Celestica Inc (CLS) 2018 Q4 法說會逐字稿

At this time, I would like to welcome everyone to the Celestica Fourth Quarter 2018 Results Conference Call.

(Operator Instructions)

I would now like to turn the call over to Curtis Cheam, Investor Relations with Celestica.

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

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

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 goals, strategies, priorities, areas of focus and operational targets, the expected impact of our cost efficiency initiative, the expected impact of our CCS segment portfolio review, planned disengagements, the expected impact of acquisitions, anticipated proceeds related to and the expected timing of the sale of Toronto real estate and our expected gross debt to non-IFRS adjusted EBITDA leverage ratio under the consummation of such transaction, trends and expectations in the Electronics Manufacturing Services industry generally and in relation to our business, our anticipated financial and/or operational results and our anticipated non-IFRS adjusted effective tax rate.

Such forward-looking statements are based on management's current expectations, forecast 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 our 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 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 statements 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.

In addition, during this call, we will refer to various IFRS measures, including operating earnings, operating margin, adjusted gross margin, adjusted return on invested capital or adjusted ROIC, free cash flow, gross debt and non-IFRS adjusted EBITDA leverage ratio, adjusted net earnings, adjusted EPS, adjusted SG&A expense and adjusted effective tax rate.

Listeners should be cautioned that references to any of the foregoing measures during this call denote non-IFRS measures whether or not specifically designated as such.

These non-IFRS measures do not have any standardized meaning prescribed by IFRS and may not be comparable to similar measures presented by other public companies that use IFRS or who report under U.S. GAAP and use non-GAAP measures to describe similar operating metrics.

We refer you to today's press release and our Q4 2018 earnings presentation which are 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.

We do not provide reconciliations for forward-looking non-IFRS financial measures as we are unable to provide a meaningful or accurate calculation or estimation of reconciling items, and the information is not available without unreasonable effort.

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

Let me now turn the call over to Rob.

Thank you, Curtis, and good afternoon.

Celestica's Q4 results underscore the benefits of our portfolio diversification, productivity initiatives and commercial actions as we drove another quarter of sequential margin expansion, achieving our operating margin target of 3.5%.

We delivered approximately $1.7 billion in revenue, up 10% year-over-year, driven primarily by solid revenue growth in our CCS segment, A&D and industrial markets.

In our CCS segment, we delivered strong year-over-year revenue growth at 10% while improving segment margins by 110 basis points to 3.3% from the same period last year.

Revenue was strong in our storage and communication markets, and we continued to see traction with cloud-based service providers to whom we provide both traditional EMS and JDM services.

Last quarter, we indicated that we plan to action approximately $500 million of CCS segment revenue over the next 12 to 18 months, with the aim of expanding CCS margins.

I'm pleased to say that this review is substantially complete with the majority of the actions anticipated to occur in 2019.

As a result, we expect total company revenues in 2019 to be down in the single-digit percent range year-over-year.

In our ATS segment, we grew revenues 11% year-over-year, driven primarily by solid performance in our A&D and industrial markets, partially offset by increased pressure in our capital equipment business.

Our A&D market continued to perform well, including strong performance in Atrenne which outperformed our expectations in 2018.

We continued to see strong growth in our industrial market, driven by demand strength and new program growth.

The strong performance in our A&D and industrial markets was overshadowed by weaker-than-expected performance in our capital equipment business, adversely impacting our ATS segment margins which were below our target range of 5% to 6%.

As a reminder, our capital equipment business includes our semiconductor, display and power equipment businesses.

The demand softness we experienced in our capital equipment business was predominantly acute in the semiconductor market, which operates with higher fixed costs than some of our other businesses.

As a result, our margins in this market declined in the weaker revenue environment.

Over the past few quarters, the semiconductor market has continuously eroded.

And over the last few months, end-market demand forecasts have been revised downwards.

In our capital equipment business, while we are encouraged by the number of program wins and market share gains we achieved during 2018, we anticipate that this new business will only partially offset the sharp declines in market demand anticipated in our core programs.

As we currently believe that the demand softness in our capital equipment business will continue throughout 2019, we are accelerating our productivity and taking near-term actions to better align this business to the current revenue environment.

We continue to believe that the long-term fundamentals in this space are favorable based on emerging technologies as well as the leadership position we have established in capital equipment.

I'll emphasize that the capital equipment business remains very attractive to us, which was the reason we acquired Impakt last year.

We believe that Impakt positions us to participate in the growth of next-generation display technologies, such as OLED, which is in the early stages of adoption.

We also believe it provides us an important entry into South Korea, enabling us to support some of the world's top OEMs.

The innovation of Impakt is well underway and proceeding as planned, and we believe that we are well positioned to win incremental business as a combined entity.

Furthermore, during this down cycle and in anticipation of a ramp of display programs in late 2019, we are accelerating product transitions to take advantage of our available network capacity.

As I look back on our performance in 2018, I am pleased with the significant progress we made on our transformational strategy.

First, we executed on our cost efficiency initiatives, helping us to achieve sequential operating margin expansion throughout 2018.

Second, we continued the expansion of our ATS segment both organically and through the acquisition of 2 strategic businesses.

The long-term nature of these investments is key to the extension of our leadership in the A&D and capital equipment markets, and we believe that this expansion will benefit our business for the years to come.

Third, we continue to improve the mix and efficiency in our CCS segment.

JDM continued its steady growth with revenues growing over 30% year-over-year to approximately $0.5 billion on strength from our communications products.

And with our CCS portfolio review, we believe we will have a more consistent and resilient business, offering higher value-added services to our customers.

And finally, we continued with our balanced approach to capital allocation.

We utilized the strength of our balance sheet to execute on share buybacks and on 2 strategic acquisitions to drive long-term growth.

As we enter 2019, we remain focused on the key initiatives that we believe are required to reach our operating margin goal of 3.75% to 4.5%, which we expect to achieve by the first half of 2020.

Within ATS, to achieve our segment margin target of 5% to 6%, we intend to focus on stabilizing our capital equipment business and successfully executing on our integration plans and further building on our leadership position in A&D and expanding our position in our remaining ATS markets.

Within CCS, we are focused on driving margin stability by executing on our portfolio actions and growing the most profitable parts of this business, such as JDM, and continuing to drive productivity across our operations.

In 2019, our capital allocation priorities also remained unchanged.

Over the long-term, we intend to invest half of our available free cash flow into the business, including disciplined acquisitions to acquire complementary capabilities or increase scale in our existing markets and to return half to our shareholders.

In summary, we believe we've made solid progress executing our strategy over the past year despite the constrained materials environment and pressured capital equipment business.

We are committed to continuing to drive our transformational roadmap which we believe will lead to increased revenue and earnings diversification and sustainable profitable growth.

I want to thank the entire Celestica team for executing our priorities and for servicing our portfolio of leading global OEMs.

Let me now turn the call over to Mandeep to provide further details on the [financials].

Thank you, Rob, and good afternoon, everyone.

For the fourth quarter of 2018, Celestica reported strong revenue of $1.73 billion, an increase of 10% year-over-year and within our guidance range for the quarter.

Our non-IFRS operating margin was 3.5%, up 20 basis points sequentially, up 30 basis points year-over-year and in line with the midpoints of our revenue and non-IFRS adjusted EPS guidance ranges for the quarter.

Adjusted earnings per share were $0.29, within our guidance range.

In our ATS segment, we saw year-over-year revenue growth of 11%, driven primarily by demand strength and new programs in our A&D and industrial markets and contribution from Atrenne.

However, ATS segment margin reflected weaker-than-expected demand in our capital equipment business primarily in our semiconductor market.

For the quarter, ATS segment income was $20.9 million compared to $25.5 million for Q3.

ATS segment margin was 3.7%, down 90 basis points from the third quarter and below our ATS segment margin target range.

The swift drop-off in demand in our capital equipment business drove lower utilization resulting in an operating loss in this business in the mid-single-digit millions range.

This loss had an 80 basis point impact on ATS segment margins and a 20 basis points impact on non-IFRS operating margins for the quarter.

Turning to CCS.

Segment revenue was strong, up 10% year-over-year, led by strong demand in our enterprise market, including JDM.

CCS segment income was $38.8 million, translating to a segment margin of 3.3%, a solid 60 basis point increase from the third quarter, resulting primarily from improved operational performance and better customer and program mix, including a higher concentration of JDM services.

Furthermore, as Rob mentioned in our second quarter call, we have been engaging in commercial discussions with several of our customers as part of our CCS portfolio review, and those discussions are starting to yield positive results.

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

Communications revenue in the quarter was up 7% year-over-year, but down 8% sequentially.

Performance was below expectations, driven primarily by lower-than-expected demand in some programs, offset by strong revenue growth in networking, including from our JDM portfolio.

Revenue from our enterprise end market represented 28% of consolidated revenue in the fourth quarter.

Revenue in this end market increased 14% on a year-over-year basis, driven primarily by strong program demand in storage.

Our top 10 customers represented 69% of revenue for the fourth quarter, down 2% from the third quarter of 2018 and down 4% from the fourth quarter of 2017.

For the fourth quarter, we had 3 customers individually contributing greater than 10% of total revenue.

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

IFRS net earnings for the quarter were $60.1 million or $0.44 per share compared to the $13.6 million or $0.09 per share in the fourth quarter of 2017.

Higher year-over-year IFRS net earnings were driven primarily by a one-time deferred tax benefit of $0.36 per share related to the acquisition of Impakt, partially offset by higher financing and amortization costs.

Restructuring charges related to our cost efficiency initiative were $6.4 million this quarter, bringing the total program spend to date to $43 million.

We continue to estimate that the program will be in the range of $50 million to $75 million.

However, we are extending the program to the end of 2019.

As Rob mentioned, in light of the demand environment in our capital equipment business, we are finalizing plans to take targeted actions in the near term in this business in order to accelerate profitability as we anticipate lower revenue levels in our semiconductor market during 2019.

These actions are intended to drive sequential improvement in ATS segment margins throughout 2019.

Adjusted gross margin of 7.2% was up 50 basis points sequentially, primarily due to better customer and program mix and improved operational performance in our CCS segment, offset by weaker ATS results.

Our adjusted SG&A of $55.0 million was up approximately $5 million sequentially, driven primarily by expenses associated with the acquisition of Impakt and higher variable costs.

As a percentage of revenue, adjusted SG&A was 3.2%, up from 2.9% sequentially and 3.0% from the same period last year.

Non-IFRS operating earnings were $59.7 million, up $3.3 million sequentially and up $9.8 million from the fourth quarter of last year.

Our adjusted effective tax rate for the fourth quarter was 21%, higher than our guidance range of 17% to 19%, driven primarily by cross mix in different geographies.

For the full year of 2018, our adjusted effective tax rate was 21%, which included 2% of foreign exchange impacts, at the high end of our 17% to 19% annual guidance range which did not include foreign exchange impacts.

Adjusted net earnings for the fourth quarter were $39.7 million.

Adjusted earnings per share of $0.29 represents a growth of $0.02 year-over-year.

Adjusted ROIC of 15.0% was down 1.2% sequentially and down 1.4% year-over-year, primarily as a result of higher working capital.

Moving on to working capital.

Our inventory at the end of the quarter was $1.1 billion, an increase of approximately $30 million from the third quarter.

Inventory turns were 6.0, down 0.2 turns from last quarter and down 1.2 turns from the fourth quarter of 2017.

Sequentially, the higher inventory levels were driven primarily by inventory acquired as part of the Impakt acquisition, and year-over-year, by increases to support new programs, by inventory acquired through our acquisitions and by increases as a result of the constrained material environment.

Capital expenditures for the fourth quarter were $19 million or 1.1% of revenue.

Our capital expenditures for 2018 were $82 million or 1.2% of revenue, which was below our expected range.

In 2019, we expect our capital expenditures to be in the range of 1.5% to 2.0% of revenue.

Cash flow from operating activities for the quarter was negative $2 million compared to cash flow from operating activities of $44 million in the prior year period.

Free cash flow was negative $36 million in Q4 compared to positive free cash flow of $19 million for the same period last year, driven primarily by higher working capital requirements and higher financing costs compared to last year.

Cash cycle days in the fourth quarter of 58 days increased 4 days compared to the third quarter of this year.

While the increased working capital has limited our free cash flow, we expect to receive proceeds from the sale of our Toronto property on close in March of 2019.

We expect to receive approximately USD 110 million of proceeds, which is higher than previous estimates as a result of a density bonus and early vacancy incentives.

Moving on to our balance sheet.

Celestica continues to maintain a strong balance sheet.

Our cash balance at quarter end was $422 million, down $36 million sequentially and down $93 million year-over-year.

In the fourth quarter, we further expanded our credit facility to finance the acquisition of Impakt, increasing our outstanding term loan by $250 million for a total balance of $598 million at December 31.

The remainder of the cost of the acquisition was funded through our revolving credit facility, bringing the outstanding balance to $159 million at quarter end.

Our gross debt to non-IFRS adjusted EBITDA leverage ratio was 2.6x as of December 31 and is expected to be in the low 2x after the collection of proceeds relating to our Toronto property sale.

This quarter, we repurchased 1.3 million shares for approximately $14 million as part of our 2017 NCIB program.

Since commencing this program in November of 2017, we repurchased 8.7 million shares at a cost of $95 million.

In mid-December, the TSX accepted our notice to launch a new Normal Course Issuer Bid, allowing us to purchase up to 10% of the public float or up to approximately 9.5 million shares through December of 2019.

We did not repurchase any shares as part of this NCIB during the quarter.

Now turning to our guidance for the first quarter of 2019.

Our guidance reflects normal seasonality in our CCS segment for the start of our fiscal year and the continued weakness expected in our capital equipment business.

We are projecting first quarter revenue to be in the range of $1.45 billion to $1.55 billion.

At the midpoint of this range, revenue would be flat with the first quarter of 2018.

First quarter non-IFRS adjusted net earnings are expected to range between $0.12 and $0.18 per share.

At the midpoint of our revenue and EPS guidance ranges, non-IFRS operating margin would be approximately 2.6% and would represent a decline of 40 basis points from the same period last year.

This guidance includes our estimate of a single-digit million dollar loss in our capital equipment business in the first quarter of 2019.

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

For the full year of 2019, we estimate that our non-IFRS adjusted effective tax rate range will be 19% to 21%, excluding any impact from taxable foreign exchange.

Turning to our end-market outlook for the first quarter.

In our ATS end market, we are anticipating revenue to be up low double digits year-over-year.

In our communications end market, we anticipate revenue to increase in the mid-single-digit range year-over-year.

In our enterprise end market, we anticipate revenue to be down in the mid-20% range year-over-year, driven by customer disengagement related to our CCS portfolio review, partially offset by new programs in storage.

Overall, we are pleased with the significant progress we are making executing our strategy.

While our Q1 guidance reflects the challenges we are seeing in the semiconductor market, we expect the balance of our business to perform well.

We will be taking near-term actions to improve the profitability of our capital equipment business and expect these actions to lead to improved profitability in our ATS segment as we go through 2019.

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

(Operator Instructions) Your first question comes from the line of Robert Young from Canaccord.

So you reiterated your operating margin target of 3.75% to 4.5% by H1 2020.

The timing is a little bit different there.

Are you -- do you view that as the same that you gave before or are you seeing that as something that is extended by 6 months?

I think previously you said 12 to 18 months would be the timeframe.

Hi, Rob.

Yes, we did say 12 to 18 months, and we were really just attempting to give a little bit of more clarity.

We're working towards the first half of 2020.

We don't really see that as being too different than what we had talked about before.

And we think that the actions that we're taking in driving improvements through ATS will help us get there in that time.

Okay.

And then I guess a concern that might -- a common concern might be that given the operating margin headwind here in Q1 driven by the semi equipment cap market, which you -- I think you said you expect that to last through 2019.

How do we reconcile still hitting that range given the headwind from semi cap you've talked about?

Yes.

So there's a few dependencies, of course, to get to the target margin range that we talked about of 3.75% to 4.5%.

It continues to require a strong and healthy ATS business which we believe we have.

For ATS to be performing in the 5% to 6% target range, we think it's a key ingredient to getting there, continuing to grow our ATS business and continuing to execute the actions in our CCS portfolio review.

So really, the question is how do we move ATS back to the 5% to 6% range.

If you look at the ATS portfolio, excluding capital equipment, we're actually operating in that range right now.

And the capital equipment business, as we mentioned, had a mid-single-digit million dollar loss in the fourth quarter.

Something similar is what we're expecting in the first quarter as well.

We're taking actions immediately in that business to drive the business back to profitability.

It will take us a few quarters.

But as we drive that business back to profitability and as we expect that there will be stabilized revenue, we believe we can get the business back to -- the overall ATS business back into the target range.

Okay.

And then I might have missed it, but do you reiterate the ATS expected growth of 10% for the full year?

I know that you're saying double digits for the coming quarter, but is that still the expectation?

Yes, the ATS had a good year in 2018.

We saw top line growth of 13%.

When we talked about the 10%, as you'll recall, we have stated that it's a long-term growth rate and there will be some years that it will be above, as we saw in 2018, there will be some years that may be slightly below.

So we're not giving specific guidance on the ATS revenue for 2019.

But I'll guide you back to the remarks that we made, which is that overall 2019, we're expecting revenue for the company to be down in the single-digit range.

And Rob, I'll add a little bit more color on semi cap, if you will.

While some people in the industry are saying the volumes will return in the second half of '19, we're taking the assumption that they will not, and therefore, we're driving the actions to kind of level set revenue assuming it's going to be a down-cycle year, if you will.

As such, when the volumes do return -- and we can't predict when they will, but when they do return, we think we're going to have a much stronger business on the way back out because of the actions we're taking now, much more operating leverage.

Okay.

So this a bit of a reset after getting your legs under you in the new business, I guess, in addition to that?

Yes, it's not just the new business, but it's all of semi cap.

Frankly, what happened with us here is very late in the fourth quarter, the revenue dropped off fairly significantly.

We were assuming going into the quarter that Q4 would be relatively flat with Q3 within capital equipment.

We saw some of the major OEMs pre-announce, then we saw the whole industry kind of revise their forecast down.

So very late in the quarter, we saw some significant demand drops, and now, we're just doing a reset and realigning our capacity and getting the business right-sized.

Again, we will be a much stronger capital equipment business coming out of this as well to the actions we're taking right now.

Okay.

And then, will you be sharing an additional restructuring program around that business that we'll get in the future, like size and timing of that, if there is going to be official restructuring?

Yes.

No, so there the actions that we are taking are included in the restructuring program that we already have.

As you'll remember, it had a range, $50 million to $75 million.

We had, in the past, said that we were anticipating being at the lower end of that range.

And if we were going to go the higher end, it would require more network changes.

Based on what we're seeing today, we believe that the program range remains adequate for us.

We'll run that program through the end of 2019.

But I think from an estimation perspective, you can assume that we will be at the higher end of the range.

Okay, great.

And then maybe one last little one.

Take a shot at it.

Would you share the contribution from Impakt in Q4, the stub period there, or perhaps in the Q1 guidance?

So we won't share the Q1 guidance, specifically, as you know.

But it is part of capital equipment business, and as mentioned, the total capital equipment business we're expecting a single-digit million dollar loss.

And in the fourth quarter, the contribution was negligible.

Your next question comes from the line of Gus Papageorgiou from Macquarie.

Just on the semi cap equipment, I mean it's not -- it hasn't really been a surprise that it's been weak.

I mean, it's been weak for a while.

I mean why the sudden drop off?

And I mean, what's your comfortable -- how comfortable are you that you have visibility in getting this business kind of back to profitability over the next year?

Yes, the drop-off -- on the way up, I think we were underestimating customer forecasts.

Customers used to say X, and then we ended up -- at the end of every quarter, they asked us to expedite in.

What happened over the last 2 quarters is the exact inverse was true.

We saw some leakage in Q3, but nothing bad in Q4.

The leakage in terms of what our customers were asking versus what they actually ended up taking at the end of the quarter was quite significant and quite late in the quarter.

And I think the market got surprised by some of the OEM pre-announcements.

And the latest view coming out is that frankly, memory is just way down, largely spurred by NAND and largely spurred by the mobile phone market.

So the industry is going through a reset.

We have a really strong leadership team across all our capital equipment.

We've been through many cycles on the way up and the way down.

We know how to manage through these cycles, but now, it's just a question of putting some of those actions in place and moving the business forward.

The other thing I'll also offer, within our Impakt business, we are taking the advantage of some available network capacity that we have across the entire network to accelerate our integration, if you will, because we are assuming and planning for some display growth in the back half of 2019 into 2020 based on all the news that you're hearing coming out of CES and some of the new products that are being introduced on the display side.

Okay.

And I just wanted to -- just wondering what you're seeing in terms of component supplies.

I mean I know component supplies have been one of the causes of higher inventory levels.

Are you seeing that ease?

And can you talk about what impact that might have on inventory levels?

Sure.

I'll start off on the component, and I'll let Mandeep talk about the inventory.

We are seeing some signs of easing, if you will, small case size MLCCs, which has been a dirty 4-letter word here for a while, but that's getting better memory.

Obviously, it's getting better.

The larger case size MLCCs are still a challenge.

We're seeing challenges in [moff] sets, and passives and discrete.

So I'll say we're seeing the early signs of some improvements.

We haven't yet seen it reflect in our customers' order books yet, but we would anticipate that, that would be forthcoming assuming that the momentum continues.

As it reflects in inventory, I'll let Mandeep talk about that.

The only thing I'll add, Gus, to it, is from an impact to the revenue perspective, it was relatively flat quarter-to-quarter.

We had about $12 million that was gated in revenue due to the material-constrained environment.

As Rob was mentioning, we are starting to see some levels of improvement.

Some of our peers have commented as such as well.

But we're not yet seeing it really flow through our customer forecasts.

But what we would expect is as we go through 2019, we would expect there to be some level of inventory unwind and then the cash flow generation that would come with that.

Okay.

And just finally, just on Impakt.

I mean, one of -- the good thing about Impakt was just the high -- the margins were higher.

Can you tell us -- given the drop-off in semi cap equipment, can you tell us if it was accretive to -- do you expect it to be accretive in Q1 or dilutive to margins?

And so we're not giving specifics right now.

We're talking about the capital equipment business in total.

So as you'll know, again, we're going to be forecasting a small loss in the first quarter.

But yes, we continue to believe that the fundamentals of Impakt are very attractive, and we do expect that business to perform very well during its first year of integration.

There is a portion of Impakt's revenue that is semi cap related that has felt a little bit of pressure, and we are also seeing some display sliding a little bit from one quarter to the next.

But the broader outlook, the mid- to long-term outlook for that -- the display business is very strong.

And the majority of the business there is OLED, is that correct?

Yes.

Displays with LCD and OLED, yes.

We do continue to anticipate that the business will be accretive to EPS and with strong ROI in its first year.

So within 2019?

Yes, given that the transaction closed mid-Q4.

Your next question comes from the line of Ruplu Bhattacharya from Bank of America.

Maybe Rob, can you talk a little bit about what you saw in the communications end market?

I think the guidance was up -- revenues to be up mid-teens and it came in up 7%.

I mean given competitor commentary on the strength that they've seen, just maybe talk a little bit, if you can, about what the specific end markets within communications did and what you're seeing going forward?

Yes.

We saw some strength in our optical systems business, but that was offset with some pressure in some of our core routing and switching business, largely driven by a couple of key customers.

So that's what impacted Q4 relative to our guidance.

In Q1, we're seeing a similar story play out.

Again, demand strength in optical systems, but it's being partially offset with some of the core routing and switching program demand softness that we have.

And it's really demand -- I'll call it program mix-driven programs that were supplying our demands, kind of light on those.

Okay.

Yes, that's helpful.

Maybe on the margin side, Mandeep, can I ask you, the ATS margins declined 150 basis points year-on-year.

I missed what you said about the contribution from the capital equipment business.

How much of that 150 basis points was because of the capital equipment weakness?

And given that you're maintaining the long-term target for the operating margins, should we expect that ATS gets back into the 5% to 6% range in the first half of '19?

Yes, Ruplu.

So the impact that I had mentioned in my prepared remarks was that the loss from the capital equipment business in the fourth quarter drove an 80 basis points impact to ATS in the fourth quarter.

So if capital equipment was at breakeven, ATS would've achieved 4.5% instead of the 3.7%.

And then, of course, we're working to get that business to be more than just a breakeven business.

If you look at our ATS business, excluding capital equipment, and if you look at it through 2018, it's been operating within our target margin range through the year.

And so the overall ATS business continues to be very healthy.

Capital equipment, we are working to move back to profitability.

As we talked about, we're taking actions right away.

It will take a few quarters for that to happen.

And while we're not going to give guidance by quarter, what I would say is that our expectation is that we would move back to the target margin ranges for all of ATS, including capital equipment, as we move through the end of the year.

Okay.

No, that's helpful.

And maybe just the same margin question on CCS.

I mean, margins were quite strong this quarter, 3.3%.

In fact, it's above the long-term guidance range of 2% to 3%.

Do you think that sustains -- I mean was there something unusual this quarter?

And given the pruning actions you are taking, how should we think about that segment margins going forward over the next couple of quarters?

Yes, we were really pleased with the performance that we saw in CCS.

And it underscores the benefits of having a diversified portfolio.

The target margin range, as you mentioned, is 2% to 3%.

We're very happy with the performance in the fourth quarter where they were able to overachieve.

There's a couple of things that are driving that.

As we talked about, we are seeing improved commercial turns with certain customers.

We are also seeing the benefits of the productivity program.

As I had mentioned in my remarks, we spent $43 million towards our $50 million to $75 million program, and a large portion of those improvements have gone towards the CCS business.

But specific to the fourth quarter, we also had improved mix, and there were certain commercial recoveries that took place.

Those aren't always going to be repeatable.

We were also pleased with the contribution of JDM.

JDM grew quite a bit through 2018, and it is accretive to the overall CCS portfolio.

But just to level-set expectations, I mean, as we move into the first quarter of 2019, we continue to think that the 2% to 3% range is the right range, and we expect a more normalized level of performance going into Q1.

Okay, that's very helpful.

And the last question for me, I think on the last earnings call, you talked about the normal free cash flow is about $100 million to $200 million per year and then you have like $250 million to $300 million of inventory increase last year.

So from a free cash flow standpoint for fiscal 2019, has the expectation changed or still are you thinking the same base level of $100 million to $200 million, and then on top of that, any inventory that frees up because of the components?

Or is this alleviating?

Yes, to be frank, the $100 million to $200 million range, may be a little bit over simplistic because as you know in this industry on the way up, you consume cash and on the way down, you release cash.

So to be a little bit more specific, on 2018, I mean, what we were pleased with is we saw 8% revenue growth year-over-year.

So our revenue grew by almost $500 million.

That led us to investing more in inventory, and then, of course, the constrained environment, it really give us an impact.

Our inventory turns, though, were down 1.2 turns.

So that had a material impact on it.

Our inventory grew by close to $300 million.

So we're not pleased with the cash flow performance that we had in 2018.

We lost $98 million of free cash flow.

But as we turn the page and go into 2019, the property proceeds we are confirmed on receipt -- on when we'll be now receiving them, we're expecting it in early March.

That's going to be in the range of USD 110 million.

But even excluding that, just from an operational perspective, we're expecting that as our portfolio -- as our revenue goes down in a single-digit range year-over-year, so we're not going be growing again $500 million.

And as we see some release in inventory as the constrained environment improves, we would expect to kick off cash.

And so we're expecting positive cash flow in 2019 operationally in addition to the property proceeds.

Your next question comes from the line of Paul Treiber from RBC Capital Markets.

Just wanted to help better frame semi cap.

What is the percent of ATS revenue is semi cap for you, and then how does that compare for Impakt?

So as you know, we don't break out the specifics of our individual segments, Paul, within ATS.

But we will reiterate that our A&D business is our largest business.

We are a leader in the market in the EMS space and that within our capital equipment business, that's our second-largest, inclusive of Impakt.

Overall, though, less than 10% of our total company's revenue.

Okay, for semi cap, specifically?

Capital equipment.

Okay.

And then shifting to CCS.

In light of the $500 million revenue that you expect, the disengagement revenue, how should we expect that over the next 12 to 18 months, the cadence of that coming out?

Yes, so the program review is largely complete, as Rob has mentioned.

And the impact in 2019 we're expecting to be in the neighborhood of just over $400 million.

So those programs, if you were to compare those programs, 2018 to 2019, we would expect revenue to be down about $400 million.

The annualized impact, though, of those programs, because some of it will flow into 2020, is around $500 million.

Okay.

And then I just want to touch on tariffs and Brexit as well.

The -- I think in the past you mentioned that tariffs, particularly in the [rest] of China may -- you may have an opportunity to gain share.

Have you seen anything like that in terms of program wins?

And then in terms of Brexit, how are you thinking about your manufacturing footprint in the U.K.?

And what are you -- from an operations point of view, how do you think -- or how are you [playing in] that business?

Yes, on the -- first one on Asia.

We've seen quotes for going into China way down and quotes for other regions way up.

And we've had some modest share gains over the quarter as customers are looking to shift work from other providers into our other factories outside of China as well.

So I'd say we're quoting on some work and we've gained some modest share gains, I guess, in Q4.

With respect to Brexit, we don't have a footprint in that region, if you will.

So it's largely -- not a huge concern.

It could have a secondary and tertiary supply base concerns, but we haven't dug that deep into it to kind of understand whether that's going to complicate our supply chains.

But right now, we're not seeing anything from our supply base or our customers that they're alarmed by it.

And in terms of the opportunity outside of China and Asia, how is your manufacturing utilization or capacity in those other regions?

Do you have room for further growth there?

We do.

So we have a very strong presence in Southeast Asia, as you are aware.

Right now -- we've mentioned in the past, just over $1 billion of our revenue comes out of China.

And there's a significant amount of our revenue that is manufactured in Southeast Asia.

We do have good levels of utilization.

We're running relatively consistently across our network in the close to 70% range, but we do have the ability to continue to onboard new programs.

Your next question comes from Todd Coupland from CIBC.

I wanted to ask you one follow-up on component market and free cash flow or releasing cash.

It was pretty striking with the peers seeing actually strong cash release in the fourth quarter.

What do you think the difference was between a couple of your peers calling this out and it really not hitting you yet?

Yes, so if you break down the components a little bit more, we continue to see strong performance in accounts payable in the fourth quarter.

Our AP days were relatively consistent.

The inventory unwind has not yet happened as we have discussed.

But we are seeing the material constrained environment improve slightly.

It's not flowing through all of our customer forecasts just yet, but we're expecting that to be coming into 2019.

But then, when you look at the receivables side, interestingly, we are seeing -- we did see at the end of the fourth quarter, a higher level of pullbacks from our customer than we normally do.

There are no issues with those receivables, but just certain customers managing their own cash flow generation.

And we don't expect that to be repeating as we move into Q1.

So we are expecting a good level of cash generation in 2019.

But you're right, we did not see it in the fourth quarter.

And the rhythm and visibility to that inventory unwind, how should we think about that as you go through the year?

So it's a customer-by-customer discussion, and it's ensuring that the customers who have been buffering their forecast don't do that as much.

It also links into the portfolio review discussions that we've had.

As a reminder, our focus really is on ROIC.

And the conversations that we've been having with our customers are how do we drive the right levels of ROIC.

And if invested capital in those accounts are going to continue to grow, frankly, you really only have 1 of 2 levers.

You either bring that invested capital back under control or you have to talk about pricing.

And so those are discussions that have been taking place now for probably close to 9 months.

We've been seeing some positive results as a result of that, but those conversations also continue.

And we have customers who understand that, and we're working with them really on a customer-by-customer basis.

Okay.

And then my second line of questions was on the display market.

Can you just give us a little idea on the rhythm and the types of programs we should watch for as that picks up later in the year?

Sure.

So right now, I guess there's no surprise, there's little need for capacity for OLED phones.

But there is a demand for larger screens and improved technology in TVs and tablets and foldable phones.

They're going to come in larger form factors.

Those larger form factors have higher ASPs and higher complexity, and all that plays to our strengths based on our vertical integration capability, engineering capability in Korea.

And there's going to be -- we're tracking lots of capacity adds in terms of new fabs that's going to need this new equipment to make these new form factors, if you will.

Timing is somewhat variable.

Some of it is demand factor, some of it is construction.

Some of it is proof-of-concept for some of these new technologies.

Some of it is other suppliers pacing the way because the equipment has to go into the fab in an orderly fashion.

But we are very optimistic that those -- those products have already been announced to the marketplace, so it's just a question of when the equipment will be purchased and produced.

(Operator Instructions) Your next question comes from the line of Jim Suva from Citi.

When you talk about the disengagements, which I believe is about a run rate of $500 million, can you kind of back us up and remind us about the decision tree that went into that?

Was it customers that are leaving Celestica that you don't see a long-term viability to do business with?

Or individual programs?

And is it more they became end-of-life or the customer wanted better pricing?

Or kind of what changed from when you bid these out originally when, at that time I imagine, they were quite attractive?

Jim, the majority of these -- the overwhelming majority, I should say, of these programs are these configure-to-order type of programs or fulfillment-type services programs.

So they're characterized by very low margin.

When we originally bid these programs, they -- even though they had low margin, they had very strong turns, very strong ROIC.

And due to the high level of material constraint and the forecast variability, the turns model fell off.

And when you combine that with the low-margin nature of this work, it just stopped adding shareholder value, if you will.

So the decision tree was really just around approved economics whether we could improve the turns profile of the business or the margin profile of the business to get the ROIC.

And in some cases, we're able to work with our customers and do that.

And in other cases, it wasn't in our best -- both of our best interests to continue, and that's leading to the disengagement, really around shareholder value.

Yes.

And what I'll just add, Jim, that it's program specific.

And so we have -- it starts with talking to the customer, and to your point, when we enter into engagements with customers, there is a strategic rationale for doing so.

But there's also an assumption on the economics that we are undertaking.

And so we look at it on a program-by-program basis.

And when a program is underperforming, we, of course, realign that it continues to be strategic.

And when it is strategic, we have conversations with our customers on how do we improve the economics.

And the focus primarily is around ROIC.

And then as I mentioned in my other remarks to another question, there's really 2 areas that we look at, and it's invested capital and we look at profitability.

In the areas that Rob had mentioned, with the inventory growth that has happened in the industry over the past year, what were marginally attractive economics on fulfillment, those economics quickly unwind in a constrained inventory environment.

And which is why when you look at the programs that we're disengaging from, they're largely in the fulfillment area.

And then for your Q1 outlook, on your slides, you gave the 3 different end markets.

You mentioned enterprise down, if I remember correctly, mid-20% year-over-year.

Is that where all the disengagements are?

Or is that demand of server and storage falling off that much?

Or are you disengaging from a customer in that segment?

It is predominantly program disengagements that are taking place within the enterprise.

And you're right, it is down in the mid-20s, and we're seeing it primarily in the storage area.

That's driven by the portfolio review, and some of that is also offset with some strength we're seeing in flash.

Yes, we are seeing some program ramps that are offsetting it.

Okay.

Then my last question is year-over-year your Q1 outlook for March versus a year ago, the revenues are relatively flat, but the EPS is disproportionately lower year-over-year.

Am I correct that's due to the wind-down of the disengagements?

Or is it like shifting in these new display and the acquisition integration, some ramping?

Or what's the disconnect between relatively flat year-over-year revenues yet the earnings and profitability not being similar?

Yes, so it is -- the profitability is, of course, down.

And then with the $600 million of additional debt that we took on to finance the acquisitions, the higher financing costs are flowing through as well.

And of course, profitability, as mentioned, is being driven by capital equipment.

Okay.

And then just housekeeping, what interest rate -- or interest amount should we kind of put in for a quarterly run rate dollar amount?

I think if you assume around $12 million for the first quarter and hold that steady through the year, that's adequate.

There are no further questions at this time.

Mr. Rob Mionis, I'll turn the call back over to you.

Thank you.

We continue to execute on our strategy that we put in place 3 years ago, and I think we're making solid progress.

Within CCS, we stabilized our business and we returned the business to target margins.

Within our ATS franchise, we have a very strong business.

We're a market leader in A&D.

We've been growing our HealthTech and industrial business by double digits year-over-year.

And as we mentioned, within capital equipment, we're taking the appropriate actions to drive profitability at these revenue levels.

And when the volume returns in that business, we will be better positioned to further drive profitability with -- through improved operating leverage.

We look forward to updating you on our progress on our next call, and also, that coincides with our AGM in April as well.

Thank you, and have a good evening.

Have a good evening, everyone.

This concludes today's conference call.

You may now disconnect.