M&A Announcement

Oct 10, 2018

Good morning. My name is Kelly, and I will be your conference operator today. At this time, I would like to welcome everyone to the Celestica Acquires Impact Holdings Conference Call. Please go ahead. Thanks, and good morning, everyone. Thanks for joining us today to discuss our acquisition of Impakt as well as the increasing of our target margin range and the accelerated full payment of proceeds associated with the sale of our Toronto facility. As a reminder, we are in quiet period and will not be providing any information associated with the Q3 or broader outlook information beyond what we have provided in our release today. Also as a reminder, we will be reporting our Q3 results on October 24. On the call today are Rob Maonis, President and Chief Executive Officer and Mandeep Chawla, Chief Financial Officer. Rob and Mandeep will provide some comments on the acquisition, and then we'll open up the call for any questions. During the Q and A session, please limit yourself to one question and a brief follow-up. During this call, we will make forward looking statements within the meaning of the U. S. Private Securities Litigation Reform Act of 1995 and applicable Canadian securities laws, including those related to the Impakt transaction and its impact on our business. 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, please refer to the company's various public filings. These include our most recent MD and A and Annual Report on Form 20 F, including the Risk Factors section therein filed with and in reports on Form 6 ks furnished to the U. S. Securities and Exchange Commission and is applicable to Canadian Securities Administrators. Please also refer to our cautionary statements regarding forward looking information in such filings and in today's press release concerning the Impakt transaction. Our public filings can be accessed at secgovandsedar.com. In addition, during the call, we will refer to operating margins, non IFRS measures. Non IFRS measures do not have any standardized meaning 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 our Q2 2018 press release and financial statements, which are available at celestica.com under the Envista Relations tab for more information about this and other non IFRS measures. Unless otherwise specified, all measures to dollars on this call are U. S. Dollars. Let me now turn the call over to Rob. Thanks, Paul, and good morning, everyone. As you saw in our press release this morning, Celestica has signed an agreement to acquire Impakt. Impakt is a leading vertically integrated capital equipment manufacturer providing advanced engineering and manufacturing services to the display and semiconductor capital driven markets. We believe it to be an exceptional company with capabilities well beyond traditional contract manufacturers and will represent a very strong fit with Celestica's strategy. Impact has a 40 year track record serving leading global capital equipment OEMs across multiple end markets, including the world's largest manufacturers of display and semiconductor capital equipment. They are strategically located in the U. S. And South Korea near key display and semiconductor capital equipment providers and have an extensive range of vertical integration capabilities, enabling end to end product lifecycle solutions. Impac's business has high barriers to entry and is attractive to Celestica based on the long term nature of contracts in their business, highlighting the strategic role they play with their customers. We both enjoy strong relationships with the industry leaders in capital equipment manufacturing and Celestica is also gaining new customers through this acquisition. In addition, Impakt has a differentiated position in the capital equipment market. Thanks to its specialized expertise and long track record of quality and performance, customers trust Impakt to provide final tested and complete systems that are accepted by semiconductor OEMs directly at Impakt's own Korea facilities. This allows Impakt to consistently achieve excellent lead times and responsiveness. They have built a business in key capital equipment markets that we could not easily grow organically nor could we replicate the decades long track record with its customers. We also like the long product lifecycle nature of Impac's business and the new capabilities they bring to the table. We anticipate that their capabilities will allow us to further grow our end to end business solutions across multiple markets. Importantly, we anticipate this to be a bolt on acquisition with minimal integration risk and with long term growth synergies. The acquisition of Impakt is also aligned to our strategy of augmenting our ATS business through diversifying the segment's revenue mix and by adding higher value add capabilities. Clearly, we feel that this acquisition will continue to differentiate Celestica in the eyes of our customers and also accelerate our well defined growth, diversification and profitability initiatives. Beyond Impac's capabilities, we are excited with what this team of 450 experienced employees will contribute to our growing and diversifying ATS business. Our ATS business currently represents approximately $2,200,000,000 in annual revenue and we continue to target to operate this segment in the 5% to 6% margin range. Within ATS, we have established the industry's leading position in A and D and the acquisition of Impact would further solidify our industry leading position in capital equipment manufacturing. MPAP will enable Celestica to broaden its solutions across a diversified set of markets, including displays, power and industrials. To provide some additional transparency on our revenue mix, our capital equipment business is our 2nd largest end market in ATS. With semiconductor equipment and now display equipment, each representing just a single digit percent of total company revenue. While our overall capital equipment scale makes us meaningful to our customers, it is also nicely balanced within our total revenue portfolio. We believe that with the addition of Impakt, our expanded capabilities and scale will be attractive to customers and should allow us to participate in what we view as a strong long term dynamics of the key end markets this business supports. For example, we believe that Impac's strong position in providing capital equipment to current LCD and emerging OLED display markets will represent an additional future growth driver for the company. In addition to Impakt's current strong position in capital equipment for the LCD market, recent industry projections estimate the future OLED market to be valued at $35,500,000,000 by 2022, growing at a CAGR of approximately 10% between 20172022. Now some of the key factors driving this growth include the rapid adoption of OLED displays across a variety of applications, including growing investments in technology and manufacturing facilities. We believe that this market opportunity, combined with Impact's strategic in region presence in South Korea near key customers, should provide Celestica an attractive opportunity to participate in another next generation growth stream in the coming years. Now, let me turn the call over to Mandeep to provide some additional financial color on the transaction. Over to you, Mandeep. Thanks, Rob. The purchase price for Impakt is $329,000,000 subject to specific adjustments set forth in the definitive agreement and will be financed by a combination of the company's revolver and term loans. We expect that the transaction will be accretive to EPS, non IFRS operating margin and ATS segment margin upon closing. More importantly, the strategic actions we have announced over the past year to drive improved margins are showing progress and giving us the confidence to raise our future target consolidated non IFRS operating margin range. As you read in our press release this morning, we are increasing the consolidated non IFRS operating margin target objective for Celestica to 3.75 percent to 4.5% over the next 12 to 18 months compared to our previous objective of 3.5% to 4.0%. The anticipated increase and accelerated timetable of these objectives is a result of the positive traction we are seeing across a number of our transformational initiatives, including the continuation of our proactive CCS portfolio review, where we are targeting and better aligning the investments we make in programs to support our strategic and financial priorities our $50,000,000 to $75,000,000 restructuring program, which is scheduled to run until mid-twenty 19 and the ongoing expansion of our ATS segment revenue portfolio, which has been growing organically as well as through strategy aligned acquisitions such as Atren and Impact. Attaining this level of margin performance is what we intended the company to achieve when we started our transformational journey 3 years ago. We look at the dynamics of purchasing impacts now based on our view of the current cyclical moderation of this industry and the positive trends that we see longer term such as growing electronic content, connectivity in all industries, the Internet of Things and artificial intelligence. Accordingly, we have reviewed the transaction on a risk adjusted basis. In addition, this transaction is aligned with our strategic growth initiative and consistent with the capital allocation strategy we have previously communicated. It exceeds the internal financial thresholds we have set forth for an acquisition even when evaluating through a lens of heightened conservatism of a more cyclical industry. Consistent with previous acquisitions in ATS, we expect to generate a return in excess of our cost of capital in the 1st 3 years. The acquisition is expected to close in the Q4 of 2018, subject to receipt of applicable regulatory approvals and satisfaction of other customary closing conditions. As you also read in our press release this morning, we now anticipate all cash proceeds associated with the previously announced sale of our Toronto facility to occur upon closing. We continue to expect this closing to occur late in Q4 of 2018 or in Q1 of 2019. Through an updated agreement with the purchaser, the company will now receive the full outstanding balance of CAD122 million or just under US100 $1,000,000 upon closing. Celestica's balance sheet remains strong and our capital allocation strategy remains unchanged. As such, the acquisition of Impac does not alter our commitment to complete our current NCIB stock buyback program. We are thrilled to have the impact team and their customers join the Siletzka family. Their customers and employees will become part of the largest capital equipment manufacturing provider in our industry and we look forward to growing with them in the coming years. We are approaching an exciting time in our transformation journey and Rob, I and the entire team at Celestica is motivated at the opportunity to achieve improved operating and financial performance levels. Let me now turn the call back to the operator and Rob and I would be happy to take your questions. Your first question comes from the line of Ruplu Bhattacharya from Bank of America Merrill Lynch. Please go ahead. Your line is open. Hi, good morning and thank you for taking my questions. Mandy, the first question for you is, you raised the midpoint of your 12 to 18 month operating margin target by about 40 bps from 3.75% to about 4.1 3% at the midpoint. And you talked about 3 things, the CCS portfolio, ATS portfolio and restructuring as the three things leading to that. Can you help us quantify how much improvement is coming from each of those areas? Hi Ruplu, it's Andy We're not breaking it out between the 3. It's really a combination and we've been working these various streams in parallel for up to a year now. So as we talked about in the prepared remarks, we're seeing good traction on the restructuring program. As you know from the last quarter and we'll provide an update in a couple of weeks on the Q3 year to date. We had been taking restructuring charges along the way, but we still feel that the $50,000,000 to $75,000,000 program is the right program for us. The CCS portfolio review, we announced it at the end of last quarter. Those activities are going to continue going into 2019, but we're starting to see some traction there as well. And we believe that that's going to benefit the company from a margin perspective. The Atrient acquisition is well integrated at this point and it's performing to its management case, so we're seeing benefits there. ATS continues to grow. And as you saw from our guidance for the Q3, we were expecting to see strong organic revenue growth in ATS. And then when you add on impact as well, it just continues to add to the ATS story. And so when you put the 3 together, it allows us to go from, frankly, what we were targeting in the Q4, as you know, 3.5% margin to closer to the 3.75% to 4.5% range near the end of 2019 or into 2020. Okay. Thanks for all those details. And maybe for my follow-up question for Rob. With respect to the acquisition of Impakt, how many people are you taking on? And are you acquiring all of their 7 facilities? And if you can give us some estimate of how you think about integration and what level of effort is required to integrate it into the Celestica maybe back end? And how should we think about OpEx going forward with this acquisition integrated? Hi, Rupu. From a people perspective, it's about 4 50 people across all their facilities. And yes, we're purchasing all of Impakt. From an integration approach, we're going to be integrating their business into our capital equipment business and as such expanding our overall capital equipment solutions across a number of different industries. Moving forward, we'll have display business, semiconductor business, a power business and industrial business and that will all be under 1 leader. We do view this as somewhat of an integration light approach. We don't view it as overly complex or overly disruptive. And from an OpEx perspective, we're not it's not really driven by synergies per se. It's really a capability play. And we're thinking that OpEx is about 3%. 3% of revenue, Ruplu, and we don't expect it to alter our company target of 1.5% to 2% CapEx. Okay, great. Thank you so much for the details. Great. Thanks, Fruple. Next question, Kelly. Your next question comes from the line of Thanos Moschopoulos from BMO Capital Markets. Please go ahead. Your line is open. Hi, good morning. Rob, could you provide a bit more color on the display markets and that's a new market for you? Is that a market in which customers still have a lot of stuff in sourced? Has outsourcing been broadly adopted? Is that a fragmented market competitively? What does that look like? Yes. So thanks Thanos. We're very excited about the display market. It's somewhat fragmented right now and we think that Impact has somewhat of a unique position in this business as being vertically integrated. It does everything from engineering to manufacturing to sheet metal, cleaning, anodizing, powder coating all the way through modules, all the way through final test and integration right at their facilities. So it's somewhat of a unique position. They do both LCDs and also with the secular trends moving towards OLED moving forward and the growth of OLED, we think is we're getting in at the right time to take advantage of future growth potential moving forward. I think it's an opportune time to kind of buy into that market and take advantage of growing trends. From an in source outsourcing perspective, there are a couple of leaders from our customer perspective in this space and we're aligned with those leaders and they have adopted an outsourcing strategy and we're partnered with them to help them grow into the future. And then on the semi equipment side, can you speak to customer overlap? Does this get you into some new customers? Or does that further increase the penetration of existing customers that you have? Both. There is some overlap and we also are picking up some new customers. From a customer concentration perspective, it doesn't materially change our top ten list, if you will. But it does allow us to participate in future growth opportunities as a combined entity because of our vertical integration capabilities and also the global presence that Impak has specifically in region in Korea. Great. Thanks, Seth. Great. Thanks Thanos. Next question, Kelly. Next question comes from the line of Todd Coupland from CIBC Capital Markets. Please go ahead. Hi, good morning, everyone. Are you going to be providing any guidance on how to model the financial impact of this acquisition? Hi, Todd. Good morning. It's a private company and for that reason, competitive reasons, we stated the amount of disclosure that we're prepared to share at this point. What we can say is that it fits in well into the overall ATS portfolio. The ATS portfolio, to reiterate is now a $2,200,000,000 business and it allows us to still stay within that 5% to 6% range if anything helps us move higher up into the range. From a deal financials perspective, we're pleased on a number of fronts. So from an ROI perspective, it exceeds our cost of capital in the 3 year time window that we've set out for ourselves. It's immediately accretive to EPS. It's immediately accretive to company margins as well. And from a purchase price multiple perspective, as some of the characteristics that we shared about the industry are, there's higher barriers to entry, the product life cycles are relatively long and the relationship strength that you need with key customers is paramount and the deal checks all of those. But at the same time, we typically see those types of characteristics in the A and D space and we're happy that we're able to purchase this business for a multiple that is much more attractive than what you would see in typical A and D deal. Okay. So I guess we'll see the revenue impact and margin impact when you guide Q1 assuming you include it close in Q4 or something like that, right? That's correct, Ted. Yes. Okay. Just secondly, so just to give us an idea on the OLED market, I mean, we think about this in terms of TVs or smartphones or everything in between? And I think you mentioned this in your prepared remarks that they were in fact aligned with the largest player in the South Korean market. Did I hear that right? Thanks. Yes, that's correct, Todd. And they support all those markets. OLED take rates OLEDs are supposed to increase in both smartphone and TV markets. And because they have very high manufacturing costs, all the displays still come out somewhat of a premium, but those premiums are coming down and they're quickly taking over share from the LCD market. From that point of view, we see LCD coming down and OLED coming up and and Impact participates in both of those markets. The OLED market, however, is characterized by much higher CapEx investment, which is good for impact and good for our business due to the retooling and the higher capital intensive nature. So do you see outsized growth in your funnel in 2019 while assuming this business closes? Yes. So, Todd, from an outlook perspective, we took into account the fact that the cycles right now are in a period of retrenchment and so that was factored into our modeling. But yes, absolutely, the business has a very strong growth profile attached to it and there is an opportunity for us to see some meaningful growth in the coming years. Okay, great. Thanks. Appreciate the call. Thanks, Todd. Thanks, Todd. Next question, Kelly. Your next question comes from the line of Gus Papageorgiou from Macquarie. Please go ahead. Your line is open. Hi, thanks. Just a couple of questions. Again, just on customer overlap, can you just talk about total customer overlap across all of Impac's business, not just in semiconductor? And secondly, it looks here like they are involved in Solar Solutions. Can you just discuss how meaningful Solar Solutions is to their revenue and what markets you're what markets are involved in? Sure, guys. So from a solar solutions, it's a very small de minimis portion of their revenue. From a customer overlap perspective, we're picking up a couple of 5, 6, 7 additional customers. The top two customers that they have overlap nicely with our portfolio and we think we'll be able to kind of expand our solutions to those customers based on having in region, I. E, Korea manufacturing presence and also have a lot of those vertical integration capabilities that I mentioned as well. And just a quick follow-up. Can you just discuss their customer concentration? I mean, would it be similar to yours or would they be more heavily concentrated? In terms of our semi cap business, it would be similar to ours in terms of concentration. The semi cap market and the capital equipment market is usually characterized by a couple of market leaders. And we're aligned with those market leaders. You could make an analogy to aerospace and which you have Boeing Airbus to major market leaders. And if you're anybody from anybody, you're doing business with those 2 OEMs. And within our capital equipment business, we're aligned with those market leaders. One thing to add to that, Gus, though, is that although the outsourced TAM is relatively concentrated with a few main equipment manufacturers, the number of programs that we do with these customers are numerous. And so we do have a diversification across the program set. Great. Thank you very much. Thanks, Gus. Thanks, Gus. Next question, Kelly. Your next question comes from the line of Paul Treiber from RBC Capital Markets. Please go ahead. Your line is open. Thanks very much and good morning. Just hoping you mentioned that the return on the acquisition is expected to exceed your cost of capital. Could you just elaborate on that a little bit? Just what's your estimated IRR in the acquisition? And then if you can remind us again what you're assuming for your cost of capital? Yes. So we look at the cost of capital right now as being between 8% and 9%. And the filter that we've been using, it's one of numerous filters, but one of the filters is that we want the IRR to be above that rate within the 3 years and this deal achieved that similar to what we saw on H TRAN as well. It's important to note though that we took a quite a risk adjusted view on this one. There is a lot of upside within this business and within this industry, but we've been in at least the semiconductor space now for almost 10 years. And so we have a very good feel on the nature of the business. And so we've taken a very risk adjusted view when coming up with those ROIs. And then secondly, you mentioned that the purchase multiple is less than what you've seen in the A and D space. How would it compare against other acquisitions that you've made in the semiconductor space like Brooks Automation or D and H? Well, what I can share is and I don't have the D and H multiple off at my fingertips, Paul. But what I'll say is it was a single digit multiple. And it's the nature of the types of deals that we look at. We were able to get an exclusivity on this type of deal similar to the exclusivity that we got on Atren. We were able to ensure during a very detailed due diligence process that it met our value drivers. And again, we wanted to make sure that we got good value. And we were able to do that on Atren, which we indicated was a high single digit multiple in a space that typically sees low double digit multiples. And on this acquisition, it was favorable even to Atren, even though it has some similar characteristics. Okay. Thank you for taking my questions. Thanks, Paul. Next question, Kelly. Your next question comes from the line of Tim Yang from Citi. Please go ahead. Your line is open. Hey, this is Tim Yang calling on behalf of Jim Suva. Can we know that do you have any over 10 new over 10% of customers because of this acquisition? And then what's the tax implication after you close this transaction? Thanks. Yes. Hi, Tim. Good morning to you and early good morning to you. So in terms of the customer concentration, no, this acquisition will not lead to a new top 10 customer. So we don't see that impact. And as Rob also mentioned, we don't see a very material change in our top 10 concentration from this acquisition. From a tax rate perspective, the company's target rate of 17% to 19% continues to be the right range for us even with this business integrated in. Thank you. Thank you so much. Thanks Tim. Next question, Kelly. And there are no further questions at this time. I will now turn the call over to Rob Myones for closing comments. Thank you very much for joining the call at this early hour. We appreciate the support. We're very excited to have the Impak team join the Celestica family, and we look forward to updating you further on the transformational progress at our earnings release in a couple of weeks. This concludes today's conference call. You may now disconnect.