Celestica Inc. (CLS) Q1 2012 Earnings Report, Transcript and Summary

Good morning. My name is Melissa, and I will be your conference operator today. At this time, I would like to welcome everyone to Celestica's 2012 First Quarter Earnings Conference Call. [Operator Instructions] Mr. Manny Panesar, Director of Investor Relations, you may begin your conference.

Thank you, Melissa. Good morning, everyone, and thank you for joining us on Celestica's First Quarter 2012 Earnings Conference Call. On the call today are Craig Muhlhauser, President and Chief Executive Officer; and Paul Nicoletti, Executive Vice President and Chief Financial Officer. This conference call will last approximately 45 minutes. Paul and Craig will provide some brief comments on the quarter, and then we will open the call for Q&A. [Operator Instructions] Copies of the supporting slides accompanying this webcast can be viewed at celestica.com. Before we begin, I would like to remind everyone that during this call, we'll make forward-looking statements related to our future growth, trends in our industry, our financial and operational results and performance, and financial targets that are based on current expectations, forecasts and assumptions that involve risks and uncertainties that could cause actual outcomes and results to differ materially. We refer you to our cautionary statements regarding forward-looking information in the company's various public filings, including the Safe Harbor statement in today's press release. We refer you to the assumptions, risk factors and uncertainties discussed in the company's various public filings, which contain identified factors that could cause actual results to differ materially from those contained in our projections or our forward-looking statements. These filings include our Form 20-F and subsequent reports on Form 6-K filed with the Securities and Exchange Commission, which can be accessed at sedar.com and sec.gov. During this call, we will refer to certain non-IFRS financial measures, which include adjusted gross margins, adjusted SG&A, adjusted operating margin or EBIAT, adjusted EPS, ROIC and free cash flow. These non-IFRS measures do not have any standardized meaning under IFRS, and are not necessarily comparable with other non-GAAP financial measures presented by other companies, including our major North American competitors. We refer you to our press release, which is available at celestica.com for more information about these non-IFRS measures, including a reconciliation of the non-IFRS with the corresponding IFRS measures as appropriate. I will now turn the call over to Paul Nicoletti.

Thank you, Manny, and good morning, everyone. As many of you know, we are holding our Annual General Meeting at 9 a.m. Eastern Daylight Time this morning. We'll keep our formal remarks brief on this call to allow enough time for questions and conclude the call at 8:45 a.m. I will summarize the first quarter results and will then turn the call over to Craig to provide his comments before we open up the call to questions. Celestica has delivered a solid first quarter with strong operational and cash performance, despite an overall muted demand environment. First quarter revenue was slightly below $1.7 billion and came in at the high end of our guidance range. First quarter revenue declined 4% sequentially, while on a year-over-year basis, revenue was down 6%, mainly due to weaker demand across a number of customers. Some further highlights for the quarter. IFRS net earnings of $43.2 million increased 44% year-over-year. Adjusted earnings per share of $0.25 came in slightly higher than our guidance range. Non-IFRS operating margin of 3.4% was up 10 basis points from the same period a year earlier. ROIC continued to be strong at 23.7%. We generated $44 million of free cash flow for the quarter, and we repurchased and canceled 6 million shares as part of our share repurchase program. From an end-market perspective, our diversified end market grew 3% sequentially, while on a year-over-year basis, this end market grew 58%, with approximately 1/2 of the growth contributed from our acquisition in 2011. The diversified end market now represents 19% of our total revenue, up from 11% in the first quarter of 2011. Our Consumer end market, which represent 23% of revenue, declined 12% sequentially, as we expected, and was down 14% year-over-year, primarily due to demand weakness in program transitions…

Thank you, Paul, and good morning, everyone. As Paul mentioned, I'd like to provide an update of our current market outlook and an update on several of our key initiatives. Let me start with our Consumer end markets, and more specifically RIM. As you know, RIM continues to be an important customer of Celestica, where we currently serve from 3 geographies for manufacturing services, as well as being one of their primary North American repair partners. As recently disclosed by RIM, they are conducting an evaluation of their global supplier base with the objective of reducing their supply chain capacity and number of manufacturing locations. We are currently working very closely with RIM as they assess their supply chain manufacturing strategy by providing tailored solutions for what we believe would be the most effective design point. This a very dynamic situation of many variables for RIM and Celestica to consider. We continue to be one of RIM's best-performing partners and are currently ramping one of their new programs globally. However, there remains a fair degree of uncertainty on the outcome of these discussions and the impact or timing these future discussions may have on Celestica. We continue to support RIM with the same level of intensity and focus on driving value for their customers while assessing the appropriate trade-offs for Celestica. Now moving on to an update on several of our key initiatives. Let's begin with an update on our progress in increasing the revenue mix of diversified markets. As we have discussed previously, our target has been to expand our customer base and grow our revenues in the higher value-added diversified markets, 25% to 30% of our total revenue. Once again, this quarter, we made progress toward this objective. Despite typical seasonal demand declines, we saw sequential revenue growth…

[Operator Instructions] Your first question comes from the line of Wamsi Mohan from Bank of America Merrill Lynch.

Paul, you touched on this briefly, but can you address what specifically drilled as much better than seasonal outlook than Servers? And it sounds from your comments that this is strength that will continue at least until the second quarter. Could you share some more color on that, please?

Yes, Wamsi, I think if you look at essentially a few programs and a couple of key customers we have, we're seeing a bit of recovery from what we saw in late 2011. As you know, we saw a bit of weakness in the fourth quarter, and we've seen some of that come back. That, in addition to new programs that we have been ramping, is really underpinned by the growth that we're seeing.

Okay. And if you look at your first half revenues, if you look -- make the high end of your guidance for the second quarter, you'll still be down about 5% year-on-year. So given that, do you see anything in the second half that gives you confidence that you can actually grow revenues for the full year end? And if not, then why invest in more capacity right now, especially given all the uncertainty that surrounds RIM and potentially having to redeploy some of the existing assets?

So, Wamsi, first, on the overall growth and year-to-year, certainly, we're seeing a lot of dynamics in the Consumer side. So granted if you were to look at things without the Consumer side, you get a bit of a different story, vis-a-vis the overall growth of the company. As far as investments, I mean, clearly, we're investing for the long term. So as Craig mentioned, we do see a significant opportunity for us to establish capabilities to support the diversified markets in Malaysia. So to your point on redeploying capital, certainly, we will do that as far as equipment is concerned, but the investment we highlighted is really to, to really increase the size and to up our presence in Malaysia and to drive revenues into 2013.

Your next question comes from the line of Amit Daryanani from RBC Capital Markets.

Just have a question on the Diversified segment. We see it was up 58% year-over-year, but I think organically, if that not works out, it's up 28% year-over-year, which was well below, I think, the 40% to 50% growth rate you guys have been targeting for the year. Do you guys still remain comfortable with that 40% to 50% growth target? And is it more driven by new ramps in the pocket or an expectation to go have new wins?

Hey, Amit, it's Paul. We still think that 40% to 50% is something that we will achieve. Clearly, there has been a contribution from the acquisition, as you mentioned. But when we look at the pipeline of new programs that we've won and when they ramp, that's something we're still comfortable with.

All right. And then secondly, if you could just talk about -- well, you guys touched on RIM and the potential supplies in consolidation that you could have. In theory, if you were good to go from 3 manufacturing sites to 2 or 1 with that customer, would it, a, entail a material restructuring, and b, do you think it would be you or the OEM that would be liable for that in that scenario?

Amit, I think that if we were to consolidate it, it certainly depends where. As you know, our major manufacturing support for RIM is in North America. If things were to shift in Asia, there would be some costs. Who would eventually pay for that is not clear. I mean, certainly, our position would be that we would expect the customer to participate in that. It's really too early to say right now.

All right. And is there a sense like -- I guess, in the scenario that you do move from North America to Asia, would that charge be fairly material, or would it be not a big number at the end of the day?

So, Amit, I'll underscore that we're having ongoing discussions with RIM, and what is going to happen is not clear. Having said that, if we needed to restructure and essentially get rid of all the capacity that we had, which at this point is not our plan, I think we've talked in the past that we would see a charge in the neighborhood of something around $35 million would probably be the maximum.

The next question comes from the line of Sherri Scribner from Deutsche Bank.

I just wanted to dig a bit into the Communications segment, clearly down year-over-year, and we've heard a lot of comments from other companies about an inventory correction there. What are you seeing from your customers, and what are you hearing from your customers, more specifically about their expectations, as we move through the year and for the back half?

In the second quarter, I think, we're looking -- I mean, demand is not consistent across the customers, so we aren't seeing some increased demand from some customers, and then we're experiencing some new program ramps. And then we're seeing some soft demand from others. So it's very spotty by customer. And then obviously, we see pressure in Europe based on the difficulties there. So that's kind of the broad Communications situation.

Are you seeing any areas -- it sounds like you're seeing some areas that are seeing a pickup? And are customers forecasting the demand improve in the second half of the year?

Again, visibility is limited. I'd say at this point, it's difficult to predict the second half. We are seeing increased demand from some of our customers going into Q2. And then obviously, we're seeing some new program ramps.

The next question comes from the line of Matt Sheerin from Stifel, Nicolaus.

So a question on the operating margin guidance that you gave for the June quarter. You talked about SG&A so that implies that gross margin will be flat or down. And is that mostly a mix in volume issue, and do you expect gross margins to get back to that 7%-plus range that you saw last year as you get volumes ramping at the end of the year?

Sure. Hey, Matt, it's Paul. I think that we'll see gross margins to be pretty flat from where they were in Q1, perhaps slightly up, and really a function of the overall revenues in the company vis-a-vis where we were last year. The going rate right now is just a little bit lower, as you know. That and, frankly, investments that we're making to support our growth into Diversified and the core revenue increases into 2013, so right now, I'd expect gross margins -- when we look forward, what we achieved in Q1 is what I would expect to be kind of the floor looking at 2012 and expect us to grow from there. Obviously, there's some contingency as to what would happen on the top line, in particular, back to the comments around our largest customer.

Okay. That's helpful. And I just wanted to get back to the RIM relationship. And Craig, you talked about various scenarios and this exercise that you're going through with RIM on to figure out where that relationship goes, but it sounds like there's still some time there. Could you give us a framework for the timeline? And does this also imply that if you were to go through with this and make more significant changes to your business to accommodate RIM, does that mean that you would be taking more share, and then they would be basically consolidating their supply base?

Well, it's difficult to predict the range of options that RIM will actually consider and implement. So I'll say, given the situation, I would expect us to have more clarity as we get to the middle of the year, hopefully before then. Obviously, as you can imagine, we're working very closely with RIM. And in general, the implications to Celestica, it's too early to tell. Obviously, we remain at the top of our game. In terms of execution, we're executing globally with one of their new programs in 3 geographies, as we mentioned. But at this point in time, it's difficult to predict the outcomes. So that's why we give you kind of the corners of the box to what the range of possibilities, and we look forward to continue to work with RIM to resolve the situation quickly.

The next question comes from the line of Jim Suva from Citi.

Regarding your very candid discussions around your customer, the largest one that is going through some challenges, which I think everyone expects you -- and I appreciate you being so open with that. When we think about that relationship, they've been a strong customer for years and years for the company. I just found your commentary around the potential charges, and you could be sharing the cost of them to be interesting. Can you just kind of refresh our memory about when you have such a customer for such a long time, it's common sometimes when that customer and their original relationship with the contract manufacturer expires and restructuring costs are, for the most part, largely borne by the contract manufacturer as opposed to the OEM. So I guess I was a little surprised for you to mention that some of those costs would be shared by the company as opposed to all borne for Celestica. So can you just let us know, have the terms been changing or are you kind of making them agree to things? You're typically -- I would think that the cost of restructuring is typically borne by the contract manufacturer. Just update us on how that has transpired over time?

Well, as you rightly mentioned, Jim, I mean, we have had a very long and very solid relationship with RIM, and we are passionate to work with them to help them absolutely get through their difficulties right now. So our focus has always been on doing the best thing for RIM, as well as the best thing for Celestica. And as a result of this partnership and the mutual respect we have, and I think the contributions we've made over the years to RIM, RIM is very, very fair with us in helping both of us get through this situation. The absolute certainty that we need to make sure when we come out at the other end, both of us, that they're competitive, and we are actually in a situation where we've done the right thing for our company. So it's too early to tell the situation. I think as a result of our relationship, we have a very strong platform. As I mentioned, we have contributed significantly to the success in the launch of their previous products. I think that's going to be important characteristic of the future in terms of just solid, flawless launches. And as I said, we've given you the edges of the box just so you could do a fair assessment from your perspective, but obviously, our commitment right now is to work with RIM to find what's right for both parties.

And then just a quick clarification. You did mention some program transitions there. It was unclear if those are transitions to Celestica, transitions away from Celestica or program transitions in new wins. And then finally, a quick clarification on the CapEx. Can you give us some CapEx outlook guidance of where you see capital spending kind of going for the year?

The program transitions largely impacting Celestica are programs that, as the mix changes, programs reaching end of life and then new programs ramping, so that's been the primary Celestica impact. With regard to capital spending, it'll still be in our normal range of somewhere between 1% and 1.5%.

The next question comes from the line of Shawn Harrison from Longbow Research.

Just wanted to focus in on the OpEx, I guess, through the rest of the year, you made some commentary earlier about investments. Just wondering how we should expect kind of both SG&A and R&D dollars to trend as we progress through the rest of 2012?

It's Paul. I think I commented in the script that SG&A would be in a range that's pretty close to where we were this past quarter. There are no major changes there. The R&D was a little less than $2 million -- pardon me, $3 million in the first quarter, and I expect it to be in the similar range looking forward into second quarter and beyond. So I guess that message is there'd be no significant changes to OpEx and R&D. Some of the investment comments, Shawn, were in relation to gross profit and some of the expansions that we're making in our facilities.

Okay. And then a follow-up, just the buyback. Have you repurchased any shares here during the June quarter, and what should we expect the share count to be for the June quarter?

So we're not -- it's difficult to forecast. It certainly depends on the volumes in the market and what we can pick off. You saw that we bought 6 million of the possible 16 million in the first quarter, so it was a pretty healthy pace. So I would expect to continue to be active in the market, but the exact number is hard to predict. I think if you wanted to assume that the balance is completed over the next couple of quarters, I think that would be a fair assumption on your side.

Your next question comes from the line of Naser Iqbal from Salman Partners.

Just circling back on the relationship with RIM. Just in terms of if -- I guess, when you gave your forecast of revenue growth going back in December and in January, in terms of like were there different expectations which you expected from your largest customer versus where you are today? I mean, is it that you had some expectations of that customer and those aren't bearing fruit or so, just in terms of our expectations for your full year revenue?

It's Paul. I would say that when we set our plans, certainly, we would not have anticipated seeing, for example, some of the weakness going into the second quarter, so I think everyone here -- the story around what's happening with our biggest customer is well chronicled, and I won't add much value to that conversation, but suffice to say, overall demand, from that point of view, is weaker than we would've expected. That said, we are in the midst of ramping up one of their new programs. So that's an area that we do expect to see revenue increases from, but where the full year plays out, it's just too hard to predict at this point.

I know, and I appreciate that. And I guess just as a follow-up, in terms of whatever happens, I guess, with that relationship, I mean, in terms of just the overall market opportunity that in terms of if you had to redeploy any of your capacity in your operations to new opportunities, is there enough opportunities out there such that you could make up for this largest customer in terms of the changing relationship?

It's Craig. It's difficult to say as it -- as you obviously know, it depends on a number of factors. I mean, backfill is very difficult to predict. I mean, as we said, we have a very solid platform of winning new business. Our funnel is growing, but replacing a 20% customer will not happen overnight. But -- and it's going to depend on the timing. Obviously, those factors will factor into it. And like this, we've overcome other difficult situations. And if we're faced with another one here, it will take time, but obviously, we will overcome it.

Right. But then just if I could press you on that point, are we talking like maybe a 2-quarter phenomenon or a 1-year phenomenon or like a 2-year -- I mean, any kind of a sense would be greatly appreciated, and I think you understand, is it one?

No, I mean, I think if you could bear with us here, obviously, we've got a bit of a track record that says we can and will deliver what we promise. At this point, we're not in a position to make firm commitments in terms of timing until we get further in the year. So give us till the end of June, and we'll come back and certainly have another frank conversation with all of you.

The next question comes from the line of Todd Coupland from CIBC.

Just I'll ask one question on RIM and then one question on the cash. So is the point that you're making on RIM that you're trying to decide whether or not you want to take on additional business, whether that makes economic sense or is the point that, overall, you're trying to decide whether you want to be there at all as a company?

Well, I think, Todd, you have to look at this as a collaborative effort. I mean, we are looking with RIM, and we consider ourselves one of the top-performing supply chain partners in the industry. We are looking with RIM at the challenges that they face, the opportunities that lie ahead for RIM and the timing in which we could accelerate their turnaround. And as a result of that, it's very collaborative, and we're not looking at it from a selfish perspective. We're looking at it from a joint perspective. And what's best for RIM and what will make sure that RIM will be successful coming out the other side, as well as what's best for Celestica, and we're trying to be open-minded as to the range of options. Right now, it's just too soon to tell. So it's not sitting here, selfishly looking at what's best for Celestica. It's doing it with the real understanding that we have a major opportunity here to work with RIM to reestablish the brand, accelerate the introduction of their new products and make the products that we have successful. And that's the essence of the conversation, and this is just another industry phenomenon that we're going through with them, and we want to make sure that we take every opportunity to do it right. So it's just a very, very collaborative, very important time and something that's going to take a bit of time, but we wanted to provide enough transparency and give you a sense that we have the confidence in what we're doing. We have the confidence in what we're doing with RIM in terms of our relationship, and we have the confidence that we'll come out the other side. Even if we have difficulty, we will come out the other side a stronger company.

Okay. Secondly, on the cash, Paul, you went through those splits on the cash. Could -- you went through that pretty quick. Could you just recover the splits in terms of what is allocated and how much you need to run the business?

Sure, Todd. So basically, from our view, and as a range, but I think a good way to think about it is that you need to rev 5% of revenues, annualized revenues in cash to run the company just to manage the ebbs and flows. When you look at our cash balance, we commented there is a deposit in from one customer, so we kind of normalized that out. And certainly, we continue to use A/R sales of dealing with liquidity needs in different areas around the world. We've kind of normalized that if it takes cash to essentially $500 million, and using that 5% rule of thumb would just put you in a zone where "excess cash" is around $130 million. As we've looked forward into 2012, as you know, we have the stock of the NCIB that's underway, that we would expect to complete. On top of that, certainly, we expect to generate additional cash flow into 2012. So as we look forward, I think that excess cash number is something that we, in that range, is what we see. Our objective, as I made I guess on my comments, is to look for the right investments to add capabilities to increase the penetration into those targeted areas, be it diversified, be it services and the likes, so that continues to be our priority. I mean, if we don't see those opportunities, then we'll continue to look for ways to return the capital.

The next question comes from the line of Brian Alexander from Raymond James.

Should we assume the 3% to 5% growth outlook for 2012 is off the table given the Q1 results, Q2 outlook and most importantly, the RIM uncertainty? Or maybe characterize your revenue outlook for 2012, excluding RIM or excluding the Consumer segment, however, you think it's appropriate. And I'm just trying to get a sense to whether that has changed meaningfully since the last quarter.

It's Craig. Given the uncertainty with RIM, I think it's fair to say we cannot provide the full year 2012 outlook at this time. I mean, as we mentioned, once we have better clarity, which I would expect to be around midyear, I will provide an update.

If you were to just look at the other segments, Craig, are they more or less kind of within the range that you've thought they would be a quarter ago?

Yes, I mean, I think the rest of the business is pretty much unfolding as we expected. So in particular, growth in diversified markets continues to be strong. Clearly, when we spoke last time, we did talk about our expectations to see a bit of economic recovery into the second half, so I think that, that's probably not as strong today looking at the forecast in the second half as we would have expected sitting here 90 days ago. But notwithstanding that, I think fundamentally, as Craig mentioned, we're winning new business. You're seeing that come through in areas such as Diversified and others, so we're optimistic about what we're doing. The overall revenue envelope is just too difficult to predict, given those dynamics.

Okay. On Diversified, specifically, just to make sure we're clear, the 40% to 50%, that's still attainable. Does that include the contribution from Brooks? And does that include any contemplation of future acquisitions? Or is that purely organic? And then the final one is just on the Server strength or I guess, the rebound that you're seeing, I think I dropped off, but I think you might have said something about new programs. Is that new programs with your largest Server customer? Or is that new programs with a new customer?

So the growth we talked about includes the contributions from last year's acquisition but would not include any additional acquisitions that we might do. So that 40% to 50% was taken both into account. And as we said, look at the first quarter, the 58% year-on-year growth, over half of that was driven from the acquisition and half organic. And lastly, on that point, it will become more difficult to separate those 2 going forward as we are winning new business as a result of that acquisition. So the delinearity on that -- delineation on that will be more difficult to predict as we go forward. As far as the Server markets are concerned, we're winning business with existing customers, new programs with existing customers, and it's in more than just one customer.

And, Brian, it's demand strength as well on a couple of customers. And if I could just take one more question.

Your last question comes from the line of Gus Papageorgiou from Scotiabank.

Most of my questions have been answered, but just quickly, you're still undergoing this tax credit from revenue in Canada, I guess. I'm just wondering, any sense of that coming to completion, and can you give us a sense of any potential impact on the cash position?

Gus, there's nothing to report as far as that audit is concerned. I would expect -- I would not expect to get resolution to that anytime soon. We're pretty confident about our position. So along those lines, I would also not expect there to be any impact on cash, but that's something that I would expect will take quite some time to resolve.

Okay. I'd like just to thank everybody for joining the call this morning, and I appreciate your confidence and continued support, and we look forward to updating you in July. Thank you very much.

Ladies and gentlemen, this concludes today's conference call. You may now disconnect.