Celestica Inc (CLS) 2019 Q1 法說會逐字稿

Good morning.

At this time, I would like to welcome everyone to the Celestica First Quarter 2019 Results Conference Call.

(Operator Instructions) Thank you.

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

Good morning and thank you for joining us on Celestica's First Quarter 2019 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 US Private Securities Litigation Reform Act of 1995 and applicable Canadian securities laws, 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 assumptions as well as further information concerning financial guidance, please refer to today's press release including the cautionary note regarding forward-looking statements therein, our Annual Report on Form 20-F and our other public filings, which 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 non-IFRS measures including operating earnings, operating margin, adjusted gross margin, adjusted return on invested capital or adjusted ROIC, free cash flow, gross debt to 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 to 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 US GAAP and use non-GAAP measures to describe similar operating metrics.

We refer you to today's press release and our Q1 2019 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.

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

As a reminder, we adopted IFRS 16 on January 1, 2019.

IFRS 16 has eliminated a distinction between operating and finance leases.

As a result, we recognized approximately $112 million in new right of use assets and lease liabilities as of January 1 and related depreciation charges of approximately $8 million and interest expense of $1.5 million during the quarter.

The impact of adopting IFRS 16 on our non-IFRS operating margin and non-IFRS adjusted EPS was immaterial and do not affect our non-IFRS free cash flow.

Also commencing in Q1 2019, we have modified how we calculate each of the non-IFRS adjusted ROIC and non-IFRS free cash flow to be consistent with prior representations.

Please see our earnings release for details on these changes.

Let me now turn the call over to Rob.

Thank you, Curtis, and good morning.

Celestica's first quarter results reflect volatility in some of our key end markets with revenues slightly below our guidance range and non-IFRS adjusted EPS at the low end of our guidance range.

Our capital equipment business performed generally in line with our expectations, as the demand environment appears to have stabilized at the depressed levels we experienced in the fourth quarter of 2018.

Additionally, our communications end market was weaker than expected with the linked quarter demand softness in some of our traditional OEM customers.

We expect this softer demand environment in both capital equipment and communications to continue into the second quarter.

We are responding to the current environment by aligning our cost to the current revenue levels while staying focused on our long-term goals and the execution of our transformational strategy.

I will provide you with an update on the status of our strategic initiatives and our priorities for the rest of the year shortly.

But first, I'll let Mandeep review our first quarter results and second quarter guidance.

Thank you, Rob, and good morning, everyone.

For the first quarter of 2019, Celestica reported revenue of $1.43 billion, a decline of 4% year-over-year.

This was slightly below our guidance range, primarily due to late quarter demand softness from certain communications customers.

Our non-IFRS operating margin was 2.4%, down 60 basis points year-over-year and below our guidance midpoint of 2.6%.

Non-IFRS adjusted earnings per share were $0.12 at the low end of our guidance range.

Our ATS segment revenue was 40% of our consolidated revenue and grew 9% year-over-year but was slightly below our expectations, largely driven by material constraints in A&D.

The increase year-over-year was driven by strong growth across our A&D, Industrial and Healthtech businesses as well as the impact of acquisitions, partially offset by significant demand reductions in our capital equipment business.

CCS segment revenue was down 12% year-over-year, driven by actions stemming from our CCS portfolio review as well as late quarter demand softness in our communications end market.

Within our CCS segment, the communications end market represented 39% of our consolidated revenue in the first quarter, flat with the 39% level in the first quarter of 2018.

Communications revenue in the quarter was down 5% year-over-year below our expectations, as lower-than-expected demand in traditional OEM programs more than offset the demand strength and new program revenue in support of data center growth.

Our enterprise end-market represented 21% of consolidated revenue in the first quarter, down from 25% in the first quarter of last year.

Revenue in this end market decreased 21% year-over-year in line with expectations, driven primarily by actions from our CCS portfolio optimization initiative.

Our Top 10 customers represented 62% of revenue for the first quarter, down from 69% the last quarter and down from 71% from the same period last year.

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

Turning to segment margin.

ATS segment margin was 2.6% , down from 5.2% in the first quarter of 2018.

The year-over-year decline was driven primarily by losses within our Capital Equipment business at a level similar to last quarter, as well as lower segment margin contribution in the remainder of our ATS business.

In A&D, we experienced margin pressure due to shortages of high reliability parts resulting in operational and material inefficiencies.

In our Industrial and Healthtech businesses, we are generating margins below target as we ramp multiple programs across the network as a result of strong bookings in the last two years.

We believe that as the material constraint environment in A&D improves and as the programs being ramped reach steady state, we will see an increased level of profit contribution.

CCS segment margin was 2.3%, up from 1.7% year-over-year, driven by improved mix and productivity, partially offset by lower revenue.

Moving to some other financial highlights for the quarter.

IFRS net earnings for the quarter were $90.3 million or $0.66 per share compared to $14.1 million or $0.10 per share in the same quarter of last year.

Higher year-over-year IFRS net earnings were the result of the gain on the sale of our Toronto property, partially offset by lower operating earnings and higher financing and amortization costs.

Adjusted net earnings for the quarter were $15.8 million compared to $33.9 million for the prior year period.

Adjusted earnings per share of $0.12 represents a decline of $0.12 year-over-year, driven by lower operating earnings and higher interest costs.

Adjusted gross margin of 6.6% was down 60 basis points sequentially, primarily due to lower CCS revenues and weaker ATS performance.

Adjusted gross margin was flat year-over-year.

Our adjusted SG&A of $51 million, in line with our guidance, was up $4 million year-over-year.

As a percentage of revenue, adjusted SG&A was 3.6%, up 50 basis points year-over-year.

The increase in SG&A year-over-year is primarily driven by Atrenne and Impakt.

Non-IFRS operating earnings were $35.1 million, down $24.6 million sequentially and down $9.6 million from the same quarter last year.

Our non-IFRS adjusted effective tax rate for the first quarter was 27%, higher than our annual guidance range of 19% to 21%, driven primarily by unfavorable profit mix in different geographies, offset in part by taxable FX benefits.

Non-IFRS adjusted ROIC of 7.9% was down 710 basis points sequentially and down 650 basis points year-over-year driven by lower operating earnings.

Moving on to working capital.

Our inventory at the end of the quarter was $1.1 billion, a decrease of $12 million sequentially.

Inventory turns were 5.0, down 1.0 turns from last quarter and down 1.4 turns from the same quarter of last year.

Our teams have been working diligently on improving our working capital, which I'll explain in more detail shortly.

Capital expenditures for the first quarter were $20 million or 1.4% of revenue.

We completed the sale of our Toronto property in March and received total proceeds of USD 130 million, slightly higher than our original estimate of $110 million.

Non-IFRS free cash flow was $145 million in Q1 compared to negative $34 million for the same period last year, driven primarily by the completion of the sale of our Toronto property, but also due to improved working capital.

Excluding the Toronto property sale proceeds, free cash flow was $32 million in the quarter.

We're pleased with the improvement in free cash flow this quarter, especially given that seasonality and variable incentive compensation typically are headwinds to our cash flow in the first quarter of our fiscal year.

As we progress through the year, we expect to see further free cash flow generation, primarily driven by the unwind of inventory as we execute on our portfolio optimization actions.

Cash cycle days in the first quarter of 69 days increased 14 days compared to the fourth quarter of last year.

Higher cash days were driven by an increase in accounts receivables days as well as inventory days, partially skewed higher this quarter due to the large sequential decline in revenue.

We've been experiencing elevated levels of inventory the last several quarters, driven primarily by material constraints.

To partly mitigate these headwinds, we have been working with our customers and suppliers to drive working capital efficiency and we're starting to see momentum from these efforts.

Our accounts payable performance has improved to 70 days from 65 days sequentially and from 62 days year-over-year.

Additionally, our customer cash deposits have increased to $120 million as of March 31, up from $58 million at the end of last December.

We expect this balance to partially decrease in 2019 as we work with our customers to unwind inventory.

Starting this quarter, we are including the impact of cash deposits in our determination of cash cycle days as we believe it provides a more representative view of our working capital.

Days in cash deposits in the quarter were negative six days compared to negative two days in the first quarter of 2018.

Moving onto our balance sheet.

Our cash balance at quarter end was $458 million, up $36 million sequentially and up $22 million year-over-year.

We've made progress towards deleveraging our balance sheet in the quarter by reducing the balance of our bank revolver from $159 million on December 31 to $97 million as of March 31.

During the quarter, we made a repayment of $110 million against our revolver, which was partially offset by a drop of $48 million primarily for share buybacks.

Our net debt position at the end of March was $236 million and gross debt to non-IFRS adjusted EBITDA leverage ratio was 2.4 times compared to 2.6 times as of December 31.

We are pleased that we continue to maintain a strong balance sheet and remain confident in our long-term capital allocation priorities, focused on continued improvements in free cash flow and returning part of our capital to shareholders, paying down debt and investing in the business to drive long-term profitable growth.

These investments include CapEx in the business to support growth and may include targeted strategic M&A intended to enhance our capabilities or increase our scale.

This quarter, we actively executed on our share buyback program, repurchasing 5.1 million shares at a cost of $44.5 million representing over two-thirds of the 7.5 million shares we expect to cancel under our current normal course issuer bid.

Restructuring charges related to our cost efficiency initiatives were $7 million this quarter, bringing the total program spend to date to $51 million.

Based on our current plans, we anticipate spending near the high end of the $50 million to $75 million program amount with an expected completion by the end of 2019.

Now turning to our guidance for the second quarter of 2019, we are projecting second quarter revenue to be in the range of $1.40 billion to $1.50 billion.

At the midpoint of this range, revenue would be down 14% year-over-year.

Second quarter non-IFRS adjusted net earnings per share are expected to range between $0.09 to $0.15.

At the midpoint of our revenue and adjusted EPS guidance ranges, non-IFRS operating margin would be approximately 2.4%.

Non-IFRS adjusted SG&A expense for the second quarter is projected to be in the range of $53 million to $55 million.

Based on the projected geographical mix of our profit in the second quarter, we anticipate our non-IFRS adjusted effective tax rate to be similar to the first quarter.

As a result of the higher tax rate we are experiencing in the first half of 2019, we expect our non-IFRS adjusted effective tax rate on a full year basis to be in the mid-20% range, excluding foreign exchange impacts and one-time tax settlements.

As we exit the year though, we are targeting to return to our previously guided annual range of 19% to 21%.

Turning to our end market outlook for the second quarter, in our ATS end market we are anticipating revenue to be up low single-digits year-over-year.

Although, we are seeing strong growth across most of our ATS segments, this growth is being largely offset by the softness we are seeing in the capital equipment market.

In our communications end market, we anticipate revenue to decrease in the high teens range year-over-year driven by continuing demand softness in this end market.

In our enterprise end market, we anticipate revenue to decrease in the low-30% range year-over-year, primarily driven by actions from our portfolio optimization initiative.

I'll now turn the call over to Rob for additional color and an update on our priorities.

Thanks, Mandeep.

Notwithstanding the challenging demand environment we are currently facing, I'm encouraged by the traction we are experiencing across most of our ATS segment, which now represents 40% of our consolidated revenue, up from 33% of revenues in 2018.

Although this increased level of ATS segment revenue concentration was partly due to the accelerated reduction in CCS revenues, we believe that an increased level of profit contribution from ATS will lead to expanded margins for the company over time.

Turning to the quarter, within ATS, we had strong double-digit year-over-year revenue growth in our A&D, Industrial and Healthtech businesses, helping to offset the soft demand environment in capital equipment.

A&D benefited from new program wins and the acquisition of Atrenne, which performed above expectations in its first year under Celestica ownership.

As Mandeep referenced, growth of our A&D business was impacted by material shortages in the quarter.

This has resulted in a growing backlog in A&D, which we expect to gradually improve as we move through 2019.

In our capital equipment business, the cyclical pressures and the semiconductor demand environment continued and as discussed last quarter, we believe this soft demand environment will persist for the remainder of 2019.

On the display side, we believe programs that we had anticipated to ramp in the second half of 2019 will be pushed out into 2020.

Although we are currently seeing soft capital equipment demand in both the semiconductor and display markets, we continue to believe that the longer-term market fundamentals are promising.

In addition, we are encouraged by the strong bookings we've had in capital equipment over the last 18 months, including wins in an emerging power and signal distribution business and our first synergistic with Impakt.

Turning to CCS.

The soft demand we saw in the quarter was driven by the unwinding of customer inventory buffers and mix volatility, driven by next generation technology.

We expect these dynamics to continue into the second quarter, which is reflected in our outlook.

If the softening of the communications end market persists into the second half of this year, we expect total company revenues for 2019 could be down in the high single-digits percentage range on a year-over-year basis.

The industry dynamics within our CCS segment are changing, as emerging technologies enable new business models that disrupt our traditional OEM customers.

This trend has resulted in demand pressure for traditional OEMs but has also helped with the emergence of a new class of customer such as cloud-based service providers.

Celestica is well positioned to serve these new entrants, as well as OEMs as the value proposition from higher value-added services such as JDM become important differentiators.

We expect that over time, growth in these customers will help offset declines in business with our traditional OEM customers.

In this very challenging demand environment, we're taking a series of actions to improve our overall profitability.

This includes accelerating our integration of Impakt, accelerating our productivity initiatives and completing the ramp of multiple programs across our ATS segment.

Looking beyond 2019, we intend to keep driving towards our goal of achieving operating margins in the target range of 3.75% to 4.5% for the first half of 2020.

There are some key drivers required to achieve this margin range.

In ATS, a key priority is restoring ATS segment margins and operating to the mid to higher end of its target range of 5% to 6%.

To do this, first, we need the current demand environment in capital equipment to improve to levels seen before the current downturn.

While we are executing actions with the business to better align the cost structure to current demand levels, we are mindful of maintaining our critical mass in our capital equipment business, so that we are well positioned for a return to growth.

Second, we need a stable materials environment, so we can maximize both labor and material efficiencies.

And finally, we need to successfully ramp the new programs in our Industrial and Healthtech businesses to their intended levels of profitability.

In our CCS segment, the key priority is maintaining CCS segment margins within its target range of 2% to 3%.

We intend to achieve this by focusing on two areas.

First, completing the actions from our CCS portfolio review, which we expect to finish by the end of 2019.

And second, continuing to drive high levels of cost productivity in a volatile demand environment.

As we navigate through this challenging environment, we expect 2019 to be a rebuilding year.

We remain focused on our transformation strategy intended to drive increased revenue and earnings diversification and sustainable and consistent profitable growth.

I believe the near-term actions we are taking will drive improved profitability as we progress through 2019 and that these actions are consistent with our long-term margin expansion goals.

Celestica has shown repeatedly in the past that it can rebound from market challenges such as these supported by the hard work and perseverance of our employees.

I want to thank all of our employees for their dedication and determination.

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

(Operator Instructions) Your first question comes from Thanos Moschopoulos of BMO Capital Markets.

Your line is open.

Maybe starting off on the A&D side, can you elaborate a little bit on the component shortages you're experiencing, what components we're talking about and what color do you have as to when that might alleviate?

Hi, Thanos.

This is Rob.

Yes, we seeing some severe material constraints on high reliability [passives] -- capacitors, if you will, large case MLCCs.

We've had decommits from several suppliers across the supply chain.

We think based on their action plans, it's going to gradually improve as the year gets long.

But we think this is going to be a constraint for most of 2019.

Okay.

And then, on the semi side, I believe you said that the semi losses were the same as last quarter.

I had hoped we'd see a little bit of sequential improvement from cost actions.

Should we expect to see that in the upcoming quarter, and might you be able to quantify the size of the semi drag on Q1?

Yes.

Hey, Thanos, this is Mandeep here.

So the loss was similar to the last quarter.

As you'll recall, we had indicated that that was in the mid-single digit range, millions of dollars.

And so we saw something relatively consistent in the first quarter.

We are taking a number of restructuring actions.

We're also in the process of ramping the number of programs, integrating Impakt as you know.

And so the actions that we're taking we believe right now will lead us towards profitability near the end of the year and that's going to be a result of the cost actions we're taking.

We continue to believe that the depressed market levels will continue through 2019.

There are some external parties that are a bit more optimistic on the back half of the year, but we are adjusting our cost structure assuming that that's not going to happen.

But I guess the message from you guys is, relative to last quarter, you really haven't seen any tangible signs of a recovery at this point.

We haven't.

But at the same time, we haven't seen it getting a lot worse either.

We believe that the market has stabilized at these low levels and we expect that it'll continue for the remainder of the year.

Thanks, guys.

I'll pass the line.

Thanks, Thanos.

Your next question comes from Robert Young of Canaccord Genuity.

Hi, good morning.

Outside of A&D, some of your CCS customers are eating into their buffer inventory, is that an indication that the supply constraints are getting better in that part of the business or is that still a problem?

Hi, Rob.

Yes, I think it is.

We are seeing CCS customers eating into their buffers, which is really showing the improved supply chain volatility in the commercial side.

The small case MLCCs are getting better memory, obviously, is getting better.

But what we saw in communications this quarter is the unwinding of buffers.

We also saw some product technology transitions as some products phase out, new products are phasing in, there's a pause in demand curve when that happens.

So we experienced some of that in this quarter as well.

Okay.

And then I guess the second question from me, you said that you'd be looking at targeted M&A, maybe if you could just refresh us on generally on your appetite for M&A?

A lot of changes like going on -- this year you said is a transition year and so just refresh your appetite here in 2019 for M&A?

Sure.

So, in the short term, we're very focused on Impakt.

We completed the integration of Atrenne and we're now focused on Impakt.

We do have an active M&A pipeline, but I would say we're looking for niche capabilities in the short term to fill in very specific holes in our strategic plan and our capability offerings.

And last question, the CCS portfolio reviews that is mostly done, is there any change in the timeline or the expected size is still $500 million revenue rationalization?

And then I'll pass the line.

Yes, it is done in the sense that the review is complete.

We've identified the programs and they are actively underway, if you will, the train has left the station.

And we -- this time we're seeing relatively consistent forecasting from the remainder of the enterprise businesses.

When we had talked about some of the softness in CCS, it's primarily in the communications end market for many of the reasons that Rob mentioned.

Okay.

Thanks, I'll pass the line.

Thanks, Rob.

Your next question comes from Matt Sheerin of Stifel.

Yes, thank you.

Just following up on the last question regarding the enterprise business, I know that you've got some programs unwinding.

Could you give us an idea -- I mean, if the rest of the business remains stable, what sort of revenue run rate we should be expecting the business ending or let's say entering 2020?

Yeah.

So, hey, Matt, good morning to you, early good morning.

Overall, the majority of the portfolio actions we're taking are in the enterprise space.

And we believe that that is not going to be offset with the significant level of demand.

The market itself is growing in the very low single-digits right now, and then when you look at the programs specific to where we play, there are some pluses, in some areas we're seeing some additional growth happening in areas like Flash, we're seeing a little bit softness in areas like server.

So we expect the remainder of the enterprise portfolio to be relatively flat through 2019.

Okay.

Yes.

Right.

My point is that the run rate we should be expecting for the business is in that kind of environment.

You talked about $500 million or so going away.

So is it like a $1.2 billion number?

Yes.

Is that kind of a fair number to think about?

Yes, I think the way to think about it is we did $1.7 billion last year.

$500 million is going to come out of that $1.7 billion.

We should be exiting the year -- pluses and minuses as we go off course, but based on what we can see right now, an exit of $1.2 billion is probably reasonable.

And you talked about just relative to this -- these programs in your inventory, your working capital.

I would imagine that should have a very -- a significant favorable impact on your free cash flow.

Yes, so on the free cash flow, we were targeting and we continue to target $100 million or more in a given year, when we were guiding towards revenue being down in the mid single-digits.

We believe that there will be an opportunity to go beyond that and if the revenue does soften, even more, as we said, could happen if the communications dynamics continue, then it would lead to a greater opportunity.

That being said, what you're seeing right now is we are pleased with the free cash flow we generated in the first quarter.

We have not yet seen the inventory unwind fully, which matches up with the revenue levels.

It's partially due to the material constraint environment just not fully improving, our lead times are still extended, but as the constraint environment improves and as revenue drops down, our inventory over time will adjust.

Okay.

And just within enterprise in the program's unwinding.

I know you've got both servers and storage.

Are you seeing programs go away in both areas or is it just one, servers, for instance?

It's primarily in the storage area, we do...

In the storage.

We do have some program disengagements on the server side, but it's primarily storage.

Okay.

And then communications, you talked about some of the reasons why you're seeing weakness from it and it sounds like your broader enterprise, traditional enterprise customers.

And are you seeing any share shifts or because of the lower demand or softer demand environment, more increased pricing, which could lead you to maybe exit some programs, as you said, you may be reviewing some of those businesses?

Yes, within communications, that is part of our portfolio review.

And we are taking some actions in the back half of the year on our communications portfolio.

Broadly speaking, what we're seeing in the communications space is disaggregation is creating new business models, infrastructure as a service -- or our OEM customers are getting disrupted, if you will.

There's an increased level of competition.

There's more choices for the end customer.

As a result of that, that's putting pressure on our traditional customers.

That being said, Matt, that's also creating a new opportunity for us with a new class of customer, and serving that new class of customer with our JDM portfolio and also with some traditional EMS services.

But, it'll take a bit of time to equalize those curves out, if you will.

Okay.

And just a last question from me, Rob, a bigger picture question for you.

You've been in the CEO role now for three years or so, and I know the intent was to turn the business around, really get into those diversified markets, and it seems like every two steps forward, we've had to take two or three steps back for different reasons.

Some reasons, obviously, not in your control.

It sounds like you're at the bottom here in terms of margins and the strategy is still moving ahead.

But what sort of word do you have for investors here, which probably have to wait through another two or three quarters really before we see signs of things turning around?

Yes, thanks for the question, Matt.

I would say we have absolute conviction that the strategy that we're pursuing is the right strategy.

What we experienced here in this quarter is a pushout of some higher calorie ATS demand and the cyclical down pressure of capital equipment.

And we also saw some pressure in the communications market, but the portfolio actions that we're taking are absolutely going to work, at least that's our belief, and the balance of the ATS portfolio is actually growing very nicely.

We've had a target to grow our ATS portfolio 10% per year organically over the long term.

And if you take out the depressed CE market, we're actually on track to do that organically.

So our ATS portfolio is performing quite well.

It's just given the cyclical pressures we're seeing here in capital equipment, it's making the comps and the overall results suppressed here in the short-term.

Okay.

Thank you.

Your next question comes from Todd Coupland of CIBC.

Hi, good morning, everyone.

Good morning.

I wanted to ask about the semiconductor business.

Obviously, the anticipated rally in many of the companies in this space has started to show through.

And I'm just wondering, what is a typical lag and why are you, I guess, seemingly not accepting those outlooks for recovery in the second half of the year?

Just sort of bridge that gap, which I would've thought you would've started to see in the second half of the year.

Thanks a lot.

Yes, so within semi cap, we're 11 months into the current cycle measuring peak to troughs.

The average cycle is about 17 months, so some of the optimists are saying toward the back half of the year we should see a little bit of a uptick.

However, when you look at the metrics, we're still seeing elevated inventory levels in memory.

Pricing is suppressed.

And when those two things are present, people don't start spending on CapEx until pricing recovers.

So we don't see any indicators right now that it's going to pick up in the second half of the year.

However, some people feel that it will.

Again, we're playing it conservative, such that we're allowing our cost structure for a down year.

But we'll be in a position to hopefully support that increase in revenue should it come in the back half of the year.

Todd, I'll just add to that to say the market dynamics are what they are and the demand upswing has not yet come through in terms of POs.

But what we're really pleased with is that, we're seeing a lot of market share gains happening.

We've had incredibly strong wins in 2018.

We've had strong wins so far in 2019, helped even more by the Impakt acquisition and the joint capabilities that we both bring to the market.

And so that's why we talk about the fact that the fundamentals are there over the longer term.

We're seeing those fundamentals being confirmed via the wins that we're getting.

We just haven't seen the demand pick up in terms of actual orders.

Okay.

Sounds good.

And then, just on the display side of the market, what's the dynamic that's caused the push out into next year?

I would've thought you started to see some of those next generation TVs actually start to sell in second half of '19.

So, just take us through that.

Thanks.

Yes, the display pushout is a combination of two factors, one is just the slower mobile cellphones going on.

That is a factor in your display pickup.

And also, the TVs, as you mentioned, a lot of the display spending is project based.

And when those big projects hit, they hit pretty fast and pretty hard.

And we were tracking them to hopefully start spending toward the back half of this year and decided for a variety of reasons, largely softer mobile phone sales in Asia, to push out by a quarter or so.

When it does return though, we do think it's going to be on the larger form factors, which have higher selling prices, higher complexity, and that plays to our strengths.

And during this down cycle, as we mentioned during the call, we're actually accelerating our integration activities and moving more of the capability to our lower cost regions.

We'll have a much more efficient network when the demand does curve and be able to respond in kind.

And to give us an idea what the potential leverage is when it returns, like what would be sensitivity to overall ATS growth?

Is there any way to give us a sense on display and semi cap coming back?

What that could mean to the top line?

Does it give you out-sized growth or does it just get you to the 10%?

Give us an idea on what that sensitivity could look like when it comes back?

Thanks a lot.

Sure.

Mandeep here.

So I'll talk overall ATS if I can.

If you exclude the capital equipment business, we're seeing strong organic growth happening in the rest of our portfolio moving toward the long-term 10% growth rate that we have been targeting.

And then, of course, we have M&A on top of that.

Capital equipment, of course, is materially down.

The margin profile of our capital equipment business, when it's running strong, is quite healthy.

Many parts of the programs are within our target range.

There are some programs that are accretive to our margin target range in ATS.

And then, of course, as we talked about with the Impakt acquisition, we were very pleased with the overall performance of that business.

Capital equipment, again, lost mid-single digit millions of dollars this year.

We're going to cut costs and adjust our cost structure so that we can get that business to a nominal level of profitability by the end of the year.

But then when demand returns, the profitability will grow from that and be expected to be in line with ATS overall margins.

And it should support us moving into the mid- to higher-end of our ATS target margin range when the volume returns.

The other thing I'll also add is, since it didn't come up, but the synergistic win that we just had between Celestica and Impakt, it was a competitive takeaway.

It was really won based on our joint capabilities.

The size of it relative to the business as a whole is pretty significant.

And it was really the function of our vertical integration and Korean footprint.

So that's just one example of how the value proposition is playing out.

We have a very strong sales pipeline or booking pipeline based on bringing those two businesses together.

So when market demand does return and we're able to get our integration accelerated like we're working on now, I think we'll be in a very good shape.

Thank you.

Thank you.

Operator, next.

Your next question comes from Gus Papageorgiou of Macquarie.

Hi.

I'm just wondering, can you discuss the JDM business and how it's doing, kind of, on a year-over-year basis?

And I know you're hoping that that, kind of, offsets a bit of your communications business.

Can you talk about the margin profile of your communications versus JDM and maybe the growth trajectories of the two?

Sure, I'll start off and let Mandeep finish.

JDM has been a strong growth for us over the last [few] years.

This year, we're not expecting similar growth.

It's largely driven that we have a higher base and some of the inventory buffers that our customers put in place are starting to unwind.

There's also going to be a little bit of an impact this year with some technology changes, HD going to Flash, 40G going to 100G and comps.

That being said, our bookings growth rate is still in double digits.

We introduced 13 new programs last year.

But this year, we think the growth might be a little muted based on just inventory buffers and technology transformations.

I'll let Mandeep comment on margins.

Yes, so overall the business has seen some significant levels of growth and we're seeing steady performance in 2019.

But there are the dynamics that Rob mentioned.

As we exited 2018, the business had moved EBIAT-wise to being in line with the overall CCS portfolio.

As we talked about for a while, the gross margins have been overall accretive, but there is a large investment that we make in that business.

But with the demand levels that it's at now, it's now moved the EBIAT margin to being largely in line with CCS.

As we continue to grow that business though, and continue to win new business, there should be some more leverage opportunity in the future.

Do you think it'll grow faster than the overall business going into next year?

Yes.

The product platforms that we are on have strong overall demand.

We're seeing good levels of bookings.

But because of some of the transitions happening in '19, it's a little bit more muted.

But we would expect to see growth moving into 2020.

Okay.

Thank you.

Thanks, Gus.

Your next question comes from Ruplu Bhattacharya of Bank of America Merrill Lynch.

Hi, Ruplu.

Good morning.

Thanks for taking my questions.

Just on communications, if you can just dig a little bit deeper into that?

So revenue is down 5% year-on-year.

I think you mentioned three things, right?

You said program disengagements, inventory buffer reduction, and reduced -- towards the end of the quarter, reduced demand.

Is there any way to quantify each of those three and the impact year-on-year either on a dollar basis or on a percent basis?

So, hey, Ruplu.

I'll give you a little bit more color at, maybe, the market level.

So as Rob had talked about, the bigger drivers were buffer inventory that our customers had built up over time.

But then there's also some impact from product transitions as well.

We've seen it primarily with our legacy OEM customers versus some of our newer service provider customers but there is that demand volatility across the space.

When you look at an end market level, we're seeing some strong growth overall in optical.

Optical systems is an area of strength right now.

Components was relatively flat.

But we are seeing the softness though across a number of the other lines of businesses.

Routing and switching is down, networking is down, including routers as well.

So it was relatively broad based, but optical systems was a little bit of a shining piece to it.

Okay.

Thanks for the color, Mandeep.

That's helpful.

And then just on inventory buffer reduction, is that now done or do you think there's still more of that happening in the June quarter?

I think it's going to take a couple of quarters for that to unwind.

Our estimate right now is as we exit Q2, the inventory buffers should have subsided but we'll have to assess that at that time.

Yes, so right now we have assumed in our guidance that the softness continues into the second quarter.

And then as we've indicated, should that softness continue beyond the second quarter, that's what would lead to further company margin or company revenue growth pressures moving from mid-single digits toward the high-single digits.

Okay.

Got it.

Okay, and the last question from me just on this is when we think about the -- you talked about technology transition.

Was that related to 5G?

And the softness you saw, was that on the enterprise communications side or on the telecom side?

Was there anything in particular that was weak?

Yes, part of it could be on the 5G; on the telcos, we believe what might be happening in the marketplace is that the telcos are causing some of their demand, if you will, waiting for next generation platforms to come.

So they're not investing as much in that 4G infrastructure.

So that could have a play to it.

The other thing that's also happening is just some of our traditional OEM customers are coming up with next generation products.

As soon as those are announced, there's always a little bit of a natural slowdown on the existing platforms until the new platforms get into market.

And we're seeing a little bit of that as well.

Okay, thank you for the color on this.

I appreciate you taking my questions.

Thanks.

Thanks, Ruplu.

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

Thanks very much.

Good morning.

Just on the late quarter demand softness in the communications market, could you just elaborate on the uncertainty at this point that could lead to the demand softness spreading into the second half of the year?

Yes, I would say it's a little bit more of the same.

Right now, we're under the assumption that the inventory buffers will take a couple of quarters.

But if there's more inventory buffers that kind of need to bleed out to the back half of the year, that would suppress communications down.

Also, what could suppress it down is just a longer adoption period on some of the new product technology transitions that are going on.

And then just broadly speaking, taking it up a level, the end-to-end customers have a lot more of a choice, putting more competitive pressures on our traditional OEMs.

So infrastructure as a service is just creating more pressure, I guess, on our traditional OEMs.

So if our customers lose share, if you will, or can't maintain share, that'll obviously have a negative impact on us as well.

Thanks.

That's helpful.

Within CCS, what's the proportion of revenue that relates to traditional OEM versus some of the new cloud providers?

And then related to that, are any of the new cloud providers in your Top 10 customer list?

Hey, Paul.

So we don't disclose right now the breakout between traditional OEMs and service provider.

What I can tell you is that we have been growing quite a bit with our service providers.

It's a diverse customer base, and it's a customer base that's been growing for a number of years both buying our JDM product but also not only in JDM.

That's the level of color that we're able to provide.

Okay.

And then, just one last one from me.

Just on uses of capital in the remainder of 2019, and, obviously, share repurchases have been quite strong in Q1.

How do you think about share repurchases going into the second half of the year?

Yes.

So we have, as you know, purchased 5.1 million shares, 7.5 million shares is what estimate is what we're going to be able to do under the NCIB.

That may flex up to 8 million.

It depends on how we spend on stock-based compensation.

But our intention right now is to complete the share buyback program in 2019.

We also expect to continue to generate positive free cash flow, which would be in excess of that.

And we intend to invest that excess free cash flow into paying down our debt further as well as investing in the business.

Okay.

Thank you.

Thank you.

Your next question comes from Jim Suva of Citi.

Your line is open.

Hey, this is Tim Young calling on behalf of Jim Suva.

Thanks for taking the question.

A quick follow-up question on communication softness from traditional OEM customers.

Are those customers within your current program review or outside of the program review?

So the program review that we've taken, the $500 million that we've identified, is largely within enterprise.

But as Rob had mentioned, our portfolio review consists of looking at all of our business.

But the revenue reduction that we're seeing in communications is not tied to the program disengagements.

It has to do with the end market volatility.

Got you.

So, is it possible that you expand this program review given the volatility in the market?

To some extent, as Mandeep mentioned before, the program review that we did, that review is complete.

But to another extent, we always evaluate current market conditions, current program profitabilities, our current network.

And we would make those decisions at the time if we need to expand it.

The program review that we did is as much about market and customers as much as line of business.

The programs that we've targeted for the review have several things in common.

They are low margin, low ROIC, low value-added solutions.

And as Mandeep mentioned, those largely impacted the enterprise space.

But if those traits fall into the communication space, then we would certainly look to take action both on the operational side, commercial side or on portfolio actions as well.

And Tim, just to remind everyone, the portfolio review was initiated by taking a look at the strategic nature of what we're doing with our customers.

And when we deemed that, it didn't necessarily have a strong strategic fit, and the financials were not reflective of the work that we're doing for our customers, that's when we began the work that we did.

And as a result, it landed largely in enterprise.

It's also largely landing in fulfillment type of business, which we have spoken about for a number of years as a business that is attractive to us when the margins are really good.

But if the ROIC model doesn't hold, it has not a very strong strategic fit for the company.

Got it.

That's very helpful.

Some of the supply chain companies mentioned softness in storage market.

Are you seeking similar weakness in the end market?

And if so like can you maybe give us some color on the dynamics in the end market demand and what you are going to deal with this softness?

Thank you.

Yes, broadly speaking we have seen weakness in HDD.

But we also are seeing some strength in our JDM -- our Flash programs, which are supported by JDM platform.

Based on our mix of business, growth in Flash only partially offsets the pressure that we're seeing in HDD.

Got you.

That's all my questions.

Now I'll pass the line.

Thank you.

Thanks, Tim.

There are no further questions at this time, I will now return the call to our presenters.

What we experienced in this quarter is a lower demand from a slight group of CCS customers.

That combined with weak capital equipment market created significant headwinds for us in the first quarter.

However, over the long-term, we're making the hard decisions to shape our portfolio and to expand it to higher value-added markets.

And we believe that this strategy is sound and, over time, that the actions that we're taking will improve our diversification and enable consistent profitable growth.

However, in the short-term, we're going to work through these headwinds with an eye towards the mid-term prize.

When our end markets recover, we will be well positioned.

Thank you for joining this call and I look forward to updating you as we progress throughout the year.

This concludes today's conference call.

You may now disconnect.