BELDEN INC. 10-Q

Item 2: Management’s Discussion and Analysis of Financial Condition and Results of Operations Overview Belden Inc. (the Company, us, we, or our) is a global supplier of specialty networking solutions built around two global businesses - Enterprise Solutions and Industrial Automation Solutions. Our comprehensive portfolio of solutions enables customers to transmit and secure data, sound, and video for mission critical applications across complex enterprise and industrial environments. We strive for operational excellence through the execution of our Belden Business System, which includes three areas of focus: Lean enterprise initiatives, our Market Delivery System, and our Talent Management System. Through operational excellence we generate free cash flow on an annual basis. We utilize the cash flow generated by our business to fuel our continued transformation and generate shareholder value. We believe our business system, balance across markets and geographies, systematic go-to-market approach, extensive portfolio of innovative solutions, commitment to Lean principles, and improving margins present a unique value proposition for shareholders. We use a set of tools and processes that are designed to continuously improve business performance in the critical areas of quality, delivery, cost, and innovation. We consider revenue growth, Adjusted EBITDA margin, free cash flows, and return on invested capital to be our key operating performance indicators. We also seek to acquire businesses that we believe can help us achieve these objectives. Trends and Events The following trends and events during 2022 have had varying effects on our financial condition, results of operations, and cash flows. Pandemic On March 11, 2020, the World Health Organization (WHO) declared the outbreak of the novel coronavirus (COVID-19) a pandemic. Since the beginning of the pandemic, our foremost focus has been on the health and safety of our employees and customers. In response to the outbreak, to protect the health and safety of our employees, we modified practices at our manufacturing locations and offices to adhere to guidance from the WHO, the U.S. Centers for Disease Control and Prevention and other local health and governmental authorities with respect to social distancing, physical separation, personal protective equipment and sanitization. In light of variant mutations of the virus, even as vaccinations become more prevalent and more employees return to our offices, many of these safeguards will continue. Our suppliers, distributors, and other partners have similarly had their operations disrupted, and in regions of the world where infection rates have remained high, human suffering and market disruptions have persisted. We will continue to actively monitor the situation and may take further actions that alter our business operations as may be required by local or foreign governmental authorities, or that we determine are in the best interests of our employees and customers. Foreign Currency Our exposure to currency rate fluctuations primarily relates to exchange rate movements between the U.S. dollar and the euro, Canadian dollar, Hong Kong dollar, Chinese yuan, Mexican peso, Australian dollar, British pound, Indian rupee and Swiss franc. Generally, as the U.S. dollar strengthens against these foreign currencies, our revenues and earnings are negatively impacted as our foreign denominated revenues and earnings are translated into U.S. dollars at a lower rate. Conversely, as the U.S. dollar weakens against foreign currencies, our revenues and earnings are positively impacted. Approximately 45% of our consolidated revenues during the quarter ended April 3, 2022 were to customers outside of the U.S. In addition to the translation impact described above, currency rate fluctuations have an economic impact on our financial results. As the U.S. dollar strengthens or weakens against foreign currencies, it results in a relative price increase or decrease for certain of our products that are priced in U.S. dollars in a foreign location. -21- Commodity Prices Our operating results can be affected by changes in prices of commodities, primarily copper and compounds, which are components in some of the products we sell. Generally, as the costs of inventory purchases increase due to higher commodity prices, we raise selling prices to customers to cover the increase in costs, resulting in higher sales revenue but a lower gross profit percentage. Conversely, a decrease in commodity prices would result in lower sales revenue but a higher gross profit percentage. Selling prices of our products are affected by many factors, including end market demand, capacity utilization, overall economic conditions, and commodity prices. D uring periods of inflation, if we are unable to raise prices timely and sufficiently to recover our material costs, our earnings could decline. We are mindful of ongoing inflationary pressures and as a result, proactively implement selling price increases and cost control measures. T here is no exact measure of the effect of changing commodity prices, as there are thousands of transactions in any given quarter, each of which has various factors involved in the individual pricing decisions. Therefore, all references to the effect of copper prices or other commodity prices are estimates. Channel Inventory Our operating results also can be affected by the levels of Belden products purchased and held as inventory by our channel partners and customers. Our channel partners and customers purchase and hold the products they bought from us in their inventory in order to meet the service and on-time delivery requirements of their customers. Generally, as our channel partners and customers change the level of products they buy from us and hold in their inventory, it impacts our revenues. Comparisons of our results between periods can be impacted by changes in the levels of channel inventory. We use information provided to us by our channel partners and make certain assumptions based on our sales to them to determine the amount of products they bought from us and hold in their inventory. As such, all references to the effect of channel inventory changes are estimates. Market Growth and Market Share The markets in which we operate can generally be characterized as highly competitive and highly fragmented, with many players. We monitor available data regarding market growth, including independent market research reports, publicly available indices, and the financial results of our direct and indirect peer companies, in order to estimate the extent to which our served markets grew or contracted during a particular period. We expect that our unit sales volume will increase or decrease consistently with the market growth rate. Our strategic goal is to utilize our Market Delivery System to target faster growing geographies, applications, and trends within our end markets, in order to achieve growth that is higher than the general market growth rate. To the extent that we exceed the market growth rates, we consider it to be the result of capturing market share. Tripwire Divestiture On February 7, 2022, we signed a definitive agreement to divest Tripwire for $350 million in cash, and completed the transaction on February 22, 2022. We recognized a loss on disposal of discontinued operations, net of tax of $4.6 million during the three months ended April 3, 2022. See Note 5. Debt Repurchase During the three months ended April 3, 2022, we repurchased all of the €200.0 million aggregate principal amount of 4.125% senior subordinated notes previously due 2026. We recognized a $6.4 million loss on debt extinguishment for the premiums paid to the bond holders to retire the 2026 Notes and for the unamortized debt issuance costs on the 2026 Notes that we were required to write-off. See Note 13. Macmon and NetModule Acquisitions On January 17, 2022, we acquired Macmon, a leading provider of products and services that secure network infrastructures in a variety of mission critical industries , for approximately $42.4 million, net of cash acquired. Headquartered in Berlin, Germany, Macmon brings proven products and technologies that protect network infrastructure and extend our offerings in the areas of segmentation, zoning and access control. The results of Macmon have been included in our Condensed Consolidated Financial Statements from January 17, 2022, and are reported within the Industrial Automation Solutions segment. See Note 3. On March 3, 2022, we acquired NetModule, a leading provider of reli able, fast and secure wireless network infrastructures through advanced capabilities in 5G and WiFi6 technologies in a variety of mission critical industries with a strong focus on mass transit and intelligent traffic systems within the transportation vertical for approximately $23.5 million, net of cash acquired. Headquartered in Bern, Switzerland, NetModule contributes to Belden’s Industrial Automation strategic plan to accelerate our capabilities within wireless technology and to expand applications we serve to meet the growing solution requirements of our customers. The results of NetModule have been included in our Condensed Consolidated Financial Statements from March 3, 2022, and are reported within the Industrial Automation Solutions segment. See Note 3. -22- Share Repurchase Program During the three months ended April 3, 2022, we repurchased 0.9 million shares of our common stock with cash on hand for an aggregate cost of $50.0 million at an average price per share of $56.51 as part of our share repurchase program approved in 2018 by our Board of Director s. See Note 18. Off-Balance Sheet Arrangements We have no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, results of operations, or cash flows that are or would be considered material to investors. Critical Accounting Policies During the three months ended April 3, 2022: • We did not change any of our existing critical accounting policies from those listed in our 2021 Annual Report on Form 10-K; • No existing accounting policies became critical accounting policies because of an increase in the materiality of associated transactions or changes in the circumstances to which associated judgments and estimates relate; and • There were no significant changes in the manner in which critical accounting policies were applied or in which related judgments and estimates were developed. Results of Operations Consolidated Income before Taxes Three Months Ended % Change April 3, 2022 April 4, 2021 (In thousands, except percentages) Revenues $ 610,371 $ 508,683 20.0 % Gross profit 208,860 169,183 23.5 % Selling, general and administrative expenses (103,066) (80,635) 27.8 % Research and development expenses (23,456) (22,612) 3.7 % Amortization of intangibles (8,817) (7,993) 10.3 % Asset impairments — (6,995) (100.0) % Operating income 73,521 50,948 44.3 % Interest expense, net (14,411) (15,511) (7.1) % Loss on debt extinguishment (6,392) — n/a Non-operating pension benefit 1,200 684 75.4 % Income from continuing operations before taxes 53,918 36,121 49.3 % Revenues increased $101.7 million in the three months ended April 3, 2022 from the comparable period of 2021 due to the following factors: • Higher sales volume and favorable pricing from industrial automation, smart buildings, and broadband & 5G products resulted in a $97.4 million increase in revenues. • Higher copper pass-through pricing had a $13.9 million favorable impact on revenues. • Acquisitions contributed an estimated $3.2 million in revenues. • The divestiture of our oil and gas cable business in 2021 had a $5.5 million unfavorable impact on revenues. • Currency translation had a $7.3 million unfavorable impact on revenues. Gross profit increased $39.7 million in the three months ended April 3, 2022 from the comparable period of 2021 due to the increases in revenues discussed above. Selling, general and administrative expenses increased $22.4 million in the three months ended April 3, 2022 from the comparable period of 2021. The increase in selling, general and administrative expenses is primarily attributable to strategic investments to enhance our solution selling capabilities as well as increases from incentive compensation and acquisitions. -23- Research and development expenses increased $0.8 million in the three months ended April 3, 2022 from the comparable period of 2021 primarily due to increased investments in R&D projects as we continue our commitment to growth initiatives. Amortization of intangibles increased $0.8 million in the three months ended April 3, 2022 from the comparable period of 2021 primarily due to acquisitions. Asset impairments decreased $7.0 million in the three months ended April 3, 2022 from the comparable period of 2021 as a result of the impairments on assets held and used and assets held for sale of $3.6 million and $3.4 million, respectively, during the three months ended April 4, 2021 . Operating income increased $22.6 million in the three months ended April 3, 2022 from the comparable period of 2021 primarily as a result of the increase in gross profit discussed above. Net interest expense decreased $1.1 million in the three months ended April 3, 2022 from the comparable period of 2021 primarily due to currency translation. Loss on debt extinguishment increased $6.4 million in the three months ended April 3, 2022 from the comparable period of 2021 due to the redemption of the 2026 Notes during the first quarter of 2022. The $6.4 million loss on debt extinguishment represents the premium paid to the bond holders to retire the 2026 Notes and for the unamortized debt issuance costs on the 2026 Notes that we were required to write-off. See Note 13. Income from continuing operations before taxes increased $17.8 million in the three months ended April 3, 2022 from the comparable period of 2021 primarily due to the increase in operating income discussed above. Income Taxes Three Months Ended % Change April 3, 2022 April 4, 2021 (In thousands, except percentages) Income before taxes $ 53,918 $ 36,121 49.3 % Income tax expense 9,822 7,056 39.2 % Effective tax rate 18.2 % 19.5 % For the three months ended April 3, 2022, we recognized income tax expense of $9.8 million, representing an effective tax rate of 18.2%. The effective tax rate was primarily impacted by the effect of our foreign operations, including statutory tax rates differences and foreign tax credits. See Note 15. Consolidated Adjusted EBITDA Three Months Ended % Change April 3, 2022 April 4, 2021 (In thousands, except percentages) GAAP and adjusted revenues $ 610,371 $ 508,683 20.0 % Adjusted EBITDA 99,494 76,553 30.0 % as a percent of revenues 16.3 % 15.0 % Revenues increased $101.7 million in the three months ended April 3, 2022 from the comparable period of 2021 due to the following factors: • Higher sales volume and favorable pricing from industrial automation, smart buildings, and broadband & 5G products resulted in a $97.4 million increase in revenues. • Higher copper pass-through pricing had a $13.9 million favorable impact on revenues. • Acquisitions contributed an estimated $3.2 million in revenues. • The divestiture of our oil and gas cable business in Brazil in 2021 had a $5.5 million unfavorable impact on revenues. • Currency translation had a $7.3 million unfavorable impact on revenues. -24- Adjusted EBITDA increased $22.9 million in the three months ended April 3, 2022 from the comparable period of 2021 primarily due to leverage on higher sales volume, as discussed above. Accordingly, Adjusted EBITDA margins in the three months ended April 3, 2022 expanded to 16.3% from 15.0% in the comparable period of 2021. Use of Non-GAAP Financial Information Adjusted Revenues, Adjusted EBITDA, Adjusted EBITDA margin, and free cash flow are non-GAAP financial measures. In addition to reporting financial results in accordance with accounting principles generally accepted in the United States, we provide non-GAAP operating results adjusted for certain items, including: asset impairments; accelerated depreciation expense due to plant consolidation activities; purchase accounting effects related to acquisitions, such as the adjustment of acquired inventory to fair value, and transaction costs; severance, restructuring, and acquisition integration costs; gains (losses) recognized on the disposal of businesses and tangible assets; amortization of intangible assets; gains (losses) on debt extinguishment; certain gains (losses) from patent settlements; discontinued operations; and other costs. We adjust for the items listed above in all periods presented, unless the impact is clearly immaterial to our financial statements. When we calculate the tax effect of the adjustments, we include all current and deferred income tax expense commensurate with the adjusted measure of pre-tax profitability. We utilize the adjusted results to review our ongoing operations without the effect of these adjustments and for comparison to budgeted operating results. We believe the adjusted results are useful to investors because they help them compare our results to previous periods and provide important insights into underlying trends in the business and how management oversees our business operations on a day-to-day basis. As an example, we adjust for acquisition-related expenses, such as amortization of intangibles and impacts of fair value adjustments because they generally are not related to the acquired business' core business performance. As an additional example, we exclude the costs of restructuring programs, which can occur from time to time for our current businesses and/or recently acquired businesses. We exclude the costs in calculating adjusted results to allow us and investors to evaluate the performance of the business based upon its expected ongoing operating structure. We believe the adjusted measures, accompanied by the disclosure of the costs of these programs, provides valuable insight. Adjusted results should be considered only in conjunction with results reported according to accounting principles generally accepted in the United States. The following tables reconcile our GAAP results to our non-GAAP financial measures: Three Months Ended April 3, 2022 April 4, 2021 (In thousands, except percentages) GAAP and adjusted revenues $ 610,371 $ 508,683 GAAP income from continuing operations $ 44,096 $ 29,065 Interest expense, net 14,411 15,511 Depreciation expense 11,226 10,727 Income tax expense 9,822 7,056 Amortization of intangible assets 8,817 7,993 Loss on debt extinguishment 6,392 — Severance, restructuring, and acquisition integration costs (1) 3,723 5,171 Asset impairments (2) — 6,995 Amortization of software development intangible assets 1,007 409 Adjustments related to acquisitions and divestitures (3) — (6,374) Adjusted EBITDA $ 99,494 $ 76,553 GAAP income from continuing operations margin 7.2 % 5.7 % Adjusted EBITDA margin 16.3 % 15.0 % (1) Severance, restructuring, and acquisition integration costs for the three months ended April 3, 2022 primarily relate to our Acquisition Integration Program. See Note 12. Costs for the three months ended April 4, 2021 primarily relate to our Acquisition Integration Program and completed Cost Reduction Program. (2) During the three months ended April 4, 2021, we recognized a $3.6 million impairment on assets held and used and a $3.4 million impairment on assets held for sale . See Note 11. -25- (3) During the three months ended April 4, 2021, we reduced the Opterna earn-out liability by $5.8 million , collected $1.4 million of receivables associated with the sale of Grass Valley that were previously written off, and recognized cost of sales of $0.8 million related to purchase accounting adjustments of acquired inventory to fair value for the OTN Systems acquisition. Segment Results of Operations For additional information regarding our segment measures, see Note 6 to the Condensed Consolidated Financial Statements. Enterprise Solutions Three Months Ended % Change April 3, 2022 April 4, 2021 (In thousands, except percentages) Segment Revenues $ 268,430 $ 226,355 18.6 % Segment EBITDA 30,821 28,291 8.9 % as a percent of segment revenues 11.5 % 12.5 % Enterprise Solutions revenues increased $42.1 million in the three months ended April 3, 2022 from the comparable period of 2021. The increase in revenues in the three months ended April 3, 2022 was primarily due to increases in volume and favorable pricing as well as higher copper pass-through pricing of $37.5 million and $5.4 million, respectively, partially offset by unfavorable currency translation of $0.8 million. Enterprise Solutions EBITDA increased $2.5 million in the three months ended April 3, 2022 compared to the year ago period primarily as a result of the increase in revenues discussed above. Industrial Automation Solutions Three Months Ended % Change April 3, 2022 April 4, 2021 (In thousands, except percentages) Segment Revenues $ 341,941 $ 282,328 21.1 % Segment EBITDA 67,528 47,611 41.8 % as a percent of segment revenues 19.7 % 16.9 % Industrial Automation Solutions revenues increased $59.6 million in the three months ended April 3, 2022 from the comparable period of 2021. The increase in revenues in the three months ended April 3, 2022 was primarily due to increases in volume and favorable pricing, higher copper pass-through pricing, and acquisitions of $59.9 million, $8.5 million, and $3.2 million, respectively, partially offset by unfavorable currency translation and a divestiture of $6.5 million and $5.5 million, respectively. Industrial Automation Solutions EBITDA increased $19.9 million in the three months ended April 3, 2022 from the comparable period of 2021 primarily due to leverage on higher sales volume, as discussed above. Accordingly, Adjusted EBITDA margins expanded to 19.7% from 16.9% in the year ago period. Liquidity and Capital Resources Significant factors affecting our cash liquidity include (1) cash from operating activities, (2) disposals of businesses and tangible assets, (3) cash used for acquisitions, restructuring actions, capital expenditures, share repurchases, dividends, and senior subordinated note repurchases, and (4) our available credit facilities and other borrowing arrangements. We expect our operating activities to generate cash in 2022 and believe our sources of liquidity are sufficient to fund current working capital requirements, capital expenditures, contributions to our retirement plans, share repurchases, senior subordinated note repurchases, quarterly dividend payments, and our short-term operating strategies. However, we may require external financing in the event we complete a significant acquisition. Our ability to continue to fund our future needs from business operations could be affected by many factors, including, but not limited to: economic conditions worldwide, customer demand, competitive market forces, customer acceptance of our product mix, and commodities pricing. -26- The following table is derived from our Condensed Consolidated Cash Flow Statements and includes the results and cash flow activity of discontinued operations up to the February 22, 2022 disposal date: Three Months Ended April 3, 2022 April 4, 2021 (In thousands) Net cash provided by (used for): Operating activities $ (57,955) $ (41,495) Investing activities 261,789 (82,337) Financing activities (286,660) (5,035) Effects of currency exchange rate changes on cash and cash equivalents (1,349) (2,277) Decrease in cash and cash equivalents (84,175) (131,144) Cash and cash equivalents, beginning of period 643,757 501,994 Cash and cash equivalents, end of period $ 559,582 $ 370,850 Operating cash flows were a use of cash of $58.0 million in the three months ended April 3, 2022 compared to $41.5 million in the three months ended April 4, 2021. Operating cash flows declined $16.5 million compared to the prior year primarily due to unfavorable changes in accrued liabilities, accounts payable and inventories, partially offset by favorable changes in receivables. The use of cash in accrued liabilities was primarily due to higher incentive compensation payments and channel partner rebates, both of which were a direct result of improved company performance during 2021, and the use of cash in inventory was primarily driven by increased demand. Net cash from investing activities was a source of cash of $261.8 million in the three months ended April 3, 2022, compared to a use of cash of $82.3 million in the prior year. Investing activities for the three months ended April 3, 2022 included cash receipts of $338.7 million for the Tripwire disposal, partially offset by payments of $65.9 million for the acquisitions of Macmon and NetModule and capital expenditures of $11.0 million. Investing activities for the three months ended April 4, 2021 included cash payments of $72.2 million for the acquisition of OTN Systems and capital expenditures of $11.2 million, partially offset by cash receipts of $1.1 million associated with the sale of Grass Valley. Net cash used for financing activities totaled $286.7 million for the three months ended April 3, 2022, compared to $5.0 million in the prior year. Financing activities for the three months ended April 3, 2022 included payments under borrowing arrangements of $230.6 million, payments under our share repurchase program of $50.0 million, net payments related to share based compensation activities of $3.7 million, and cash dividend payments of $2.3 million. Financing activities for the three months ended April 4, 2021 included cash dividend payments of $2.2 million, repayments of debt obligations of $1.8 million assumed as part of the OTN Systems acquisition, and net payments related to share based compensation activities of $0.9 million. Our cash and cash equivalents balance was $559.6 million as of April 3, 2022. Of this amount, $176.4 million was held outside of the U.S. in our foreign operations. Substantially all of the foreign cash and cash equivalents are readily convertible into U.S. dollars or other foreign currencies. We consider the undistributed earnings of our foreign subsidiaries to be indefinitely reinvested, and accordingly, no provision for any withholding taxes has been recorded. Upon distribution of those earnings in the form of dividends or otherwise, we may be subject to withholding taxes payable to the respective foreign countries. Our outstanding debt obligations as of April 3, 2022 consisted of $1,228.3 million of senior subordinated notes. Additional discussion regarding our various borrowing arrangements is included in Note 13 to the Condensed Consolidated Financial Statements. -27- Forward-Looking Statements Statements in this report other than historical facts are “forward-looking statements.” Forward-looking statements include statements regarding future financial performance (including revenues, expenses, earnings, margins, cash flows, dividends, capital expenditures and financial condition), plans and objectives, and related assumptions. These forward-looking statements reflect management’s current beliefs and expectations and are not guarantees of future performance. Actual results may differ materially from those suggested by any forward-looking statements based on a number of factors. These factors include, among others, those set forth in Part II, Item 1A and in other documents that we file with the SEC. We expressly disclaim any obligation to update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise, except as required by law.