline likely in the double digits in 2020, we have and are taking significant action to address our cost model, and we expect continued EBITDA margin improvements.
From a carrier standpoint, we currently expect wireline spend to decline next year, but importantly for CommScope, our business is more dependent on wireless spending. While early, we'd expect the continued network transition to five gs to drive steady wireless spending next year. Additionally, while we're experiencing short term headwinds due to a pause in spending related to the pending merger of two large carriers, over the long term, we expect this to benefit Comsfield. We are well positioned in an in to provide an industry leading set of solutions to enable their potential sell side architecture. From a geopolitical standpoint, beginning with tariffs, we've mitigated the majority of the impact, but we still have a few items remaining to address, namely filters and some of our distributed antenna products.
In addition, by the end of the fourth quarter, nearly all CPE video set top set top box production is expected to be out of China. Moreover, we expect The U. S.-China trade tensions to continue to impact Chinese spending levels on our enterprise fiber and copper products. In consideration of these factors, while still very preliminary and based on what we know today, we would expect our sales to decline modestly in 2020, primarily driven by a decline in CPE. Again, while early, we believe there's an opportunity for our remaining segments to be stable to growing in 2020.
From a cash flow standpoint, our primary focus will continue to be debt pay down. While we aren't providing firm cash flow or debt pay down guidance at this point, our second half results should be a good indicator of what we think we can deliver in 2020. Thanks again for your time this morning. And operator, if you please open the call up for questions.
Speaker 0
Yes, sir. Your first question comes from the line of Jeffrey Keval of Nomura Instinet. Your line is now open.
Speaker 4
Thank you very much for taking the question. I guess my first question begins with the shift in revenue out of the fourth quarter and pull in into the third quarter. Could you gentlemen give us a sense of how sizable that shift might have been and what that tells us about the outlook for 2020?
Speaker 2
I'll take the first part of that and Alex can quantify know, it's it's significant, I think, from the standpoint of the carrier business. We're a large provider to to all the carriers here in North America. So so we had a shift in q three, and we're we're gonna have a a shift in q four. We would expect in in 2020 that that will come back depending upon timing of of the merger or depending upon as they anticipate when when the bills may restart. So so I think Alex mentioned that was 5% or so in q three, and, q four will be a a number bigger than that.
So, the the other, is the the the the MSO related spend in networking cloud, that these carriers spend, depending upon needing to add licenses to, to their systems, and that's that's not necessarily in our control. So they they spent more in q three than we had anticipated. We had we had planned for it weeks ago, to be a q four, revenue generator, but that will just happened early. So it's not a it's not a loss of business or or anything relative to the market. It's just timing as to as to how the large operators, do their spin cycles.
I think with the with the the the the wireless carrier, you know, we we've talked about their pauses and shifts and starts with with when these mergers happen. And so we we probably will see others as we go through the the next year. And so, Jeff,
Speaker 3
let me let me take the second half of your question around, implications for 2020. The the the short answer is there really aren't any implications for 2020. The the merger related, delays that that Eddie mentioned, you know, that's business that that we'll get as soon as the uncertainty of the merger is behind us, and and we know that from conversations with the customer. So we're anticipating that basically being an additional opportunity in in 2020 when that deal finally gets approved. It's it's not atypical at all for the purchases of these license agreements to to migrate from one quarter to the next because it's a nearly instantaneous purchase.
The the fundamental thing is the underlying bandwidth demand, which is continuing to grow at 30 to 50%. And so as capacity gets consumed in the network, we'll see operators add, add licenses, which will return the the networking cloud business to its more historical levels. So we're really just in the process of working through, this capacity in the network. The overall guide for for 2020, really, with the exception of CPE, you're looking at, you know, stable to modest growth across all of the segments. The mobility would be the probably the leader in that trend, and then, you know, some recovery, some modest recovery in network and cloud.
And then, you know, cable or I'm sorry, connectivity probably being more on the flattish, side. Although all the significant, wins we've made recently in hyperscale should provide some some tailwind, which which I referred to. And then really the big the big top line headwind will be, will be the decline in CPE, which we've been managing through. Although, we do anticipate maintaining, EBITDA across that. So overall, even in a, kind of slightly declining to flattish top line environment, you should see an improvement in overall EBITDA performance.
So hopefully, helps.
Speaker 4
Okay. And I guess, should we translate that EBITDA performance slight improvement into free cash flow slight improvement? Or is there or or or are there some fluctuations on the balance sheet we should be aware of? Or how how do we think about that for next year?
Speaker 3
Yeah. It's safe to assume that that would translate to free cash flow. I mean, the only offset for that would be capital spending, but we don't anticipate large amounts of capital spending next year. They were on unlike what we normally do. Yeah.
Speaker 4
Excellent. Thank you both very much.
Speaker 2
Thank you, Jeff.
Speaker 0
Thank you. Your next question comes from the line of George Notter of Jefferies. Your line is open.
Speaker 5
Hi, thanks a lot guys. I wanted to ask about the Network and Cloud division. And that's a business that historically has been much more predictable in terms of the revenue run rates, 5 to $600,000,000 a quarter if you look back at the last few years within ARRIS. And yet the step down is still really significant. And I guess I'm kind of wondering what you think the kind of normalized revenue run rate for that business might look like.
And I understand there's a lot of moving parts here in the industry with obviously the large customer there dialing back capital spend. You've also got a lot of technology confusion I think around. But is there some kind of normal levels of sales and EBITDA run rate you think you could ultimately get out of that business?
Speaker 3
Yes. Let me take a crack at it and then Eddie can elaborate. So so I think, you know, really, you should think about, probably three drivers of what we're seeing in Networking Cloud right now. So the first is that, kind of large investments in capacity that happened, over the course of 2018, and that, you know, capacity is is late. And so there's probably a, you know, a year or eighteen months as bandwidth demand continues to grow 30 to 50% to consume that capacity that was introduced in 2018 before you need to continue to invest in a meaningful way.
That's the first driver. The second driver is this uncertainty around just virtualization and distributed access architecture and a bit of a freeze in spending as folks want to understand how that how that evolution is likely And as Eddie mentioned, this is going to be a a multiyear journey. And, you know, is it true that we're, you know, a month or two behind in starting that journey? Yes.
But it's equally true that we're building off a base of, you know, twenty years of experience in the industry leading position in both CMTS and and, and Access Technologies. And and we believe, you know, we have an extremely competitive product that Eddie talked about in, in his remarks. And then the last piece, really has to do with a an FDX, architectural decision and really one of the major large operators, that typically leads the industry in these choices, choosing to go one direction versus the rest of the operators kind of waiting and seeing. And that's led to sort of a broad based pause in in spending. You know, you'll you'll know that a lot of that pause is likely behind us as it's just become clear that this this architecture becomes very, expensive for a number of the operators, and so they decided to pursue a different a different option.
So what does all that mean? Really, it means that we we see, we don't see a a structural shift in the networking cloud that's away from the historical performance of networking cloud. What we see is a a temporary soft patch that will likely persist through the balance of 2020 and perhaps into into 2021, but there's no reason to believe why this business can't get back to its, you know, its historical its historical quarterly revenue and earnings potential as as we work through these challenges. Eddie, what would you
Speaker 2
I think you covered it well. I think the the important thing I'd like to reiterate is that there's been much said about us not being in the virtualized network. I think what what I tried to say is that we have a deployable product right now. We believe that that will be in the market in q one. We we don't believe that market is gonna be strong.
We we we have a relationship with with all customers, but one of them has a special relationship with one of our competitors. So, you know, we'll deal with that. But we will have in the marketplace competitive product to to provide full offering to to all the customers.
Speaker 6
Thank you. Thank
Speaker 0
you. Your next question comes from the line of Simon Leopold of Raymond James. Your line is open.
Speaker 7
Great. Thank you. I wanted to just get a quick, I think, important clarification from you on the I 2020 want to make sure that the baseline for 2019 is pro form a for Aris being with you for the entire year as opposed to the fact that you had acquired it in the spring? Just if
Speaker 1
get
Speaker 3
yes. Thanks for that. That's an important clarification. Yes, it's a pro form a as if we'd owned the company for the full year.
Speaker 7
Great. I think that everybody can breathe now. I appreciate that. Wanted to see if we could talk a little bit about maybe a shorter term perspective on 4Q cash flow from ops and delevering. It looks like the very strong cash you generated in 3Q a little bit coming from working capital.
So just wondering whether there's sort of timing issues there, how we should think about the fourth quarter cash from operations?
Speaker 3
Yes. It's a good question. So you'll remember, cash flow generation in Q2 was actually a little bit light. So there's a combination of things happening in Q3. The first is all the proactive steps we're taking on inventory management that I mentioned in my script.
And and that is enduring, and there's still work to be done on just getting inventory out of the channel and using that as a source of source of cash. There was also some very strong customer collections activity, which was related to some of the softness we saw in Q2. So that would certainly be more of a more of a timing issue. I I would just we didn't guide cash flow for for q four. I I would expect it to be, you know, fairly significantly weaker than q three given the strength we saw in q three.
A lot of that will depend on, you know, the collection the customer collection cycle. It's it's not unusual to see the customer collection cycle bridge, you know, from from the end of the year to the beginning of the year, and that can have, you know, significant fluctuation. But we do we do anticipate, as I mentioned, continuing to pay down debt, and and we'll, you know, focus all the all the cash flow to continue to pay down those those twenty twenty ones and derisk the balance sheet.
Speaker 7
Thanks. And then just one last one and a quick clarification, which I think I interpreted from your comments on the Network and Cloud segment results for 3Q. It sounded like the two sources of strength here were really licensing sales for capacity into CCAP and then transmission business being quite strong. Just wanna make sure I heard that correctly.
Speaker 3
The first point, absolutely correct. I'm not sure exactly what, when you say the transmission business, what what are you referring to?
Speaker 7
Well, basically, the the things that aren't services and aren't CCAP.
Speaker 3
Yes. That's that's fair. Yeah. I mean, overall, I would say, on the networking cloud piece, Simon, we we are seeing that business firm up. You know, this we are seeing capacity being being added to the system.
So I think there's some, some positive things. And then the really positive thing, just to reiterate, as Eddie mentioned, you know, we we rolled out our our virtualized solution. We've got remote PHY nodes being deployed in the field. You know, we're making a lot of progress on this next generation of technology.
Speaker 7
Great. Thank you.
Speaker 2
Thanks, Rami.
Speaker 0
Thank you. Your next question comes from the line of Samik Chatterjee of JPMorgan. Your line is open.
Speaker 8
Hi, good morning. Thanks for taking my question. If I could just start off on the Mobility Solutions Group, you had positive comments about the outlook for that group next year. Just looking to see if you can dive in a bit into the pipeline for Metro Cells and the OneCell product. And how should we be thinking about the timing of the ramp here?
And if you can give us a sense of how you big you think these businesses together can be for CommScope in two to three years?
Speaker 2
What what what I said is that that business is we have 10,000 sites that have some type of of coverage. What what we've seen of late is really a full stack, fully compatible cell site. It's just in a telephone pole or street light. Business is rebuilding itself about every other month right now. So, we have very high expectations.
I I think the the three cities that I mentioned, where we have coverage are are good examples of of what we can do in different difficult environments. We we have the ability to to sell the the full capability. We understand RF. We understand power and backhaul, and and that's something that we strive to continue to outperform. So we think it can be multiples of what the current macro sites are because with five g coming, you're gonna need these sites to be closer.
You're gonna need that for for latency issues as well as coverage. And and we think that we're just at the beginning of what this is going to be. So we we haven't quantified it in relation to, to the to the macro. It will be, you know, less per site, but out of it many times more, in in coverage. So we we're very excited about it.
And, you know, we've gotten some really accolades from, some of the cities where these things have been deployed also because of the aesthetics, the the ability of, better coverage, and and the visibility of of these these poles. So, Samik, let me just hit on
Speaker 3
on on the the kind of sequential growth. So when we talked about the mobility segment, as Eddie mentioned, these where the growth is going to come from are these, Metro Cell and and One Cell in building solutions. So that's more back half, back half weighted. We typically would see q one as being one of the weaker quarters of the year. But but in addition to that, the the growth in the segment will come from the the back half as these things, start to ramp.
So I think it's it's realistic to to anticipate a reasonably soft Q1, which would not be atypical.
Speaker 8
Okay. Alex, if I can just quickly follow-up with you on the long term operating cost model. I mean, you're planning towards some improvement in the top line trends for certain segments next year. But if some of them were not to materialize, like how should we think about the long term cost model? You're running at about 1.7%, I think, this point.
And you have synergies and savings of around 200,000,000. Is that, like, the right level of cost model for the business going forward?
Speaker 3
Yeah. So so as as Eddie mentioned, I believe, in in his remarks, you know, we're aggressively going after cost and not not just not just synergies, but but also, you know, broader cost actions. So the the business that's probably we're focused on most is within the CPE business where you do have a declining top line environment, and our commitment is to maintain profitability, first and foremost. And if that means that we, you know, are deliberately exiting certain programs that aren't profitable, then then that's a trade off we're willing to make. So the the business is in the process of building, you know, a combination of a revenue optimization plan as well as a cost takeout plan to maintain profitability despite that that top line environment.
In in the other businesses, you know, we're continuing to to evaluate the cost structures. And and as I mentioned, even in a, you know, modestly, declining the flat top line environment for 2020, we we should anticipate, you know, relatively healthy EBITDA performance.
Speaker 6
Thank you.
Speaker 0
Thank you. Your next question comes from the line of Steven Fox of Cross Research. Your line is open.
Speaker 6
Thanks. Good morning. My first question was on the connectivity business. I'm not quite sure I understand all the negative leverage that was produced in the quarter. So I understand sales volumes being down drove some of the margin decline.
But can you explain what else contributed to the 25% year over year decline in EBITDA?
Speaker 3
On on connectivity, really, it's it's largely volume related. So so, you know, this is a a relatively high fixed cost business since we own the manufacturing assets. And so if we're not if we're not, you know, keep keeping the assets full, then you have you have an absorption issue. So that's really what what the issue is there. You know, what I would point to, which is which is a extremely positive sign, is the growth that Eddie mentioned in the hyperscale.
So what we've said is that, you know, copper is is going to be a in a a business that's in structural decline over time. We believe that the growth in fiber will offset that decline and return connectivity to to growth. And so the fact that we're now we doubled the size of that business in the quarter on a year over year basis and are now, you know, extremely active. And four of the five hyperscalers, really shows that the the momentum is building, which we feel, very good about.
Speaker 6
Okay. Thank you for that. And then in terms of the Sprint merger, I mean, the expectations are that after the transaction is completed, there's an immediate recovery in spending on your products? Or like historically, there's still a pause post deal. Are we counting on any business recovery there for 2020 with your comments?
Or should we sort of exclude that for now? Well,
Speaker 2
I think, Steve, comment made about a combined merger being the reason for a delay in antenna spend in the third and fourth quarter. We and I think Alex further said that we that's not lost. That's just delayed, and and we think that that will be caught up. And so, you you know, these mergers are all different, and, some take a pause. I think a lot of work's been done in this one beforehand.
So I think it's just a matter of getting approval or near approval before the spin will start back in earnest. So I think there's opportunity for for catch up volume. We'll have to see. That's that's something that's not been communicated to us yet, but it's something that we're close to and well positioned with with both sides of the merger.
Speaker 6
Okay. Appreciate that color. Thank you.
Speaker 3
Thank
Speaker 0
you. Your next question comes from the line of Meta Marshall of Morgan Stanley. Your line is open.
Speaker 9
Great. Thanks. I just wanted to get a sense of whether some of these mid band spectrums getting completed prevent some of the spending that you would expect on macro cells or if you would expect it to be an accelerator afterwards. And then maybe just diving into kind of the ruckus segment and when you would expect to kind of see some upward movement from the Wi Fi six upgrade?
Speaker 6
Thanks.
Speaker 2
You know, the Meta, the the, you know, in the macro environment, unless they change frequencies, the antennas we sell today are the same ones we sold yesterday. And, you know, as I said, we're selling much more complex antennas today than we than we did, years ago. You know, we have 32 port antennas today, and some looking at at even larger. And we're doing it in a smaller form factor, so we save our customers money from the from the rental standpoint. So so we see we see that continuing at a at a reasonable pace.
I think we we do see an uptick in in what our our densification is going to to be. I think we see an uptick in one cell as as, AT and T wants to do work with, FirstNet to make sure that they have a more efficient network. So I think a lot of positives are gonna be there as as we, as we see from all the, all the different ranges of products or sizes within the mobility segment. So we're we're very bullish. I think, next year will be weighted more toward that side than the than the wireline side.
Speaker 9
Got it. And then just on Ruckus and Wi Fi six.
Speaker 2
Okay. So we were the first in the market, and we we're excited about the the the take rates that we're starting to see. We're getting a lot of of of really good momentum between the the both sides of the company as we've combined the sales forces so we have the the full range of capability of the partner part of our historical enterprise business. So that's taking off, we're getting a lot of cross selling. And now I said 400 or so, much of that is in the enterprise ruckus side of the business.
The the ability of us to go and have a wired wired and wireline or licensed and unlicensed capability is unique in the marketplace, and and a lot of our partners and and installers and all that see the see the benefit of that. So it's a lot of lot of those questions are some of the first things that the the people I see with the customer base talk about. And so, we're we're think that's gonna be as Alex said, we think that has a lot of potential next year and year and a half years after.
Speaker 9
Great. Thanks.
Speaker 6
Thank
Speaker 0
you. Our last question comes from the line of Gene Suva of Citi. Your line is open.
Speaker 10
Thank you very much. And, I have two questions. They're a little bit related, so I'll ask them at the same time. And that regards the December guidance. Three months ago, you mentioned that it would be up, and now it's going to be down.
So what really changed so fast in three months that caught you by surprise? And then my second question relating to that is it looks like the December earnings or the profitability of the company quarter over quarter really takes a pretty big or abnormally big step down. So what's from Q3 to Q4, what's really pressuring the margins or the earnings so much? Is it fully attributed to tariffs or mix or ASP pressure? It just seems like the earnings is pressured more than just simply the sales.
Thank you.
Speaker 2
I'll talk about maybe the revenue. Factor in the in the the difference between what we would said last you know, maybe even two weeks ago is, is the merger impact of, in the wireless, the mobility side of the business, that went from possible acceleration to stoppage or or or at least a slowdown until next year. That would that would be the biggest part of the top line, and, you know, that that would certainly, those volumes in that product line would be impactful to the bottom line as well. That that also is impacted because of the utilization of our factories. Alex mentioned that in in one of his other comments.
So we we do make all the antennas that we sell. So if if we don't have the demand, we don't we don't make them, and and the plant is is underutilized somewhat. The same part of the question.
Speaker 3
Yeah. And I I I if I understood the question, your your line is a little muffled, I think you were talking about the margin compression from q three to q four sequentially. And so assuming that was what your question was, it's really driven by a handful of things. The first and biggest driver would be would be a mix shift. So this license sales revenue that we've been talking about carries with it substantially higher mix than than the manufactured products.
And so to the extent there was more of that in q three than in q four, you would see a a big mix shift. The second would be sales decline in the CCS business, which we pointed to, and and also in mobility. And so as Eddie just mentioned, the the deleveraging effect of of those the you know, that top line decline is, is causing some margin compression. But for for mobility in particular, just wanna reiterate what Eddie's said. This is this is purely timing related.
This is related to the merger, and we anticipate that business coming, coming back. We have the product, ready to go as soon as the customer is ready to buy it.
Speaker 10
Thank you so much. That's very, very helpful and clear. Thank you.
Speaker 2
Okay. Thanks, everyone, for your your interest in CommScope. We appreciate your your your continuing attention, and we look forward to talking to you next quarter. Thanks a lot.
Speaker 0
Ladies and gentlemen, this concludes today's conference. Thank you for participating, and have a wonderful day. You may all disconnect.