Celestica Inc. (CLS) Q3 2019 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by. And welcome to the Celestica Q3, 2019 Earnings Call. At this time, all participants are in a listen only mode. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions] Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Lisa Headrick, Vice President of Finance.

Good afternoon and thank you for joining us on Celestica's third quarter 2019 earnings conference call. On the call today are Rob Mionis, President and Chief Executive Officer; and Mandeep Chawla, Chief Financial Officer. As a reminder, during this call we will make forward-looking statements within the meanings of the U.S. Private Securities Litigation Reform Act of 1995 and applicable Canadian securities laws. 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 assumptions as well as further information concerning financial guidance, please refer to today's press release including the cautionary note regarding forward-looking statements therein, our annual report on form 20-F and other public filings, which can be accessed at sec.gov and SEDAR.com. We assume no obligation to update any forward-looking statements except as required by law. In addition during this call, we will refer to various non-IFRS measures including operating earnings, operating margin, adjusted gross margin, adjusted return on invested capital or adjusted ROIC, free cash flow, gross debt to non-IFRS trailing 12-months, adjusted EBITDA leverage ratio, adjusted net earnings, adjusted EPS, adjusted SG&A expense and adjusted effective tax rate. Listeners should be cautioned that references to any of the foregoing measures during this call denote non-IFRS measures whether or not specifically designated as such. These non-IFRS measures do not have any standardized meanings prescribed by IFRS and may not be comparable to similar measures presented by other public companies that use IFRS or who report under U.S. GAAP and use non-GAAP measures to describe similar operating metrics. We refer you to today's press release and our Q3 2019 earnings presentation, which are available at celestica.com under the Investor Relations tab for more information about these and certain other non-IFRS measures including a reconciliation of historical non-IFRS measures to the most directly comparable IFRS measures from our financial statements. Unless otherwise specified, all references to dollars on this call are to U.S. dollars. Now let me turn the call over to Rob.

Thank you, Lisa. Good afternoon and thank you for joining today's conference call. Our third quarter results reflect solid execution in a dynamic demand environment. We delivered stronger than expected results improving our operating margin sequentially while driving strong free cash flow. Our CCS segment delivered another quarter of sequential and year-over-year margin improvement, driven by improved mixed boosted by our portfolio revenue and cost productivity actions. While demand in the capital equipment market remains muted, and the business continue to operate at a loss, we delivered sequential improvements primarily as a result of ongoing cost reduction actions and slightly higher volume. I'll provide some additional color on our end markets and outlook, but first I'll turn the call over to Mandeep to give you some details on the third quarter and our fourth quarter guidance.

Thank you, Rob. And good afternoon, everyone. For the third quarter of 2019, Celestica reported revenue of $1.52 billion, above the hind end of our guidance range due to programs specific demand, strength in enterprise. Revenue increased 5% sequentially and was down 11% year-over-year. Our non-IFRS operating margin was 2.8%, above our guidance midpoint of 2.5% and down 50 basis points year-over-year. Non-IFRS adjusted earnings per share were $0.13, above the mid point of our guidance range and were negatively impacted by $0.02 per share of taxable foreign exchange. Our ATS segment revenue was 37% of our consolidated revenue, up from 33% compared to the third quarter of last year. ATS revenue was relatively flat sequentially and compared to last year. And was slightly above our expectations due to demand strength in both industrial and capital equipment. On a year-over-year basis, lower demand in our capital equipment business and lower revenue in our energy business was offset by high, single digit growth across our other ATS businesses. Sequentially, lower revenue in our energy business including from disengagement with unprofitable customers was offset by growth in our capital equipment and industrial businesses. In the third quarter, our CCS segment revenue was down 17% year-over-year. But was above our expectations due to demand strength in enterprise. The year-over-year decline in revenue was primarily driven by enterprise program disengagements as part of our CCS portfolio revenue, as well as continuing end market demand softness in our communications business. Sequentially, CCS segment revenue was up 9% driven by increased demand. Within our CCS segment, the communication end market represented 42% of our consolidated third quarter revenue, down from 43% in the same period last year. Communication revenue in the quarter was largely in line with our expectations and down 13% year-over-year due to continuing end market weakness, mostly with the few specific programs in our portfolio. Demand strength and new program revenue and supported datacenter growth, partly offset this demand softness. Our enterprise end market represents a 21% of consolidated revenue in the third quarter, down from 24% in the third quarter of last year. Enterprise revenue in the quarter was above our expectation, driven by demand strength and was down 24% year-over-year due to planned disengagements in connection with our CCS segment portfolio review, partially offset by new JDM program ramps. Excluding these disengagements, enterprise end market revenue would have been relatively flat year-over-year. Our top 10 customers represented 67% of revenue for the quarter, up from 65% last quarter and down from 71% in the same period of last year. For the third quarter, we had one customer contributing more than 10% of total revenue. Turning to segment margins. ATS segment margin of 2.8% was flat relative to last quarter, as slightly improved performance in our capital equipment business was offset by unfavorable mix in the remainder of ATS. Our capital equipment business operated at a loss in the mid single-digit million dollar range which was slightly better than expected due to stronger than anticipated demand and the impact of our cost reduction initiatives. Year-over-year, ATS segment margin of 2.8% was down 180 basis points, primarily driven by losses within the capital equipment business and software performance in our A&D business, largely due to material constraints. These impacts were partially offset by improved contribution from our ramping, industrial and health tech businesses. Excluding capital equipment, our ATS business performed well. CCS segment margin of 2.8% was up 40 basis points sequentially, up 10 basis points year-over-year and was in the high end of our CCS target margin range of 2% to 3%. The year-over-year improvement was the result of improved mix and productivity more than offsetting the impact of lower year-to-year revenue. Moving to some other financial highlights for the quarter. IFRS net loss for the quarter was negative $6.9 million or negative $0.05 per share, compared to net earnings of $8.6 million or positive $0.06 per share in the same quarter of last year. The decrease was due to lower gross profit and higher financing and amortization costs. Adjusted gross margin of 6.6% was down 40 basis points sequentially primarily driven by mix and higher variable expenses. Adjusted gross margin was down 10 basis points year-over-year due to weaker ATS performance including in capital equipment, partially offset by improved mix and productivity in CCS. Our adjusted SG&A of $49 million was better than expected and down $7 million sequentially, primarily due to favorable foreign exchange impact and lower than expected variable spend. Non - IFRS operating earnings were $42.6 million, $5.9 million sequentially and down $13.8 million from the same quarter of last year. Our non-IFRS adjusted effective tax rate for the third quarter was 46%, higher than our anticipated estimate of approximately 36% due to taxable FX cost driven by the depreciation of the Chinese RMB against US dollar. As discussed last quarter, our tax rate continues to be higher than our originally anticipated range for 2019 due to lower levels of income, including losses in certain low tax geographies. Adjusted net earnings for the third quarter were $16.6 million compared to $36 million for the prior year period. Non -IFRS adjusted earnings per share of $0.13 was above the midpoint of our guidance and was down $0.13 year-over-year, mainly due to lower non -IFRS operating earnings and higher interest expense. Non-IFRS adjusted ROIC of 10.1% was up 1.7% sequentially and down 6.1% year-over-year, primarily driven by lower operating earnings. Moving on to working capital. Our inventory at the end of the quarter was $1.0 billion, a decrease of $52 million sequentially. Inventory turns were 5.4, an improvement of 0.4 turns quarter-over-quarter and down 0.8 turns year-over-year. Capital expenditures for the third quarter were $22 million or 1.4% of revenue. Non- IFRS free cash flow was $66 million in the third quarter, compared to $25 million for the same period last year, primarily driven by improved working capital. We continue to be encouraged by the improvements we have made in our working capital performance. Year-to-date, we have generated $257 million of non-IFRS free cash flow or $144 million without accounting for the Toronto property sale proceeds of $113 million. Cash cycle days in the third quarter were 61 days, an improvement of four day sequentially, primarily due to improvements in inventory performance. Our cash deposits reduced to $108 million, down $31 million from last quarter as certain customer deposits were returned as inventory reduced. We continue to work with our customers on targeted inventory reductions which we expect will be partially offset by a reduction in cash deposits in future quarters. Moving on to our balance sheet and other key measures. We continue to maintain a strong balance sheet and remain committed to our long-term capital allocation priorities. Our cash balance at quarter end was $449 million, up $12 million sequentially and down $9 million year-over-year. We made further progress in the quarter on deleveraging our balance sheet by repaying the full outstanding balance on our bank revolver, reducing the balance from $53 million as of June 30th, 2019 to $0 as of September 30th. Our gross debt position was $594 million at the end of September, down $54 million sequentially, while our growth debt to non-IFRS trailing 12-months adjusted EBITDA leverage ratio was 2.1x, down from 2.3x as of June 30th. Restructuring charges related to our cost efficiency initiative were $10 million this quarter, bringing the total program spend to date to approximately $70 million. Now turning to our guidance for the fourth quarter of 2019. We are projecting fourth quarter revenue to be in the range of $1.425 billion to $1.525 billion. At the midpoint of this range revenue would be down approximately 15% year-over-year. Fourth quarter non -IFRS adjusted earnings are expected to range between $0.12 to $0.18 per share. At the midpoint of our revenue and adjusted EPS guidance ranges, non-IFRS operating margin would be approximately 2.8% flat to the third quarter with lower revenue. Non-IFRS adjusted SG&A expense for the fourth quarter is expected to be in the range of $50 million to $52 million. Based on the projected geographical mix of our profit in the fourth quarter, we anticipate our non-IFRS adjusted effective tax rate to be approximately 35%. This does not include the impact of taxable foreign exchange and any unanticipated tax settlements. Turning to our end market outlook for the fourth quarter. In our ATS end market, we anticipate revenue to be up in the low single digits percentage range year-over-year as growth across most of our ATS businesses including capital equipment is expected to be partly offset by the impact of program disengagement in our energy business. In our communications end market, we anticipate revenue to decrease in the low teen percentage range year-over-year, driven by continuing end market demand softness, mostly with a few specific programs in our portfolio. In our enterprise end market, we anticipate revenue to decrease in the high 30% range year-over-year, driven by planned program disengagement as part of our CCS portfolio review and lower demand when compared to a very strong fourth quarter last year. I'll now turn the call over to Rob for additional color and an update on our priorities.

Thank you, Mandeep. Overall, although adverse market conditions persist, I am encouraged that in the third quarter we delivered substantial improvement in our operating margin, continued to generate strong free cash flow and in the fourth quarter are projecting stable operating margin performance while growing adjusted EPS. We are seeing the benefits of our CCS portfolio review program, our cost productivity initiatives and the benefit of certain program ramps across our business. Within the ATS segment, our productivity initiatives in our capital equipment business are beginning to deliver results. Although not yet at breakeven, our capital equipment business improved and delivered a smaller sequential loss in the third quarter, resulting primarily from our productivity initiatives and slightly higher revenue from new program ramps. The demand environment in the semiconductor market continues to remain soft, however, we are seeing some signs of improvement and our customers are forecasting a moderate level of demand growth in the first half of 2020 driven by growing demand for new technology equipment. While it's too early for us size the level of demand that will return in 2020, we are encouraged that the demand outlook in semiconductor is more promising than it was three months ago. Within our display business, revenues remain depressed. We expect a moderate level of recovery late next year as we anticipate that the demand for next-generation smartphones and large form factor displays will increase. While we anticipate our capital equipment business to generate a loss in the low single-digit millions in the fourth quarter, we are working towards breakeven profitability or better in the near term. Improvements will largely be driven by cost productivity initiatives and volume leverage as our bookings convert to revenue. I firmly believe in the long-term fundamentals of the capital equipment market. We believe that when the capital equipment market recovers, the capabilities and infrastructure we have in place will position us well for revenue growth and margin expansion. Across the balance of our ATS segment, we are seeing the benefits of new program ramps in industrial and health tech, and we expect improve profitability as we continue to add scale to these businesses. Our A&D business continues to perform well notwithstanding inefficiencies largely caused by materials constraints. Looking ahead, we continue to focus on expanding margins in our ATS segment as a result of strengthening demand in our capital equipment business, growth in our other ATS markets and productivity initiatives. We have a strong pipeline of sales opportunities and strong bookings momentum. With new wins across all of our ATS markets which we believe positions us well to drive growth over the long term. Turning to CCS, overall, I am pleased with the performance of our CCS segment in the third quarter. Despite significantly lower revenue relative to last year, our CCS segment improved margin and operated in the high end of our 2% to 3% target range, as a result of our portfolio and cost productivity actions. As a reminder, we launched our CCS portfolio review at the end of 2018. In light of evolving market dynamics in the EMS industry, including the increased commoditization of certain products. The goal of this review was to identify programs that were not expected to generate sufficient returns over the long term, and to work closely with our customers to address these gaps, with the goal of improving CCS segment margins and releasing working capital. As a result of this review, we successfully negotiated improve commercial terms on a number of programs and identified programs with approximately $500 million of annualized revenues which we agreed with our customers to transition or not renew. These planned programs disengagements which are largely in our enterprise market are on track to be completed by the end of 2019 with an anticipated full year 2019 revenue decline of just over $400 million relative to last year. As a result of a portfolio review and cost productivity actions, third quarter year-to-date CCS segment margin is up 30 basis points relative to last year. We are pleased that the actions associated with this program are having their intended results. Over the last two years, we have experienced significant declines in our communications end market, with revenue down 14% year-to-date on a year-over-year basis. These declines are largely due to program specific market dynamics and in some cases have resulted in returns below our financial targets. While we have been in active discussions with a number of our customers on actions to improve our returns, we have come to a mutual agreement with Cisco to begin a planned and phase exit of existing programs beginning in 2020. We believe this decision will enable both companies to better deliver on their strategic priorities. As a result of the non-renewal of these programs, we're adding our revenue with Cisco to the CCS portfolio review program, which is currently underway. In the third quarter of 2019 Cisco represented 13% of revenue. At this level, Cisco would represent approximately $750 million of the company's revenue in 2019. As a result, the overall revenue impact of the CCS portfolio review will increase from approximately $500 million to $1.25 billion. The impact of expanding this portfolio review will be negligible to our fourth quarter and has already been factored into our guidance. As we look to 2020, we expect that the impact of our portfolio review program to which we are now adding Cisco revenue will result in a revenue reduction in the range of $400 million to $600 million as compared to 2019. And expect the transition to be largely completed by the end of 2020. As a result of the Cisco program transitions, we anticipate approximately $30 million in additional restructuring charges in 2020 as we realign our cost base. We anticipate a negligible impact to adjusted EPS next year as we execute the necessary cost actions and redeploy our resources to support growth in other areas of our business. We look forward to working with Cisco's incredible team and providing remarkable customer support to ensure our successful transition. While we are not providing revenue guidance for 2020 at this time, we do anticipate revenue growth in other areas of our CCS segment, including our emerging enterprise and cloud engagements fueled by our JDM solutions and revenue growth in ATS to help partially offset the revenue decline resulting from the Cisco transition. We continue to drive the actions we believe are necessary to deliver shareholder value of the long term and while we anticipate 2020 revenue declines on current levels, we anticipating year-to-year growth in both operating margin and adjusted earnings per share. To be clear, Celestica's long-term success will be built by having strong franchises in both our ATS and our CCS segments. We remained focus on delivering high value solutions in CCS including JDM, while continuing to invest in new capabilities. We believe the actions we are taking are strengthening our company and will position us to help our customers succeed over the long term. Now before I open the call for questions, I want to highlight a recognition that we recently received from one of our CCS customers, Hitachi. We are proud to have been recognized by Hitachi with their partner of the Year Award. This prestigious award is presented annually to one partner from across the Hitachi's global network of companies. The significant achievement is a testament to the work of all our employees around the world to support this important customer. I'd like to take this opportunity to thank our employees for their hard work, our customers for their support and loyalty and our shareholders for their continued support of Celestica. We look forward to updating you on our progress over the coming quarters. With that I would like now to turn the call over to the operator to begin our Q&A.

[Operator Instructions] Your first question comes from the line of Gus Papageorgiou from PI Financial. Your line is open.

Great. Thanks. I'm just wondering can you kind of remind us again what your margin goals are for ATS and CCS. And as you transition Cisco out, your longer-term goals that you establish, do you think they have --there is upside to those goals or you're not ready to make that commitment yet? And then secondly, obviously Cisco is a big deal and I just wondering Juniper had or has been historically your second biggest customer. And what are the implications for the existing customer base in CCSD? Do you anticipate that you -- that there's a chance you lose other big customers or do you think that with Cisco that kind of you kind of turn the page on that chapter.

Okay. Hi, Gus. It's Mandeep here. Kind of nice to talk to you again. I'll take the first question, all right, Rob and chime in for the second one. So, yes, as a reminder on our margin targets they remain the same. So we are targeting to get back into the 5% to 6% margin range for ATS. As a reminder, we were in that range as early as the second quarter of last year. And we believe the things that we are working on right now we're going to get us there and capital equipment recovers as we continue to ramp the programs in industrial and health tech and as the constrained environment in A&D eases. We're expecting to be back in that range. And we're working towards being in the higher end of that range. On the CCS side, the range is 2% to 3%. We're happy that we've been able to be in that range now ever since the second quarter of last year, pleased with the performance that we saw this year as well. And just targeting to continue to be firmly within the middle of that range. We believe that when those things happen, it will bring our margins to the higher levels. We continue to target moving towards 3.75 to 4.50 and when we're in both of those zip codes, if you will. And we believe that will happen. We're just not calling up the timing right now just because of the market and how dynamic they can be. And I'll let Rob talk about the second question.

Yes. Hi, Gus. So with respect to any potential additional portfolio action, the action that I guess the programs that is in the current program. I think once fully realized will leave us with a solid CCS portfolio. So we're not planning any major actions, additional actions at this time. Obviously, as the markets evolve and things will continue to assess but right now as you put it, I think once we turn the page with Cisco I think the CCS portfolio will be in very good shape.

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

Good afternoon. Rob, maybe to extend on Gus' question. Was there any characteristics regarding the Cisco business that we did a bit different from the rest of the CCS business that's remaining with you? Maybe lower levels of JDM content or anything else you can point to that would make a different.

Yes. Thanks Thanos for the question. We can't really comment specifically on the Cisco portfolio. The only thing I can say is Cisco as we've reported regularly the revenues have been declining recent in our business which actually put cost pressure on the entire program. And that had a lot to do with a mutual decision to do a planned and safe exit.

And then maybe just from a competitive perspective, is it the case that other EMS providers are being maybe less disciplined than you are with respect to the profitability they're targeting? Or is it that perhaps others can deliver on the Cisco business more profitably than you can for some structural reasons?

I think some of it has to do with mix; some of it has to do with volume leverage. I would think those two things are key contributors from a cost perspective. Frankly, I think our factories are the best in the world and we're very productive in our factories and our quality is second to none.

And then finally for -- I guess either of you on the tariff impact any update there in terms what you're seeing?

The tariff impact I think it's because Thanos they say we haven't noticed any more material changes than we've seen in the past. We generally think about in two ways. We have traditional OEMs which have been more measured in their actions and then there's customers who consume their own demand, if you will, and they've been a little bit more active in their measures and we're working with them to find alternative solutions if they seek some. Broadly in the market, I would say we're in the net recipient of market share as we chose them to go after.

Your next question comes from the line of Paul Steep from Scotia Capital.

Great. Thanks. Rob or Mandeep, could you talk a little bit about what --how we should think about the working capital release that might come post the disengagement with Cisco in terms of the inventory reduction? I know you talked about some offsets on cash deposits, Mandeep, but that would be helpful. And then I've got two quick follow-ups.

Yes. Hi, Paul. So we do expect to see a positive cash impact as a result of this and that will be net of restructuring. We're not giving any specific targets at this point. But I'll point to a few things. We continue to target $100 million to $150 million of free cash flow in a steady state. And we believe that with the decline in revenue with Cisco, we will be able to look at that as an opportunity on top of the $100 million to $150 million. If you look at the free cash flow generation this year where revenue is down a little bit over 10%. We're in the mid-200; close $250 million right now. You back out the property sale, we're still at close to $150 million of free cash flow. And that's for the first three quarters. So it shows that the formula can work and we believe that we're going to see some positive impacts next year as a result.

Okay and how should we think about the distribution component of that CCS business? Is it -- have we materially sized it to nominal amount after this when you sort of exit this amount finally? And then one follow-up on ATS. If you could talk a little bit about some of the new wins that you referenced across other areas as well that'd be helpful. Thanks.

Sure. Paul, I take the first part. So maybe just as a recap again, we expect that the impact from the program disengagement is going to be in the ballpark of $400 million to $600 million next year. And so we will be still having a decent amount of revenue with Cisco in 2020. Of course, it will be a little bit more heavily weighted in the first half of the year versus the second half of the year as we expect it to be substantially complete by the end of the year. As a reminder, we will be expecting growth in other parts of our business. So we expect a strong organic growth in ATS based on the many wins that we have been ramping and then we do expect some organic growth in CCS as well. The other thing I'll just highlight again is that due to cost actions that we are targeting to take in the Cisco portfolio, we're expecting that the impact to EPS from that will be negligible in 2020. And then given the growth that we're expecting in other parts of the business as well as some of the profitability improvements we're expecting through volume leverage. We do expect to grow EPS in the rest of the business.

And, Paul, with respect to the second question, we're seeing strong growth in A&D. We're seeing strong growth in industrial that's driven by industrial connectivity, Internet of Things, healthcare is growing quite nicely. Surgical devices, implants, diagnostic equipment, capital equipment, these four elements of capital equipment in our business, semi cap is coming into its own, it's being led by logic and foundry spend and 3D NAND. We're also seeing some strength in industrial to capital equipment and actually covered it all.

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

Hi. This is [Indiscernible] filling in for Ruplu. Thank you for taking my questions. So regarding the plan to focus the business in the enterprise segment, sounds like you're pretty happy with where the portfolio is. Should we see the processes as completely done or do you still see opportunity to fund the portfolio further? And maybe to more generally, how should we view the CCS margin progression over the next few years? Thanks.

Yes. So I'll take the first part of that. In terms of the actions that we've announced so far, I think once they are completed I think the portfolio within CCS will be in very good shape. The first round of actions was obviously centered around enterprise and adding the communication, Cisco communications program to it. I think those two things combined will it's exactly where we are with a nice mix in our CCS portfolio. And with respect to margins I'll let Mandeep to address that.

Yes. So as mentioned our target margin range for CCS is 2% to 3%. We were at the higher end of that range this past quarter, but just to highlight what is obvious which is we are doing not only a significant transformation in the company, but we're also doing a significant transformation within CCS as we continue to invest in areas like JDM and grow in many other growth areas. And so as we go through that transformation, we're looking to continue to stay within this range. There is some pressure on margins as you bring revenue down and we have to drive cost productivity. But we believe that the 2% to 3% range is still is the right target for now.

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

Thanks very much. Just in regards to the facilities that may be utilized for Cisco, what's the strategy for either exiting them or reutilizing them for other customers?

Yes. Hi, Paul. So the work we do Cisco is isolated to our Thailand facility. It's in a dedicated building and there are other programs that we have within our Thailand facility that are actually growing. So while we're working to action some of the costs associated with that. We're also looking to redeploy as many people as possible to other parts of the business as the program runs.

And maybe just add on to that, Paul. As you're probably familiar, Thailand is a very large campus for us, one of the largest areas of our business. And as a result of the tariff challenges that have been going on now for a couple of years, we have been seeing a significant amount of growth moving towards Thailand as Rob mentioned earlier. We believe we've been net recipient of the tariff situation with business coming out of China. And so number one is we believe that we can isolate the costs that need to be actioned within the campus. And then we are also in the process of ramping business where we can redeploy a lot of that structure.

Thank you. That's very helpful. Just secondly just in terms of the comment that the EPS impact from the Cisco disengagement will be negligible. I mean is thinking it through like should we think of the profitability on that type of business as well below they targeted 2% to 3% range for CCS overall?

So we're not going to comment, Paul, on the profitability of specific customers. But I'll reiterate something that Rob had mentioned in his answers earlier, which is through our public disclosure you're able to see that the revenue has been declining with Cisco. And when a customer sees that level of decline, we do have profitability challenges along the way. And so we are going to be able to target the cost that account currently absorbs. And that's why we believe that we can manage any EPS impact going into next year. And we do think that the portfolio will be just as strong or stronger when we come out of it.

Your next question comes from the line of Daniel Chan from TD Securities.

HI. Thanks. When you guys get into these conversations on restructuring these programs, how do you get to the conclusion of disengaging rather than reducing certain programs or moving programs to other suppliers?

Broadly speaking I mean the first thing we try to do is to drive as much productivity as we can in collaboration with our suppliers internally and with our customers. The second thing we try to do is to try to work on improving the mix of the business, offering JDM solutions or higher value-added solutions. And the last thing we try to do generally speaking is to work with our customers on commercial terms to kind of improve overall ROICs. And in collaboration with them in some cases we find, in many cases wee find a win-win. In other cases, we find a win-win another way through just deciding that it's in our own best interest collectively to help them through disengagement. And that's typically how the portfolio shaping program has kind of played out.

Thanks. That's helpful. And then considering that these guys were your largest customer, any impact on your buying power with much lower volumes exiting this program?

No. We don't anticipate that at all. In most of our CCS customers, the build material is largely owned by and managed by the OEM, if you will. So hence we are buying off their.

Okay. And the final one for me does this open up more opportunities where you would have had a conflict with Cisco in the past? In the past you did mention that hyperscale cloud providers have become a customer. Are there more opportunities like those now that Cisco's disengaging?

Yes. I would say the -- I wouldn't say that it was a barrier in the past, an emerging part of our business is supporting cloud providers. And that's an area that we have and continue to be focused on moving forward and has grown very nicely, we look past [corporate] time and we've been investing in our JDM solutions to help fuel that growth.

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

Hi. This Josh Kehoe on behalf of Jim Suva. Thanks for taking our question. Just wondering how order trend and visibility into the comp equipment space is changing? Have there been any delays or push out?

Yes. So within capital equipment the orders are certainly starting to pick up. In Q3, we had some late quarter upside, so the decline wasn't as much as we thought it would be and the Q4 was certainly seeing a little bit of an uptick. The order book is looking positive for the first half of 2020, but still needs to kind of fill in a little bit for us to get further confidence. And the back half of 2020, a lot of speculation on whether that will fill in or not by the entire industry. And you were in the other camp of wait-and-see mode to see if the broad memory market recovers to fill in the back after 2020. Does that answer your question, Josh?

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

Good evening, everyone. Just follow up on the semi market. So if we were to think about slices within semi, you're recommending that we focus on the memory side of the business so when we see CapEx increases with foundry companies like TSMC up 40%, you aren't necessarily going to benefit from that in terms of flow through, is that the way to think about that?

No. Actually I think we're the benefactor of both foundry and logic and also 3D NAND based on our customer base. And that's what we've seen in terms of the demand uptick. Obviously, DRAM is a wait-and-see mode and broad NAND in terms of the broad memory market terms of when that recovers there is some speculation that it will pick up in the back half of 2020. But we have to see if inventory gets depleted and prices rise and CapEx spending starts increasing. But right now in terms of foundry and logic certainly and 3D NAND certainly.

Okay. And what level of I guess recovery in those slices. I know you talked about sort of a moderate slow first half. What level of recovery would you need to see in 2020 to actually get the overall EPS to move up consistent with the company comments, post the disengagement I mean?

Well, Todd, Mandeep here. And tell me if I'm able to answer your question properly or not. So we started to see the downturn in capital equipment begin in the third quarter of last year. And as you know, that's when we start to fall out of our ATS target margin range of 5% to 6%. We're glad to see some demand upside that came in the third quarter. We're seeing some of that demand upside continuing into the fourth quarter. And but we're not yet at a breakeven point. And so we're expecting to see additional growth from where we're at right now in order to get to that profitability level. Two things are going to get us there. One is the impact of the productivity actions we've already taken. But then of course a volume leverage as well. Now just as a reminder though if you look outside of our capital equipment business, the rest of the ATS portfolio is actually performing quite well. This quarter it was a little bit outside of the target margin range. We're ramping programs. We are working through material constraints in A&D, but the rest of the ATS business is able to, if you will, hold its own. And so capital equipment though when it's performing in a normalized environment and normalized would be maybe closer to the first half of 2018 levels. We expect to be back in the range. And then, of course, as that's the semiconductor side when display starts coming online which we're currently seeing towards the end of next year. We believe that's going to help lift us to the higher end of that margin range because capital equipment is able to perform above the ATS target margin range when both display and semi are performing well.

Okay. That's helpful. And then just one for me on Cisco. So if I remember correctly the major disengagement piece last year was largely fulfillment business. Can you just give us broad strokes, the kinds of things you're doing that aren't allowing you to get to target profitability in -- with this customer?

Yes. I would say the mix that we have is a combination of EMS and also direct auto fulfillment. There's no JDM content in the mix.

And you are right that the majority of the portfolio program that we've had which is all in enterprise has been fulfillment business. We're pleased that we've been able to reduce our exposure to fulfillment by almost half over the last year.

Okay. And if I were to just sort of step back two major global OEMs, I get you want to make money for the things you're doing. But clearly lower levels of businesses causing consolidations needs through the supply chain. So when you see these kinds of major moves over a couple of years, what does that make you think about in terms of rationalization consolidation within Tier-1 EMS players? Just talk about your view of whether that's needed in the market at this point. Thanks.

Yes. On the broad EMS market, as you mentioned, there's certainly more capacity than there is demand. But history has kind of dictated, a long history has dictated that consolidation amongst Tier-1 EMS hasn't necessarily created shareholder value historically speaking. And moving forward there are various views on whether that will create shareholder value moving forward. But it's --I think it's very hard thing to do for Tier-1 to consolidate because the value proposition will be driven by a lot of restructuring and a lot of mess and the net benefactor would probably be the folks who don't consolidate. So for those reasons I'm not big optimist that, that's in the cards moving forward, but time, will say moving forward certainly the markets are dynamic and things change. But in the various papers out in the industry that certainly will disagree with me. End of Q&A

There are no further questions at this time. I will turn the call back over to the presenters.

So thank you and we're pleased with our margin expansion and strong free cash flow generation in Q3. Within our ATS markets, we are encouraged by the early signs of our semi cap recovery. And our CCS business is actually performing well amidst the portfolio shaping program. The decision we reached with Cisco is the right one for both parties. And we're working towards a well planned and phase transition. I've mentioned before our strategy is certainly sound and over time the actions we're taking will improve our diversification and enable consistent and profitable growth. I thank you all for joining. And I look forward to updating you as we progress throughout the year.

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