Celestica Inc (CLS) 2015 Q1 法說會逐字稿

Good morning, my name is Melissa, and I will be your conference operator today.

At this time I would like to welcome everyone to the Celestica first quarter results conference call.

All lines have been placed on mute to prevent any background noise.

After the speakers' remarks there will be a question and answer session.

(Operator Instructions).

Thank you.

Mr. Jim Fitzpatrick, Vice President, Investor Relations and Communications, you may begin your conference.

Thanks Melissa.

Good morning, and thank you for joining us on Celestica's first quarter 2015 earnings conference call.

On the call today are Craig Muhlhauser, President and Chief Executive Officer, and Darren Myers Chief Financial Officer.

This conference call will need to end in approximately 45 minutes, as we are heading to our Annual General Shareholders Meeting at 9.00 A.M. this morning.

Darren and Craig will provide some brief comments on the quarter, and then we will open the call for questions.

During the Q&A session, please limit yourself to one question and a brief follow-up.

We will be available after the conference call for additional follow-up.

Also please visit our website at www.Celestica.com to view the supporting slides accompanying this webcast.

As a reminder, during this call we will be making forward-looking statements related to our future growth, trends in our industry, our intentions concerning the return of capital to our shareholders through a substantial issuer bid, our financial and operational results and performance, and financial guidance, that are based on management's current expectations, forecasts and assumptions, that are subject to risks and uncertainties that could cause actual outcomes and results to differ materially.

Please refer to our cautionary statements regarding forward-looking information in the Company's various public filings, including the cautionary note regarding forward-looking information in today's press release.

We also refer you to the Company's various public filings, which contain and identify material factors that could cause actual results to differ materially from those contained in our projections or forward-looking statements, and which discuss material factors and assumptions on which those forward-looking statements are based.

These filings include our Annual Report on Form 20-F and subsequent records on Form 6-K, filed with or furnished to the Securities and Exchange Commission, and our Annual Information Form filed with the Canadian Securities administrators, which can be accessed respectively at SEC.gov and SEDAR.com.

During this call we will refer to certain non-IFRS financial measures, which include adjusted gross margin, adjusted SG&A, adjusted operating profit or adjusted EBIAT, operating margin, adjusted net earnings, adjusted EPS, return on invested capital or ROIC, inventory turns, cash cycle days, free cash flow and adjusted tax rate.

These non-IFRS measures do not have any standardized meaning under IFRS, and may not be comparable with other non-GAAP or non-IFRS financial measures presented by other public companies, including our major competitors.

We also refer you to today's press release which is available at celestica.com for more information about these and certain other non-IFRS measures, including a reconciliation of the historical non-IFRS measures to the corresponding IFRS measures, where a comparable IFRS measure exist.

Unless otherwise specified, all reference to dollars in this call are to US dollars.

I will now turn the call over to Darren Myers.

Thank you Jim, and good morning everyone.

Celestica continued to deliver solid operating margin and free cash flow performance in the first quarter, while continuing to return capital to shareholders.

First quarter revenue of $1.3 billion was at the low end of our guidance range, as overall demand was softer than expected, particularly in the areas of our communications and our diversified markets.

Revenue in the quarter was down 9% compared with the fourth quarter of 2014, and down 1% compared with the first quarter of 2014.

Let me start with a few highlights for the first quarter.

Adjusted gross margin of 7.4% was up 20 basis points compared to the first quarter of 2014.

Adjusted operating margin of 3.1% was flat compared to the first quarter of 2014.

Adjusted earnings per share came in at $0.19, which was at the lower end of our guidance range.

IFRS earnings per share were $0.11 compared to $0.20 per share in the first quarter of 2014, primarily due to a tax recovery benefit recorded in the first quarter of 2014.

We generated $22 million of free cash flow for the quarter.

We achieved ROIC of approximately 17%, and we repurchased and canceled 6.1 million subordinate voting shares.

Moving on to the first quarter details, looking at our revenue from an end market perspective, year-over-year revenue growth from our storage, server and diversified businesses was offset by demand softness in our communications end market, as well as a continued de-emphasis of certain consumers programs.

Our diversified end markets comprised 28% of our total revenue for the first quarter of 2015.

Diversified revenue decreased 3% sequentially, slightly higher than expected, largely due to softer demand in industrial.

Compared with the first quarter of 2014 however, diversified revenue increased 1%, with revenue growth in energy and semiconductor offset by small declines in our other end markets.

Our communications end market represented 40% of total revenue for the quarter.

Communications revenue decreased 8% sequentially, which was higher than expected, due to delays in certain program ramps.

Compared with the first quarter of 2014, communications revenue declined 3%, primarily due to lower overall demand.

First quarter revenue from our storage end market came in as expected, and represented 18% of revenue for the quarter.

Storage revenue decreased 21% sequentially, due in part to seasonality and a strong fourth quarter.

Compared to the first quarter of 2014, our storage business grew 9%, driven by new wins across a number of customers.

First quarter revenue from our server end market was relatively flat sequentially, representing 11% of total revenue for the quarter, which was consistent with our expectations.

Server revenue increased 6% compared to the first quarter of 2014, primarily due to growth from one customer program.

And finally, our consumer end market representing 3% of total first quarter revenue, decreased 13% on a sequential basis as expected.

Consumer revenue for the quarter decreased 44% compared with the first quarter of 2014, primarily due to our continued deemphasis of certain lower margin business in this space.

Our Top 10 customers represented 64% of revenue for the first quarter, down 5 percentage points from the fourth quarter of 2014.

For the first quarter, we had two customers individually contributing greater than 10% of our total revenue, down from three customers in the fourth quarter of 2014.

Moving on to some of the other financial highlights for the quarter, adjusted gross margin of 7.4% was up from 7.2% a year ago, primarily due to improved program mix and continued cost containment.

Sequentially gross margin was down slightly on lower revenue.

Adjusted SG&A expense for the quarter was $48 million, which was better than our expected range of $49 million to $51 million.

Research & Development expense was $6 million in the first quarter, an increase of $1 million sequentially, and $2 million year-over-year, as we continue to increase our investments in our joint design and manufacturing offering.

Adjusted operating profit for the quarter was $40.5 million, or 3.1% of revenue, a sequential decrease of 50 basis points, largely due to lower revenue, compared with the first quarter of 2014, despite slightly lower revenue, adjusted operating margin was flat, driven primarily by improved program mix and our continued focus on cost management.

Our adjusted tax rate in the first quarter was 17.4%, above our estimated annual tax rate range of 11% to 13%, largely due to foreign exchange fluctuations, most noticeably the weakening of the Malaysian ring against the US dollar.

Adjusted net earnings for the first quarter was $33 million, or $0.19 per share, compared to $47.1 million, or $0.26 per share for the same period of 2014.

The year-over-year decrease was primarily related to Malaysian tax incentives recorded in the first quarter of 2014.

First quarter IFRS net earnings were $19.7 million, or $0.11 per share, compared to $37.3 million, or $0.20 per share in the same period of 2014.

Again, tax incentives recorded in the first quarter of 2014 contributed to the year-over-year decline.

Turning to our working capital performance, return on invested capital was 16.8%, up from 16.1% for the same period last year.

Our inventory increased $35 million from the end of the fourth quarter to $754 million at March 31st.

Inventory turns for the quarter decreased to 6.6 turns from 7.1 turns last quarter, an increase from 6 turns for the first quarter of 2014.

Capital expenditures for the first quarter were $12.7 million, at the lower end of our estimated range of 1% to 1.5% of revenue.

Cash cycle for the first quarter was 47 days, compared to 44 days in the fourth quarter of 2014.

For the first quarter of 2015 we generated $22 million of positive free cash flow, compared to negative $16 million for the same period last year.

Moving on to our cash position, our cash position remains strong.

Our cash balance increased $4 million from the fourth quarter to $569 million.

At the end of the first quarter we did not have any outstanding debt, and our credit facility remains undrawn.

During the first quarter we repurchased for cancellation 1.7 million subordinate voting shares for $20 million, at a weighted average price of $11.56 per share.

We also completed the $50 million prefunded program share repurchase launched in the fourth quarter of last year, and repurchased and canceled 4.4 million shares, at an average price of $11.38.

In total, we canceled 6.1 million shares in the quarter.

At the end of the first quarter we had 169.2 million subordinate and multiple voting shares outstanding.

Moving forward to our guidance for the second quarter of 2015, for the second quarter we are projecting revenue to be in the range of $1.35 billion to $1.45 billion.

At the midpoint of our guidance, second quarter revenue is projected to increase 8% sequentially with growth in all end markets.

Year-over-year at the midpoint of our guidance, second quarter revenue is projected to decline 5%, driven by our de-emphasis on certain lower margin consumers business and demand weakness in communications.

At the midpoint of our guidance, we expect non-IFRS adjusted operating margin of approximately 3.2%, an improvement of 100 basis points compared to the first quarter.

Our guidance reflects continued investments in our joint design and manufacturing offering, as well as transferred ramp costs for certain programs.

Second quarter non-IFRS adjusted earnings are expected to range from $0.20 to $0.26 per share.

Our non-IFRS SG&A expense for the second quarter is projected to be the range of $48 million to $50 million, and we estimate an annual adjusted tax rate range of 11% to 13%.

I would now like to turn the call over to Craig for some comments on the quarter, as well as our second quarter outlook.

Thank you Darren, and good morning to everyone on the call, and thank you for joining us today.

Despite a challenging business environment, Celestica delivered revenue and operating margin in line with our guidance, with year-over-year improvement in free cash flow, driven by the strong performance across our operations network.

Before I provide some additional perspective on our end markets, I want to highlight two announcements in the area of investments and shareholder value.

First, in support of our long-term strategy to increase our diversification into higher margin businesses, we are announcing the expansion of our relationship with one of our largest aerospace customers, Honeywell.

As part of an operate in place agreement, Celestica will manage the final assembly and test ,and repair and overhaul for certain product lines at Honeywell's facility in Mississauga, Ontario.

The assembly and test operations will continue to be based at Honeywell's Mississauga location, but will now be managed by Celestica.

As part of this agreement, approximately 330 full-time employees from Honeywell Mississauga have joined Celestica.

This agreement further strengthens the relationship between Celestica and Honeywell Aerospace, and provides the platform for Celestica to deliver additional value to Honeywell.

The operational and regulatory capabilities that Celestica is acquiring as part of this agreement, combined with the skills and experience of the team in Mississauga, complement the broad range of global aerospace and defense solutions we can provide our customers in this area of our business.

I'm also pleased to share that as a result of the strength of our balance sheet, and continued strong cash flow performance, our Board of Directors has authorized a substantial issuer bid to repurchase for cancellation up to $350 million of our subordinate voting shares.

Today's substantial issuer bid announcement, along with the continued investment in the diversification of our business, reinforce our confidence in our strategy and ability to deliver profitable growth, while continuing to return capital to our shareholders through share repurchases.

Celestica was also recognized with two significant awards in the first quarter.

First, it received a 2014 Supplier of the Year award from Juniper Networks.

The award recognized Celestica for taking a leadership role in executing a highly successful complex product transfers, of proactively managing the risk and maintaining exceptional levels of quality and operational excellence.

Second, Celestica was named as one of the 2015 Global 100 Most Sustainable Corporations in the World by Corporate Knights, an organization dedicated to encouraging responsible business practices.

The award recognizes Celestica as one of the world's top companies in the area of sustainability, based on our environmental and corporate governance performance.

Now let me turn to our near term outlook for our end markets.

For the second quarter relative to our diversified business, we are expecting sequential revenue growth in the high single-digit range, representing growth across the majority of our diversified markets.

On a year-over-year basis, we expect our diversified end market to decline in the low single digits, as we transition some of the supply chain and manufacturing capacity and resources for our energy business from North America to Asia.

In our semiconductor business, we continued our efforts to accelerate the improvements in operational performance, ramped new programs, and improved cost productivity in the first quarter.

Despite delivering sequential growth of 19% in the first quarter, we incurred higher than expected losses in the quarter, as certain improvements were offset by continued cost challenges and new program qualification and ramp delays.

Although we're anticipating continued revenue growth in our semiconductor business in the second quarter, we are taking additional cost reduction actions to accelerate the rate of financial improvement in this business.

We are continuing our investments to improve our quality and delivery performance to meet the increasingly demanding customer requirements in the areas of quality, lead time, and flexibility.

We are working to streamline and simplify our supply chain through the consolidation of two of our semiconductor operations into one location.

As a result of these efforts and the timing of the consolidation, we expect losses in our semiconductor business to decline modestly in the second quarter.

Based on our current revenue forecast, we anticipate that the semiconductor business will deliver positive gross margin in the second half of 2015.

Our communications business is expected to increase sequentially in mid-single digits.

However, on a year-over-year basis, we're expecting a decline in the mid-single digits based on the overall demand volatility, specifically in the carrier segment of our business.

Our storage business in the second quarter is projected to grow in the low double digits on a sequential basis.

On the year-over-year basis, storage is expected to grow in the mid-single digits driven by the impact of new program ramps.

Our server business is expecting sequential growth in the mid-single digits, resulting from the ramping of a new program win, and on a year-over-year basis, server is expected to increase in the low single digits.

And finally, our consumer business is expected to increase slightly on a sequential basis, but will be down significantly year-over-year, as we continue to de-emphasize this area of our business.

In summary, while end market demand continues to be dynamic in terms of volume and mix, we are expecting quarter-over-quarter growth in all of our end markets.

We look forward to accelerating our progress throughout 2015 as we focus on winning new business in our target markets with existing and new customers.

Based on our confidence and ability to consistently generate cash, we are making the investments necessary to support profitable growth, while also driving additional cost productivity in support of operating margin expansion, providing additional shareholder returns through share repurchases.

That concludes our prepared remarks.

Melissa, please open the call for questions.

(Operator Instructions).

We'll pause for a moment to compile the Q&A roster.

Your first question comes from the line of Brian Alexander from Raymond James.

Your line is open.

Hi, good morning.

Just a question on the communications business, and maybe if you could just elaborate a little bit more on what you saw in the quarter, whether that business weakened throughout the quarter, and ended on a weaker note than it began.

It sounds like it was more on the telecom side than networking side.

I just wanted to confirm your networking business is actually performing as expected, and that it's really more on the telecom side, and your outlook going forward and how temporary you think this is?

Good morning, it's Craig.

The business in the first quarter was impacted primarily from a delay in the new program ramp regarding some technical issues with the software, but the biggest impact we've seen obviously is area markets, telecom side, primarily in the areas of North America and RK, specifically Japan.

Okay.

And then just a follow-up would be, maybe a little bit more on kind of the rationale and timing for the significant share repurchase announcement, why now, why so large?

I think this might be the largest program in history, so I'm just trying to understand, what's changed at Celestica to drive you to buy back such a significant amount of stock?

Well, I think we're looking at the confidence in our strategy and we're looking at the performance of the business, we're looking at the outlook for the growth over the course of 2015, and it's just to emphasize, our previous comments about our desire not only to invest in the business, which we're doing, but also have the ability to deliver value to the shareholders through share repurchases, and we think the timing right now is right, given all of those factors.

Okay.

Thank you.

Thanks.

Your next question is from the line of Sherry Scribner from Deutsche Bank.

Your line is open.

Thank you.

I wanted to get a little more detail on the Honeywell announcement that you made today, Craig, I'm sorry if you missed it, but did you talk about the revenue impact to that?

And in terms of bringing those additional employees on, how much of a cost impact is that to the full year?

Thanks.

Sherri, good morning.

As I mentioned, we brought approximately 330 employees, obviously we bring a business with that.

It's an operating in place agreement.

It's supporting the product in the areas of electric power and air and thermal management.

We expect a growing contribution to our revenue and profitability over the course of 2015, and on into 2016 and 2017.

For the near term, our focus will be on making this successful and working closely with Honeywell, and then I think in the out years, it will have a bigger impact on a broader base of customers, but for the near term it will be an important contribution to the continued growth of our aerospace, and accelerate our growth in the aerospace segment, and obviously the overall diversified segment.

Sherri, it is Darren here, I will just add to that.

Although we're not giving the terms of the deal or the size of the deal, I will say that we are using $34 million of cash in the quarter, around $34 million, in the quarter to pay for working capital for the manage in place.

And is this going to put pressure on your operating margin since you add these people?

I would say at the beginning, certainly, there's always the ramp costs and you can see in our guidance, at 3.2%, we are lower than we would expect at $1.4 billion, so there's 20 to 30 basis points of ramp costs in the short-term that's impacting us, but we expect that to improve as the year goes on.

Okay.

Thanks.

And then just looking at the full year revenue outlook, it looks like, based on the guidance for the 2Q we see your year-over-year revenue decline.

Do you guys think you'll grow revenue this year?

Thanks.

Yes, we do.

We think we'll grow revenue over the course of the full year.

Thank you.

Your next question is from the line of Amit Daryanani from RBC Capital Markets.

Your line is open.

Thanks, good morning guys.

Two questions from me.

One on the communications side, one of your peers last night talked about some of their inventory overhang that needs a couple of quarters to burn out.

I'm curious, are you seeing anything on that level that could be made to impact especially the June quarter numbers, and any thoughts on what the implications of the Alcatel-Lucent Nokia Siemens transaction could be for you guys?

Good morning.

Inventory overhang, I can't comment on the competition, I mean, obviously we manage our inventory very tight and, frankly, I don't see any risk to the quarter from inventory overhang.

The point is, on the Alcatel-Lucent Nokia, the Nokia purchase of Alcatel-Lucent you should know that Alcatel-Lucent is about a 2% customer of Celestica.

We currently do not do business with Nokia, although that could be an opportunity certainly in the JDM area, but that's the story from our side.

Got it.

And a follow-up on the consumer side, you have seen some headwinds due to proactive disengagement from your side, is there more of that left to go and could that 3% revenue eventually work its way toward zero by the end of the year?

Curious what sort of headwind you will have in 2015, through incremental disengagements maybe in the consumer, or just broadly for you guys?

I think we're at the point now where we can say the portfolio in our consumer business is exactly what we want.

We've got a strong position with HP in the inkjet business, leading market share there, and the majority of the rest of the remaining business is in our aftermarket business, where it's reporting products and customers that we have a very, very good relationship with.

Perfect.

Thank you.

Thank you.

Thanks Amit.

Next question is from the line of Joe Wittine from Longbow Research.

Your line is open.

On the JDM activities, could you maybe give us some more detail by helping us take it to the segments, the way you lay the business out in the five segments, where could the JDM impact the business the most, where is it now, and where is the opportunity going forward?

Sure, Joe.

Good morning.

It's Craig here.

Let's start with where we are now.

Where we are now is over the past six years as we've talked, we've made investments primarily in the storage and server portion of the business.

The biggest impact we're seeing today is in the storage business.

The biggest investment are going into the storage server and now networking business, and it's leading us to have developed a converged platform, which is both rack based, as well as based in the single chassis.

So suffice it to say now we're moving, as Darren mentioned, to increase our expenditures in this area, and those expenditures are largely directed toward the energy segment of our business, in the area of power electronics.

And then we anticipate this business will begin to grow across the diversified space as we establish stronger market positions, build our credibility through the execution of our traditional EMS business, and then certainly across the entire Company, JDM will be a transformational opportunity for us to really take our business relationships, as well as the growth of the Company to a higher level, by participating in the design of the products, being in a position to select preferred suppliers, managing the material supply, and then in fact contribute much better performance to customers, time to market advantages, ID protection, OEM quality, but today the emphasis and the impact has been primarily in the communications and enterprise space.

Great.

Then a follow-up on inventory, you said you don't see any kind of builds of inventory in the supply chain that are troubling at this point.

How about your internal inventories?

Was that build during the March quarter intentional, or similar to the competitor last night, was it kind of a temporary product of soft demand that you'll need to work down in the June quarter?

No.

As I mentioned to the comment on our communications outlook, we have one major launch here that is going to be a very successful program with customers working through some technical difficulties in the marketplace, and that inventory build was related to that program specifically.

Okay.

Thanks, Craig.

You bet.

Your next question is from the line of Daniel Chan from Scotiabank.

Your line is open.

Good morning, thanks for taking my question.

Darren, I was just wondering how much cash and how much debt do you plan to use to fund the buyback?

Good morning, Daniel.

We plan at this time to use approximately $75 million of cash, and the rest will be funded through our credit facility and a term loan, so that's $275 million through that, and of course we would look to, we expect to continue to general race positive cash flow and would look down to pay down that balance over time.

Okay.

Thanks.

Craig, just on the semiconductor business, a couple major players in the space announced some CapEx cuts this year.

Do you expect that to impact you guys or is that the semi cap story for Celestica more about operational improvements this year?

Good morning Daniel.

I think the impact, as you see we had a 19% revenue increase in the first quarter, we're continuing to experience a strong demand in the second quarter.

I think from the impact of the announcements you're seeing, we will see that slow down in the second half, but we expect the primary improvements that in our business here will be driven by the cost productivity.

Decisions we've made, and we will be executing over the balance of the year.

I think what we see, what you hear, is hopefully built into our second quarter forecast already.

Great.

Thank you.

You bet.

Your next question is from the line of Matt Sheerin from Stifel, your line is open.

Yes, thanks.

Just a question, Craig, regarding your comments on the industrial markets.

Obviously seeing growth there on new program wins, but it sounds like you saw some softness.

Could you talk about any exposure that you have to the oil and gas markets, and any ripple effects that your customers are seeing in those markets right now in?

Is that part of the softness you are seeing?

Matt, good morning.

We're seeing softness in the industrial business kind of on a spotty basis around a number of customers.

I think you've seen through some of the announcements from the major OEMs a similar impact.

At this point in time, the plan that we see for the balance of the year is based on new program ramps that we have won last year.

We expect to materialize over the course of the balance of this year, and although I don't know exactly how much of our EMS exposure in industrial is related to oil and gas, but we don't have, in my belief, we don't have a significant exposure to oil and gas.

Okay.

Thanks.

And regarding the Honeywell announcement, it sounds like you're taking over employees, but you're not actually acquiring assets or taking over the factory.

Is that right?

We're managing in place the factory in terms of the investment in the business is the inventory that we put in place, and acquiring that talent in Mississauga, but we're not acquiring significant assets as part of this deal, nor are we paying any premium.

Okay.

And could that relationship change where you would actually take over, and actually acquire the assets and the equipment?

Matt, this is Darren here.

We are going to be running that facility, so Honeywell will continue to own those assets, but we will be running the facility.

Okay.

And just lastly, I know you just answered a question on the inventory, and you're guiding up a little bit sequentially, but would you expect to work some of that inventory down?

It sounds like some of that was related to one customer.

Has that worked through the system already, or is there still some work to be done there?

We'd expect to work through that inventory in the second quarter and over the balance of the year.

Okay.

All right.

Thanks a lot.

And, Matt, as we look at growth in the second half, obviously there will be parts where we're building up some inventory for that growth, but the piece that we've mentioned, that definitely will be worked through in the second quarter.

Certainly the Honeywell inventory will be a build that will be reflected in the second quarter, but that will be over the course of the balance of the year that we'll blow through that.

Okay.

Thanks.

You bet.

Thanks, Matt.

Your next question is from the line of Thanos Mustapoulous from BMO Capital Markets.

Your line is open.

Good morning.

On the semi business can you quantify that the loss you experienced at the gross margin levels?

I believe that's a metric you disclosed in the past?

It was just shy of $1 million for the quarter.

So as Craig mentioned, we expect that to, I think this quarter we'll see that flattish to a little bit better and then to positive in the third quarter.

Great.

That's helpful.

As a result of the actions we're taking.

Good.

On the networking segments, can you talk about the demand environment you're seeing there as far as enterprise networking, telecom has been challenging but has the outlook been considerably more positive on the networking front?

Certainly for the second quarter we're positive for the outlook on the networking segment for the enterprise space, we think the biggest risk for us right now is places like Japan, and the carrier space, frankly.

And we have reduced exposure at the ALU.

And we see optimism around some of the recent announcements from some of the carriers, like Verizon, on the being optical build out that we'll participate in through some of our communications customers.

So I think the big numbers you're hearing probably are related to issues on the carrier side with some of the larger scale OEMs in that space, which we tend the not highly concentrated in frankly.

Great.

Thanks.

I'll pass the line.

Your next question is from the line of Jim Suva from Citi.

Your line is open.

Thanks very much, and congratulations on the again capital deployment for stock buyback or repurchase.

Can you talk a little bit about the debate or decision about a stock buyback versus a dividend?

You guys have done several stock buybacks in the past, but you talk about the confidence in cash flow and position, and help us understand the balance between that versus maybe a split of a dividend and stock buyback, and how we should think about your decision versus those two?

Thank you Jim, an excellent question.

As we've said previously, in the prior, primary objective of the Company is long-term growth and profitability and our first priority is reinvesting in the business, and you see that certainly that through the Honeywell, and we're also making investments in the energy space.

The decision around capital deployment, obviously we discussed with the Board, our long-term plan is to balance what we invest in the Company with what we return to shareholders.

I think in this particular case, number one, the near term outlook for the kinds of opportunities that we're looking for is really, we don't have a funnel in the near term.

We do have strong confidence in our cash generation over the balance of the year, and for the next, for the foreseeable future.

We look at things like dividends though, when the Company is structurally really at the next phase of our development, which is where our share of our diversified business is at a level of 40% to 50%.

That is the portfolio reshaping that we're after.

We'll probably be at or slightly above 30% this year.

We want to get another 20 points of diversification.

We want to further invest and grow this segment, the JDM segment within the entire Company, as we mentioned.

And when we get to that point, which let's say, is three to five years from now where you're talking about a Company that's totally highly valued, structurally sound from a balance/risk standpoint, end markets that are not only sticky, but with offerings that are relevant, where disengagements or large scale OEM consolidations don't offer the kind of threat they may today, then I think you're in a position to talk about the dividend strategy.

Until then, I think the strategy that we've embarked on is the best strategy for the shareholder, and frankly for the Company.

Great.

And as a follow-up, things like JDM and push towards diversified has been something that you've been focusing on for a while.

To get to the goals that you laid out, of the percents and things like that of the total Company, can that all be done organically or would you be looking at some select tuck-in acquisitions, again because many of these efforts have been going on for a long and you're making progress, I just don't know if they're getting there fast enough and you need to accelerate getting there?

I'm sure from your perspective it's never fast enough.

From our perspective, we would like it to be faster.

As you know, in these diversified markets, there are certifications, qualifications, and in many cases these customers move much slower, and these programs do not materialize at the scale they do in the IT enterprise space.

That being said, if you look at a $6 billion company with a mix of roughly 70%, or thereabouts 30% today, in terms of IT/enterprise diversified, going to 50/50, maintaining the IT enterprise space flat, enriching the mix of the business with JDM offerings, and moving to a $4 billion diversified segment, at this time, based on what we see over the next three to five years, you would have to use about $1 billion of acquisitions to make that transition, which we think is about the most realistic, but that is all well within our capability.

We have a strong portfolio of growing customers.

We think realistically we can get to maybe a level of $3 billion, but if you look beyond that, I think you're talking about acquisitions.

And finally --

A three to five-year time period.

Right.

And then finally on the Honeywell transaction, I'm not that familiar with the plant or the customer, or what really happens at that site.

It sounds like they're still maintaining the ownership of the facility and you're managing it, or maybe I got that wrong, and is that all the operations of that entire site, or is it just a portion of it and there may be opportunities to kind of expand that relationship there, or how should we think about that?

Well, you should think about it as, frankly, I think it's an industry breakthrough in terms of cooperation between two companies, to take this kind of step.

But what's at the facility.

We're leasing the facility, okay?

So we're not buying the facility.

It's a Honeywell facility.

We're taking over the people.

We're managing the business within that facility.

And then over time we will take over, what I'll call the entire business, where we have the ability to bring other customers into the site, okay?

And that will require an additional step forward in the next integration in the area of IT.

But the message is, that is a facility where we're also co-located with Honeywell employees that continue to work for Honeywell, so yes, there is considerable opportunity to expand the relationship further.

Thank you very much.

And congratulations to you and your team.

Thank you very much, Jim.

Thanks, Jim.

Your next question is from the line of Robert Young from Canaccord Genuity, your line is open.

Hi, good morning.

Just a quick question on the cash balance now.

Even after this buyback, if you're using $75 million in cash, and if I heard $34 million in working capital for the Honeywell expansion, it would seem to me that there's still quite a bit of cash available.

Can you talk about what level of cash you need to keep on the balance sheet for operations and perhaps what would be excess cash inside of, inside of there?

Yes, good morning, Rob.

In terms of our cash balances, we've said in the past it's about 5% of revenue, so it's around $300 million.

And in our balance, we have about $50 million of AR sales, so there's excess of approximately $200 million.

As Craig has highlighted, we're making investments not only in the area of aerospace, but we have some exciting things going on in the energy business as well, where we're moving from really a local Ontario offering to more of a global offering.

So we have expansion occurring there.

We do expect to have negative free cash flow in the second quarter as we make those investments.

And then as I mentioned, we will use $275 million of debt to fund the SIB.

Just a comment, after that we will have still a very, very healthy balance sheet with not a lot of leverage, so to the comments made before, and what we have talked about, we've had an inefficient balance sheet, and we're really this quarter putting that balance sheet to use, both investing in the business and giving back to shareholders.

Okay.

Great.

And just to clarify something you said earlier, before I think it was Craig said that there was the near term outlook there wasn't anything in the funnel in the near term.

Were you talking about tuck-in acquisitions, is that the context you were referring?

Yes, that's it.

The acquisitions.

Then my second question would be around the operating margin profile.

You said that there's a bit of a headwind in the near term from this expansion.

And you also said that you'd expect revenue growth in the year.

How should we think about operating margins as you start to get close to that $1.4 billion quarterly run rate, which I guess you probably have to get there to see growth?

Should we still be thinking about 3.5% operating margin, or is it going to be lower than that in the near term?

Rob, certainly for the second quarter we're at 1.4.

We lowered based on those headwinds of the investments we're making, and a little more investments in JDM as well as in the business, but as we go into the second half, certainly think about, back to that normalized 3.5%, that $1.4 billion.

Okay.

Great.

Thanks.

Thanks.

One more question, please.

The next question is from the line of Naser Iqbal from Salman Partners.

Your line is open.

Thanks and congratulations on the buyback.

Just following up on the semi cap, so if the second quarter impact is at 20 to 30 basis points impact, should we expect that for the balance of the year, that this business will have an earnings positive contribution, or should we think it should be a net neutral contribution?

Good morning, Naser.

The 20 to 30 basis points is just the general investments that we're making to ramp the businesses, aerospace and defense, and energy and a few other areas like industrial as Craig has mentioned, so that was really ignoring the semiconductor performance.

Semiconductor has been consistent Q4 to Q1, but as we improve that, you will certainly start seeing the benefit of those improvements in our operating margin.

I think you should think of that happening, not overnight.

We do expect to see improvements into Q3 and Q4, and you can model that accordingly.

Right.

Yes.

Actually, I think I missed the two of them.

But in terms of the Honeywell business itself, again, is it that the expectations are that there's going to be a top line growth, but will there also be an earnings contributor?

It certainly will be, when you think not for the second quarter and even in the third quarter, it will be flattish, and by fourth quarter we would be starting to generate some profit out of that business.

Thank you guys, everyone for joining, sorry we have to call a little bit short as we head to our meeting for shareholders.

We'll be available for follow on calls throughout today.

And again, thanks everyone for joining.

Thank you.

This concludes today's conference call.

You may now disconnect.