Celestica Inc (CLS) 2015 Q3 法說會逐字稿

Good afternoon.

My name is Mike, and I will be your conference operator today.

At this time, I would like to welcome everyone to the Celestica third-quarter 2015 earnings conference call.

(Operator Instructions)

I will now turn the call over to Jim Fitzpatrick, Vice President, Communications and Investor Relations.

You may begin your conference.

Thanks, Mike.

Good afternoon, and thank you for joining us on Celestica's third quarter of 2015 earnings conference call.

On the call today are Rob Mionis, President and Chief Executive Officer; and Darren Myers, Chief Financial Officer.

This call will last approximately 45 minutes.

Darren and Rob will provide some brief comments on the quarter, and then we'll open up the call for questions.

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

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

As well, please visit www.Celestica.com to view the supporting slides accompanying this webcast.

As a reminder, during this call, we make forward-looking statements related to our plans for future growth, trends in our industry, 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 such forward-looking statements are based.

These filings include our annual report on the Form 20-F filed with and subsequent reports 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 earnings or adjusted EBIAT.

Adjusted operating margin, adjusted net earnings, adjusted EPS, return on invested capital or ROIC, inventory turns, cash cycle days, free cash flow, adjusted tax rate and adjusted tax expense.

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 exists.

Unless otherwise specified, all references to dollars on this call are to US dollars.

And I will now turn the call over to Darren Myers.

Thank you, Jim, and good afternoon, everyone.

Celestica delivered sequentially higher operating margin and return on invested capital in the third quarter, despite a challenging end market environment.

Revenue of $1.41 billion was at the lower end of our guidance range, driven by weaker-than-expected demand, as well as the slower-than-expected ramp of our solar business in Asia.

Third-quarter revenue decreased 1% sequentially and year over year.

Some highlights for the third quarter include: adjusted operating margin of 3.8% improved 40 basis points sequentially.

Adjusted earnings per share was $0.22.

Our adjusted earnings per share was $0.30 excluding an $0.08 per share income tax expense resulting from taxable foreign exchange.

Excluding this tax impact, adjusted earnings per share was just below the midpoint of our guidance.

IFRS net earnings for the quarter were $11 million or $0.08 per share.

We generated $13 million of free cash flow for the quarter, and we achieved ROIC of 20.9%.

Looking at our revenue from an end market perspective, our communications end market represented 41% of total revenue for the quarter.

Communications revenue increased 2% sequentially and 2% year over year, as expected.

Our diversified end markets comprise 30% of our total revenue for the quarter.

Diversified revenue increased 7% sequentially, driven primarily by new program wins in our energy, and aerospace and defense businesses.

Despite our growth, diversified revenue for the quarter was lower than expected due to weaker overall demand, as well as a slower than expected ramp of our solar business in Asia.

Compared with the third quarter of 2014, diversified revenue increased 2%, largely due to the program wins, which was offset in part by the transition of our solar business.

Let me provide some additional context about our solar business.

On our April earnings call, we highlighted our plan to transition some of the supply chain and manufacturing capacity and resources for our energy business from North America to Asia as part of the global expansion of our energy offering.

This expansion into Asia, which includes transitioning existing equipment as well as expanding our capacity, began in the second quarter of 2015.

We experienced some delays in the equipment installation and are working diligently to ramp our operations and fulfill current demand.

We expect to grow the energy business in the fourth quarter, and plan to complete the majority of the expansion by the first quarter 2016.

Moving to our storage end market.

Storage revenue represented 18% of our business in the third quarter.

Sequentially, storage revenue declined 9%, which was more than expected, due to seasonality and lower demand.

Compared to the third quarter of 2014, our storage business was largely flat.

Our server end market represented 8% of our revenue in the third quarter.

Server revenue was down 13% sequentially, a higher-than-expected decline, primarily due to the delay of a customer's product launch.

Compared to the third quarter of 2014, server revenue declined 9%, largely due to softer demand.

And finally, our consumer end market, representing 3% of total third-quarter revenue, declined 32% compared with the third quarter of 2014, largely due to our continued de-emphasis of certain lower margin business in our consumer portfolio.

Our top 10 customers represented 68% of revenue for the third quarter, consistent with the second quarter, and up from 65% in the third quarter of 2014.

For the third quarter, we had two customers individually contributing greater than 10% of total revenue, down from three customers in the second quarter.

Moving on to some of the other financial highlights for the quarter.

Adjusted gross margin of 7.5% improved 40 basis points sequentially, in part due to improvements in our semiconductor business.

Year over year, our gross margin was relatively flat.

We continue to focus on optimizing our business and driving productivity.

We recorded $12 million of restructuring charges in the quarter, which was at the high end of the $8 million to $12 million outlook that we provided on our last earnings call.

Our adjusted operating earnings for the quarter was $53 million or 3.8% of revenue, an increase of 40 basis point sequentially.

Adjusted SG&A expense for the quarter was approximately $47 million, largely flat sequentially and compared to the third quarter of 2014.

Adjusted net earnings for the third quarter were $31.4 million or $0.22.

Excluding the $0.08 per share of income tax mentioned earlier, adjusted net earnings for the quarter was $43.7 million or $0.30 per share compared to $47.2 million or $0.26 per share for the same period of 2014.

Let me provide some further insight with respect to our tax expense in the quarter.

Our adjusted tax rate in the third quarter was 38.5%, above our previously expected annual tax rate range of 11% to 13%.

Taxes were higher than expected, primarily due to taxable foreign exchange impacts in Malaysia and China.

During the quarter, relative to the US dollar, the Malaysia currency declined in value by 18%, while the Chinese currency declined by 4%.

The total currency impact represented approximately $12 million of the $19.5 million of tax expense recorded in the quarter.

Third-quarter IFRS net earnings were $11 million or $0.08 per share compared to $34 million or $0.19 per share in the same period of 2014.

The year-over-year reduction is largely attributable to the higher-than-expected tax expense, as well as the higher restructuring charges this quarter compared to the prior period.

Return on invested capital was 20.9%, up from 19.6% last quarter.

Turning to working capital performance.

Our inventory increased $31 million from the second quarter to $849 million at September 30.

The increases in the inventory were largely due to late-quarter demand changes, as well as inventory to support the ramping of our energy business in Asia.

Inventory turns for the quarter were 6.3, down from 6.7 last quarter and 6.8 in the third quarter of 2014.

Capital expenditures for the third quarter were $15.6 million or 1.1% of revenue, within our estimated range of 1% to 1.5% of revenue.

Cash cycle for the third quarter was 46 days compared to 42 days in the second quarter of 2015, driven primarily by increased inventory.

For the third quarter of 2015, we generated $13 million of positive free cash flow compared to $93 million for the same period last year.

The year-over-year decline was driven by strong free cash flow generation in the third quarter of 2014, as well as increased inventory in the third quarter of 2015.

Our balance sheet continues to be strong.

Our cash balance was relatively flat sequentially, with $496 million of cash at the end of the third quarter.

Our net cash position at September 30 is $227 million, which includes $496 million of cash, $244 million drawn on our term loan and $25 million drawn on our revolving credit facility.

At the end of the third quarter, we had 143 million subordinate and multiple voting shares outstanding.

Moving forward to our guidance for the fourth quarter of 2015.

For the fourth quarter, we are projecting revenue to be in the range of $1.375 billion to $1.475 billion.

At the midpoint of our guidance, fourth-quarter revenue is projected to increase 1% sequentially, and to be flat year over year.

At the midpoint of our guidance, we anticipate non-IFRS adjusted operating margin of approximately 3.7%.

Fourth-quarter adjusted earnings are expected to range from $0.27 to $0.33 per share.

Our non-IFRS SG&A expense for the fourth quarter is projected to be in the range of $47 million to $49 million.

Our fourth-quarter adjusted tax rate range is estimated to be 14% to 16%.

I would now like to turn the call over to Rob for some opening remarks and additional comments on the quarter, as well as on our fourth-quarter outlook.

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

First, I would like to thank the entire Celestica team for their dedication and effort in the third quarter in supporting Celestica and our customers.

Along with this being my first quarterly earnings call, I want to acknowledge the outstanding leadership that Craig Muhlhauser has provided the Company over the past nine-plus years through his dedication and commitment to our employees, customers, suppliers, shareholder and analyst communities.

Craig's support and friendship during the transition period is also very much appreciated.

Since assuming the role of CEO in August, my main priority over the first two-plus months has been to gain a deeper perspective on the Company from both the inside and outside by meeting a number of customers, employees, suppliers and other key stakeholders, in order to learn more about the challenges and opportunities in front of us.

In speaking to a number of our customers over the last several weeks, the consistent themes I'm hearing from them about why they like doing business with Celestica include our integrity, our unique customer engagement model, our focus on innovation, our expertise and high complexity and high reliability.

And the Company's strong execution engine, which is validated by the fact today that we are ranked number one or number two on 90% of our customers' supplier performance scorecards.

Based on the caliber of the Celestica team, our reputation for operational excellence, our strong list of customers, I'm excited about the opportunity to lead the Company to the next phase of our evolution.

In the near term, we will continue to be focused on driving profitable growth in our targeted business areas, expanding our revenue base of higher value-added services, continuing our solid track record of operational execution, and exercising disciplined cost and cash management.

As well, over the next number of months, we are completing an assessment of the Company's capabilities and go-to-market strategies for all of our lines of business.

We expect to have the early phases of this exercise completed in the second quarter of 2016.

Now let me comment on our third-quarter results and fourth-quarter outlook.

Celestica delivered sequential improvements in operating margin and return on invested capital in the third quarter, despite a relatively challenging end market environment.

Revenue was at the lower end of our guidance, was driven primarily by weak end market demand, as well as a slower-than-expected ramp of our solar business in Asia.

Darren provided additional perspective earlier in the call about the transition we are making within our solar business.

While we are working through the transition, we are pleased with the healthy demand from a number of our energy customers, and we're optimistic about our ability to grow our energy business.

Celestica continued its track record of industry recognition in the third quarter, as we were the proud recipient of Cisco's EMS Partner of the Year Award for the second consecutive year, and the fourth time in six years.

The award recognizes Celestica for demonstrating outstanding operational performance in all areas measured within Cisco's EMS scorecard process, and for showing strong support in conjunction with all supply chain operations, programs and initiatives.

Let's move on to the fourth-quarter outlook.

Our communications end market is expected to decline in the low single-digits sequentially, due to overall weaker demand.

On a year-over-year basis, we expect communications revenue to be flat.

Relative to our diversified market business, we are expecting revenue to be relatively flat, driven by the strength in our energy business, primarily offset with some anticipated weaknesses in semiconductor demand.

On a year-over-year basis, we expect diversified end market increase to be in the low double digits, driven primarily by new program ramps in aerospace and energy.

Our storage revenue in the fourth quarter is projected to increase in the low double-digits, primarily due to seasonality.

On a year-over-year basis, storage is expected to decline in the high single-digits, driven by softer demand.

Our server end market is expecting a high single-digit sequential increase in the fourth quarter, based on seasonality and a new program ramp.

On a year-over-year basis, server revenue is expected to decline in the mid single-digits, due to demand softness.

And finally, for our consumer end market, we are expecting revenue to be relatively flat sequentially.

In summary, while we are expecting sequential revenue growth in some of our end markets, the overall demand environment across our business is mixed.

Although the markets have been challenging, we have delivered sequential operating margin and return on invested capital improvements throughout the course of the year, which is a testament to our ongoing focus on operational excellence and financial discipline.

This Company is very well-positioned for growth, and I'm excited about the opportunities in front of us.

We are focused on accelerating new business wins and revenue realization both in current and new customers, while continuing to drive continuous improvement in the areas of quality, profitability and free cash flow generation.

That concludes our prepared remarks.

Mike, please open the line for questions.

(Operator Instructions)

Amit Daryanani, RBC Capital Markets.

Thanks, good afternoon.

Two questions.

One, Darren, could you just talk about the free cash flow dynamics for the last two quarters?

Combined free cash flow has been about $15 million.

This quarter, it seems like inventory was the driver that spiked up.

What's going on with free cash flow?

Why has it been depressed for the last six months, and how do you think it shakes out in the December quarter?

Good afternoon, Amit.

Free cash flow certainly has been a little bit of a challenge, starting with this quarter.

The late demand changes certainly have impacted our inventory balance.

That's a little higher than we would have expected.

But we will work our way through that and get some improvement into the fourth quarter.

The other thing just to highlight again: we've spent about $50 million with investments between aerospace and defense, and in solar, mostly in the second quarter, really in the second quarter.

So from a full-year perspective, that certainly impacted us this year.

We're still holding out for achieving our $100 million of free cash flow for the year.

It's going to require a lot of good things to happen in the fourth quarter, require about $65 million of free cash flow.

But we're working towards that, and we'll make as much progress as we can.

Got it, thank you.

And Rob, in your initial comments, you talked about conducting a more thorough assessment of the Company's capability to go forward.

I'm curious.

What results do you anticipate in a few months when you're done with this?

Do we rethink the revenue trajectory of the Company or the end markets we are participating in?

Are there capital allocations?

I'm just trying to get a sense in what's the end result of this assessment, and what vectors are you looking at, at the end of this?

Amit, thanks for the question.

As a little bit of a backdrop, I've admired Celestica from the outside for quite a bit when I was leading the operations at Honeywell.

And it was known for its integrity and customer service model and operational excellence engine.

The purpose of the strategy refresh that we are doing is, overall, we feel the strategy of the Company is directionally correct.

We're just taking a deeper dive into the specifics around that, and try to figure out how we accelerate the strategy along those lines and get more traction on creative growth moving forward.

Perfect.

Thank you, and congratulations, Rob.

Thank you very much, Amit.

Thanos Moschopoulos, BMO Capital Markets.

Hi, good afternoon.

Starting off with the gross margins, they were about flat year over year, despite what on the surface seems a slightly better revenue mix.

Can you remind us some of the near-term headwinds on margins?

You mentioned solar.

I imagine there's still a bit of a drag still from the ramp of the Honeywell project.

Anything else going on?

Hi, Thanos; Darren here.

In terms of our margins, I would say, overall, we are pleased.

If you look at what we've done this year, we've gone from a 3.1% operating margin in the first quarter to 3.4% in the second, to 3.8% in the third.

And at the mid-sevens in gross profit, that's a relatively good level.

There's always things going on.

And you're right, in terms of solar; that is impacting us on the negative side, in terms of the gross margin.

I'm pleased with the progress we've made with aerospace and defense second quarter, third quarter, and semiconductor.

There's always lots of mix factors to this.

For the fourth quarter, I would expect it to be in similar levels than it is to the third quarter.

Okay.

And Rob, you commented on some of Celestica's strengths.

Just given your experience in the industries you've worked in, what would you say are some of the challenges that need to be overcome in order to get customers more comfortable with outsourcing to a Company like Celestica?

What can Celestica do to help address those issues?

Good question.

Thank you, Thanos.

Celestica excels in the higher liability, high-complexity market.

And one of the glaring strengths of the Company is our aerospace practice.

And frankly, I just think we need more feet on the ground to promote our very strong message to a broader set of customers.

As you know, outsourcing is very young in that space.

So it's really convincing folks it's the right thing to do and that we can add value.

And then secondly, really demonstrate our world-class capability in those markets, and try to speed up the rate of outsourcing and adoption of a model that is very prevalent in the other side of our Business.

And Thanos, what I would add is, with Rob, and certainly, Jack -- which you will see an announcement on -- that we announced, that the deeper relationships in areas like aerospace and defense certainly will go a longer way for making those customers get through those decisions to outsource faster.

Great.

Thanks, and congratulations on your new role, Rob.

Thank you, Thanos.

Robert Young, Canaccord Genuity.

Good evening.

Hi, Rob.

The first question I'd like to ask is about the semicap business.

Can we assume that it was gross margin positive in the quarter?

You said that you're pleased with the improvement there.

If you could give us a little more color on the status there and where it's going to go over the next couple of quarters?

Yes, Robert, we were gross margin and EBIAT positive for the quarter, and the team has really done a phenomenal job of resizing that business to make it a profitable business.

Moving forward, as we mentioned earlier, we do see some headwinds.

But the operational excellence is alive and well, and we think we're in a good position to weather any down cycles that we might see in the coming couple of quarters.

Unfortunately, Rob, we don't always get a chance to celebrate for too long.

But it's been a pretty long journey, and the team has done a great job of turning it around and being in the black.

But as Rob says, a little bit of headwinds.

Some of the forecasts say that will improve in the first quarter next year, but we will wait and see.

Okay.

And then Thanos mentioned the Honeywell deal.

Could you give us an update on where that is, that managed-in-place deal here in Mississauga?

Is that fully ramping?

Was the quarter-over-quarter increase in the diversified space -- is there anything we can read into -- by that ramp-up?

Yes, we've seen now the full quarter, Rob, so we had a pretty good quarter in the second quarter, as it closed to the middle of April.

So now we've got the full quarter.

We are seeing a nice pick-up there.

But the base business, I would say, in aerospace and defense, is a little bit soft.

That is a little headwind, as well as in industrial.

But overall, we still had good sequential growth, a little bit of year-over-year growth, despite the solar transition.

And that should all improve in the fourth quarter, and, hopefully beyond that.

I would also add, we just had a recent executive review with the Honeywell team, and they're quite pleased with the progress to date, and the seamless way the transition was handled.

Okay, that's great.

Thanks.

Thanks, Rob.

Todd Coupland, CIBC.

Good evening, everyone.

Hi, Todd.

I'll ask a couple of top-line questions, if I could.

Firstly, on the solar transition.

Approximately how much revenue would you have left unshipped in the quarter?

I don't know if we're going to answer that one today, Todd.

It was one of the -- it's part of the reason we're at the lower end.

Maybe think it's a third to little over a third of it.

I guess I am answering it.

A third from the midpoint?

Yes.

Second question.

Flex talked about a pretty strong networking segment last night.

You're up 2%, but calling it to be down in the fourth quarter.

Are there any share shifts going on there?

No, just the regular dynamics you see.

Account by account, everyone's programs are happening at different pace.

We been winning business with our existing customers, and so I think it's just more the ebbs and flows of programs.

That market overall, the com space, is still a challenging end market, though.

I cannot comment on our competitors, but certainly that's a challenging space, I would say, overall.

Certainly that was the commentary.

But new programs were highlighted as the driver for growth in spite of weak end markets.

Okay.

And then if I could just step back from the details of Q4, as you think about 2016 and your book of business, is there an opportunity to break out of this plus or minus 1% revenue in any given quarter?

Or do you need a material change in end markets to actually drive it?

Well, let me try that.

When you look at what we've done this year with portfolio management and the large drops that you saw in consumer, and those headwinds, we are now -- as you mentioned, we're in that flat to up, or maybe down a little bit.

So I think we are much better-positioned for growth.

We have new programs -- as an example, solar and other wins that we've had in the business.

But without knowing what the end markets are going to do, it's hard for us to say with confidence what growth will look like next year.

We're certainly targeting growth, but the end markets are going to have to behave, to some extent.

Okay, that's great.

Thanks very much, gentlemen.

Appreciate it.

Thanks, Todd.

Jim Suva, Citi.

Hi, this is Tim Young on behalf of Jim Suva.

Thanks for taking the question.

My question is on customer concentration.

There were two customers above 10% of revenue versus three customers last quarter.

Can you talk about which segment is that customer went from above 10% of revenue to below 10% of revenue?

Is it -- which segment?

And then, is it due to ramping issue from the customer?

Or do you think the customer will no longer be above 10% revenue going forward?

Thanks.

Hi, Tim.

We had two customers -- as you mentioned, last quarter it was three.

The third customer is close to 10% this quarter, just not -- doesn't happen to be over 10%.

And they would generally be in the communications enterprise space.

Got you.

And just a temporary basis maybe.

We'll be back to about 10% on (multiple speakers).

Yes, it will clearly depend on the ebbs and flows of the business and how everyone performs.

The good news is, we're winning with our top customers.

As Rob mentioned, we're ranked well with our top customers.

We just got -- the Cisco award is another example of the acknowledgement that we're getting from our top customers.

We're pleased that we continue to win business with our very good customers that we have.

Got it, thanks.

(Operator Instructions)

Gabriel Leon, Beacon Securities.

Thanks a lot.

I just have two questions.

First, Darren, on the tax rate, for 2016, how should we think about the adjusted tax rate range?

Should we still consider 11% to 13%?

Or is that really going to be a function of how ForEx plays out next year?

Hi, Gabriel.

I'm not proposing I know how to predict ForEx.

So when that -- generally, we've never seen a movement this big, so it's just something that gets absorbed in the rate.

I would say that the -- we're not giving guidance to next year, but there's probably more pressure to the rate -- not material pressure, but some pressure to the rate, probably more closer to what we are guiding for the fourth quarter, I would say, is more appropriate.

The other thing, just for the benefit of everybody -- when you look at the adjustment we had under IFRS, it's a little bit different.

It includes both -- the way this works is, when you revalue the assets in the local books and you have US assets, they become worth more, and so in essence, is a gain.

For US GAAP, that gain would be more on a realized basis.

But IFRS also has a deferred factor to that.

So under IFRS, we have stuff on the balance sheet today that also attracted an adjustment.

That's great, thanks.

And for my second question, for Rob, I'm sure this will come out post your strategic review.

But I'm wondering if I can get your early thoughts on how you think M&A will fit into Celestica's growth profile over the course of the coming year?

What are you seeing out there?

Do think this is the right time for you guys to be augmenting your organic growth with M&A?

Hi, Gabriel.

I think M&A is an essential part of any growth strategy, and we will certainly look to pull that lever as time goes forward.

But we're going to be very selective and make sure we are very disciplined in our selection process, and make sure that we offer true synergies, and to fill any capability gaps that we're looking to help progress accretive growth moving forward.

That's great, thanks a lot.

Thanks, Gabriel.

There are no further questions at this time.

I'll turn the call back over to the presenters.

Thank you, Mike.

I'd like to thank everybody on the call.

I'm looking forward to leading Celestica over the next good clip of time.

Thank you for your support, and look forward to meeting this community in the very near future.

Thank you.

This concludes today's conference call.

You may now disconnect.