Celestica Inc. (CLS) Q4 2009 Earnings Report, Transcript and Summary

Good afternoon. My name is Amanda, and I'll be your conference operator today. At this time, I would like to welcome everyone to the Celestica’s fourth quarter and year-end results conference call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. (Operator instructions) I will now turn the conference over to Mr. Carpino, Vice President of Investor Relations. You may begin.

Thank you, Amanda, and good afternoon everyone and thank you for joining us on Celestica’s fourth quarter conference call. On our conference call today will be Craig Muhlhauser, President and Chief Executive Officer and Paul Nicoletti, Chief Financial Officer. Craig and Paul will provide some brief comments on the quarter and then we’ll open up the call for Q&A. Copies of the supporting slides accompanying this webcast and supplemental information can be viewed at Celestica.com during the call. This conference call will last approximately 45 minutes and after the call we can be reached for follow-up questions. During the Q&A, please limit yourself to one question and one follow up to ensure everyone on the call who would like to ask a question has the opportunity to do so. You’re welcome to get back in the queue after you ask your question. Please note that starting with the fourth quarter, to be consistent with our major peer group, we have aligned our definition of adjusted net earnings and other non-GAAP profitability metrics to exclude all stock-based compensation expense, that is, both option expense and restrictive stock expense. Prior to this quarter, only option expense was included in these definitions. All adjusted earnings and profitability metrics discussed today for the current quarter, prior periods and future periods reflect the new definition. We have provided detailed quarterly and annual information in our webcast slides as well as supplemental information in our press release and on our Web site that highlight this change. We have also included comparisons showing adjusted earnings and various other operating metrics using both the previous and new definitions as well as a reconciliation to GAAP results where applicable. Please note that current external analyst models and First Call estimates for the fourth quarter, full-year 2009 and future periods…

Thanks, Paul, and good afternoon everyone. Celestica delivered strong results in the fourth quarter and continued to build on our track record of meeting or beating our commitments to our shareholders. Five of our six end markets had sequential revenue growth for the quarter and have begun to exhibit signs of a modestly improving demand environment. We had sequential revenue growth of 7% in the December quarter with servers, storage, consumer, enterprise communications and our industrial, aerospace, defense, and healthcare segment all showing sequential growth. Company revenues for the fourth quarter were 14% below the comparable period in the fourth quarter last year, although consumer and storage grew 1% and 25% respectively. Operating margins for the quarter were 3.6% and continued to reinforce Celestica’s commitment to achieve profitable growth and strong returns. For the full-year 2009, we averaged 3.5% operating margin which represented our best full-year operating margin performance in more than five years. This was achieved despite a year-over-year revenue reduction of 21% as many of our end markets were negatively impacted by the global economic recession and financial crisis. Despite this environment and these external factors, Celestica was able to achieve industry-leading financial performance through continued focus on operational excellence and delivering improved quality, shorter cycle times, greater flexibility, increased cost productivity, better capacity utilization and cost reductions in 2009 across all aspects of our business. Good example of our financial discipline was evidenced in the reduction of our SG&A spend for 2009, which on an absolute dollar level was also the lowest spend in over five years. Celestica continued its industry leadership in inventory turns and return on invested capital this quarter. For the fourth quarter, our inventory turns were 9.1 and our return on invested capital reached a 27.5%, the best in the company's recent history.…

Thanks, Craig, and good afternoon. Revenue for the fourth quarter was $1.66 billion compared to $1.94 billion in the fourth quarter last year, and $1.56 billion in Q3 of this year. Lower revenue primarily from our telecommunications and enterprise communication segments accounted for a significant portion of year-over-year decrease offset somewhat by growth in our storage segment and a stable consumer segment. On a sequential basis, revenue from all of our end markets increased except for the telecommunications market which was flat. Looking at our revenue by end market for the fourth quarter; the consumer segment was 32% of sales and grew 7% sequentially. Enterprise communications grew 5% sequentially and represented 20% of sales. The server segment represented 14% of sales and delivered 17% sequential growth. Storage accounted for 13% of sales and increased 9% from the September quarter. Telecom was 11% of revenue unchanged from Q3, and finally industrial, aerospace, defense, healthcare came in at 10% and had a 4% sequential growth. Moving to our customer concentration; our top 10 customers represented 72% of revenue for the quarter and our top five were 51% of revenue. We had two customers with revenue greater than 10% in the quarter. Research In Motion represented 17% of total revenue for the full year of 2009 and 21% of total revenue for the fourth quarter of 2009. GAAP net earnings were $31.1 million or $0.13 per share. Included in GAAP earnings was a $24 million non-recurring recovery from a legal proceeding and a $10 million gain on the redemption of the 2011 notes, offset by a $10.9 million mark-to-market impact of stock-based compensation in the quarter, $14 million in restructuring and a $12 million impairment charge against property, plant and equipment. These results compared to a GAAP net loss of $822.2 million or…

(Operator instructions) Your first question comes from Joe Wittine. Your line is open. Joe Wittine – Longbow Research: Hi, good afternoon. Joe Wittine with Longbow Research. Can you hear me okay?

Could you speak up just a hair? Joe Wittine – Longbow Research: Yes, sure.

Thank you. Joe Wittine – Longbow Research: My first question is last time around we spoke about intensifying price competition I guess in the consumer segment in particular. Just curious if there is an update there that’s changed at all, particularly considering that the pipeline is still robust from your perspective?

Yes, I think we have got a robust pipeline pretty much across all of our segments. We do see continued price competition across all markets. I wouldn’t say consumer is any more hyper-competitive than the rest of the industry. So I would say, it’s generally price competitive market, but obviously for the right customers and the right opportunities, they recognize the value of Celestica. We're comfortable that we’ve got the right outlook. Joe Wittine – Longbow Research: Got you. And then just as a quick follow up, the numbers for your top customer is 17% for the year and 21% during the fourth quarter. Just curious is there any risk from your perspective as far as that being above the comfort zone of your view or the top the customer? Has that been discussed yet?

We don’t believe there is any risk. We have a very strong relationship with these customers. So this customer, we are comfortable on supporting their future growth as needed. So obviously we expect other growth from other segments as we mentioned given the strength of the market that we see in our target segment. So we expect this concentration to reduce over time. Joe Wittine – Longbow Research: All right, thanks so much.

Thank you.

Next question comes from Sherri Scribner from Deutsche Bank. Your line is open. Sherri Scribner – Deutsche Bank: Hi, thank you. Craig, I was hoping you could speak a little bit more about your strategy of expanding into engineering services? You mentioned acquisition, and just trying to get a sense of really flushing out what your plans are there? And also if that becomes a bigger piece of your business, is that something you would break out? Can you give us a sense of the size of that right now and where you think that goes?

Sure, I think the strategy as we have articulated is really four-pronged. First of all, to raise the bar of the existing operating performance in the company; we are expanding into the higher value added services, as you mentioned, engineering and design services as well as our aftermarket services. We are looking at new markets, primarily healthcare, aerospace and defense, industrial and alternative energy. And then we want to build a much stronger vertical and support aftermarket service in support of our customers. The engineering services are defined broadly. We have got large scale engagements and with some customers in some facilities, primarily with our large OEMs in the areas of design, in the areas of sustaining engineering, in the areas of failure analysis, root cause and corrective action. We also do a large amount of MPI business for I would say the highest end of the technologies for some customers that we don’t do any manufacturing for. So what we are doing is we’ve created the ability for us to accelerate the learning across the network as to why that makes sense in some facilities and that doesn’t make sense in others. So the strategy is around expanding the share of our business in the area of sustaining engineering, design service and support of our customers, root cause failure analysis, corrective action and product introduction, and to do that with more of our established customers and also create a foothold in our new customers. And I think over time it will be focusing on showing margin expansion in the core of our business by doing that. We will continue to evaluate the transparency on how we give you better color. So you can monitor the success of the implementation and the deployment of this strategy. So that’s sort of an ongoing evaluation and you can expect us to be more forthcoming in that type of segmentation as these things begin to take hold. Sherri Scribner – Deutsche Bank: And can I assume acquisition to be sort of similar to the Invec acquisition or sort of –

Very much, especially in areas where we don’t have a large established market position like health care for example. So you are absolutely right. We’ve got strong positions in the computing, we’ve got strong positions in the consumer, and strong positions in the sense of server and storage design capabilities. We’ve got strong positions certainly in the telecommunication space in particular and wireless and optical. So you can see us enhancing those capabilities but more importantly building the breadth of our engineering capability outside of our traditional markets. Sherri Scribner – Deutsche Bank: Okay, great. Thank you.

Thank you, Sherri.

Next question comes from Lou Miscioscia from Brigantine Advisors. Your line is open. Louis Miscioscia – Brigantine Advisors: Okay, thank you. Wonder if you can talk about your larger customer now in the sense of, if you look to grow the customer in 2010 or do you think that that you will look to grow other businesses to get a little bit more diversification there?

Our mix of business with our largest customer has grown significantly in 2009, and it’s really driven by their success and fortunately it’s driven by our success in being able to be growing with them in their fastest growing programs and the mix of products we provide is a broad mix across their, I’ll say, product life cycle. Obviously, end market demand will affect the future success of the engagement, but we are very, very optimistic both in terms of our relationship we are establishing some strong competencies in our ability to support their product launch capability. And as I mentioned, prior to this question, the encouraging thing for all of this year is the fact that we expect growth in other segments to begin to mitigate the concentration which is very encouraging based on the pipeline we’ve got. Louis Miscioscia – Brigantine Advisors: Maybe, could you go into any more detail about the pipeline? Is it – just which areas or maybe the strongest and maybe if you could give us some size measurements both on how big the pipeline is, and then if could also just the wins that you had maybe in calendar ’09.

Well the funnel for opportunities is very rich, across the segments. We had one business last year in all verticals. So we have one business in all verticals if we had to highlight I would say in the most recent quarter where we’ve seen the greatest strength in large scale business, it would be in the server sector. In general we feel very good about the opportunities we are seeing. We feel very good at the number of opportunities; they are actually in the negotiation and proposal phase. But as I mentioned previously we are seeing opportunities in all segments, and obviously we are strengthening our focus on new markets, which are in a very early stages and also on the aftermarket space. Louis Miscioscia – Brigantine Advisors: And then final question, you mentioned quarter two would be similar to quarter one from a revenue standpoint. Usually you can get a bump depending on what areas. Anything going on with that comment?

Hi, Lou, it’s Paul. I think for our comments earlier we would have typically seen a higher decline or a bigger decline in Q1, and then followed by an increase as you noted. I think what we are seeing here is we are just not seeing that decline into Q1 that doesn’t necessarily mean that you add on into each quarter from Q1. I think it's, for us right now, for the mix that we see, we're not seeing the typical decline in Q1, but we're not translating that to say that you add that going forward to each quarter so to speak. Louis Miscioscia – Brigantine Advisors: Okay. Thanks guys.

Thank you.

Your next question comes from Brian White. Your line is open. Brian White – Ticonderoga Securities: I am wondering if you could talk a little bit about the telecom market, the flatness in the December quarter. Is that simply the same reason we heard about it in the September quarter went down?

Yes, Brian, it’s Paul, that's exactly right. So I think that's one area, while you know, per Craig's comments, we've seen some modest growth in all sectors. Telecom is one that stuck out as far as continuing to be pretty challenged, particularly for the mix of customers and products that we have. So what we saw through the year, if you recall, in the beginning of 2009, we did see some growth. It was very lumpy depending up on the particular installations from the customers that we had. But we are not seeing that flow through. Enterprise com has been quite strong for us. It was – telecom is one that’s continued to lag but there is no specific story behind that other than just the demand with the customers that we have. Brian White – Ticonderoga Securities:

There has been no flow through impact on that, Brian, just a fundamental demand. Brian White – Ticonderoga Securities: Okay. And then when we think about, it's a great revenue outlook for March quarter, down 8% at the midpoint, how much of that better than typical seasonality is just new programs versus your customers’ business?

I think that when you look at it we’ve got new programs ramping every quarter, so trying to separate with kind of normal course versus an anomaly. I think generally right now, when you look at first quarter, it’s mostly just fundamental demand across the board is stronger than what we would have seasonally expected. Brian White – Ticonderoga Securities: Okay. And just you talked about the server market, GSM opportunities there. There is lot of convergence in the infrastructure in the data center storage, server and networking. I think that’s going to be very positive for some EMS companies, some guys are going to get weeded out because of that. Big players like Cisco and HP are doing this, and I am just wondering how Celestica is positioned to take advantage of that.

Well, Brian, and it is Craig. We think we are very well positioned. I mean the strength in this company from a core competent standpoint is servers and storage at the inception. So very strong on the product side, building capability throughout the supply chain with our customers as we take on new outsourcing with our current customers and we got some very innovative concepts in the area of data solutions. So we anticipate that we will be an important contributor to the success of our current customers and actually attracting new customers and what we think is going to be an exciting emerging segment. Brian White – Ticonderoga Securities: Great. Thank you.

Thank you.

Your next question comes from William Stein from Credit Suisse. Your line is open. William Stein – Credit Suisse: Hi, two questions. First, on the restructuring; can you talk about the timing of the benefits of that? How long do we continue to see benefits from restructuring activities?

Well, it’s Paul. So nothing has changed as far as the profile of how benefits unfold. So to recap what we’ve talked about in the past, when we take a charge in a current quarter, typically the benefits will come out not the next quarter but the quarter after that generally from a timing point of view. So we don’t see any change overall. It’s kind of the way that’s unfolding. So as each quarter progresses here and we’re booking our charges. That’s what you should expect to see going forward. William Stein – Credit Suisse: Great. And then another topic that has been discussed at length last quarter is component shortages, lead times, etcetera, have you seen that condition extend into the Q4, maybe into Q1? Can you give us some update on lead times and whether maybe shortages affected the revenue in the quarter?

Yes, it will. It’s Paul. I think that first on your last question, through the quarter we definitely, I call it, it got jammed up. So we got parts later than we wanted and let to some inefficiencies as far as how we’d like to run the plants. But I would not characterize that we left anything meaningful on the table from a revenue point of view. We are pretty much shipped what demand was there, again just not on a linearity that we would have liked. Overall lead times, I would not say have gotten any worse over the last 90 days, we did see some pressure in Q4. That’s pretty much been unchanged. I will say that and you know that we’ve been making significant investments in our supply chain tools. And not only are we running with industry leading turns but those tools have enabled us just to get better collaboration with the suppliers, and frankly we believe to get better performance in getting parts when we need them. William Stein – Credit Suisse: Great. Thank you.

You are welcome.

Your next question comes from Amit Daryanani from RBC Capital Markets. Your line is open. Amit Daryanani – RBC Capital Markets: Perfect. Thanks, good afternoon, guys. Just a quick one I guess. Given the fact we are adjusting how we account non-GAAP EPS going forward, my understanding is all that you're doing is taking [ph] out RSU expenses, which is in line with what everyone does, but that is benefiting your December and your March quarter guided EPS by $0.02 roughly, is that math accurate?

That’s about right. Yes. Amit Daryanani – RBC Capital Markets: And I guess, if I kind of drag that forward does that mean the longer term target really should – we should think about a 3.8% to 4.2% kind of range versus 3.5% to 4%?

Yes, I mean, Amit, we gave a range right? So 3.5% to 4%. So we're not going to slice it that fine, suffice it to say, I mean, look at our performance here this quarter, we are into that range. So clearly we are going to – this accounting change of side, we are driving to the highest numbers we can drive to. I would like think that we can get to the higher end of that range, as far as this will obviously help us get there. So we are just going to stick to that range because there is a mix of business that coming in as you saw very strong quarter on consumer and very pleased to have that, but that does drag it down. So we are sticking to that range, but obviously it will be easier to get to the top end of the range now. Amit Daryanani – RBC Capital Markets: I think it makes more of an apples-to-apples comparison with all your peers this way. So that helps. Just on the SG&A side, you guys talked about sort of investing in new opportunities on the design side, aftermarket services, can you just help to quantify what sort of OpEx expansion of growth are we going to see in the first half of 2010 versus ’09 number that you just gave out?

Yes, I mean I think if you look at where we ended up the fourth quarter, our growth here is what we are talking was pretty modest. So single-digit millions from where we are today. So we are not talking about anything significant from the current levels. So looking at the going rates of where we are in fourth quarter, I would expect on an annualized basis for our investments to be between $5 million and $8 million, something along those lines on a net basis, yes. Amit Daryanani – RBC Capital Markets: And just finally, a rough math on the debt repurchase that you are going to do, $17 million savings, that’s about $0.67 annualized to the bottom line. Is that factored into your March quarter guidance as well?

No. So the way the time works, Amit, we will – because we plan to complete it during the quarter, it will be late in the quarter given the necessary notice period to the bondholders. So there will be very little benefit into Q1. The annualized benefit that we will see will begin in full force as of Q2. Amit Daryanani – RBC Capital Markets: Got it. Thanks a lot.

I will – Amit, one thing just you talked about the earnings per share benefit. Just to make sure that $17 million is obviously pre-tax and so you do have to tax-effect that. Amit Daryanani – RBC Capital Markets: Fair enough. Thanks.

Your next question comes from Brian Alexander from Raymond James. Your line is open. Brian Alexander – Raymond James: Thanks. Just going back to your pipeline, I know you are not quantifying what your new wins are, but can you give us a sense to actually whether the magnitude of new business wins are increasing each quarter, decreasing or staying the same? And are the win rates improving as your cost structure is putting you in a better position to compete for new business?

Well, if we look on a quarter-to-quarter basis, year-over-year basis – on a quarter-to-quarter, year-over-year basis our win rates are increasing as well as the number of new – the volume of new wins. And as I mentioned it’s across all segments. But the overall impact based on the timing of those wins, the ramp timing for the various programs, we are very comfortable with the 6% to 8% revenue guidance that we’ve really got for this operating model that we are putting in place here is the medium term target. Brian Alexander – Raymond James: And Craig, of the 6% to 8% how much of that would you characterize as just overall demand improvements with existing customers versus these new wins?

Well, it’s difficult to really feather in, but let’s assume we get 10% year on year erosion of the base. We got a very solid base of customers now. So it’s difficult to give an accurate number to the exact mix. But the net result is the 6% to 8% growth rate, which is a combination of new wins, existing customers, new customers and then new programs coming into the fold. But on the order of somewhere between 25% and 30% of the revenue in the next year will come from the new wins we got this year. Brian Alexander – Raymond James: And then just a clarification on the comment earlier in the call that I think you guys said each quarter you should see modest growth in revenue and EPS. I assume that was year over year, not sequentially?

That’s correct. Brian Alexander – Raymond James: Okay. Thanks a lot.

Thank you.

Your next question comes from Todd Coupland from CIBC. Your line is open. Todd Coupland – CIBC World Markets: Hi, good evening, everyone. I am just wondering if the shift in your consumer business might cause a shift in your own seasonality based on product launches and timing of carrier, launches of those products, etcetera. It seems to me look at public statements that your seasonality might be shifted out to a degree into the June quarter as a result of that.

Todd, it’s Paul. So I will agree with the view that historically looking at Celestica much more enterprise weighted, IT weighted, and as you know Q4 will typically be the highest and Q1 will be the lowest. It’s difficult to conclude now clearly a big piece of our business is in the Smartphone market as you know that market continues to grow at exponential rates. And new product life cycles are short. New products are starting every quarter. So don’t even know – I will agree with the statement, this is seasonality pattern shifts. I am not sure about the June piece of it. Todd Coupland – CIBC World Markets: Okay. So basically, the point is we are just too early into 2010 to know similar to what we’ve heard from some larger OEMs and so you will just wait and see how that plays out.

Todd Coupland – CIBC World Markets: Okay. That’s great. Thanks very much.

Thank you.

Amanda, we will take two more calls, I know everyone has got a call at 5 o’clock as well. So we will take two more calls.

And your next question comes from Frank Jarman from Goldman Sachs. Your line is open. Frank Jarman – Goldman Sachs: Just a quick question for you. Can you discuss your thoughts behind running with your long-term debt and give me a sense for what you are thinking about what an optimal capital structure is going forward?

Frank Jarman – Goldman Sachs: Great. And have you had any discussions with the rating agencies. I guess at this point it’s kind of a move point to the extent that you don’t have debt outstanding.

The answer is we’ve had no direct conversions yet, but I agree with the second part of it. Frank Jarman – Goldman Sachs: Okay, thanks so much.

Thank you.

Your last question comes from Joe Wittine from Longbow Research. Your line is open. Joe Wittine – Longbow Research: The last one is going to be quick. I am just curious, Paul, if you could layout how you see interest expense trending in dollars over the next couple of quarters, the March and June quarters, just considering that the last buyback was enacted midway through this past quarter as well.

Yes. So I think that our plans are to try and get this repurchases done in the early March time frame. I think interest will be around $4 million for the quarter, the first quarter. Moving in beyond that, it really just becomes standby fees on the credit facility and on the AR facility. So you should think about it as being about $1 million a quarter.

Okay. That’s great. Thanks. If anyone has any follow-up questions, we will be here and appreciate your time. Thank you.

Thank you.

Thank you very much.

This concludes today’s conference call. You may now disconnect.