Belden Inc

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, and if you would like to ask a question, please press star one on your touchtone phone. If you are in the question queue and would like to withdraw your question, please press star 2 on your touchtone phone. I would now like to turn the call over to Mr. Kevin Mazka. Please go ahead, sir.

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 Mazka. I'm Belden's Vice President of Investor Relations and Treasurer. With me this morning are Belden's President, CEO, and Chairman, John Stroop, Chief Operating Officer Ruel Vestjens, and CFO Hank Dirksen. John will provide a strategic overview of our business. Ruel will provide a detailed update of our operations and review our segment results. And then Hank 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 Stroop.

John? 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 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. Rule 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 plan, 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 of 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 recovery. 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 of 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 in 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 subvertical. We would also expect robust demand in some of our smart building markets. We serve government, healthcare, 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 recovery. For instance, in smart buildings, our customers in the hospitality, retail, and commercial real estate markets are clearly facing fundamental changes in their business 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 on our first quarter results and balance sheet and liquidity positions. Revenues in the first quarter declined 7% on a year-over-year basis to $463.5 million. In-demand for our products exceeded our shipments in the first quarter, with incoming orders declining 2% to $489 million. EPS was 67 cents compared to 84 cents 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 providing 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 two to three 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 a review of our business segment results. Roel?

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 US 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 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 segment enterprise solution 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 $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?

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 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 million favorable impact from acquisitions was partly 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. And demand for our products exceeded our shipments in the quarter. Incoming orders of $489 million resulted into 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-go period. This decline was due to lower production volumes and unfavorable product mix. EBITDA was $60.8 million 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 of 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. At Cohen, for an exchange rate, we expect interest expense in 2020 to be approximately $57 million. Our effective tax rate was 18.2% in the first quarter as we benefited 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 compared to $42 million in the prior periods. Earnings per share was 67 cents in the quarter compared to 84 cents 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 solution segment to the industrial solution segment. We have recast the prior period segment information. to conform to the change in the composition of reportable segments. These realignments help us to simplify our operating structure and enable the restructuring actions related to our cost reduction initiatives, as well as potential divestitures. The industrial solution segment generated revenues of $251.3 million in the quarter, decreasing 14% from the prior year period. Currency translation and copper prices had a negative impact of $5.4 million. 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 solution segment generated revenues of $212.2 million during the quarter, increasing 2% from the prior year period. Revenues were favorably impacted by $17 million from acquisitions. After adjusting for acquisitions and changes in channel inventory in the year-ago period, revenues declined 3% organically on the 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'll begin with our balance sheet highlights. Our cash and cash equivalents balance at the end of the first quarter was $294 million, 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 turns in the prior quarter and 5.7 turns in the prior year. Based sales outstanding of 59 days increased by two days sequentially and six days from the prior year. Inflatory turns were 4.6 turns compared to six 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 1.4 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 two to three times. Turning now to slide 14, I will discuss our debt maturities and governance. 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 governance on our debt. So we're not at risk of an event of default caused by worsening economic conditions. We're 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. compared to a use of 46.1 million in the prior period. Net capital expenditures were 18.8 million for the quarter, compared to 23.6 million from the prior year period. The year-for-year difference is primarily related to project timing. Free cash flow in the quarter was a use of $70.9 million, consistent with 69.6 million in the prior period. On a trailing 12-month basis, at the end of the first quarter, free cash flow was $165.7 million compared to $166.9 million in 2019. We're implementing countermeasures to protect cash flow, 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 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 during the remainder of the year as we reduce our inventory levels, manage accounts receivable, and accounts payable. Our capital deployment plans have changed in response to the global pandemic. We're committed to our growth capital investments, and we continue to expect capex of approximately $70 million 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're 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 Struk.

John? Thank you, Hank. 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. That concludes our prepared remarks. Mark, please open the call to questions.

Yes, sir. Ladies and gentlemen, if you would like to ask a question, please signal on your telephone keypad by pressing the digit star followed by the digit one. And to remove yourself from the queue, it's the digit star followed by the digit two. All questioners are asked to limit their questions to one with one follow-up question to allow other participants to ask a question. So we will now pass to our first questioner, Noel Diltz from Stifield. Please go ahead.

Hi, guys. Good morning, and thanks for everything you guys are doing to support the healthcare industry during the crisis. So my first question was just on the channel partner inventory reduction, 50 going to 70 million. Just clarify, you know, how much of that inventory reduction you did, channel partner inventory reduction you did see in the quarter. And then, you know, I know in the past we've talked about the impact that the WESCO annexed or merger could have on inventory reductions, you know, that hasn't closed yet. So are you expecting, you know, potentially some additional inventory reduction beyond the second quarter? As that closes, I'd just like to get a little – oh, I'm sorry. And also by segment, how you're thinking about that inventory reduction would be helpful. Thanks.

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 would 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 their turns up 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 Wesco and Anixter. So this is all in. 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.

Okay, that's very helpful.

Thanks.

you know, again, understanding that there's not all that much visibility, but any way you could expand upon the trends that you're seeing so far in April and, you know, kind of how the month has tended so far.

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

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

And I think rule are order run rate, in april so far has been fairly similar to what we saw the last couple of weeks of march correct 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 correct which was down pretty substantially compared to february correct great thank you you're welcome

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

Hi. Good morning, everybody. John Rule, I wanted to just think more about the smart building business because that's typically been a bit of a lagger as we've entered these downturn or recessionary type events. And so is that something where maybe the pain isn't as immediate as you are seeing in your particularly the industrial business right now, and you would see maybe more of a downturn as we get into 2021, but just how the cyclicality of that business has potentially changed since 2008, 2009?

So as we highlighted, our smart buildings business is approximately 25% of our total. Within that 25%, The part that is, 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 building products, but that demand would be a consequence of projects that would have been started probably 9 to 12 months ago. So our belief is that most of the projects that were already started will be completed. Where 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.

Okay, that's so cool. And then second, just on free cash flow, this is percentage of net income. I know you're typically targeting 100%. Are there any dynamics this year other than kind of the lower profitability that would affect, you know, Belden achieving that goal?

Well, there's a little impact. This is Hank, Sean. There's an impact of restructuring, for sure, as we execute upon our OPEC simplification programs. We expect funding here of approximately 50 million to get a 60 million annualized cost reduction. Thanks.

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

Thank you. Good morning, everybody. Good morning, David. Maybe just start with a follow-up on the question about smart buildings. On slide A, I'm a little surprised to see the commercial real estate part of that. Red, can you just maybe elaborate on what you're What you're expecting there, and I guess the heart of the question is we've heard a lot of or you've seen in the 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 would be more of a need for change. smart buildings and connectivity, if you will, in the office space. Is that not necessarily a big part of that 11%? Is it a big part of a new construction? And that's why it's red. Can you just kind of touch on that piece a little bit more?

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.

Great. Thanks, John. That was 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 train standpoint? I'd imagine that there's more of a need than ever for increased speed and bandwidth. Can you just kind of tell us what you've seen so far over the last four to six weeks?

Yeah, this is Roel. So absolutely, that's absolutely true. As we mentioned in our prepared remarks, we saw orders up 4% in that segment. We furthermore continue 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.

Thanks. Good luck navigating through all this, guys.

Thank you.

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

Great. Thank you for taking my questions. Two, first, we understand your expectation for revenue to decline in Q2, understand you can't size it. Can you help us perhaps better understand what we should expect from a decremental perspective on gross and operating margins, please?

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

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

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

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 we look to crises to expect well-managed companies to undertake some activities to transform the business to become stronger coming out. Felden's sort of fortunate in that some of these are already underway with the Grass Valley divestiture and the $250 million of cable and wire and the restructuring and so forth. One of those seems to be on track to happening, Grass Valley. We have the $40 million upsized to $60 million. The $250 million divestiture is 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 from them? Anything like that we could point to to be more optimistic about Belden's future?

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 fortuitous 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 Rule 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 Rural 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 occur and when we get revenue. And that means that Rural 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 that Rule already pointed out 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 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.

Thanks. Thank you, Will.

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

Hi, thanks. Thanks for those slides. It's helpful to kind of, you know, recognizing that they're, you know, that there's some variability. It at least shows that 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. It looks like your expectations are at some point in time and kind of holding those yellows as 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 as a wild card for the variability?

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 see 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'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.

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 a 35% reduction in EBITDA over Q1 sequentially and then reserving $4 million for recovery in Q3?

No. What we said is the decremental EBITDA margins on the sequential down in revenue needs to be roughly 30% to 35%. And then in addition, we'd like you to model another four to five million of temporary inefficiencies that we're holding to ensure we can respond to recovery and improvement in demand in the third and the fourth quarter. Got it. Thank you. You're welcome.

We'll now pass to the next question from Mark Delaney, Goldman Sachs. Please go ahead.

Yes, good morning. Thanks very much for taking the questions. First of all, I was hoping to better understand the cost reduction plan, the $40 million and $60 million number. How much of that is net savings? So in other words, is any of 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 or You get $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. It takes down to the mid-$80 million range, but maybe it could even go lower than that because of some of the other temporary cost savings. So just kind of help us think about the quarterly trough in SG&A this year.

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

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. So just trying to better understand some of the trends that you've been seeing in terms of orders within cybersecurity and the customer discussions about how quickly that the business could potentially come back. Thank you.

Yeah, 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 for 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 secure networks in this environment of people working more from home.

Thank you.

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

Hi, guys. Thanks for taking my questions. So just a quick follow-up on free cashless seasonality kind of. Assume an even stronger second half, kind of given the kind of 2Q headwinds on COVID, but what are kind of puts and takes on working cap that you can kind of benefit from?

Yeah, so we expect inventory improvements 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 our accounts payable.

Okay, thanks for that. And just a follow-up on the cybersecurity question. Are you seeing any kind of, you know, pent-up demand, you know, once the COVID concerns come down and it's becoming increasingly important for your enterprise customers?

Well, we're certainly seeing if the projects are not being canceled and we're not losing to the competition, then we will win them at a later point in time. So that would be . It's obviously the question of the projects that were originally scheduled to occur later on in this year, will they still occur or 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.

Thanks, Mark.

Thank you.

Kevin Mazka, there are no further questions at this time. Please continue.

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 email address is investor.relations at Belden.com. Thank you.

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