Celestica Inc (CLS) 2018 Q1 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to Celestica First Quarter 2018 Financial Results Conference Call.

(Operator Instructions)

I would now like to turn the meeting over to one of your hosts for today's call, Paul Carpino, Vice President Investor Relations.

Please go ahead.

Good morning, and thank you for joining us on Celestica's First Quarter 2018 Earnings Conference Call.

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

This conference call will last approximately 45 minutes.

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

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

As a preliminary note, as described in our press release issued earlier this morning, during the first quarter of 2018, we reorganized our business into 2 operating and reportable segments.

Advanced Technology Solutions, or ATS, consisting of our ATS end markets, and Connectivity & Cloud Solutions, or CCS, consisting of our communications and enterprise end markets.

Management's remarks on this call correspond to this new segment structure.

Segment performance is evaluated based on segment revenue, segment income and segment margin, each of which are defined and described in this morning's press release.

Please visit celestica.com to view the supporting slides and accompanying webcast.

Also of note, our Annual Shareholder Meeting will be held this morning at 9:30 a.m.

and the accompanying webcast can also be heard at celestica.com.

As a reminder, during this call, we will make forward-looking statements within the meanings of the U.S. Private Securities Litigation Reform Act of 1995 and applicable Canadian securities laws, including those related to: our strategies and plans for future growth; priorities, trends in our industry, end markets and segments; our anticipated financial and operational results and performance; non-IFRS operating margin goals and financial guidance.

Such forward-looking statements are based on management's current expectations, forecasts and assumptions, which are subject to risks, uncertainties and other factors that could cause actual outcomes and results to differ materially from conclusions, forecasts or projections expressed in such statements.

For identification and discussion of such factors and the material assumptions on which such forward-looking statements are based as well as further information concerning financial guidance, please refer to the company's various public filings.

These include our most recent MD&A and annual report on Form 20-F, including the Risk Factors section therein, filed with and in reports on Form 6-K furnished to the U.S. Securities and Exchange Commission and, as applicable, the Canadian Securities Administrators.

Please also refer to our cautionary statements regarding forward-looking information in such filings and in today's press release.

Our public filings can be accessed at sec.gov and sedar.com.

We assume no obligation to update any forward-looking statement, except as required by applicable law.

During this call, we will also refer to certain non-IFRS measures, which include: adjusted gross margin; adjusted SG&A; non-IFRS operating earnings; non-IFRS operating margin, which is non-IFRS operating earnings as a percentage of revenue; adjusted net earnings and adjusted EPS; free cash flow; adjusted return on invested capital, or adjusted ROIC; adjusted effective tax rate; inventory turns; and cash cycle days.

These non-IFRS measures do not have any standardized meaning under IFRS and may not be comparable with other non-U.

S. GAAP or non-IFRS financial measures presented by other issuers.

We refer you to today's press release, which is available at celestica.com, under the Investor Relations tab, for more information about these and certain other non-IFRS measures, including a reconciliation of historical non-IFRS measures to the most directly comparable IFRS measures from our financial statements.

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

I will now turn the call over to Rob.

Thanks, Paul, and good morning.

Despite continued volatility in our CCS segment, Celestica delivered on Q1 non-IFRS operating margin and revenue guidance, driven by strong results in ATS.

We reported record revenue in ATS of $533 million, up 8% from Q4 of last year and up 4% sequentially.

This growth was primarily led by strength in our aerospace and defense end markets as well as our semiconductor end market.

Additionally, not only did ATS achieve record revenue growth, but the segment has now grown year-to-year for 11 straight quarters, excluding the impact of exiting our former solar panel business.

Importantly, as highlighted in our new segment disclosure release today, our growth in ATS is accompanied by a strong and stable margin profile.

Year-over-year, segment operating margins in ATS for Q1 were up 50 basis points to 5.2%.

In comparison, CCS segment income was down 44% or 130 basis points on a year-over-year basis.

This meaningful growth in ATS segment income highlights one of the key value drivers of our transformation and represents what we believe to be a key turning point for our company.

Uniquely, our total segment income this quarter now reflects the opposite split of our total revenue mix.

In Q1, ATS contributed 36% of total company revenue and 62% of total segment income compared to CCS, which contributed 64% of total revenue and 38% of total segment income.

Importantly, this financial mix shift should help stabilize our overall results from the volatility we're seeing in our CCS end markets.

Although we are still working to diversify our overall revenue, we are now meeting a key objective of our transformational strategy: focus on driving more than half of our segment income from ATS.

With ATS now contributing greater than 50% of our total segment income, we are excited that this transformation put Celestica well underway as it redefines itself as a broad-based industrial technology services and supply chain company.

Clearly, our ATS investments over the past 2 years are starting to demonstrate their intended benefits.

These benefits include delivering a more stable margin base for our overall consolidated results, providing both revenue and margin diversification and driving overall revenue growth.

To build on this ATS momentum, we plan to continue to invest in this segment organically and through acquisitions.

A good example of executing on our strategy is our Atrenne acquisition, which closed earlier this month and whose financial results and operational performance will start being reflected in our Q2 results.

As you recall, Atrenne is a leading designer and manufacturer of ruggedized electromechanical solutions serving primarily military and commercial aerospace applications.

We anticipate that this acquisition will add over $80 million per year in revenue to our ATS segment.

Atrenne enhances our established industry-leading A&D platform, with their capabilities in design and engineering, backplane and connector manufacturing and ruggedized chassis enclosures for air and land A&D applications.

These key capabilities, combined with their solid track record of servicing global leaders in commercial aerospace and defense, aligns well with our strategy and leadership position in this end market.

Moving to CCS.

In Q1, we continued to see the volatility in this segment that we first highlighted in the second half of last year.

By the very nature of its end markets, CCS is more volatile than ATS.

However, we believe that we have significant experience in effectively managing this volatility.

Overall, CCS revenue was down 2% on a year-over-year basis, but in line with our Q1 target range.

Within this segment, our communications revenue was down 7% compared to a very strong first quarter of last year.

Offsetting this decline was our enterprise end market revenue, which was up 6%, driven by stronger storage sales.

With our expanded disclosure, you can clearly see the margin pressure in CCS over the past year associated with program volatility, pricing pressure and unfavorable mix change.

In CCS, our segment margins dropped from 3.0% to 1.7% on a year-over-year basis.

We expect these margins to show steady improvement throughout 2018, as we implement our restructuring and other productivity initiatives.

While we achieved our overall company revenue and non-IFRS operating margin targets, working capital and free cash flow remain under pressure, as customer inventory continues to increase in both our ATS and CCS segments.

We are currently in the midst of one of the tightest component markets in recent memory.

Electronic component demand has rapidly increased, driven by significant deployment of digital technology in the automotive industry and the growth in IoT.

The demand for materials gets -- continues to accelerate.

Supply capacity has not kept pace with this demand and lead times have increased dramatically.

This has resulted in material shortages, inventory buffering across the OEM and customer demand churn.

By way of example, the impact of this environment was evident in Q1, where inventory increased sequentially by more than $100 million, while revenue declined by $71 million.

Even more significantly, year-over-year first quarter revenue was higher by $18 million, but inventory grew by $192 million over the same time period.

We expect this constrained inventory environment to continue throughout 2018.

However, we have strong customer relationships and significant experience working with them through these types of environments.

We are also working on various supply-based cash cycle initiatives.

In this environment, maintaining a strong cash position is essential, and Celestica's balance sheet remains one of the strongest in the industry.

Despite the cash impact associated with its elevated inventory levels, Celestica has been able to remain active with its stock buyback program.

During the first quarter, we repurchased and canceled 3.3 million subordinate voting shares for $35 million under our normal course issuer bid.

Since announcing our NCIB program last November, we have now completed over $55 million of this program and have canceled 5.2 million shares.

This program continues until the end of November, and we intend to continue buying back shares between now and then.

Thoughtful capital allocation and maintaining a strong balance sheet are essential to drive value for our customers and shareholders.

As I have stated in the past, this management team will continue to be balanced and strong stewards of our capital.

As we continue to move through our transformation, our priorities for capital remain focused on pursuing targeted and on-strategy acquisitions to further enhance the company's margin profile; drive scale and capabilities in key end markets and expand our customer base; returning capital to our shareholders through share buybacks; and finally, investing to expand our network capabilities through targeted CapEx initiatives and investing in cost management programs to accelerate our productivity.

As we plan for the remainder of 2018, we expect our CCS markets will continue to be dynamic.

However, as reflected in our Q2 outlook, we expect to see further overall revenue growth and non-IFRS margin expansion in Q2, including improvements in our CCS segment margins.

Importantly, our Q2 revenue growth outlook reflects continued momentum in ATS.

We are targeting a mid-teens growth rate in Q2, even before any contribution from Atrenne.

In summary, we are delivering on a strategy we put in place over 2 years ago and are committed to delivering additional margin, mix and revenue improvements throughout 2018 and beyond.

We have positioned ourselves well in ATS, with a good mix of customers and growing capabilities.

We believe there continues to be an excellent opportunity to capitalize on the growth dynamics and outsourcing trends of customers in this segment.

In CCS, we have more work to do.

But with the world's best OEMs of customers and the very talented and experienced team members of Celestica, we believe we can make the necessary improvements to reduce cost for our customers and improve profitability in this segment's result.

Let me close by thanking our global team, who, against the backdrop of significant volatility and the implementation of a meaningful transformation strategy, continue to strive to deliver results for our customers and shareholders alike.

Thank you for joining us.

And now, let me turn the call over to Mandeep for additional details.

Thank you, Rob, and good morning, everyone.

First quarter revenue of $1.5 billion was above the midpoint of our guidance range and up 1% year-over-year.

Non-IFRS operating margin was 3.0%, in line with the midpoint of our guidance range.

Adjusted earnings per share was $0.24, $0.01 above the midpoint of our guidance range, and we achieved adjusted ROIC of 14.4%.

As a reminder, we have adopted IFRS 15 beginning in the first quarter of 2018, and we'll provide restated comparatives each quarter.

Additionally, as we announced last quarter, we are now disclosing segment revenue and segment income for 2 reportable segments, ATS and CCS.

This will provide additional insight as we continue to move through our transformational strategy.

Let's start with our ATS segment.

Growth in Advanced Technology Solutions has contributed significantly to the company's overall growth and has helped mitigate the impact of the adverse market conditions in our CCS segment.

ATS revenue for the quarter was 36% of total revenue and was up 8% on a year-over-year basis, largely driven by new program revenue in aerospace and defense and strong demand in semiconductor capital equipment.

Strong semi demand also contributed to ATS achieving 4% sequential growth.

For the first quarter of 2018, segment income for ATS was $27.9 million and segment margin was 5.2%, up 50 basis points from the first quarter of 2017.

This is the first time in the company's history that our ATS business has operated at this level.

This margin improvement was largely driven by improved mix and scale benefit from higher revenue.

The CCS segment, which is communications and enterprise combined, accounted for 64% of total revenue for the first quarter of 2018.

CCS segment income was $16.8 million, translating to a margin of 1.7%.

This compares to 3.0% for the first quarter of 2017.

The decline in CCS margin reflects the pricing competitiveness in this segment and the margin headwinds we faced, including shifts in revenue mix.

However, as Rob noted and as we have reflected in our Q2 outlook, we anticipate improvements in this segment as we complete our productivity and restructuring initiatives.

Within our CCS segment, the communications end market represents 39% of our consolidated revenue in the first quarter.

Revenue from this market was down 8% sequentially due to demand softness and seasonality.

Communication revenue was down 7% year-over-year compared to a very strong first quarter of 2017, on softer demand, partially offset by new program revenue, including in JDM.

In our enterprise end market, revenue decreased 10% sequentially mainly due to seasonality, but increased 6% on a year-over-year basis due to stronger demand in storage.

Revenue from our enterprise end market represented 25% of total revenue.

Our top 10 customers represented 71% of revenue for the first quarter, a decrease of 2% from the fourth quarter of 2017 and up 1% from 1 year ago.

For the first quarter, we had 2 customers individually contributing greater than 10% of total revenue.

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

From an IFRS perspective, net earnings for the quarter were $14.1 million or $0.10 per share compared to $22.5 million or $0.16 per share in the first quarter of 2017.

Lower IFRS net earnings were driven by lower gross margin and higher other charges, including higher restructuring and acquisition costs.

Restructuring charges were $6.9 million this quarter.

As we outlined last quarter, we launched an enterprise-wide productivity program to identify cost reduction opportunities in our network to increase operational efficiency and productivity.

These actions enable us to respond to the volatility in our CCS market, including pricing volatility.

We anticipate that we will incur an aggregate of between $50 million to $75 million in restructuring charges in connection with this program and expect it to run through the middle of 2019.

So far, we have incurred approximately $15 million of charges.

Adjusted gross margin of 6.6% was down 10 basis points sequentially, primarily due to lower revenue.

On a year-over-year basis, gross margin was down 70 basis points due to mix and pricing pressure in CCS.

Our adjusted SG&A was $47 million, within our range of $45 million to $47 million for the quarter and similar to the same period last year.

Non-IFRS operating earnings were $44.7 million or 3.0% of revenue, which was at the midpoint implied in our revenue and EPS guidance range for Q1.

This was down $5.2 million sequentially and down $8.5 million relative to the same period last year.

Our adjusted effective tax rate for the first quarter was 18%, within our annual expected range of 17% to 19%.

Adjusted net earnings for the first quarter were $33.9 million.

Adjusted earnings per share of $0.24 represents a decline of $0.05 year-over-year.

Adjusted ROIC of 14.4% was down 2% sequentially and approximately 5% year-over-year, primarily affected by lower profitability and higher inventory.

Moving on to working capital.

IFRS 15 has changed the timing of our revenue recognition for a significant portion of our business from point in time to over time, resulting in revenue for certain contracts being recognized earlier than under the previous recognition rules.

However, the overall impact of this change was immaterial and was reflected in the Q1 outlook we originally provided.

The new IFRS standard also shifts dollar balances between inventory and accounts receivables, whereby accounts receivable dollars increase and inventory dollars decrease.

Important to note, these changes do not affect the company's cash flow.

Under IFRS 15, our inventory increased by $105 million from December 31, 2017, to $929 million at the end of March.

The increase in inventory in the first quarter was driven by continuing high levels of demand volatility, late-period demand reduction, material constraints and investments in new programs.

Inventory turns for the first quarter were 6.4, a decline from 7.2 turns in the fourth quarter of 2017, and a decline from 7.8 turns in the first quarter of 2017.

Capital expenditures for the first quarter were $17 million or 1.1% of revenue.

Cash used in operating activities for the quarter was $5 million compared to cash flow from operations of $36 million in the prior year period.

Driven primarily by elevated levels of inventory, free cash flow was negative $34 million compared to positive free cash flow of $14 million for the same period last year.

As Rob noted, we purchased and canceled 3.3 million subordinate voting shares under our normal course issuer bid program during the first quarter for approximately $35 million.

This reduced our outstanding shares by 2.3%.

In total, we have bought and canceled 5.2 million shares since the commencement of this program.

At March 31, 2018, we had approximately 139.6 million shares outstanding.

Moving on to our balance sheet.

Our balance sheet remains strong and continues to demonstrate to our customers our ability to invest and grow with them, while allowing us to pursue targeted acquisitions while also returning capital to shareholders.

Our cash balance at quarter-end was $436 million, down $79 million sequentially and down $122 million year-over-year.

During the quarter, we made our quarterly repayment of $6 million against our outstanding term loan, which now has a balance of $181 million.

Our net cash position at March 31, 2018, was $254 million.

Looking at our guidance for the second quarter of 2018.

We expect to show sequential revenue, adjusted operating margin and adjusted EPS growth.

For the second quarter, we are projecting revenue to be in the range of $1.575 billion to $1.675 billion.

The midpoint of this range would represent an 8% sequential revenue increase and 4% year-over-year revenue increase.

Second quarter non-IFRS adjusted net earnings are expected to range between $0.25 to $0.31 per share.

At the midpoint of our revenue range and EPS range, non-IFRS operating margin would be approximately 3.2%.

Our operating margin for the second quarter is expected to improve based on solid revenue growth, particularly growth in our ATS segment and as we begin to realize some benefits from our restructuring program.

Non-IFRS adjusted SG&A expense for the second quarter is projected to be in the range of $51 million to $53 million.

Finally, we estimate our second quarter non-IFRS adjusted effective tax rate to be in the range of 17% to 19%, excluding any impacts from taxable foreign exchange.

Looking at our end market outlook for the second quarter.

In ATS, this market continues to experience strong demand, and we're anticipating revenue to be up in the high-teens year-over-year.

This is being driven by new program ramps, including in our aerospace and defense and semiconductor markets as well as the inclusion of Atrenne.

In our communications business, we anticipate a decline in the mid-single digits.

In our enterprise end market, we anticipate revenue to decline by low single-digits year-over-year.

In closing, we are pleased with our results and outlook despite the volatility in our CCS business.

The focus on building a strong ATS business is progressing nicely as our additional disclosure shows, and we believe we can continue to build on our strong position from here.

We are accelerating our restructuring program in 2Q to improve our overall financial performance, and our goal continues to be in the 3.5% operating margin range in the second half of this year.

Now I'd like to turn over the call to the operator to begin our Q&A.

(Operator Instructions) The first question comes from Ruplu Bhattacharya from Bank of America Merrill Lynch.

First on component shortages.

Rob, I think, you mentioned that, that is an ongoing thing.

Can you quantify if there was any revenue hit from lack of components in the first quarter?

And just related to that, in terms of inventory going up $100 million, how much of that is because of the component shortages versus WIP versus finished goods?

Hi Ruplu, it's actually Mandeep here, and I'll maybe start trying off to answer that.

So there is about $30 million revenue impact in the first quarter due to material constraints.

It's slightly higher than what we've seen in previous quarters.

Given, and as you saw in the remarks, we are seeing that these trends that are happening are going to be continuing for at least another few quarters, and so we expect likely a similar type of impact in the second quarter, but that's been built into our guidance already.

In terms of the increase in the overall inventory, you're right, material constraints have driven some of it, which is really being reflected through demand churn as well as buffering from our customers.

And then just the extended lead times is driving the remaining piece of that.

The majority of the changes in our inventory are happening with some of our larger customers.

And we are seeing, right now, that because of the buffering, a lot of it right now is current inventory against raw materials.

Thanks, Mandeep, for all -- for the clarifications on that.

And just related as a follow-up on that question.

In terms of free cash flow, how should we think about that for the full year?

And do you see the component shortages alleviating towards the last half of this year?

Yes.

So I'd say that there is -- on free cash flow, as you know, we continue to target $100 million each year.

There's two, I would say, major assumptions right now that we are continuing to monitor.

The first one, and you would've seen it in our press release, is around the timing of the close for the Toronto property sale.

Our expectations right now is that, that closing will happen either at the end of this year or early next year.

The impact of that from a cash flow perspective is about USD 45 million so to meet the targets that we're working towards, we would be looking for that property sale to close this year.

The second thing is around inventory, and it's very dynamic as you know.

Our assumption right now is that the inventory situation doesn't get any worse.

And if the inventory situation doesn't get any worse, we'll continue to work towards that target.

Your next question comes from Paul Steep from Scotia Capital.

Mandeep, maybe just to continue on the exact same theme.

Within inventory, in the restructuring efforts you've undertaken, how much could we maybe expect that the restructuring action might help you strip out some of the buffering that's going on across the platform?

Hi, Paul.

I would say, as I -- maybe I'll talk about restructuring first.

As we have shared, it's a enterprise-wide cost productivity program.

Our estimation is that we will incur $50 million to $75 million taking us into the middle of next year.

I think as I shared on the call last quarter, that range -- being at the higher-end of that range would really result in us taking more network-based type of decisions, which I think leads into your question on impact to ongoing business with customers.

Right now, I would say that we're continuing to work towards that range.

We are anticipating being at the lower-end of the range at this time.

And so if we were to see changes to our footprint, that's how you would see changes in the inventory come through.

Right now, we don't have anything to share in that regard.

Okay.

And then just maybe switching for one second back to ATS.

Rob, can you talk about what you're seeing out there in terms of demand for, I guess, new programs, new wins?

How you are maybe approaching the market, obviously, on the A&D side in the semi, maybe, the go-to-market situation?

Sure.

We're seeing -- ATS has been a strong growth component for us and continues to be a strong growth component.

In Q1, we saw heavy demand from semi cap, and we think it's going to be very good year for semi cap this year.

And we also see a good year on A&D as well.

A&D is really being fueled by adding Atrenne into our outlook and also our OIP that we announced is coming online and that's ramping fairly nicely as well.

In HealthTech, industrial, those businesses are going through little bit of softness in the first quarter.

But as some of the old programs are coming offline and some of the new programs are coming online, we expect both HealthTech and industrial and energy, actually, to be strong growth components this year.

Hence, we put out a long-term target of 10% ATS growth, organic growth, on a -- over the long term, and we feel good about hitting that target this year.

Your next question comes from Thanos Moschopoulos.

On ATS margins, there were certainly some good year-over-year improvements.

Is that predominantly a function of operating leverage?

Or was it a function of program costs -- program ramp costs going away year-over-year?

Or were there other factors that you'd point to?

And how much room for improvement would you see in that margin percentage in the coming quarters?

Hi, Thanos.

We're very pleased with the performance that ATS had in the first quarter.

It was a record performance for that business.

Overall, what we're seeing is really a lot of strength happening in the A&D business as well as continuing demand strength in semi.

So we are benefiting from leverage.

Revenue was up on a year-over-year basis, and we are seeing just strong operational performance as well.

As we go forward -- again, we're pleased with the performance right now.

The target margin range for the ATS business would be in the 5% to 6% range, and moving up that scale would come down to mix within the ATS business as well as continuing revenue growth.

And then as we look at the 3.5% margin target for the second half, would that be more weighted towards improvement in ATS or would that have more to do with CCS, given the restructuring program in place?

More the latter, Thanos.

Again, we're going to work to be within that target range of 5% to 6%, but there will be some ebbs and flows as we go quarter-to-quarter as we ramp certain programs as demand shifts from one segment to another.

In terms of achieving the 3.2% that we are guiding for the second quarter, it is reflective of some traction that we're making on the restructuring effort, and we continue to feel that we will be in the 3.5% range in the back end of the year, and that's going to be driven by some growth in ATS as well as the integration of Atrenne, but also largely because of the productivity improvements we are expecting to see in CCS.

Your next question comes from Jim Suva from Citi.

On the ATS comments, I think you said up 15% year-over-year next quarter, which is encouraging.

Can you let us know organically what would that be because, I believe, that's potentially helped by integration of an acquisition.

And then on the CCS, have pricing or the dynamics gotten worse or continued to improve or continued to worsen?

How should we think about that because now you're doing a restructuring that you announced.

It seems like it's kind of things beyond your control.

And then I may have a follow up.

Hi, Jim, I'll take your first question and pass the second question to Rob.

In terms of the ATS growth rate, so you're right, we made 2 comments in the script.

Without Atrenne, our expectation is that we will be up in the mid-teens year-over-year.

And with Atrenne, we expect to be in the high-teens year-over-year.

And on the pricing, Rob can give you his thoughts.

Yes.

I think the pricing dynamic has certainly got a little bit more severe in recent history.

We have experienced pricing dynamics in the past, and we've navigated through them well in the past.

It's really being driven by 2 factors, the OEM consolidation, i.e., they need less providers and there's excess capacity out there.

But the good news is that we have been winning and keeping our share, and now we're just working the productivity initiatives in order to drive increased profitability, and also working with our customers to increase our value-added services such that we could both be able to move up the margin chain.

Okay.

Then my follow-up is, if you mentioned you continue to win your share and not lose share, in your CCS segment, I believe, companies like Cisco and stuff like that are in there, Cisco's growing revenues and things like that.

So I'm just kind of trying to bridge the thing of you not giving up some programs or losing some programs, yet companies like Cisco growing.

So how should we bridge those differences of trends of what we're seeing out there in the marketplace?

Yes, it comes down to the mix of programs that we participate and support versus what the broader -- our broader customers participate in.

Got you.

And then lastly, so the programs that you participate on, are there a lot more in the future like the next 12 months that we should see that are rolling off that you're not on the new ones or are we at the worst part of it now or how should we think about that?

Because there's really the divergence of what we're seeing in the industry versus your CCS trends?

I would think about it as, you know, there are some programs that we're on that are trailing off.

And there's some new programs that we won that haven't yet picked up.

So we see ebbs and flows, especially in our comps markets, and that's what you're seeing in our results.

Okay.

And last thing, any comments on optical?

Yes.

On optical, we have very strong -- as you know, last year, we were up 30-ish percent, I think it was.

So the comps on a year-over-year basis for us are a little bit tougher.

But that being said, we have seen weakness here in the first quarter and expect to see weakness in the second quarter as well in optical.

We are seeing strength, though, in networking.

And why the weakness?

Well, the comps are a little bit tougher year-over-year and some of the programs that we're on, specifically on optical systems, are trailing off a little bit.

Your next question comes from Todd Coupland from CIBC.

So I just want to make sure I have the rhythm of the cash this year.

So is it fair to think about sort of restructuring and real estate to roughly offset each other, and then cash flow and the acquisition to offset each other, so the delta really is the inventory build and it's going to be tough to get that back, given the trends that you're talking about.

Is that basically include all the major items?

It does, Todd, and it's a good way to think about it, which is the proceeds from the Toronto sale would be about $45 million.

If we were at the low end of the restructuring program, and we were to complete it in 2018, it would imply about $45 million of cash that we would use.

Of course, there's a range on that, but ballpark numbers, those offset each other.

On the inventory side, if you think about the fact that we are able to typically generate $100 million of free cash flow on historical basis, a lot of that comes in through standard working capital.

So if inventory is not getting a lot worse, we would typically be in that range.

The other caveat I would say, though, is, is that, as you know, in our industry as we grow the top line, it does consume working capital.

And so if demand was to be very strong as we go into the back end of the year, that would be a near-term headwind.

Okay.

And in spite of not having sort of the traditional free cash flow in your sight this year, did the balance sheet still give you the flexibility to act on M&A and/or buyback or both?

Yes, absolutely.

So we have $436 million of cash and net cash position of close to $250 million.

With the Atrenne acquisition included, which it closed on April 4, so we funded it on our revolver at this time.

We are only at 1.2x leverage.

Our S&P rating, as you may have seen, got renewed a couple of weeks ago, and we continue to believe that we have the ability to lever up to 3.5x, but we're focused on being under 3x leverage.

But if were to leverage to even up to 3.5x, we think that we could have dry powder of close to $700 million, which we can continue to deploy on buying back shares, continue to deploy on targeted and focused M&A.

Okay, that's great.

And then just to the actual trends in inventory.

So you call out auto and IoT.

Can you maybe just comment on what types of applications in both of those areas are actually pressing the supply chain?

Just a couple of examples and color would be helpful.

So -- this is Rob.

So on components, we've seen lead times dramatically increase year-over-year.

In memory, we are actually seeing lead times up about 50% year-over-year, extended lead times, discrete's is about 50%, passives right now are probably the most constrained, MLCCs lead times are maybe upwards of close to 1 year and it has given the entire industry some pause as well.

And linear and logic also are up quite bit on a year-over-year basis.

Based on what we're seeing and what we're hearing, we do expect NAND to get maybe a little bit better towards the end of this year.

But we are hearing that the balance of the place will be constrained through the balance of 2018.

Your next question comes from Robert Young from Canaccord.

Just an additional bit on that last question.

How much money on -- or how much cash on the balance sheet do you require to run the existing operation?

Like is there a certain amount that you need to have there that is not available to M&A sort of that [700] number if you lever up, like what amount would you have to subtract to run the business?

Yes, when I talk about the dry powder, it does take into account excess cash.

We've typically said, Robert, anywhere between 5% to 7% of our revenue would be required.

There is a range on that, and I hate to say it, but it depends and what it depends on the geographical distribution of the cash.

We have continued to repatriate cash from overseas.

We want to do it in a tax-efficient manner.

But we believe to run the operations on a day-to-day basis, 5% to 7% is typically a good rule of thumb.

Okay.

And then on some of the margins that you've given on the call, I think you said ATS could eventually hit 5% to 6% range.

Is that informing the 3.5% in the second half, like should -- if I look at 5% and if I pick the midpoint, then that suggests that the CCS business would have to get to around 2%, which would be expansion from 1.7% this quarter.

So is that a good way to think about it?

Yes.

I would say, operating within that range of 5% to 6% is going to come down to largely mix.

There are some segments that we operate in, as you know, that we make significant investments in, there's higher barriers to entry, they're high regulatory.

And so therefore, they do drive some higher margin from P&L perspective.

We have other segments that aren't necessarily in that same situation.

But it does come down to mix.

The expansion that we are expecting to get to 3.5% are driven, again, by the restructuring program continuing to take root, the integration of Atrenne as well, which is off to a good start so far since the deal is closed and then just continuing to perform in ATS.

But we do expect, to your point, CCS to get better as we go through the year.

Okay.

And I think you said earlier on the call that you expect growth and improvement in margins in 2018 in CCS.

Did I hear that correctly?

Yes.

As the restructuring program continues to take root, we would expect margin to improve in our CCS business.

Okay.

And one last little thing.

I think you said that the impact of IFRS 15 on the Q2 guidance was nominal.

Was that correct?

Correct.

It's immaterial and it's been factored into our guidance.

Your next question comes from Paul Treiber from RBC Capital Markets.

I just wanted to follow up on your -- one of your last comments just in regards to Atrenne in the integration plan.

So how is the integration going?

And then also, it's my understanding that Atrenne was a couple of businesses.

Are you looking to more closely align and integrate those businesses into the ATS segment?

Yes, so it's still early days, but the Atrenne acquisition is going quite well.

In fact, the team was up here in Toronto, the sales team, and our ATS sales team was already doing account mapping and plotting the path ahead in terms of top line opportunities.

Our approach right now with Atrenne is to focus on the areas of integration that yield the most synergies, and that's really in some of the areas of COGS and some of the areas on the top line in terms of penetrating new accounts with our expanded offering.

And a follow-up to that is...

sorry go ahead.

No.

In terms of integrating it into the entire business, Atrenne is reporting into our A&D segment.

And just -- yes, the follow-up is in regards to the ATS outlook for 5% to 6% margins, should we think of Atrenne as being accretive to that level, or is that basically inclusive of Atrenne already?

Yes.

We haven't disclosed the specific margins for Atrenne, but it is a -- we did share, though, that it was purchased at a high-single digit multiple.

It is accretive to the company's average.

And it is inclusive within A&D.

Your next question comes from Gus Papageorgiou from Macquarie.

So you said that there's 2 customers that account for 10% plus of sales.

I'm wondering could you tell us would you have any customers that would account for more than 10% of segmented income?

Gus, on the CCS side, the answer would be yes.

Those 2 customers will carryover.

And on the ATS side, I'm going to get back to you on the specific percentage.

I don't want to misspeak if they're straddling the line.

And what about in total?

Like in total segmented income, would anybody represent more than 10% of segmented income?

We don't break it out in that way.

And as you know, there are, again, ebbs and flows within our businesses.

So we don't break out profit concentration at the customer level.

There are no further questions.

I'll turn the call back over to the presenters for closing remarks.

Thank you.

And in my view, we're doing what we said what we're going to do and executing on our strategy.

We have some fantastic momentum in ATS.

We had record revenue and profits in Q1.

And CCS, we are experiencing some headwinds, but we have great experience in navigating through these waters, and our actions are starting to yield results.

I look forward on updating you on our next quarter results.

Thank you, again.

Thank you, everyone.

This concludes today's conference call.

You may now disconnect.