Celestica Inc. (CLS) Q2 2015 Earnings Report, Transcript and Summary

Good afternoon, I would like to welcome to everyone to the Celestica Second Quarter 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] Thank you. Jim Fitzpatrick, Vice President of Investor Relations and Communications, you may begin your conference.

Thank you, Yen. Good afternoon and thank you for joining us on Celestica's second quarter 2015 earnings conference call. On the call today are Craig Muhlhauser, President, Chief Executive Officer and Darren Myers, Chief Financial Officer. This conference call will last approximately 45 minutes Darren and Craig will provide some comments on the quarter then we will open up the call for questions. During the Q&A session please limit yourself to one question and a brief follow-up. We will be available after the conference call for additional follow-up. Please visit our website at celestica.com to view the supporting slides accompanying this webcast. As a reminder, during the call we make forward-looking statements related to our future growth, trends in our industry, our financial and operational results and performance and financial guidance that are based on management's current expectations, forecasts and assumptions that are subject to risks and uncertainties that could cause actual outcomes and results to differ materially. So please refer to our cautionary statements regarding forward-looking information in the company's various public filings, including the cautionary note regarding forward-looking information in today's press release. We also refer you to the company's various public filings, which contain and identify material factors that could cause actual results to differ materially from those contained in our projections or forward-looking statements and which discuss material factors and assumptions on which such forward-looking statements are based. These filings include our Annual Report on Form 20-F and subsequent reports on Form 6-K filed with or furnished to the Securities and Exchange Commission, and our Annual Information Form filed with the Canadian Securities Administrators, which can be accessed, respectively, at sec.gov and sedar.com. During this call, we will refer to certain non-IFRS financial measures, which include adjusted gross margin, adjusted SG&A, adjusted operating earnings or adjusted EBIAT, adjusted operating margins, adjusted net earnings, adjusted EPS, return on invested capital or ROIC, inventory turns, cash cycle days, free cash flow and adjusted tax rate. These non-IFRS measures do not have any standardized meaning under IFRS and may not be comparable with other non-GAAP or non-IFRS financial measures presented by other public companies, including our major competitors. We also refer you to today's press release, which is available at celestica.com for more information about these and certain other non-IFRS measures, including a reconciliation of the historical non-IFRS measures to the corresponding IFRS measures where comparable IFRS measure exists. Unless otherwise specified, all reference to dollars in this call are to US dollars. I'll now turn the call over to Darren Myers.

Thank you, Jim and good morning everyone. Celestica delivered a solid second quarter with revenue and adjusted earnings per share above the mid-point of our guidance range. Revenue of $1.417 billion was above the mid-point of our guidance range driven primarily by strong demand in our communication, storage and semiconductor end-markets. Second quarter revenue increased 9% compared with the first quarter of 2015 and decreased 4% compared with the second quarter of 2014. Some highlights for the quarter include adjusted operating margin of 3.4%, improved 30 basis points compared to the first quarter of 2015. Adjusted earnings per share of $0.25 were $0.02 above the mid-point of our guidance range and up from $0.19 in the first quarter of 2015. IFRS net earnings are 24 million or $0.14 per share. We generated $2 million free cash flow for the quarter which included approximately $50 million of investment in support of our energy and aerospace and defense businesses. We achieved ROIC of 19.6% and we repurchase and cancelled 26.3 million subordinate voting shares through our substantial issuer bid. Looking at the revenue from an end market perspective, we delivered quarter-over-quarter revenue growth from four of our five end markets. Our communications end market represent a 40% of total revenue for the quarter, communications revenue increased 9% sequentially which was higher than expected due to strong demand as well as new program ramps, compared with the second quarter of 2014 communications revenue declined 5% primarily due to program completion partially offset by new wins. Our diversified end markets comprise 28% of our total revenue for the second quarter of 2015 diversified revenue increased 7% sequentially driven primarily by growth in aerospace and defense and semiconductor which were more than offset, a sequential decline in our energy business as we transition part of our operations in North America to Asia. Compared with the second quarter of 2014 diversified revenue decreased 3% largely due to the transition of our energy business, which is partially offset by growth in semiconductor as low as revenue from a Honeywell transaction we announced during our April earnings call. Second quarter revenue from our storage end market came in higher than expected and represented 19% of revenue for the quarter. Storage revenue increased 17% sequentially due to seasonality in overall strong demand, compared to the second quarter of 2014 our storage business grew 10% driven by strong demand and new program ramps as well as strength in our JDM business. Second quarter revenue from our server end market was relatively flat sequentially representing 10% of total revenue for the quarter, server revenue decline 6% compared to the second quarter of 2014 primarily due to software demand. And finally our consumer end market representing 3% of total second quarter revenue increased 14% of the sequential basis. Consumer revenue for the quarter decreased 38% year-over-year primarily due to our continued emphasis of certain lower margin business in the space. Our top ten customers represent a 68% of revenue for the second quarter up from 64% in the first quarter, for the second quarter, we had three customers individually contributing greater than 10% of total revenue up from two customers in the first quarter. Moving on to some of the other financial highlights for the quarter. Adjusted gross margin of 7.1% came in generally as expected sequentially in year-over-year our gross margin was negatively impacted by the transition of our energy business as well as certain program ramps. We recorded $9.5 million of other charges in the second quarter, 4.2 million were non-cash and related to the write-down of certain equipment within semiconductor operation. The remainder for charges were primarily related to workforce reduction as we continue to look and optimize our business and drive productivity. Adjusted SG&A expense for the quarter was better than expected and came in a $46 million and 9% year-over-year reduction. A year-over-year improvement was primarily due to continued cost containment efforts in the timing of certain items. Adjusted operating earnings for the current quarter were $48.3 million or 3.4% of revenue, an increase of 30 basis points sequentially as a result of increase revenue and have continued focus on cost productivity. Our adjusted tax rate in the second quarter was 11.7% with then I expected annual tax rate range of 11 to 13% adjusted net earnings for the second quarter were $41.7 million or $0.25 per share compared to adjusted net earnings of $44.9 million or $0.25 per share for the same period of 2014. Second quarter IFRS net earnings were $24.2 million or $0.14 per share compared to $40.9 million or $0.22 per share in the same period of 2014. The year-over-year reduction is primarily reflection of the restructuring charges this quarter as well as one time recovery realized in the second quarter of 2014, return on invested capital was 19.6% up from 16.8% last quarter and 19% in the second quarter of last year. Turning to working capital performance, our inventory increased $64 million from the first quarter to $880 million at June 30, inventory turns for the quarter was 6.7 relatively flat sequentially and year-over-year, capital expenditures for the second quarter were $18.5 million or 1.3% of revenue within an estimated range of 1% to 1.5% of revenue. Cash cycle for the second quarter was 42 days compared to 47 days in the first quarter of 2015 driven by a 5 day decline in account receivables days. For the second quarter of 2015, we generated $2 million of positive free cash flow compared to $41 million for the same period last year. Free cash flow on the quarter include approximately $50 million that we invested in the quarter related to the expansion of energy business in Asia as well as Honeywell transaction that we announced last quarter. Moving on to the balance sheet. Let me recap and results of our substantial issuer bid that we announced on our last quarterly conference call and which we completed in early June. We spend $350 million to repurchase and cancelled of 26.3 million subordinate voting shares of $13.30 per share. The buyback represented approximately 15.5% of the total multiple voting shares and subordinate voting shares outstanding prior to the SIB completion. We funded a bit through combination of $250 million term loan, $25 million from the revolving portion of our credit facility and $75 million in cash. At the end of the second quarter, we had approximately $142.9 million subordinate and multiple voting shares outstanding. Our cash balance decrease $72 million from last quarter, the $497 million as of June 30th, primarily due to the $75 million of cash use to partially fund to substantial issuer bid. Our net cash position at June 30th is $222 million, which includes $497 million of cash, $255 million drawn on our term loan and $25 million drawn on our credit facility. Moving forward to our guidance for the third quarter of 2015, for the third quarter we are projecting revenue to be in the range of $1.4 billion to $1.5 billion. At the midpoint of our guidance, third quarter revenue is projected to increase 2% sequentially and 2% year-over-year. At the midpoint of our guidance, we expect adjusted operating margin of approximately 3.6% an improvement of 20 basis points compared to the second quarter. Third quarter adjusted earnings are expected to range from $0.28 to $0.34 per share. Our SG&A expense for the third quarter is projected to be in the range of $48 million to $50 million. We estimate an annual adjusted tax rate range of 11% to 13%. For the third quarter of 2015, we expect to record additional restructuring charges in the range of approximately $8 million to $12 million as we continue to focus on cost productivity. I would now like to turn the call over to Craig for some comments on the quarter, as well as our third quarter outlook.

Thank you, Darren. Good morning to everyone on the call. And thank you for joining us today. Celestica delivered a solid second quarter which revenue and earnings per share above the midpoint of our guidance, including sequential improvements in revenue, net earnings, operating margin and return on invested capital. We experience quarter-over-quarter revenue growth across four of our five end markets. With the strongest growth and our communications and storage end markets and our semi-conductor business. Now let me turn to the near-term outlook in our end markets. For the third quarter relative to our diversified market business, we are expecting sequential revenue growth in the high-double-digit range representing growth in four of our five sub-markets. On a year-over-year basis, we expect our diversified end markets to increase in the low to mid-double-digits driven primarily by new program ramps and aerospace and diversify and demand strength in our semi-conductor business. Over the last several quarters we’ve highlighted some of the operational challenges that we’ve been experiencing and our semi-conductor business. Primarily relating to production and efficiencies fixed costs absorption and the impact of new program ramps. On our last earnings call, we commented that we based on these investments we’ve been making in the actions we are taking to improve our quality, cost productivity and delivery performance including the streamlining and simplifying of our supply chain network. We expect at the semi-conductor business with deliver positive gross margin in the second half of 2015. However based on the tremendous effort by the semi-conductor business team. I am pleased to report that we deliver operational and financial improvements beyond or beginning of second quarter forecast as evidence by positive gross margin in the second quarter. More importantly based on our current forecast, we expect to further improve the financial performance of our semi-conductor business throughout the remainder of 2015 driven by year-over-year revenue growth and further operational improvements. Although the remains more work to do, I am very pleased with the progress we have may and expect to make in our semi-conductor business. Our communications end market is expected to increase in the third quarter at the low-single-digits both on a sequential basis and a year-over-year basis, based on strong demand and new programs offset in part by a program completion with one customer in the telecom segment. Our storage business in the third quarter is projected to decline in the low-single-digit primarily due to seasonality on a year-over-year basis storage is expected to grow in the mid-single-digits driven primarily by new programs. Our server business is expecting a high-single-digit sequential decline in the third quarter based on reduce demand and the delay of a new program launch. On a year-over-year basis server is expected to decline in the low-single-digits due to demand softness. In summary, overall we’re expecting a quarter-over-quarter and year-over-year revenue growth at the midpoint of our third quarter guidance as well as 20 basis points quarter-over-quarter improvement in our adjusted operating margins. As we look in the second half of the year, we remain focused on continues improvement in quality, cost productivity and delivery performance and accelerating the diversification of our revenue base by winning new business and our target markets with existing and new customers and launching new program flawlessly on a global basis. I also want to announce Celestica is entered into an agreement for the sale of our corporate headquarters and manufacturing operations located in Toronto, Ontario. Subject to the successful closure of this transaction, the purchase price will be approximately 137 million Canadian dollars or 110 million U.S. dollars based on the June 30, 2015 exchange rates. The closure of the transaction is subject to various conditions including municipal approvals and is anticipated to occur within approximately two years. As part of the agreement, Celestica will enter into an interim lease for our corporate headquarters and manufacturing operations for a two year term, which will be followed by a long-term lease for a new corporate headquarters to be built and located on or near the current sites. We expect that our Toronto manufacturing operations with relocate to a new location in the greater Toronto area within approximately four years. More detail about this property sale are provided in the press release that was issue a short time ago. In closing earlier this month, we announced Celestica’s Board of Directors have selected roughly is the company’s next President and Chief Executive Officer effective August 1st. As you all know I announced by intention to retire from Celestica in October of last year. I will continue with Celestica as an advisor to the Board until the end of this year. I am very pleased to welcome Rob to Celestica. He joins the company with over 25 years of senior leadership experience from a variety of industries including the aerospace, industrial and semi-conductor market and he is also serve as a CEO for six years. And confident that Rob is the right leader at this time for Celestica to build on our momentum and strong foundation and to accelerate the deployment of our diversification strategy across the company in order to achieve forward growth and profitability objectives that we have said for Celestica. As I said when I announced my retirement, I believe that this is the right time to transition to new leadership. Celestica at a very strong foundation for future growth and profitability, we continue to focus on accelerating the diversification of our revenue base, customers and services offerings, while improving our profitability and free cash flow generation. Our diversification strategy and portfolio reshaping is well underway. We have deep trusted customers relationships supported by an operational excellence including the supply chain and operating network that in my view is second to none. All of this is underpinned by what I truly believe is Celestica's greater strength, our 25,000 talented and dedicated employees throughout the world who are committed to making our customers successful. That concludes our prepared remarks. Ian please open the call for questions.

[Operator Instructions]. And your first question comes from Joe Wittine with Longbow Research for --. Your line is open.

The semi-cap improvement is a little bit surprising, given what Intel and some of the others in the supply chain have been seeing. I understand you guys have operational improvements that it sounds like have you have partially conquered but any additional details on why you are seeing an uplift in the top line, which is what it sounds like was happening?

Well, I think Joe let me, we are serving the top players in the equipment industry and obviously we are serving those players in the areas of the market that are seeing strong demand for, due to the semiconductor technology aka the 3D NAND technology. So with the right customers with the programs and the right segments of the market now that we are getting the operating performance, as you can see we are getting strong year-on-year. And it is also the thesis that we have, the industry needs a powerful global player have the fragmented industry, especially in the area of machining. I think this is going to be a very very lucrative area for Celestica provided we continue to execute. I think reconfirming although it has taken a couple of years to get there, part of it is staying with learning difference between electronics. But when we start doing it, the Celestica I think we are seeing some real potential growth opportunities and profitability opportunities for this company and I believe we are very bullish on attraction and the men that we have got in that industry.

Okay. Thanks. And then maybe switching gears the cash advance to the solar supplier, maybe just you give why it was necessary? And the economics, why the deal makes sense for Celestica and whether there is any potential risk or what this kind of business as usual for a cross continental manufacturing transfer?

Yeah. Hi, Joe it's Darren. It's more typical in the solar industry, we have seen this before from time to time, we have also have deposits to us from our some of the various customers so it's I would say more or less usual business there. Part of it is around the expansion of Asia and we think there is a lot of exciting opportunities for us within solar.

And your next question comes from the line of Amit Daryanani from RBC Capital Markets. Your line is open.

Maybe just two questions. One, I think I heard you talk about $8 million to $12 million of additional restructuring that is getting announced in the back half of the year. It sounds like the demand trend is doing well. Semi-cap is kind of rebounding. Can you help me understand why the incremental restructuring right now?

Yes. Absolutely. In terms of restructuring, we look at the portfolio, yes, we have got pockets of strength, I mean we have been winning programs, we have got some momentum there we believe and starting to see that, it is always areas where we can find further cost productivity. And I would say that we are striking the balance which we are investing in the business and investing in sales, investing in design, while looking for further opportunities and productivity and we will see some room there. It is choppy in certain markets and there is always some opportunities so we are going to capitalize on some of those right now.

Got it. And then on the real estate transaction you are starting right now, I want to make sure I understand this. The site will get sold eventually in a two year process once the approvals are done, but once that is done, you would still need to figure out how to get manufacturing capacity somewhere in the greater Toronto area. So does that mean that we need to start seeing of a bigger uptick in CapEx, as you need to replicate some of the equipment in manufacturing site that you have? How do I think of CapEx plan to create that?

Yeah. Certainly you will see a couple of things happen. So when the sales close and so you will see the cash approximately half of the cash and then two years later the other half. And through that time after the two years, we will be looking for our footprint for the future for the manufacturing and yes, that will require CapEx and fill up costs. So what have we -- we have not -- we are not obviously at the stage of escalating that I think it'd be well so for the proceeds of the sales.

Got it. That's it for me. Thank you.

And our next question comes from the line of Jim Suva with Citi. Your line is open.

Thank you guys and congratulations to your team. I wasn't exactly clear on why you are selling your headquarters site and that manufacturing facility. Is it just to unlock some value of what is happening in the real estate market there or does the size not quite fits your needs? And also can you clarify that the restructuring of the additional $8 million to $12 million that is separate from your headquarters site and should we expect more restructuring to then come on after this headquarters sale or how should we think about those, if they are together or different?

So Jim I will take the first part. In terms of the property, the largest contiguous acreage in the city of Toronto is an underutilized site, it's a valuable asset. It has a significant value based on this location. Due to the current trends of plan and it's in proximity to downtown Toronto. I mean actually this is exciting new. I mean it's a 1954 facility, it's underutilized, now we have the opportunity to recite the corporate headquarters, either near or on the same location. And then Toronto DMS operation will move to a new location that will give us a more optimized footprint for the business we are doing today which is high mix, low volume largely in the diversified stage and it's really going to be tailored to the future and forward looking business that we expect to attract to Toronto. What's nice about the transaction is this provides us ample time to find the right facility for AMS operation, property designed and executed product transfer plans for the customers that we have and the customers that we intend to capture for the next four years. So it's a very very good investment and it really starts laying the groundwork for the transformation that we are looking -- undertake here and it sets the tone at the top that everything we are doing is to build this company for a very, very successful future.

And Jim for perspective it's on 60 acres so obviously a very large facility in Toronto that we have a portion of. To your other question it's the restructuring, they are not related, there is a planned restructuring as a result of the sale of the property to more, looking at the continued productivity within the business and areas where we still see some opportunity.

And then as a follow-up, can you help us with sharecount? What we should model for the next quarter given your tender off of the shares? And how it equates to the average share for this quarter versus what the diluted and share count should be for the next quarter?

We entered in a 143 million or 142.9 million share I would say at actual million to that and is around 145 million for your sharecount.

And our next question comes from the line of Thanos Moschopoulos with BMO Capital Markets.

Hi. Good afternoon. Both the SG&A and R&D expense came down sequentially. Was that just reflecting the restructuring or was there some other dynamic at play in the currency?

That was two things, one is just a continued focus on cost, but the other one was just some spends and timing of certain spends. So we expect to be back to normal life SG&A levels for the third quarter.

Okay. And Craig you commented that you are seeing strength in the communications market. Can you clarify on whether that is coming in networking or telecom or across both and what type of trends you are seeing in those markets?

It's going to be largely in networking and the enterprise states Thanos. And essentially it's program specific, customer specific related to the launch and then the take up bridge for the new program that we are participating in. So we are very pleased with the progress, looks like it'll continue. We have got a strong mix of business and it appears to be more stable part of that business today which is this enterprise and networking space as opposed to some of the infrastructure material demand. So the market is challenging today and it's dynamic and but we are expecting to hold our own underpin the diversified growth that we expect to see in the second half of the -- the good performance this year for communications and greater use in market.

That's great. Thanks and best of luck on your retirement Craig.

Thank you very much.

And there are no further questions on the phone.

Okay. Thank you, Ian. And given that this is my final quarterly earnings call and I wanted to take this opportunity to express my deep appreciation and gratitude to all Celestica's stakeholders. First to our 25,000 employees across the company, thank you for your ongoing dedication and commitment to make Celestica and our customers successful. I also want to thank all of our customers, suppliers and other partners for your ongoing trust and support and finally to the analyst community and investors it's been an honor to privilege to serve as a CEO of Celestica, I want to thank each of you for your time, your interest, your effort, and support you have given Celestica during my tenure as CEO. Thank you very much and good bye.

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