Good afternoon, ladies and gentlemen, and welcome to the Celestica Second Quarter 2018 Earnings Call. At this time all lines are in a listen-only mode. I would now like to turn the meeting over to one of your hosts for today’s call, Paul Carpino, Vice President, Investor Relations. Please go ahead.

Good afternoon, and thank you for joining us on Celestica’s second quarter 2018 earnings conference call. On the call today are Rob Mionis, President and Chief Executive Officer; and Mandeep Chawla, Chief Financial Officer. This conference call will last approximately 45 minutes. Rob and Mandeep will provide some comments on the quarter, and then we’ll open up the call for questions. During the Q&A session, please limit yourself to one question and a brief follow-up. Please visit celestica.com to view the supporting slides accompanying this webcast. As a reminder, during this call, we will make forward-looking statements within the meanings of the U.S. Private Securities Litigation Reform Act of 1995 and applicable Canadian securities laws, including those related to: our strategies and plans for future growth; our priorities and initiatives; our anticipated financial and operational results; our non-IFRS operating margin goals and other financial guidance; potential financial or other operational impacts associated with any disengagement from less profitable CCS segment programs resulting from our review of our CCS segment customer portfolio; trends in our industry, end market and segments; the impact of prolonged materials constraints; the ability of our diversification strategy and cost-reduction initiatives to further improve our revenue, mix and margins; our restructuring actions, capital expenditures and other working capital requirements; the impact of our acquisition of Atrenne Integrated Solutions; and the anticipated timing of the sale of our Toronto real estate property. Such forward-looking statements are based on management’s current expectations forecasts and assumptions, which are subject to risks, uncertainties and other factors that could cause actual outcomes and results to differ materially from conclusions, forecasts or projections expressed in such statements. For identification and discussion of such factors and the material assumptions on which such forward-looking statements are based as well as further information concerning financial guidance,…

Thank you, Paul, and good afternoon. Our second quarter results reflect strong revenue growth from both our ATS and CCS businesses as well as improving margin performance in CCS. In ATS, we reported record revenue of $553 million, up 15% from the same quarter last year and up 4% sequentially. This growth was primarily led by strength in our aerospace and defense end markets as well as growth in our semi cap business. Our ATS segment has now grown year-to-year for 12 straight quarters, excluding the impact of exiting our former solar panel business. In terms of profitability, segment margins in ATS remained stable at 5.1% and were up 40 basis points from one year ago. We are seeing revenue growth, improving mix and are achieving scale in key end markets, all of which are contributing to strong performance in this segment. Additionally, total demand in our ATS end markets, combined with greater levels of outsourcing, drove another consecutive quarter of record bookings. Our second quarter results reflect the positive impact of our growing our ATS portfolio. In Q2, ATS represented 33% of our overall company revenue and contributed over 53% of total segment income for Celestica. This is the third straight quarter where ATS has contributed over 50% Celestica’s income, which is one of the key goals we set out when we accelerated our diversification strategy three years ago. As we move forward, we are targeting to further increase the percentage of income coming from ATS as revenue from this segment continues to grow. Clearly, our investments in ATS over the past three years are producing solid results. For example, Atrenne, acquired in Q2, is integrating well and delivering on the capabilities, growth opportunities and returns as the leading designer and manufacturer of ruggedized electromechanical solutions. The quality of…

Thank you, Rob, and good afternoon, everyone. Let me begin with a reminder that we adopted IFRS 15 in the first quarter of 2018, and we’ll provide required restated comparatives each quarter. Now for a couple of consolidated highlights. Celestica reported strong revenue of $1.70 billion, an increase of 9% year-over-year and exceeding the high end of our guidance range. Our non-IFRS operating margin was 3.1% compared to 3.2% at the midpoint of our guidance range. And our adjusted earnings per share were $0.29, $0.01 above the midpoint of our guidance range. While we continue to deal with a significant material constrained environment and the working capital inefficiency it drives, we also saw modest improvements in inventory turn and cash cycle days, and we achieved adjusted ROIC of 16.0%. Growth in ATS continues to be strong. In addition to a full quarter of Atrenne activity, we also benefited from new program revenue in aerospace and defense and strong demand in semiconductor capital equipment. For the second quarter of 2018, ATS income was $28.2 million and ATS margin was 5.1%. This represented the fourth consecutive quarter where ATS margin was above 5%. For your reference, in the appendix of this presentation, we have published segment margin for both ATS and CCS for fiscal 2016 and by quarter for 2017 and 2018 year-to-date. As this added transparency shows, the investments made in ATS since beginning our transformational strategy three years ago are delivering their intended benefits. Our CCS business also showed strong revenue growth and accounted for 67% of total revenue for the second quarter of 2018. CCS income was $24.9 million, translating to a margin of 2.2%. The improvement reflected improved mix during the quarter, including higher JDM. CCS is now back in our targeted segment margin range as we are…

Thank you. [Operator Instructions] Your first question comes from the line of Matt Sheerin from Stifel.

Yes, thanks very much and thanks for taking the question. The first question, in regard to your commentary about reviewing the CCS business and the relationships, is implying that you’re going to look at deselecting certain revenue and relationships with customers. Is there a time line? Or is that something that you’ll review with your customers that, as you go along, you’ll change your contracts and relationships? Or is that – or is there going to be something more formal, where you’ll come out and make some announcements about that?

Yes. The portfolio review, I guess, you can consider it ongoing and somewhat evolving. But Matt, if I may, let me just take a step back and kind of put the portfolio review in the context of our overall master plan that we put in place several years ago. Frankly, our strategic plan, our long-term goals have always been very focused, has always been very consistent. That being, we wanted to diversify the earnings and the revenue of the company to drive sustainable profitable growth. And in that context, our first really focus was strengthening ATS and that we’ve strengthened leadership team, reshaped the portfolio, albeit we got out of panel solar manufacturing. We’ve done smart acquisitions in the name of Atrenne. And then based on our increased transparency, you could see the progress is pretty evident. And as you remember, earlier this year, we accelerated our second major initiative around network productivity, and that was aimed across the entire business at driving productivity in our operations, our supply chain and also within our functions. And we’re making some very good progress there. This third step, which is a portfolio review, is really focused in on the underperforming accounts. And frankly, given the amount of investment we’re making on these certain programs, we want to make sure that we’re achieving acceptable returns and also providing our customers with continuous fantastic service. So this review we’re doing will be unfolding over the coming quarters. And while we think our revenues will likely be impacted, we are targeting that our margins expand through these actions, although our progress may not be in a straight line. And if our revenues do decline, we’re going to be operating on a stronger, more profitable base of business, and we should unwind some working capital if our revenues do decline as well.

Got it. That makes sense. And then for my follow-up question, regarding the component tightness, several of your competitors have called that out as an issue that led to missed revenue opportunities and also some margin pressure due to some operational issues regarding that. It doesn’t look like you’ve had any of those issues. You’re certainly not blaming that on your results or guidance. So is that something that’s baked into your guidance, where there’s some expectation, where there may be some limit in terms of revenue upside or other issues?

Yes, hi, Matt. It’s Mandeep here. If we take a step back and look at the overall environment, I think our viewpoint is, is that the material constrained environment not necessarily gotten better. We are encouraged that we’ve seen some stability this quarter. As you’ve noticed, our turns have improved by about 0.2 or so. In terms of revenue, that was gated. It was slightly better. I wouldn’t say it was a fundamental shift though. Last quarter, we had about $30 million of revenue that was gated from the constrained environment. This quarter, it was around $14 million. And any constraints that we’re anticipating have already been factored into the guidance into the third quarter to answer your question. What I would say, though, is that the teams are working very diligently on it. They are improving. We’re having very active conversations with our customers, very active conversations with our suppliers. And I would say that we’re getting better at managing it. You could say at the beginning of the quarter that there may be slightly less constrained environment that we’re – or material that we’re dealing with versus 90 days ago but again, not a really fundamental shift in the industry. Just getting used to it, I guess, after a few quarters of this.

Got it. Okay, thanks a lot.

Okay, thanks, Matt. Next question proceed.

Your next question comes from the line of Robert Young from Canaccord Genuity. Your line is open.

Your competitors were highlighting pushouts in the semi cap space, and so I’m curious why you seem – you haven’t mentioned that or you haven’t talked about it in the guidance. So what’s different with Celestica than others?

Celestica, we – semi cap, we are a market leader, Rob, when it comes to that. We do high-precision machining and high-level assembly. And it’s really performing well for us through the cycle. We’ve been gaining share, and we’ve also been working on several new programs. In Q2, we’ve had double-digit year-over-year growth. In Q3, we’re expecting to have double-digit year-over-year growth. We do, however, are seeing a pause sequentially in semi cap growth. We do expect to grow in the full year, but we do think the growth will be somewhat to do over the next couple of quarters. What our customers are telling us is that the growth should return in 2019.

Okay. And then the second question I’ll ask is in regards to this CCS revenue review. Can you give us a sense of how you’d be looking at – would you be looking at these from an operating margin perspective or a return on invested capital perspective? Like how would you go about evaluating these from a financial point of view? And I guess, I’ll pass the line.

Yes. It all comes together, I guess, with ROIC, and it’s a function of asset velocity, mix, profitability. And those are the kind of general conversations we’re having with our customers. We’re also talking to them with a general mix of business. If we could provide them higher value-added services, it tends to improve the overall portfolio as well.

So these changes would have an impact – a positive impact on operating margins, is what you’re targeting, I guess, where I’m going?

That’s correct. We’re targeting that. It should improve our – through this transition, our operating margins should improve.

Okay. Thanks.

Your next question comes from the line of Thanos Moschopoulos from BMO Capital Markets. Your line is open.

Rob, might be premature to ask the question, but I’ll try asking it anyway. In terms of the portfolio review, could you give us a sense as to order of magnitude how much revenue might ultimately be impacted? Might it be limited to sub-10%, sub-20% of revenue? Or is it just too early to ask that question?

Yes, it’s a little early. We’re kind of looking at it with respect to a specific goal in terms of revenue. We’re trying to solve for the longer-term strategic goal of sustainable profitable growth. Our goal there, our ATS profitability greater than 50% of the whole, stronger ROICs, and in that, we will probably see portions of our CCS business grow as in JDM and services. And we might also see some other less accretive portions of our CCS portfolio not grow if we’re not able to kind of improve that.

Okay. And in terms of the pricing environment on CCS, given that the near-term demand outlook seems to have improved, has pricing been a little bit more favorable than it had been earlier in the year? Or does the margin improvement we saw this quarter have more to do with your internal actions you’ve been taking?

It’s Mandeep here. The pricing environment continues to be challenging and very dynamic. To the point that Rob was making, we’re having a number of conversations with our customers. They are ROIC-driven conversations. When pricing is a challenge and if inventory is a challenge, there’s a few different levers that you’re able to pull. But I wouldn’t say that the pricing environment has improved over the last little while. Going forward, as we look at the overall business, we are pleased that the margin profile of CCS has improved quarter-to-quarter. We went from 1.7% to 2.2%. We’re now at the lower end of our range. We are seeing benefits from the productivity actions that we have been taking, and we’re continuing to focus on driving the productivity program and through that as well as the portfolio review really focused on expanding the margins in CCS.

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

Tim Young calling on behalf of Jim Suva. Thank you for taking the question. You have a long-term margin target of 3.5% to 4.0%. Do you – are you still expecting that you can achieve that margin target without customer review or – in CCS? Or you have to have some like portfolio adjustment to achieve that given your current end market exposure?

So going back to some of the remarks that we shared in the script. We are targeting still 3.5%-plus margins for the fourth quarter, and it is taking into account continued expansion of our ATS business as well as driving productivity improvements in our CCS business. Now to the point that Rob had made in terms of the timing of the portfolio review, there are ongoing conversations, and it’s really program by program. We don’t anticipate that there would be any large revenue impacts from that portfolio review in the back half of this year, and so that’s not factored into us getting back to the 3.5% margin in Q4.

Gotcha. Thanks. Just to clarify, on full year basis, do you still expect the – is the 3.5% to 4% still the target and then you don’t have to adjust the portfolio to achieve that target for full year?

Yes. So getting to the 3.5% margin range in Q4, we would be seeing a similar mix to what we have today with maybe some additional expansion in the margins in both of our businesses, both CCS as well as ATS. Our goal, as we have stated, is to – with the mix that we have right now to be in the 3.5% to 4% range, but our long-term goal is to continue to expand the concentration of ATS profitability overall. And so as we continue to expand the ATS profitability over time, we’ll go to the higher end of those ranges.

Thank you.

Thank you, Tim. Next question, Christine.

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

It’s pretty technical, but I just – you said in the comments that you took some aged inventory provisions in your P&L. Just wondering, I thought that you really didn’t take any kind of inventory risks so that those are generally borne by your customers. So you could just kind of explain what those were.

Hi, Gus. Yes, and you’re right and you’re right. At the end of the day, the vast majority of the liability for inventory does go back to our customers. However, as you do know, our inventory has been growing. It’s up almost 25% on a year-over-year basis. And along the way, inventory has been aging along the way. We do take provisions along the way as inventory reaches different milestones. And we, at the same time, work with our customers for recoveries along the way. So we have taken provisions. There hasn’t been any major change in our overall operating process, and we don’t expect that those types of one-off true-ups are going to continue going into the next quarter.

So as you receive the recovery from your customers, is there potential for those provisions to be reversed?

Yes. I would say, in general, our aging of our inventory is relatively in line with the traditional aging that we would see. But again, we just have a larger inventory balance. As we would unwind inventory going forward, we would also expect that those provisions would start to unwind as well.

Okay. And just quickly on the restructuring, are you still within the confines of the original restructuring plan? I can’t remember, if you could just remind us what you’re saying, $50 million to $75 million for restructuring is – was that pretty much within the range of the initial plan?

Yes, Gus. So just as a reminder to everyone, what we had shared was that we are anticipating to spend between $50 million to $75 million on restructuring through the efficiency program that’s underway. We started it in the fourth quarter of last year, and we anticipate that it’s going to go into the middle of 2019. To date, we’ve spent $24 million on that program, and we do still anticipate that the $50 million to $75 million range is the right range. And we expect to continue to take charges going into the third quarter.

And the focus there is – will still be increasing automation in your facilities. Is that correct?

Yes, it’s focusing on material and labor productivity, optimizing the network, but we’re also looking at corporate support costs as well. Overall, as you know, we’ve had significant productivity challenges in the CCS business. And so they are largely focused towards the CCS business, but there will also some benefits coming into the ATS business as well.

Okay, great. Thank you for taking my questions.

Thank you, Gus.

Thanks, guys. Christine, next question please.

Your next question comes from the line of Todd Coupland from CIBC. Your line is open.

I wanted to see if you would give us visibility to organic growth in the ATS business both for the quarter and the outlook into Q3.

Yes. So overall, we’re seeing some very strong growth in ATS overall. While the Atrenne acquisition did help a little bit, it’s been largely driven by organic growth. So we had 16% growth in ATS in the second quarter. It would have been closer to about 11% if you had excluded the Atrenne business so still above our long-term target of 10%. As was mentioned, we’re seeing some continuing strength going into the third quarter, guiding up the low 20% range on a year-over-year basis and still being close to that range even if you were to exclude the Atrenne acquisition. It’s really being driven from a number of different areas. We’re seeing strong demand strength in a number of different programs. We are ramping programs that we have been winning. We’ve been seeing some record wins in the ATS business, and it’s going across a number of different end markets, seeing strength in A&D but also in semi as well. As Rob had mentioned, we’ve seen some good program share wins in that business, and so we’re ramping those programs. And we’re also seeing strength in industrial.

And then just on free cash flow, as margins start to tick up in the second half of the year and seems like you’re getting at least some improvement in tightness of components. Would you expect to be free cash flow positive in the second half of the year? And if yes, can you give any orders of magnitude on that?

Yes. So Todd, what we’re encouraged by is that we are seeing an improvement in our overall cash cycle days, and as was mentioned, we’ve gone from 57 days to 53 days. As I mentioned, inventory has relatively stabilized Q1 to Q2, but 2 points don’t make a trend. But at the same time, we’re seeing some positive benefits coming from the work that we’re doing with our customers and our suppliers, both in the receivables as well as in payables. Now we are negative so far this year. We typically are negative in terms of free cash flow in the first half of the year, and we’re typically positive in the second half of the year. We’re targeting positive free cash flow for the second half of the year and through continued performance on our cash cycle days. We don’t have a specific range that we’ll provide, but what I would say is that we are also continuing to work the Toronto property sale. That is anticipated to close at the end of Q4 or early Q1, and that would definitely help towards our cash flow generation.

Thanks a lot. I appreciate the color.

Thank you.

Thanks, Todd. Next question, Christine.

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

Just looking at the new disclosure on the segment profitability. ATS margins have been flat sequentially for the last several quarters, and that’s despite the addition of Atrenne. Can you just walk through some of the puts and takes that you’ve seen in ATS margins over the last couple quarters? And then what do you see as potential catalysts for further margin expansion in ATS over the next several quarters from here?

It’s Mandeep here. I see there’s a few different dynamics that are happening. So yes, Atrenne has closed. It closed at the beginning of the second quarter. That business is performing well and in line with our expectations. And so we’re very pleased to be integrating that business into the Celestica family. There’s a couple of other dynamics that are happening, though, as well. So semi is working well. There’s very strong demand strength, and we’re seeing scale in that business. There was a little bit less contribution from semi in the second quarter than what we had anticipated as we saw some late demand drops in the quarter. But still, as Rob had mentioned, strong performance on a year-over-year basis. And we’re continuing to see year-over-year strength in semi going into the third quarter. But we’re also ramping. As we’ve mentioned, our long-term target is to grow ATS at the 10% range. Then, if you look at the growth so far in this year, it’s much higher than that. So we’re in the double – we’re well above 10%. And that’s being driven by a number of program ramps that are happening in some of our not-as-large segments within ATS, and we’re continuing to get scale. And so our anticipation is, is that we will continue to work hard to improve the margins in ATS, move towards the higher end of the target range. And it’s going to really come from developing scale across a number of our segments.

And then you might have mentioned it, but just with the ATS revenue up 16%, I think, in the Q1 call, the outlook was for high teens so slight delta there. Is that all related to the semi cap business? Or there are some other things that might have missed your expectations?

No. We would point probably to the semi one again, strong quarter for semi, just slightly below our expectations for the quarter though.

Great, thanks so much.

Thanks bye.

Christine, any further questions?

There are no further questions at this time. Rob, I turn the call back over to you.

Thank you, Christine. So we continue to make great progress in executing on our strategy despite the difficult market backdrop. I think we have some great momentum on ATS, which is enabling us to move faster on our diversification. And as such, we’re turning our attention to some underperforming programs across the business. We are still targeting margin expansion as we move into the back half of 2018. Before I close, I’d like to take the opportunity to let you know that Mike McCaughey, who’s the President of our CCS business, will be taking some time to deal with health issues over the next six months or so. Jason Phillips will assume Mike’s responsibilities on an interim basis. Jason has been with Celestica for over 10 years. He has a wealth of experience across our markets. As the Senior Vice President of Enterprise Markets, he was central to building our JDM business. He has proven himself to be a formidable leader and is playing a key role in executing on our current CCS strategy. I know we are in good hands with Jason, and we all wish Mike a speedy recovery and look forward to having him back with us soon. And we also look forward to updating you on our results next quarter. Thank you, Christine, and thank you all for joining.

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