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Edited Transcript of COMM earnings conference call or presentation 8-Aug-19 12:30pm GMT

Q2 2019 CommScope Holding Company Inc Earnings Call

Hickory Sep 21, 2019 (Thomson StreetEvents) -- Edited Transcript of CommScope Holding Company Inc earnings conference call or presentation Thursday, August 8, 2019 at 12:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Alexander W. Pease

CommScope Holding Company, Inc. - Executive VP & CFO

* Kevin J. Powers

CommScope Holding Company, Inc. - VP of IR

* Marvin S. Edwards

CommScope Holding Company, Inc. - President, CEO & Director

* Morgan C. S. Kurk

CommScope Holding Company, Inc. - Executive VP & CTO

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Conference Call Participants

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* Ahmed Sami Badri

Crédit Suisse AG, Research Division - Senior Analyst

* George Charles Notter

Jefferies LLC, Research Division - MD & Equity Research Analyst

* Meta A. Marshall

Morgan Stanley, Research Division - VP

* Samik Chatterjee

JP Morgan Chase & Co, Research Division - Analyst

* Simon Matthew Leopold

Raymond James & Associates, Inc., Research Division - Research Analyst

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Presentation

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Operator [1]

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Good morning, ladies and gentlemen, and welcome to the CommScope Second Quarter 2019 Earnings Conference Call. (Operator Instructions) As a reminder, this conference call is being recorded.

I would now like to turn the conference over to your host Kevin Powers, CommScope's Vice President of Investor Relations. Please go ahead.

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Kevin J. Powers, CommScope Holding Company, Inc. - VP of IR [2]

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Good morning, and thank you for joining us today to discuss CommScope second quarter 2019 results. With me on the call are Eddie Edwards, President and COO -- CEO; Alex Pease, Executive Vice President and CFO; and Morgan Kurk, Chief Technology Officer. 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 recent SEC filings, which identify the principal risks and uncertainties that could affect future performance.

Before I turn the call over to Alex, just a few housekeeping items to review. Today, we will discuss certain adjusted or non-GAAP financial measures, which are 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.

In addition, for comparisons described as pro forma, all references to our second quarter of 2019 results will include ARRIS results for April 1 to April 3, the 3 days within the calendar quarter before the acquisition date of April 4. Also note, the second quarter of 2018 results include historical ARRIS results reflecting certain classification changes to align to CommScope's presentation. All quarterly growth rate described during today's presentation are on a year-over-year basis unless otherwise noted. Finally, all references to our second quarter 2019 net sales exclude $18.3 million deferred revenue purchase accounting adjustment that reduced our reported net sales.

I'll now turn the call over to our Executive Vice President and Chief Financial Officer, Alex Pease. Alex?

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Alexander W. Pease, CommScope Holding Company, Inc. - Executive VP & CFO [3]

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Thanks, Kevin, and thanks, everybody, for joining us today. This morning, I'll begin with some financial remarks from the quarter, discuss our outlook for the third quarter and the year, and then Eddie will give a business overview, including comments on the management change that we announced this morning. Following Eddie's remarks, we'll open the call up for questions.

Beginning on Slide 4. This morning, we were pleased to announce net sales and adjusted EBITDA results that were in line with our expectations and adjusted EPS above our expectations. Our second quarter results reflect disciplined execution as we continue to navigate a challenging operating environment.

Moving to Slide 5. Second quarter net sales increased to $2.59 billion, primarily driven by the benefit from the ARRIS acquisition, which contributed $1.38 billion. Pro forma net sales declined 12% to $2.61 billion, which includes a 1% impact of unfavorable foreign exchange. North American net sales decreased about 12% with weakness across the remaining geographic regions. The sales performance in the quarter was primarily the result of significantly reduced cable operators spending, which we and others in the industry have been experiencing throughout the course of the year. Consolidated orders for the quarter were $2.43 billion, providing book-to-bill ratio of 0.94.

For the second quarter, adjusted EBITDA increased 46% to $39.6 million or 15.3% of sales. Pro forma adjusted EBITDA declined 20% to $381 million or 14.6% of sales. The adjusted EBITDA results were primarily driven by lower volume, particularly in Network & Cloud, CMTS software licenses. We were able to partially offset this top line softness with favorable commodity and raw material pricing as well as lower operating expenses. As we will discuss later, synergy and cost savings actions for the year are cracking well ahead of plan than the commitments that we made earlier in the year.

Finishing up the P&L. Booked net interest expense was $165.3 million. Excluding the amortization of debt issuance costs and OID of $11.4 million as well as acquisition-related interest of $2.8 million. Interest expense was $148.7 million. The adjusted effective tax rate in the quarter was 26.4% versus our expected range of 27% to 29%.

The favorability in the second quarter was the result of a lower full year estimated tax rate assumption. Since the first quarter adjusted tax rate was approximately 30%, we recognized additional tax benefits in the quarter. Adjusted net income in the quarter was $153 million or $0.66 per diluted share as compared to adjusted net income of $133 million or $0.68 per diluted share.

As a reminder, included in our second quarter 2019 diluted share count is the assumed conversion of the Carlyle preferred stock resulting from the $1 billion investment to help fund the ARRIS acquisition. This resulted in an incremental 34.8 million weighted average shares outstanding. Moving forward, the full quarter impact will be 36.4 million shares or the $1 billion investment divided by the equity conversion price $27.50.

Now moving to our segment results. I'll begin on Slide 6 and discuss results for Connectivity and Mobility Solutions. Connectivity Solutions segment sales for the first quarter decreased 9% year-over-year to $671 million. Excluding the impact of unfavorable foreign exchange, sales declined 8%.

In North America, sales decreased about 5% followed by weakness in the remaining geographic regions. As expected, the results were negatively impacted by softness in the network, cable and connectivity business, driven by the current trend of lower capital spending from certain cable operators, particularly in North America. In addition, Enterprise sales declined in both copper and fiber markets, primarily in Europe and the Middle East.

While our Enterprise fiber business was soft in the quarter, our strategic focus on growing our hyperscale and cloud data center business continues to gain momentum, growing nearly 30% in the quarter. Today, we have meaningful business in 4 of the 5 top hyperscale accounts that have a significant and growing footprint in both cloud and multi-tenant data centers. We expect this momentum to continue and sales to accelerate as we move throughout the year and we capitalize in our competitive advantages. Specifically, these advantages include a highly efficient global manufacturing footprint and supply chain with the capability to meet hyperscale demand anywhere in the world; secondly, quick-turn capabilities for customized solutions, which was a key benefit from our Cable Exchange acquisition; thirdly, a low-cost pre-terminated high-fiber-count connectivity solutions; and finally, our industry-leading network of channel and distribution partners delivering on the fast-paced and high service requirements in the market.

Turning to profitability. We're pleased to say that, while adjusted EBITDA was down about 10% year-over-year to $142 million, driven by the top line volume decline, adjusted EBITDA margins were stable at 21%. The margin performance was the result of lower material cost and lower operating expenses in addition to favorable mix, which successfully offset continued pricing pressure and volume decline.

Moving on to Mobility Solutions. Segment sales for the second quarter exceeded our expectations and increased 6% to $529 million. Excluding the impact of unfavorable foreign exchange, sales increased 7%. While the seasonal nature of our mobility business typically results in higher sales in the second and third quarters, I'll note that due to the cadence of the North American operator spending, including FirstNet deployments, in 2019, we expect sales to be more weighted towards the second quarter similar to what we saw in 2018.

From a geographic perspective, results benefited from nearly 9% growth in North America and significant growth in the Middle East and Africa partially offset by a decline of $18 million in the Asia-Pacific region as we continue to proactively take steps to manage our profitability and exit lower-margin businesses. Growth in the quarter was led by our macro tower accessories and metro cell business with sales increasing over 60%, led by a record quarter in steel and accessories. Operators are accelerating spend to densify their 4G LTE network in preparation for 5G, and we expect this momentum to continue.

In the quarter, adjusted EBITDA increased 23% to $140 million or 27% of sales, a nearly 400 basis points movement 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 higher sales volumes, manufacturing footprint relocations and other cost reduction initiatives to improve profitability.

Turning to Slide 7 for our acquired ARRIS segment performance. For the customer premise equipment or CPE segment, second quarter net sales were $890 million, with adjusted EBITDA of $62 million. Second quarter pro forma net sales were $913 million, a decrease of 9% year-over-year and pro forma adjusted EBITDA of $60 million declined 2%.

Pro forma EBITDA margins of 6.6% of sales represent a 50 basis points improvement versus last year as the team has worked hard to manage raw material cost and removing controllable overhead and stabilizing pricing. Lower CPE revenues were largely a result of a broadband product shipment decline of 36%, as we continue to recover from the shift of production out of China to avoid the impact of U.S.-China tariffs.

That being said, now that non-China production has ramped, we anticipate our broadband device volumes to return to more typical levels in the third quarter. And we believe the business is well positioned as the demand for bandwidth continues to grow significantly and operators move to monetize their DOCSIS 3.1 investment. Video shipments for the quarter grew 2% year-over-year and improved sequentially, as select operators continue with technology refresh cycles. Despite these factors, we expect the combination of ongoing tariff mitigation activities and the continued growth in North America over the top trends to be likely headwinds in the second half of the year.

For the Network & Cloud segment, second quarter net sales were $344 million with adjusted EBITDA of $45 million.

Second quarter pro forma net sales were $348 million, a decrease of 37%, and pro forma adjusted EBITDA of $35 million declined 73% to 10% of sales. This is compared to 23% of sales last year, highlighting the significant effect of lower sales volumes on this business.

Our Network & Cloud segment sales were lower, driven by a combination of factors, including customer-driven M&A, strong capacity additions added in late 2018 and to a lesser extent, a temporary pause in spending as the industry aligns around a path towards virtualization. That being said, we continue to see strong growth in bandwidth demand and we view our Network & Cloud business as extremely well positioned to serve a wide range of architectures when the impact of these transitory factors abates. For many of the reasons mentioned above, the access technology portion of Network & Cloud is down. However, volumes did improve towards the end of the quarter.

Looking forward and thinking about the evolution of the network, an increasing amount of the investment dollars will take place in and around the node, favoring both this business as well as our fiber and copper cable as well as our connectivity businesses. As a market leader in installed nodes, advanced technologies and fiber and copper connectivity, CommScope is uniquely well positioned to benefit from this trend.

Also, whether in a fully virtualized legacy or hybrid network configuration, CommScope's installed base of nodes combined with our latest generation of technologies are fully upgradable to support a distributed access architecture and optimize our customers investments in the network for the future.

Moving on to the Ruckus second quarter results. For the Ruckus segment, second quarter net sales were $151 million with adjusted EBITDA of $6 million. Second quarter pro forma net sales were $153 million, a decrease of 10% and pro forma adjusted EBITDA of $3 million as compared to $15 million of last year. A decline in profits is largely the result of lower sales volumes, given the high fixed cost nature of the business.

While Ruckus sales remained soft, we're encouraged by the sequential improvement of over 30% compared to first quarter. We see an additional E-rate demand ahead, recent wins in the OEM channel, the introduction of Wi-Fi 6, fast ramping of a cloud-based architecture and several recent customer wins, all as evidence for the longer-term strength of this 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 in the market.

We believe this combined solution is extremely relevant in 5G and has the potential to solve many of the most demanding in-building and venue wireless challenges of the future. It will also serve as a critical element to unlock the full potential of private networks, which represents a substantial growth engine as 5G unfolds.

Returning to the consolidated results for CommScope, I'll address our cash flow on Slide 8. For the trailing 12 months, we generated $366 million in adjusted cash flow from operations and $267 million in adjusted free cash flow. During the second quarter, adjusted cash flow from operations was a negative $40 million and free cash flow was a negative $67 million. These amounts exclude cash paid for transaction, integration and restructuring cost.

Cash flow in the quarter was impacted by additional cash interest as a result of the ARRIS acquisition and a slower cash conversion cycle than expected. Importantly, we expect free cash flow generation to meaningfully accelerate as we move into the second half of the year.

Now let's discuss the capital structure on Slide 9. We closed the quarter with a net leverage of 6x pro forma adjusted EBITDA, which includes pre-acquisition adjusted EBITDA for ARRIS for the trailing 12 months as well as the $135 million of anticipated cost synergies and $31 million of other cost savings initiatives.

Looking ahead, our first debt maturity isn't until 2021. And as we previously stated, our primary focus is paying down debt. To that end, we're pleased to announce that this week, we redeemed $100 million of our 5% senior secured notes due in 2021 and also announced our intention to redeem a second $100 million shortly after this call. Both these payments come in advance of our typical year-end cash flow peak, and we expect further debt payments during the remainder of 2019.

While our expected cash flow and adjusted EBITDA levels heading into 2020 are lower than originally anticipated due to the temporary headwinds in the acquired ARRIS businesses, we remain steadfastly committed to delevering the balance sheet. We're focused on generating strong cash flow, managing our expenses, over delivering on our expected synergy targets and returning to a net leverage ratio of approximately 4x with all urgency. In addition, we remain fully committed to advancing to our longer-term net leverage target of between 2 and 3x.

All that being said, given that ARRIS is facing short-term headwinds resulting from cyclicality, it will now be very challenging to meet our first year financial targets for the transactions. However, we remain confident in the strategic rationale behind the combination and our ability to deliver significant shareholder value over the medium and long term.

Before I shift to our guidance for the third quarter, I want to highlight that we have met or exceeded our top and bottom line guidance now for the 3 consecutive quarters and have worked hard to rebuild investor confidence in our forecasting and communications. As we continue to integrate ARRIS, we will continue to build on the progress we have made in providing you the best visibility we can into the trajectory of the business.

Now moving on to our third quarter guidance on Slide 10. Turning to our outlook for the third quarter, we expect revenue in the range of $2.3 billion to $2.5 billion. Non-GAAP and adjusted EBITDA between $310 million to $370 million and non-GAAP adjusted earnings per share between $0.37 and $0.47. Additional assumptions include an adjusted effective tax rate between 29% and 30% and a weighted average diluted share count of approximately 232 million shares.

Turning to Slide 11, regarding our second half 2019 outlook. In our qualitative remarks last quarter, we referenced a perspective that we were hopeful that cable operators spending would normalize in the back half of the year, which we have not yet seen materialize. While we still believe strongly that subscriber and bandwidth growth, the evolution of 5G, the evolution of advanced network technologies and distributed access architectures all point to strong growth in the short to midterm, the back half of the year is likely to continue to be challenging from a revenue standpoint. With that said, I'll provide some additional color to help you model our expectations.

In our Connectivity and Mobility segments, we expect sales to follow our normal seasonal pattern with third quarter sales declining sequentially and then another sequential decline in our seasonally soft fourth quarter. From a modeling perspective, we'd expect a similar trend to what we delivered in 2018. We expect that adjusted EBITDA margin cadence to be consistent with that pattern as well.

In our CPE segment, we expect sales to sequentially decline in the third quarter but improve in the fourth quarter. To that end, we expect sales in the first half of the year to be stronger than the second half of the year. The sequential decline is primarily related to a continued reduction in the U.S. pay TV market and slower international video deployments, partly attributable to international operators' M&A activity. We expect these dynamics to be partially offset by a slightly increasing broadband market. In 2020 and beyond, we see the continued deployment of DOCSIS 3.1 modem, Wi-Fi 6 and the evolution of the next-generation of DOCSIS technologies to be tailwinds for CPE.

For Network & Cloud, we expect modest sales improvement sequentially throughout the remainder of the year, albeit not at the same pace we originally contemplated. As we indicated during our first quarter call, we anticipated reduced network spend in the second quarter, but we now believe that a return to a higher level of capital spending by operators will push out further than we originally had anticipated.

That being said, we do see 2020 as a much stronger growth year as operators continue to push fiber deeper, invest in node splitting activity and upgrade their networks to take advantage of next-generation technologies. The fundamental drivers for investing in the broadband network remain unchanged. The increased subscriber count, capacity utilization and increased access fees continue to drive growth. We remain firmly positioned to capture a significant share of this market demand, given our advantaged product portfolio and deep customer relationships, and we expect far better Network & Cloud performance in 2020.

In our Ruckus segment, we expect net sales in the third and fourth quarter to be relatively consistent with our second quarter results. While we remain confident in the long-term growth trajectory of this business, we are focused on optimizing the cost structure to align to our current sales trends to preserve profitability. Finally, I'll provide a couple full year assumptions to keep in mind. For the full calendar year of 2019, we expect an adjusted effective tax rate between 27% and 29% and a weighted average fully diluted share count of around 223 million shares outstanding.

Now I'd like to turn the call over to Eddie. Eddie?

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Marvin S. Edwards, CommScope Holding Company, Inc. - President, CEO & Director [4]

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Thanks, Alex, and good morning, everyone. As Alex referenced earlier, we are pleased to deliver consolidated second quarter results that are within or above our original expectations. From the legacy CommScope perspective, as we committed to you roughly 1 year ago, we successfully managed the margin compression caused by recent pricing dynamics to deliver profitability in line with our historic range.

For our acquired ARRIS business segment, the remainder of 2019 is unfolding to be more challenging than we expected.

This is largely due to the results of significant reduction in CapEx spend by certain large cable companies who have commented publicly on 2019 network and capital priorities. That being said, our long-term view is unchanged, and we continue to feel confident that these trends are transitory as operators will need to invest in their networks to remain competitive.

While our long-term growth trajectory expectations for the business remain intact, we are working on a renewed sense of urgency to execute our strategic plan and achieve our short-term and long-term goals. As a result, we are continuing to control what we can and continuing to streamline operations, realign resources to the highest return opportunities and focus intently on cost reductions and cash generations to adapt to challenging near-term operating environment.

And of course, we intend to intensify our strong focus on customer relationships and serving them exceedingly well. This is the proven CommScope playbook, and we will lean into our combined organization's strengths to accomplish this.

During similar downturns in the past, we have successfully shown the market we can absorb top line weakness and act with agility to preserve profitability, optimize free cash flow and meet our short-term and long-term financial obligations. To that end, we are taking immediate actions to ensure we continue to deliver value to our shareholders and customers around the world.

First, as part of our efforts to streamline the organization, this morning, we announced the elimination of Chief Operating Officer position with the responsibilities of the role shifting to me and other members of my executive team. As a result, Bruce McClelland is no longer with the company, and we wish him well in his future endeavors.

This decision to flatten our leadership structure expands accountability, which we've been striving to do in virtually every part of our company as part of our transformation. I am deeply committed to CommScope's continued growth and success, and with the Board's full support, I'm taking a more active day-to-day operational role in leading our company through these challenging times.

Second, we are accelerating our cost synergy efforts and now expect to exceed our first year target of $60 million. We are on track to achieve at least $75 million in the first full year post close, of which $50 million is expected to be realized in calendar year 2019. In addition, we are highly confident that we will exceed our stated $150 million of annualized synergy run rate savings and do so ahead of the third anniversary of close of this transaction.

Third, we have taken incremental actions to reduce cost to address our softer top line. These cost reductions are in addition to our stated ARRIS acquisition synergies and including streamlining sales and R&D operations to align with current sales trajectory. We expect to realize the benefit of at least $30 million during the balance of 2019 from these actions. In addition, we are evaluating opportunities to optimize our manufacturing footprint, among other possible actions to generate further savings.

Fourth, while we are focused on SG&A expenses control, we are also taking actions to optimize our R&D spend. We are focusing on the high-growth opportunities and have modulated based on end-market demand while not jeopardizing long-term opportunities. While we continue to invest for growth in 2020 and beyond, our R&D spend will be below our previously expected run rate of $800 million.

And lastly, we are mobilizing the organization around a renewed set of priorities to improve working capital efficiency to optimize cash flow generation. Driving free cash flow was in our company's DNA, and we will take progressive steps to meet our debt retirement -- our debt repayment goals.

Before I open up the call for questions, I'd like to make a few final remarks. Despite the challenging year, we remain very excited about the combined CommScope and ARRIS portfolio. We are now just 4 months into the ownership of the ARRIS business. As we continue to integrate our teams and processes, our enthusiasm for what we can achieve together grows stronger. Together, we have a more compelling and diversified global platform to promote service providers and enterprises.

To that end, I want to highlight what we believe were some of the exciting growth opportunities ahead for CommScope. These include a venue solution that combines our next-generation ERA/DAS technology with our Ruckus wireless LAN and switching technology that will provide a greater capacity capability than ever before. The resources are positioned to get in at the beginning of the private networks' transformation enabling Internet of Things and low latency applications, which are critical capabilities for the private -- for the industrial private network and core to 5G; positioned to lead the transformation of the cable operators' core networks as they evolve from centralized solutions to distributed access architecture in a cost-effective manner by virtualizing and combining our best-of-class CCAP platform with our unmatched installed base of optical nodes; leverage our expertise to assist operators with their current transition to the next-generation technologies, such as DOCSIS 3.1, and help define the next evolution of DOCSIS; and finally, our unique position to provide a holistic OEM-agnostic view of 5G that solves real-world network rollout problems of site acquisitions, power and backhaul. We support our operators -- our operator customers in the quest for open interfaces in all aspects of the network, from our antennas, cabling and connectors to our small cell, remote radio heads, metro cell and DAS solutions. Today, we are supporting the U.S. advanced wireless industry initiative, which is building for 4 -- city-scale 5G wireless research platforms with our products. These platforms will provide opportunities for fundamental research in areas such as millimeter wave, dynamic spectrum and new 5G architectures.

In closing, I continue to believe that the new CommScope is better positioned than ever to take shape -- to help shape the future of communications connectivity. Without question, our portfolio of industry-leading products, coupled with our strong customer relationships and talented workforce give me great confidence in our long-term growth potential. I'm highly confident that the actions that we are taking in 2019 to reposition our organization will better enable CommScope to achieve accelerated financial returns as capital spending improves from our largest customers.

And with that, we'll open the floor for -- up for questions. And I turn it back over to you, Charlie.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from the line of George Notter of Jefferies.

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George Charles Notter, Jefferies LLC, Research Division - MD & Equity Research Analyst [2]

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I guess maybe I wanted to start by talking about the Network & Cloud piece of the business. Obviously, that's been a struggle for you guys. But can you talk about what you think the real kind of impairment of that business is in terms of its ability to drive free cash flow and profitability? Obviously, a lot of trends. You guys talked about some of them, DAA. You've got a Virtual CCAP out there. You've got a competitor selling their cable OS product in an all-you-can-eat model. I mean what do you think is really just structurally impaired versus just the business that comes back and kind of rebounds in terms of transitory issues?

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Morgan C. S. Kurk, CommScope Holding Company, Inc. - Executive VP & CTO [3]

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Okay. Thank you. This is Morgan Kurk. I'll try to answer this from a structure -- from what the market looks like in general. So historically, this market and for the past 20 years has been integrating all of its core functionality into a single product called the CCAP or centralized CAP. This is now being disaggregated. And we have been a player in the aggregation of it, and we expect to be a player in the disaggregation of it.

The disaggregation is, as far as we're concerned, taking the code that we have had on our own equipment and migrating it so that it can run on traditional servers and run through traditional data network while moving the parts that cannot run on those types of servers outward to the edge of the network and something, as you may know, Remote PHY. We believe that the fact that we have been writing this code for the past 20 years, supporting it, featuring it and are now porting it to these 2 ends gives us a unique advantage in having something that is very hardened and something that is very feature-rich.

If we move now to the remote side of the world where we have a significant position in all nodes deployed around the world, we have a strategy of both taking the hardware that we use to have centralized, repackaging and putting it into these remote nodes, along with our amplifier equipment and power supplies and packaging and giving operators a seamless upgrade path for today's DOCSIS. In addition, we have the opportunity to enhance those remote nodes to support new features, like extended spectrum and full-duplex DOCSIS or even higher amounts of capacity in future.

All of this plan, which allows the migration, is really what CommScope brings to the table. It has capital preservation for our end customers. It gives them an opportunity to expand and grow as they need. And we think that, that experience and the market position is something that will be critical as we move forward. We expect to play in both the head end and in the remote side, and we expect to win in both.

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George Charles Notter, Jefferies LLC, Research Division - MD & Equity Research Analyst [4]

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Got it. I guess the genesis of the question here is, how much of that business is -- a lot of the trends you're talking about are very deflationary, right, in terms of the revenue and margin impact you guys get. So I guess I'm trying to better understand this business you've acquired in ARRIS and this Network & Cloud division that's really the profitability driver there. Like are the issues we're seeing financially there more structural? Or are they temporary in nature, just given the environment you see? That's the focus of the question.

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Alexander W. Pease, CommScope Holding Company, Inc. - Executive VP & CFO [5]

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Yes. So I think -- let's be clear. We view the issues as transitory. The things that Morgan was highlighting are more of evolutionary shift in the network that we feel unbelievably well positioned to take advantage of. So this is going to take place in a couple of ways. One is the legacy CMTS business, the E6000 chassis, we'll -- we have a platform, which we've announced recently, to introduce more virtualized technology into that side of the business as well as a hybrid technology that takes advantage of the installed architecture that we have, where we're the significant market leader. And then there's also migration process going from the CMTS piece of the business into the access technologies or the node piece of the business, which is exactly what Morgan was explaining. And that increase is the profitability and the absolute revenue in the node.

So we believe we're very well positioned to take advantage of that structural shift that's going on in the market. What you're seeing right now is really a transitory pause. And I would say that it's driven by really 3 things. So one is customer-driven M&A. So we've talked about that predominantly in Europe, although it had impacts in other piece of the business as well. One large cable operator has been very vocal on their significantly depressed level of capital spending, driven by some substantial investments that they made in 2018 and continuing to work through that capacity.

And then I do think the industry more broadly is waiting to see how this technology shift evolves before they continue to invest. But the fundamental drivers are unchanged. So subscriber growth, bandwidth demand growth, the need for lower latency, the importance of the consumer and the Internet of Things in the home, all of those are the fundamental drivers that will propel this business. And as Morgan mentioned, we have 20, 30 years of history as the market leader here and are very well positioned to take advantage of that when the capital spending rebounds.

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Operator [6]

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Your next question comes from the line of Sami Badri with Crédit Suisse.

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Ahmed Sami Badri, Crédit Suisse AG, Research Division - Senior Analyst [7]

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So I have 2 questions, really. The first one is, can you just update us on tariff plans? And when you think that tariffs will no longer impact the business on your side, is that still projected to be the end of the year?

And then the second question I have has a lot more to do with the Ruckus business. And more specifically, I think if I remember your comments correctly, you think that the revenue and maybe profitability dynamics will be similar in 3Q and 4Q of the year compared to 2Q. Some of your peers have directed us to believe that 3Q and 4Q is actually going to be a very positive ramp. And it sounds like you guys are in a little bit of different situation. Can you just give us more color on the dynamics you are seeing from a distribution, competition and technology acceptance perspective? Just because some of the trends you mentioned are very prolific and the revenues may not necessarily reflect or at least the projection of revenues.

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Marvin S. Edwards, CommScope Holding Company, Inc. - President, CEO & Director [8]

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Okay. So I'll take the first question, Sami, and then Alex and Morgan can cover the last. The tariffs, with 1 through 3 we were pretty well down the road to having those done. We've relocated pretty much the U.S.-destined antenna products that we make, much of the ARRIS product had been moved out of China into the Philippines, Vietnam and Indonesia. That was generally behind us, accomplished in the first part of the year. List 4 covers some of our DAS products that we have to relocate, so that will be done -- all of which will be done by the end of the year.

So I guess the short answer is we think by the end of the year, we'll be through it. It has been very disruptive to the flow of revenue and where it came from because a lot of this actually stopped. Some were supported but some stopped and, I think generally, it's back into some level of normalcy now. But we do have some work in the balance of the year to take care of List 4, which is well underway. So by the end of the year, we think it will be behind us unless there -- I don't think there's anything beyond the List 4. So we think that'll be behind us.

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Alexander W. Pease, CommScope Holding Company, Inc. - Executive VP & CFO [9]

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So let me just give you some color on the balance of the year for Ruckus, and then I'll let Morgan talk more about the technology trends and what we see as the longer-term potential. So for the balance of the year, we mentioned, as we talked about in Q1, there really are some short-term soft patches that we hit. And we pointed particularly to sales execution as being one issue. And then we pointed to the second as being the loss of a couple of key customer accounts. So -- and then we pointed to a third, which was a buildup of inventory in the channel.

So we're continuing to work through those issues. We've realigned the sales force. We've actually integrated the Ruckus Enterprise sales force with the CommScope Enterprise sales force to create one set of channel partners, one combined approach to market and that work is ongoing. We've worked through the majority of the issues in the channel. And we've actually won back a number of those customers. Some other wins that we point to are some real progress we're making on the OEM front to really drive manufacturing velocity. And then winning back some of those key customer accounts that we've lost. And then the last point that I've mentioned in terms of back half strength, our very strong E-rate order book, that when that spending begins to flow through, we should be very well positioned to monetize that. So there's a lot of good activity that we see as we look to 3Q and 4Q. As we think about the qualitative remarks, we did point to it being a little bit more on the flat side, largely driven by the fact that there's a lot of this work ongoing, and we're continuing to see some temporary impact of moving through the integration and really bringing this business up to what we believe is as its longer-term potential. But I'll let Morgan talk a lot about what we see as some of the key technology trends and why we think this is such a strong growth platform.

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Morgan C. S. Kurk, CommScope Holding Company, Inc. - Executive VP & CTO [10]

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Yes. So there are 2 basic trends that are going on, and they have an impact and the question always comes down to timing. So as you probably know, 802.11ax or Wi-Fi 6 as it's called is just beginning. And this is a fairly unique transition because it goes to multi gigabit bit at the edge, which means that there is an upgrade cycle not just for the Wi-Fi access point but we also get exposure for our switching portfolio and our cabling portfolio. Everything needs to be upgraded to fully take advantage of this new technology.

So we think in the medium term, this is going to rise dramatically.

However, these access points are just beginning to shift. And of course, clients are now just becoming available but are capable of taking advantage of this. So I think, perhaps, it's a question of who believes what timing is going on that may be a difference between us and the rest of the market. Finally, the other trend that we think is taking off that will have an impact to us as we move through the year and on to the next year is move towards cloud and subscription services. And in this case, we agree that's starting to accelerate, but again, we think that's a 2020 effect.

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Ahmed Sami Badri, Crédit Suisse AG, Research Division - Senior Analyst [11]

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Got it. Great. And then, I just actually have one more follow-up regarding the cash conversion cycle. Do you still anticipate the year for '19 to be relatively back half loaded or even just like last quarter loaded from an operating cash flow perspective? Just quick comments on that would be great.

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Alexander W. Pease, CommScope Holding Company, Inc. - Executive VP & CFO [12]

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Yes. Let me -- thanks for the question. So we do. Our typical seasonal pattern for cash flow is very back half loaded and it tends to be -- whether it's sort of late in the fourth quarter or even flipping to early in the first quarter, that's when we see a lot of receivables activity as folks build inventory heading into the end of the year for deployment in the first part of the year. So that's a normal sort of seasonal cycle. And really second part of Q1, Q2 and first part of Q3 tend to be our low point. So we do anticipate cash flow accelerating through the back half of the year.

I would point out the fact that we have been able to make $100 million debt pay down just last week, and we committed to another $100 million likely to go out next week. And that was in advance -- I would say that was ahead of the original expectations that we thought. So we have been doing some -- a lot of work on optimizing cash flow even in the soft top line environment and making sure we're being very efficient on cash flow repatriation to really focus on the debt pay down. So both of those are hopefully very positive signals.

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Operator [13]

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Our next question comes from the line of Simon Leopold with Raymond James.

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Simon Matthew Leopold, Raymond James & Associates, Inc., Research Division - Research Analyst [14]

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I believe, in the prepared remarks, Alex indicated that you have lower than previously expected cash flow expectations. Could you give us a little bit more quantification on what you're expecting for cash flow from operations or free cash flow would be better, either the next 12 months or 2020? If we could just get an understanding of what your expectations are now?

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Alexander W. Pease, CommScope Holding Company, Inc. - Executive VP & CFO [15]

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Yes. I would say that nothing has changed in terms of our long-term expectations for the year. We continue to see this business as being very strong in its ability to generate cash. And as I mentioned in my last answer, even despite the current soft top line environment, we're continuing to generate cash and pay down debt.

We do see that trajectory accelerating through the back half of the year, and then we see 2020 being a much more positive year than 2019. So we view everything that we're seeing currently as simply pushing expectations out by a couple of months. So longer term, sort of no change. In the short term, we are taking immediate actions that Eddie mentioned to really focus on cash generation. So we increased our 1 year synergy target to $75 million, above the $60 million that we communicated. And we've accelerated the full delivery of the $150 million, and we anticipate exceeding the $150 million. We're actively taking additional cost actions to get improved profitability, again, despite the soft top line. So we're doing everything we can to make sure we're delivering on the pay down commitments that we've made.

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Simon Matthew Leopold, Raymond James & Associates, Inc., Research Division - Research Analyst [16]

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Everybody's got a little different definition of long term. And I just want to make sure we're clear. I think you're referring to 2020. It sounds like it's probably a little bit lower than what you had talked about previously but still a pretty healthy, approaching $1 billion cash from operations kind of number. Is that the right way to interpret your comments?

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Alexander W. Pease, CommScope Holding Company, Inc. - Executive VP & CFO [17]

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I think that's fair. I mean we're not in a position yet to provide quantitative guidance obviously for 2020. We certainly view the level of cable operator spending that we see right now as being transitory and rebounding in 2020. So I see 2020 as being a much more normal year, both because of the recovering capital spending environment as well as a lot of the actions that I've described sort of reaching full run rate.

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Simon Matthew Leopold, Raymond James & Associates, Inc., Research Division - Research Analyst [18]

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Great. And then just to follow up with the management changes. Obviously, you discussed the COO change, and we understand that the leadership within the old Network & Cloud unit had changed some time ago. Could you talk to us a bit about the bench strength and whether you have the right resources to essentially move forward with the acquired assets from ARRIS?

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Marvin S. Edwards, CommScope Holding Company, Inc. - President, CEO & Director [19]

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We believe we do. We have very competent people in both sides of the company that have the ability to move up. Our technical skills that we have, which ARRIS is -- that's the primary thing in development and design. They have a lot of skill sets there. Our goal is to continue to improve the positions as we can with the combined entities and try to get some back and forth stuff between the 2. So we -- we're sending help to places, and I think we're seeing a lot of change there. But the change I think that we've made in Network & Cloud is very positive. Kevin's, I think, highly capable person. And any other changes that we make in the near term or medium term, we think, we'll have good people there as well.

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Simon Matthew Leopold, Raymond James & Associates, Inc., Research Division - Research Analyst [20]

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And when do you expect that you'll be in the market with a Virtual CCAP solution? I know there was a -- some press out on, I think, the 6-month kind of time line, not sure whether that was validated by you or not.

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Morgan C. S. Kurk, CommScope Holding Company, Inc. - Executive VP & CTO [21]

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Yes. So this is Morgan. This is the end of the year time frame, so I believe that is accurate.

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Simon Matthew Leopold, Raymond James & Associates, Inc., Research Division - Research Analyst [22]

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Great. And then just one last one, I want to double-check. I you indicated that you expected CPE sales would be up sequentially in the December quarter. Just historically, I always thought of that as a weak seasonal quarter for CPE. Is there something specific going on in that quarter that maybe makes it a little bit different?

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Alexander W. Pease, CommScope Holding Company, Inc. - Executive VP & CFO [23]

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I think it's really -- most of the communication that we've heard from customers is that they intend to have their capital spending increase in the second half of the year. And so we expect that while Q3 is likely to be a little bit on the soft side for CPE, most of the benefit of that increased capital spending comes through in the fourth quarter. And then some that is actually based in conversations that we've had so far.

Okay. I was just going to -- just to finalize that. We also -- remember when we commented on some of the softness that we've seen in CPE, it's been driven by the moving of manufacturing out of China. And that's led to a bit of a decline in some of the broadband volume. So that move is now fully behind us. And we're ramping up the production capacity and recapturing some of that share loss that we saw as we had manufacturing facilities off-line. So that's part of also what's driving the, a bit maybe, nontypical ramp.

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Operator [24]

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Your next question comes from the line of Meta Marshall with Morgan Stanley.

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Meta A. Marshall, Morgan Stanley, Research Division - VP [25]

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And maybe kind of coupling on to Simon's question. Just what kind of actions are being made in the short-term on kind of ARRIS account management, continuity and just making sure that kind of customers are circled up with to make sure that there's no disruption in the transition period? And then, if you could just comment on the mobility side. Sprint, T-Mo and kind of ongoing combination being in flux there and just what kind of purchasing behavior you're seeing there or what you kind of put into expectations as far as expectations as to when that transaction closes and their spending patterns.

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Marvin S. Edwards, CommScope Holding Company, Inc. - President, CEO & Director [26]

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Meta, thanks. This is Eddie. We have the benefit of serving the same group of customers generally. I have met with most, if not all, of the senior people in most of our customers. That will be reinforced in the coming weeks, certainly. We have very competent sales teams, combined sales teams now that cover the entire industry. And so we need to reinforce and show our face. I think we need to make sure that they understand the full capabilities of CommScope now as a combined company and what we can provide that -- and maybe leading more so than what we have in the past from a combined standpoint.

In the case of T-Mobile and Sprint, we assume it's going to happen. We think that's a positive. Generally, when these things happen, there is a pause. We think that pause could be muted because these guys have topped each other a lot and for a long time. And so we do -- we are a primary supplier of their products to them. And so we think that's an opportunity for us.

We also had a probably 35-year-long relationship with DISH. And so however, they fit into this equation, I think that we can be a meaningful provider for the bits of the combined entity that they're going to get. So we think it's a positive. And there's a caveat in these things. There is generally a pause but we didn't think it will be needed. And we've been in close conversation with the people that will be making decisions, we think. And so I think we're ready to go.

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Meta A. Marshall, Morgan Stanley, Research Division - VP [27]

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And is that pause built in the expectation they're still TBD, waiting to figure out timing of when everything is announced?

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Morgan C. S. Kurk, CommScope Holding Company, Inc. - Executive VP & CTO [28]

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Yes. This is Morgan. I think it's a TBD, but as Eddie said, it's muted. I'd like to comment on this a little bit more. That's a unique situation. So I'm very bullish on the Sprint, T-Mobile get-together and the possibilities that will happen in the industry. The addition of this fourth operator which will be building a network from the ground up represents a unique opportunity for CommScope. Not only will they need our traditional products, which we've sold to them for years, but they have an opportunity to design the network differently than current legacy operators in that they can use an open RAN standard interface to enable the core portion of the network and the edge portion of the network to be disaggregated.

This is an opportunity for CommScope to play in a way that we have had a hard time playing in the past where the remote radio heads and the baseband units have been fairly closed, having to be supplied by the same supplier. We believe this is an opportunity where we may be able to do a lot more for them. So we see this -- the developments in the wireless industry as uniquely positive.

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Operator [29]

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Our next question comes from the line of Samik Chatterjee with JPMorgan.

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Samik Chatterjee, JP Morgan Chase & Co, Research Division - Analyst [30]

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I just want to start off with the Connectivity Solutions group, and we've seen one of your competitors recently lower their expectation for fiber growth, citing push out of projects by telecom companies as well as the lower spend from cable. Just want to see what you're seeing on the ground. Have your expectations for growth in the fiber side of the business changed relative to when you started the year and anything that's changed on the pricing aspect as well?

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Marvin S. Edwards, CommScope Holding Company, Inc. - President, CEO & Director [31]

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I think others have commented on recent weeks and we're seeing the same issues. Pricing is -- it depends on when and where as to the aggressiveness or maybe more moderation of where prices are. But we do see softness in the traditional Enterprise both in -- in both copper and in fiber. The hyperscale business from our standpoint is percentage-wise a big growth market right now. We are smaller than others. But as we said earlier, we're in 4 of the 5 major named hyperscale providers. We also have a meaningful position in the multi-tenant data center marketplace, which we have been in for a long time. So I don't think what we're seeing is any different than what others have previously talked about.

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Samik Chatterjee, JP Morgan Chase & Co, Research Division - Analyst [32]

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Okay. Got it. If I can just quickly follow up with Alex. Alex, can you help me think about the seasonality in the combined business going forward? Just more curious about kind of the -- as we go from $2.6 billion run rate in 2Q to $2.4 billion in 3Q, how much of that is seasonality versus kind of more of a moderation in the overall macro driving some of the headwinds of the business?

Also it appears like you have $200 million sequential decline in revenue with a $50 million decline in EBITDA. So just wondering. That seems like a high percentage overall. So just can you help me with that?

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Alexander W. Pease, CommScope Holding Company, Inc. - Executive VP & CFO [33]

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Yes. Let me take it at sort of a macro level, Samik, and then you can ask a follow-on if I don't quite get it. At a macro level, the typical seasonality pattern for us would be a weaker Q1 and weaker Q4 and then a strong Q2 and Q3. And a lot of that's driven by just the construction season, whether it's on the tower or in the field. And so that will be sort of typical. And my understanding is that a lot of that is fairly typical within the acquired businesses as well.

The one difference is, with the acquired businesses, particularly in the Network & Cloud side, you tend to see a fairly strong ramp at the end of Q4 that's driven by large software license sales as they're positioning the network capacity additions for the following year and also, taking care of any residual capital spending that they have left in the budget. So that would be sort of, call it, the typical seasonality that's been thrown off a little bit in the recent past by what we've seen in mobility and FirstNet.

So what we've seen is that Q1 and Q2 for Mobility tend to be seasonally stronger than Q3 and Q4. That's certainly what we saw in '18, and we expect that trend to be almost mirrored in this year as well. And that's largely driven by the FirstNet spending as opposed to, what I'll say, more the macro level seasonality. So hopefully, that helps get at your question.

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Operator [34]

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That concludes our question-and-answer session for today. I will now turn the call back to the presenters.

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Kevin J. Powers, CommScope Holding Company, Inc. - VP of IR [35]

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Yes. We thank everybody for joining us for the second quarter call. We appreciate your continued interest in CommScope, and we look forward to talking to you at the end of Q3. Thanks very much.

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Operator [36]

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Ladies and gentlemen, this concludes today's conference. Thank you for your participation. You may disconnect.