Item 5.    Operating and Financial Review and Prospects

CELESTICA INC.

MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

FOR THE YEAR ENDED DECEMBER 31, 2017

 

The following Management ’ s Discussion and Analysis of Financial Condition and Results of Operations (MD&A) should be read in conjunction with our 2017 audited consolidated financial statements, which we prepared in accordance with International Financial Reporting Standards (IFRS) as issued by the International Accounting Standards Board (IASB). Unless otherwise noted, all dollar amounts are expressed in U.S. dollars. The information in this discussion is provided as of February 14, 2018 unless we indicate otherwise.

 

Certain statements contained in this MD&A constitute forward-looking statements within the meaning of Section 27A of the U.S. Securities Act of 1933, as amended, and Section 21E of the U.S. Securities Exchange Act of 1934, as amended (U.S. Exchange Act), and contain forward-looking information within the meaning of Canadian securities laws. Such forward-looking information includes, without limitation, statements related to: our future growth, including in our Advanced Technology Solutions (ATS) businesses; trends in the electronics manufacturing services (EMS) industry; our anticipated financial and/or operational results (including our anticipated non-IFRS operating margin performance during the second half of 2018); our anticipated acquisition of Atrenne Integrated Solutions, Inc. (Atrenne), the expected timing, cost, terms and funding thereof, and the expected impact of such acquisition, if consummated, on our position in the aerospace and defense and industrial markets; our goals with respect to broadening our portfolio of ATS products and services and growing our ATS business (including aerospace and defense); our diversification plans (and potential hindrances thereto); the impact of acquisitions and program wins or losses on our liquidity, financial results and working capital requirements; anticipated expenses, restructuring actions and charges, capital expenditures, and other anticipated working capital requirements, including the anticipated amounts, timing and funding thereof; the anticipated repatriation of undistributed earnings from foreign subsidiaries; the impact of tax and litigation outcomes; our cash flows, financial targets and current priorities; intended investments in our business; changes in our mix of revenue by end market; our ability to diversify and grow our customer base and develop new capabilities; the effect of the pace of technological changes, customer outsourcing and program transfers, and the global economic environment on customer demand; the impact of increased competition, pricing and margin pressures, demand volatility, and materials constraints on our financial results, and the expected continuation of such adverse market conditions in our Enterprise and Communications end markets; raw materials prices; our intention to settle outstanding equity awards with subordinate voting shares; the number of subordinate voting shares we may repurchase under our normal course issuer bid (NCIB); the expected timing of the collection of outstanding solar accounts receivable and the possibility of future write-downs on unrecovered amounts from such solar accounts receivable and other solar assets; the expected timing of the sale of our solar panel manufacturing equipment; the impact of outstanding indebtedness under our credit facility on our liquidity, future operations and financial condition; the timing and terms of the sale of our real property in Toronto and related transactions, including the expected lease of our new corporate headquarters (collectively, the Toronto Real Property Transactions); the costs, timing and execution of relocating our existing Toronto manufacturing operations and the anticipated temporary relocation of our corporate headquarters while space in a new office building is under construction; the potential impact of Britain's intention to leave the European Union (Brexit) and/or policies or legislation proposed or instituted by the current administration in the U.S. on the economy, financial markets, currency exchange rates and our business; the anticipated impact of the U.S. Tax Reform (as defined herein) on our operations and our global tax rate; our expectations with respect to future pioneer incentives for limited portions of our Malaysian business; the impact of new wins, recent program transfers, and acquisitions; the anticipated impact of new accounting standards on our consolidated financial statements and the timing of related transition activities; the impact of longer-term contracts; our expectations with respect to increasing fulfillment services offered to customers; our intentions with respect to our U.K. Supplementary pension plan; and the potential use of cash, securities issuances and/or increased third-party indebtedness to fund our operations or acquisitions, and the potential adverse impacts of such uses on our liquidity, subordinate voting share price, debt leverage, agency ratings, business and/or operations. Such forward-looking statements may, without limitation, be preceded by, followed by, or include words such as “believes”, “expects”, “anticipates”, “estimates”, “intends”, “plans”, “continues”, “project”, “potential”, “possible”, “contemplate”, “seek”, or similar expressions, or may employ such future or conditional verbs as “may”, “might”, “will”, “could”, “should” or “would”, or may otherwise be indicated as forward-looking statements by grammatical construction, phrasing or context. For those statements, we claim the protection of the safe harbor for forward-looking statements contained in the U.S. Private Securities Litigation Reform Act of 1995 and applicable Canadian securities laws.

Forward-looking statements are provided for the purpose of assisting readers in understanding management’s current expectations and plans relating to the future. Readers are cautioned that such information may not be appropriate for other purposes. Forward-looking statements are not guarantees of future performance and are subject to risks that could cause actual results to differ materially from conclusions, forecasts or projections expressed in such forward-looking statements, including, among others, risks related to: our customers' ability to compete and succeed in the marketplace with the services we provide and the products we manufacture; customer and end market concentration and the challenges of diversifying our customer base and replacing revenue from completed or lost programs or customer disengagements; changes in our mix of customers and/or the types of products or services we provide; higher concentration of fulfillment services and/or other lower margin programs impacting gross profit; price, margin pressures, and other competitive factors generally affecting, and the highly competitive nature of, the EMS industry; price and other competitive factors affecting our Communications and Enterprise end markets; responding to changes in demand, rapidly evolving and changing technologies, and changes in our customers' business and outsourcing strategies, including the insourcing of programs; customer, competitor and/or supplier consolidation; integrating any acquisitions or strategic transactions (including "operate-in-place" arrangements); our having sufficient financial resources and working capital to fund currently anticipated financial obligations and to pursue desirable business opportunities, and potential negative impacts on our liquidity, financial condition and/or results of operations resulting from significant uses of cash and/or any future securities issuances or increased third-party indebtedness for acquisitions or to otherwise fund our operations; delays in the delivery and availability of components, services and materials, including from suppliers upon which we are dependent for certain components; our restructuring actions, including achieving the anticipated benefits therefrom, and the potential negative impact of transitions resulting from our restructuring actions on our operations; the incurrence of future impairment charges or other write-downs of assets; managing our operations, growth initiatives, and our working capital performance during uncertain market and economic conditions; disruptions to our operations, or those of our customers, component suppliers and/or logistics partners, including as a result of global or local events outside our control (including as a result of Brexit and/or policies or legislation proposed or instituted by the current U.S. administration, including the impact of the U.S. Tax Reform on our operations, or those of our customers, component suppliers and/or logistics partners); retaining or expanding our business due to execution issues relating to the ramping of new and existing programs or new offerings; the expansion or consolidation of our operations; recruiting or retaining skilled talent; changes to our operating model; changing commodity, material and component costs as well as labor costs and conditions; defects or deficiencies in our products, services or designs; non-performance by counterparties, including our former solar supplier, from whom we have accounts receivable outstanding; our financial exposure to foreign currency volatility, including fluctuations that may result from Brexit and/or policies or legislation proposed or instituted by the current U.S. administration; managing our global operations and supply chain; the failure to obtain (or a delay in obtaining) the necessary regulatory approvals or the failure to satisfy the other closing conditions required for our purchase of Atrenne, a material adverse change at Atrenne, the failure to consummate our purchase of Atrenne in a timely manner or at all, our failure to obtain adequate funding for the acquisition on acceptable terms, the purchase price varying from the expected amount, and if the acquisition is consummated, a failure to achieve the anticipated benefits therefrom, to successfully integrate the acquisition, to further develop our capabilities in the aerospace and defense market or otherwise expand our portfolio of solutions, and/or to achieve the other expected benefits from the acquisition; our dependence on industries affected by rapid technological change; any failure to adequately protect our intellectual property or the intellectual property of others; increasing income and other taxes, tax audits, and challenges of defending our tax positions, and obtaining, renewing or meeting the conditions of tax incentives and credits; the potential that conditions to closing the Toronto Real Property Transactions may not be satisfied on a timely basis or at all; the costs, timing and/or execution of relocating our existing Toronto manufacturing operations and/or corporate headquarters proving to be other than anticipated; computer viruses, malware, hacking attempts or outages that may disrupt our operations; the variability of revenue and operating results; compliance with applicable laws, regulations, government grants and social responsibility initiatives; and current or future litigation, governmental actions, and/or changes in legislation. The foregoing and other material risks and uncertainties are discussed in our public filings at www.sedar.com and www.sec.gov, including in this MD&A, our most recent Annual Report on Form 20-F filed with, and subsequent reports on Form 6-K furnished to, the U.S. Securities and Exchange Commission (SEC), and as applicable, the Canadian Securities Administrators.

Our forward-looking statements are based on various assumptions, many of which involve factors that are beyond our control. Our material assumptions include those related to the following: production schedules from our customers, which generally range from 30 to 90 days and can fluctuate significantly in terms of volume and mix of products or services; the timing and execution of, and investments associated with, ramping new business (including new business associated with acquisitions); the successful pursuit, completion and integration of acquisitions; the success in the marketplace of our customers’ products; the pace of change in our traditional end markets and our ability to retain programs and customers; the stability of general economic and market conditions, currency exchange rates, and interest rates; our pricing, the competitive environment and contract terms and conditions; supplier performance, pricing and terms; compliance by third parties with their contractual obligations, the accuracy of their representations and warranties, and the performance of their covenants; the costs and availability of components, materials,

services, plant and capital equipment, labor, energy and transportation; operational and financial matters including the extent, timing and costs of replacing revenue from completed or lost programs, or customer disengagements; technological developments; that the impact of the U.S. Tax Reform on our operations will be as we currently anticipate; our ability to recover accounts receivable outstanding from a former solar supplier; the timing, execution, and effect of restructuring actions; our having sufficient financial resources and working capital to fund currently anticipated financial obligations and to pursue desirable business opportunities; our ability to diversify our customer base and develop new capabilities; the availability of cash resources for repurchases of outstanding subordinate voting shares under our current NCIB; compliance with applicable laws and regulations pertaining to NCIBs; applicable regulatory approvals will be obtained and the other closing conditions to our purchase of Atrenne will be satisfied in a timely manner; that our purchase of Atrenne will be consummated in a timely manner and on anticipated terms; that internal cash flow and our ability to incur further indebtedness under our revolving credit facility will be as expected in order to finance the Atrenne acquisition as anticipated; and that, once acquired, we are able to successfully integrate Atrenne, further develop our capabilities in the aerospace and defense market, expand our portfolio of solutions, and achieve the other expected benefits from the acquisition. While management believes these assumptions to be reasonable under the current circumstances, they may prove to be inaccurate. Forward-looking statements speak only as of the date on which they are made, and we disclaim any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by applicable law.

All forward-looking statements attributable to us are expressly qualified by these cautionary statements.  

Overview

 

What Celestica does:

 

We deliver innovative supply chain solutions globally to customers in the following end markets: Advanced Technology Solutions (ATS) (consists of our former Diversified and Consumer end markets, and is comprised of our aerospace and defense, industrial, smart energy, healthcare, semiconductor equipment, and consumer businesses), Communications (consists of our enterprise communications and telecommunications businesses), and Enterprise (consists of our servers and storage businesses). We believe our services and solutions create value for our customers by accelerating their time-to-market, and by providing higher quality, lower cost and reduced cycle times in our customers’ supply chains as compared to their insourcing of these activities. We believe this results in lower total cost of ownership, greater flexibility, higher return on invested capital and improved competitive advantage for our customers in their respective markets.

 

Our global headquarters is located in Toronto, Canada. We operate a network of sites in various geographies with specialized end-to-end supply chain capabilities tailored to meet specific market and customer product lifecycle requirements. In an effort to drive speed, quality and flexibility for our customers, we execute our business in sites and centers of excellence strategically located in North America, Europe and Asia.

 

We offer a range of services to our customers, including design and development (such as our Joint Design and Manufacturing (JDM) offering, which consists of developing design solutions in collaboration with customers, as well as managing aspects of the supply chain and manufacturing), engineering services, supply chain management, new product introduction, component sourcing, electronics manufacturing, assembly and test, complex mechanical assembly, systems integration, precision machining, order fulfillment, logistics and after-market repair and return services.

The products and services we provide serve a wide variety of applications, including: servers; networking and telecommunications equipment; storage systems; converged systems; optical equipment; aerospace and defense electronics; healthcare products and applications; semiconductor equipment; and a range of industrial and alternative energy products.

 

To increase the value we deliver to our customers, we continue to make investments in people, value-added service offerings, new capabilities, capacity, technology, IT systems, software and tools. We continuously work to improve our productivity, quality, delivery performance and flexibility in our efforts to be recognized as a leading company in the EMS industry. In connection therewith, we have recently completed our Global Business Services (GBS) initiative, which was focused on integrating, standardizing and optimizing our end-to-end business processes, and our Organizational Design (OD) initiative, which involved redesigning our organizational structure, with the goal of increasing the overall effectiveness of our organization by improving internal alignment, reducing complexity and increasing our speed to outcome. To streamline our processes and reduce costs, we have invested in automation and the connected factory. Our recently announced cost efficiency initiative, and related anticipated

restructuring actions, are also intended to further streamline our business, increase operational efficiencies and improve our productivity.

A key focus for us is to grow our ATS end market (which constituted 32% of total revenue in 2017) in order to reduce the revenue concentration of our Communications and Enterprise end markets (which constituted an aggregate of 68% of total revenue in 2017). Our current priorities include (i) growing and diversifying our customer and product portfolios to help achieve longer-term consistency, increasing our revenue and improving operating margins, (ii) increasing the contribution from our ATS end market to our overall profitability, while continuing to invest in capabilities and targeted end markets, (iii) generating strong annual free cash flow and adjusted return on invested capital (“adjusted ROIC”) and (iv) continuing to improve our execution by focusing on increased productivity and simplification throughout our organization. We believe that continued investments in these areas support our long-term growth strategy, and will strengthen our competitive position, enhance customer satisfaction, and increase long-term shareholder value. Operating margin, adjusted ROIC and free cash flow are non-IFRS measures without standardized meanings and may not be comparable to similar measures presented by other companies. See “Non-IFRS measures” below for a discussion of the non-IFRS measures included herein, and a reconciliation of our non-IFRS measures to the most directly comparable IFRS measures.

We believe that profitable revenue growth depends significantly on increasing sales and capabilities in our ATS businesses, as well as increasing sales to and expanding the range of services we provide to existing customers in all of our end markets for their current and future product generations. Accordingly, we will continue to focus on investing both organically and through acquisitions to expand our offerings of higher-value added services, including design and development, engineering, and after-market services. Our CCS businesses, together representing 68% of total revenue in 2017 (and consisting of our Enterprise and Communications end markets), generally experience a high degree of volatility in terms of revenue and service mix, as well as recent negative pricing pressures.  We were impacted by these adverse market conditions in 2017, and expect these conditions to continue in 2018.  To help grow our overall revenue and to offset these market factors, we are pursuing new customers and acquisition opportunities in our ATS businesses to expand our end market penetration, to diversify our end market mix, and to enhance and add new technologies and capabilities to our offerings. In support of this expansion, we have executed two “operate-in-place” outsourcing agreements with existing aerospace and defense customers, pursuant to which we provide manufacturing and after-market repair services for specific product lines at each customer’s site. Under such arrangements, we assume the workforce assigned to the relevant operations and purchase the required inventory. In addition, we expanded our capabilities in the aerospace and defense market with our November 2016 acquisition of Karel (defined below), and anticipate further expansion of our aerospace and defense and industrial capabilities should our acquisition of Atrenne Integrated Solutions, Inc. (Atrenne) be consummated (see “Recent developments” below).

Overview of business environment:

 

The EMS industry is highly competitive, with multiple global EMS providers competing for customers and programs. Although the industry is characterized by a large revenue base and new business opportunities, demand can be volatile from period to period, and aggressive pricing is a common business dynamic, particularly in the Enterprise and Communications end markets. Capacity utilization, customer mix and the types of products and services we provide are important factors affecting our financial performance. The number of sites, the location of qualified personnel, the manufacturing capacity, and the mix of business through that capacity are vital considerations for EMS providers in terms of supporting their customers and generating appropriate returns. Because the EMS industry is working capital intensive, we believe that adjusted ROIC (discussed in “Non-IFRS measures” below), which is primarily based on non-IFRS operating earnings and investments in working capital and equipment, is an important metric for measuring an EMS provider’s financial performance.

 

EMS companies provide a range of services to a variety of customers and end markets. However, demand patterns are volatile, particularly in the Enterprise and Communications end markets, making customer revenue and mix, revenue by end market, and overall profitability difficult to forecast. Product lifecycles in the markets we serve, production lead times required by our customers, rapid shifts in technology, model obsolescence, commoditization of certain products, the emergence of new business models (including Infrastructure as a Service (IaaS), Platform as a Service (PaaS), and Software as a Service (SaaS)), shifting patterns of demand, such as the shift from traditional network infrastructures to highly virtualized and cloud-based environments, the prevalence of solid state or flash memory technology as a replacement for hard disk drives, as well as the proliferation of software-defined technologies enabling the disaggregation of software and hardware, increased competition, oversupply of products, pricing pressures, and the volatility of the economy all contribute to the complexity of managing our operations and fluctuations in our financial results. For example, declines in end-market demand for customer-specific proprietary

systems in favor of open systems with standardized technologies has had an adverse impact on our customers, and consequently, our business.

In addition, uncertainty in the global economy and financial markets may impact current and future demand for our customers’ products and services, and consequently, the operations of EMS providers, including Celestica. We continue to monitor the dynamics and impacts of the global economic and financial environment and work to manage our priorities, costs and resources to anticipate and prepare for any changes we deem necessary.

 

External factors that could impact the EMS industry and our business include natural disasters and related disruptions, political instability, terrorism, armed conflict, labor or social unrest, criminal activity, disease or illness that affects local, national or international economies, unusually adverse weather conditions, and other risks present in the jurisdictions in which we, our customers, our suppliers, and/or our logistics partners operate. These types of events could disrupt operations at one or more of our sites or those of our customers, component suppliers and/or our logistics partners. These events could lead to higher costs or supply shortages or may disrupt the delivery of components to us, or our ability to provide finished products or services to our customers, any of which could adversely affect our operating results. We carry insurance to cover damage to our sites and interruptions to our operations, including those that may occur as a result of natural disasters, such as flooding and earthquakes, or other events. Our insurance policies, however, are subject to deductibles, coverage limitations and exclusions, and may not provide adequate coverage should such events occur. Uncertainties resulting from Brexit, policies or legislation proposed or instituted by the current administration in the U.S., and/or increased tensions with North Korea, may adversely affect our business, results of operations and financial condition. Given the lack of comparable precedent, it is unclear what financial, trade and legal implications the withdrawal of the United Kingdom from the European Union will have and how such withdrawal will affect us, our customers and their demand for our services. In addition, the current U.S. administration has created uncertainty with respect to, among other things, existing and proposed trade agreements (including the status of the North American Free Trade Agreement (NAFTA)), free trade generally, and potentially significant increases on tariffs on goods imported into the U.S., particularly from Mexico, Canada and China. We currently ship a significant portion of our worldwide production to customers in the U.S. from other countries. Changes to U.S. laws or policies may impact the pace of outsourcing by U.S. customers in the future, including the possibility of such customers' insourcing programs that were previously outsourced (including to companies like ours). It is unknown at this time to what extent new legislation, or pending or new regulatory proposals will be adopted in the U.S., if any, or the effect that such adoption may have on our business, including the full extent of the impact of recent U.S. tax reform (discussed in “Critical Accounting Policies and Estimates”​ below). However, changes in U.S. social, political, regulatory and economic conditions or in laws and policies governing foreign trade or taxation, manufacturing, clean energy, the healthcare industry, development and investment in the jurisdictions in which we, and/or our customers or suppliers operate, could materially adversely affect our business, results of operations and financial condition.

We have significant suppliers that are important to our sourcing activities. If a key supplier (or any company within such supplier's supply chain) experiences financial or other difficulties, this may affect its ability to supply us with materials, components or services, which could halt or delay the production of a customer's product, and/or have a material adverse impact on our operations, financial results and customer relationships. During 2017, we experienced materials constraints from certain suppliers, which caused delays in the production of customer products, and resulted in higher than expected levels of inventory. We expect these materials constraints and adverse impacts to continue in the near term.

Our ability to collect our accounts receivable and future sales depends, in part, on the financial strength of our customers. If any of our customers have insufficient liquidity, we could encounter significant delays or defaults in payments owed to us by such customers, or we may extend our payment terms, which could adversely impact our short-term cash flows, financial condition and/or operating results. From time to time, we have extended the payment terms applicable to certain customers, which has adversely impacted our working capital requirements, and increased our financial exposure and credit risk. In addition, customer financial difficulties or changes in the demand for our customers' products may result in order cancellations and higher than expected levels of inventory, which could in turn have a material adverse impact on our operating results and working capital performance. We may not be able to return or re-sell this inventory, or we may be required to hold the inventory for a period of time, any of which may result in our having to record additional reserves for the inventory. We also may be unable to recover all of the amounts owed to us by a customer, including amounts to cover unused inventory or capital investments we incurred to support that customer's business. Furthermore, if a customer bankruptcy occurs, our profitability may be adversely impacted by our failure to collect our accounts receivable in excess of our estimated allowance for uncollectible accounts or amounts insured (which occurred with respect to one of our solar customers during 2017 , whose bankruptcy caused us to record accounts receivable provisions, discussed below). Additionally, our future revenues could be reduced by the loss of a customer due to bankruptcy. Our

failure to collect accounts receivable and/or the loss of one or more major customers could have an adverse effect on our operating results, financial position and cash flows.

We cannot reliably determine if and to what extent customers or suppliers may have financial and other difficulties, whether we will be required to adjust our prices or the amount we pay for materials and components, or face collection issues with customers, or if customer or supplier bankruptcies will occur. In connection with our exit from the solar panel manufacturing business, we recorded aggregate charges in excess of $30 million to write down the carrying values of our solar panel manufacturing equipment, inventories and accounts receivable during 2016 and 2017 . If we are unable to collect the current carrying value of our remaining solar assets ($2.6 million in solar panel manufacturing equipment and $6.7 million in solar accounts receivable as of December 31, 2017), we will incur additional asset write downs in future periods. See “Summary of 2017 ” below for further details.

Our business is also affected by customers who may shift production between EMS providers (including shifts to our competitors) for a number of reasons, including pricing concessions, more favorable terms and conditions, their preference or need to consolidate their supply chain capacity or the number of supply chain partners, tax benefits, new trade policies or legislation, or consolidation among customers. Customers may also choose to increase the amount of business they outsource, insource previously outsourced business, or change the concentration or location of their EMS suppliers to better manage their supply continuity risk. These customer decisions may impact, among other items, our revenue and margins, the need for future restructuring, the level of capital expenditures and our cash flows.

While the demand environment remains volatile, driven largely by technology shifts and increased competition in the Communications and Enterprise end markets, we remain committed to making the investments we believe are required to support our long-term objectives and to create shareholder value. These efforts include a focus on the diversification of our customer mix and product portfolios to address changing needs, including a larger emphasis on fulfillment and after-market services, as well as broadening our ATS capabilities, including expanding our aerospace and defense, healthcare, smart energy, and industrial offerings, and continuing to expand the breadth of our JDM offerings in the areas of storage, network switching and converged storage and servers. The costs of investments that we deem desirable may be prohibitive, and therefore prevent us from achieving these diversification objectives. In addition, the ramping activities associated with investments that we do make may be significant and could negatively impact our margins in the short and medium term. Simultaneously, we intend to continue to manage our costs and resources to maximize our efficiency and productivity.

To reduce our reliance on any one customer or end market (including the concentration of our revenues in the Communications and Enterprise end markets), we continue to target new customers and services, including through our efforts to expand our ATS end market. As we expand our business and open new sites, we may encounter difficulties that result in higher than expected costs associated with such activities. Potential difficulties related to such activities include our ability: to manage growth effectively; to maintain existing business relationships during periods of transition; to anticipate disruptions in our operations that may impact our ability to deliver to customers on time, produce quality products and ensure overall customer satisfaction; and to respond rapidly to changes in customer demand or volumes. We may also encounter difficulties in ramping and executing new programs. We may require significant investments in additional capabilities and increased working capital to support these new programs, including those associated with business acquisitions, and may generate lower margins or losses during and/or following the ramp period. There can be no assurance that our increased investments will benefit our financial performance or result in business growth. As we pursue opportunities in new markets or technologies, we may encounter challenges due to our limited knowledge or experience in these areas. In addition, the success of new business models or programs depends on a number of factors including: understanding the new business or markets; timely and successful product development; market acceptance; the effective management of purchase commitments and inventory levels in line with anticipated demand; the development or acquisition of appropriate intellectual property and capital investments, to the extent required; the availability of materials in adequate quantities and at appropriate costs to meet anticipated demand; and the risk that new offerings may have quality or other defects in the early stages of introduction. Any of these factors could prevent us from realizing the anticipated benefits of growth in new markets or technologies, which could materially adversely affect our business and operating results. See “Summary of 2017 ” below for a discussion of our exit from the solar panel manufacturing business.

Recent developments:

Anticipated Acquisition to Broaden Capabilities in the Aerospace and Defense Market:

In January 2018, we entered into a definitive agreement to acquire Atrenne, a leading U.S. - based designer and manufacturer of ruggedized electromechanical solutions. This acquisition is intended to expand our capabilities, improve our diversification, and bolster our leadership position within the aerospace and defense market. Atrenne's capabilities include connectors, machining, and the thermal and mechanical design and manufacture of ruggedized chassis and enclosures, primarily for military and commercial aerospace applications. We also believe that Atrenne's capabilities in the design and manufacture of value-added mechanical solutions will expand our service offerings for industrial customers. The purchase price for Atrenne is approximately $139 million (subject to specific adjustments as set forth in the definitive agreement), which we intend to finance with a combination of cash on hand and availability under the revolving portion of our credit facility. The transaction is expected to close in the second quarter of 2018, subject to receipt of applicable regulatory approvals and satisfaction of other customary closing conditions. However, there can be no assurance that this acquisition will be consummated in a timely manner, or at all.

Toronto Real Property Update:

As previously disclosed, and assuming the timely satisfaction of various conditions, we currently anticipate the sale of our Toronto corporate headquarters and manufacturing operations to close during 2018. See “Liquidity — Cash requirements” below. However, there can be no assurance that this transaction will be completed during 2018, or at all. Whether or not the sale is consummated, we are moving our existing Toronto manufacturing operations to another location in the Greater Toronto area, and in connection therewith, entered into a long-term lease in November 2017 with occupancy anticipated to commence at the end of the first quarter of 2018. We currently expect to complete the transition to this new manufacturing location by the end of the first quarter of 2019. In addition, should the sale be consummated, we will enter into a short-term interim lease with the purchasers of our Toronto real property for our existing corporate headquarters and manufacturing premises on a portion of the real estate on a rent-free basis (subject to certain payments, including taxes and utilities), followed by a long-term lease with such purchasers for our new corporate headquarters, and intend to move such headquarters to a temporary location while space in a new office building (to be built by such purchasers on the site of our current location) is under construction. The temporary office relocation is currently expected to occur by the end of the first quarter of 2019. We will incur significant costs throughout the transition period (which commenced in the fourth quarter of 2017 and is expected to continue into 2019) to relocate our corporate headquarters and to transfer our Toronto manufacturing operations to its new location, and as we prepare and customize the new site to meet our manufacturing needs. These costs will consist of building improvements and new equipment which we will capitalize, as well as transition-related costs which we will record in other charges. The costs, timing, and execution of these relocations could have a material adverse impact on our business, our operating results and our financial position. See “Liquidity — Cash requirements” below and notes 16(d) and 18 to our 2017 audited consolidated financial statements.

End Markets:

Commencing in the first quarter of 2017 , we aligned our end markets into two customer focused areas: Advanced Technology Solutions (ATS) and Connectivity & Cloud Solutions (CCS). Our ATS end market consists of our former Diversified and Consumer end markets, and is comprised of our aerospace and defense, industrial, smart energy, healthcare, semiconductor equipment, and consumer businesses. CCS consists of our Communications and Enterprise end markets (the latter of which is comprised of our servers and storage businesses, which were combined into one end market as a result of their converging technologies). All period percentages herein reflect these changes.

The competitive landscape in the CCS area remains aggressive, as demand growth is moving from traditional enterprise network infrastructure providers to cloud-based service providers, resulting in aggressive bidding from EMS providers and increased competition from original design manufacturers as they further penetrate these markets. In addition, although we offered a broad range of services to our CCS customers in 2017 , we experienced a shift in the mix of our programs, in particular, growth in our lower-margin fulfillment services. This shift in mix, combined with the pricing pressures described above, demand volatility, and investments we have made to grow our higher-value added after-market services, resulted in lower than anticipated revenues and margins in our CCS businesses during 2017 . As a result of the high concentration of our business in the CCS marketplace, we expect continued competitive pressures, aggressive pricing and technology-driven demand shifts, as well as certain materials constraints, to negatively impact our CCS businesses in future periods. We intend to continue to monitor these dynamics and focus on cost management in response to these factors, including our new cost efficiency initiative (discussed under “Restructuring Update” below), which is targeted, in part, towards margin improvements in our CCS businesses.

Restructuring Update:

During the fourth quarter of 2017, we recorded $6.6 million of restructuring charges to complete actions previously identified as part of our OD and GBS initiatives, and an additional $8.0 million of restructuring charges in connection with our new cost efficiency initiative described below.

In response to challenging markets and continued margin pressures (driven primarily by volatility in our Communications and Enterprise end markets), we announced in October 2017 our intention to implement additional restructuring actions in the near term to further streamline our business and improve our margin performance, and engaged an outside consultant to identify cost reduction opportunities throughout our network, including through increased operational efficiencies and productivity improvements. In connection therewith, we have commenced the implementation of additional restructuring actions under a new cost efficiency initiative. Such initiative will include reductions to our workforce, the potential consolidation of certain sites to better align capacity and infrastructure with current and anticipated customer demand, related transfers of customer programs and production, re-alignment of business processes, management reorganizations, and other associated activities. We currently estimate that we will incur aggregate restructuring charges of between $50.0 million and $75.0 million, which will consist primarily of cash charges, with respect to our cost efficiency initiative, including $8.0 million of the $14.6 million in cash restructuring charges we recorded in the fourth quarter of 2017. We currently expect restructuring charges under this initiative to continue through mid-2019. We anticipate that our cost efficiency initiative, combined with the anticipated expansion of our ATS product mix, will result in improved non-IFRS operating margins by the second half of 2018.

Launch of New NCIB:

In November 2017, the Toronto Stock Exchange (TSX) accepted our notice to launch a new NCIB (2017 NCIB), which allows us to repurchase, at our discretion, until the earlier of November 12, 2018 or the completion of the purchases thereunder, up to approximately 10.5 million subordinate voting shares (representing approximately 7.3% of our total outstanding subordinate voting and multiple voting shares at the time of launch) in the open market, or as otherwise permitted. Since the commencement of the 2017 NCIB through February 14, 2018, we paid $36.9 million (including transaction fees) to repurchase and cancel 3.5 million subordinate voting shares at a weighted average price of $10.48 per share.

Senior Management Changes:

Mr. Todd Cooper was appointed Chief Operations Officer, effective January 4, 2018, following the departure of Mr. Glen McIntosh at the end of 2017.

We previously announced the departure of Mr. Darren Myers, our former Chief Financial Officer, effective at the end of July 2017. Upon such announcement, we appointed Mr. Mandeep Chawla (formerly Senior Vice President, Finance) as interim Chief Financial Officer during our search for a permanent replacement. After conducting a full and diligent search process, we appointed Mr. Chawla as Chief Financial Officer, effective October 19, 2017.

Board Member Resignations:

During 2017, two of our board members, Mr. Joseph M. Natale and Mr. Thomas S. Gross, resigned from Celestica's Board.

Program Transfer:

In September 2017 , one of our existing aerospace and defense customers outsourced certain operations to us. As part of a 10-year “operate-in-place” agreement, we currently provide manufacturing and after-market repair services for electromechanical and electronic assemblies across a wide array of technologies at the customer’s site. We have also assumed the workforce assigned to these operations and purchased approximately $5 million in related inventory. This agreement further expanded our relationship with this customer, enhanced our ability to provide end-to-end product lifecycle solutions to our customers, and supports our strategy of growing our aerospace and defense business.

Brazilian Assessment:

In 2017 , the Brazilian Ministry of Science, Technology, Innovation and Communications (MCTIC) issued assessments seeking to disqualify certain amounts of research and development (R&D) expenses for the years 2006 to 2009, which entitled our Brazilian subsidiary (which ceased operations in 2009) to charge reduced sales tax levies to its customers. The assessments against our Brazilian subsidiary (including interest and penalties) total approximately 39 million Brazilian real (approximately $12 million at year-end exchange rates) for such years.

Although we cannot predict the outcome of this matter, we believe that our R&D activities for the period are supportable, and it is probable that our position will be sustained upon full examination by the appropriate Brazilian authorities and, if necessary, upon consideration by the Brazilian judicial courts. Our position is supported by our Brazilian legal advisers.

See “Summary of 2017 ” below for an update on our exit from the solar panel manufacturing business.

Summary of 2017

 

Our consolidated financial statements have been prepared in accordance with IFRS as issued by the IASB and accounting policies we adopted in accordance with IFRS. These consolidated financial statements reflect all adjustments that are, in the opinion of management, necessary to present fairly our financial position as at December 31, 2017 and the financial performance, comprehensive income and cash flows for the year ended December 31, 2017 . See “Critical Accounting Policies and Estimates” below.

 

 The following table sets forth certain key operating results and financial information for the periods indicated (in millions, except per share amounts): 

Revenue of $6.1 billion for 2017 increased 2% compared to 2016 . Compared to 2016 , revenue dollars in 2017 from our Enterprise end market were relatively flat, as growth from new programs primarily in the first half of 2017 was offset by softer demand in the second half of 2017. Revenue dollars from our ATS end market were also relatively flat compared to 2016 as growth in our semiconductor business and from new programs (discussed in “Operating Results” below) were offset by a 7% decrease in revenue due to our exit from the solar panel manufacturing business, and a decrease in revenue due to the completion of programs with one of our then-largest consumer customers during the third quarter of 2016. Despite revenue dollars and revenue concentration (32%) being relatively flat compared to 2016, revenue concentration from our ATS end market increased to 33% of total revenue for the fourth quarter of 2017, compared to 29% for the fourth quarter of 2016 and 31% for the third quarter of 2017. We currently expect revenue from our ATS end market to continue to grow in future periods from organic growth, as well as from acquisition activities (however, there can be no assurance that any acquisitions will occur in a timely manner, or at all). Revenue dollars from our Communications end market increased 4% compared to 2016 primarily due to demand strength in certain programs and new program growth (including with respect to our fulfillment services and JDM programs). Although Communications revenue increased compared to 2016 , we experienced slower growth rates (particularly in the second half of 2017) compared to the prior

year primarily due to new programs from 2016 reaching their full production levels, and increased pricing pressures and late changes in demand from certain customers in 2017.

Gross profit of $417.8 million ( 6.8% of total revenue) for 2017 decreased 2% compared to $427.6 million ( 7.1% of total revenue) for 2016 . Gross profit and gross margin for 2017 were negatively impacted by unfavorable changes in program mix, increased pricing pressures and higher ramping costs, offset in part by margin improvements in our ATS end market. During 2017, our Communications and Enterprise end markets faced increased pricing pressures (see “Recent developments — End markets” above), and were also negatively impacted by a higher concentration than in 2016 of new programs, including fulfillment services, that contributed significantly lower gross profit than our historical full-service traditional EMS programs. We also incurred additional ramping costs with respect to new programs, including aerospace and defense programs, as well as programs that required the establishment of infrastructures in multiple jurisdictions. Gross profit and gross margin for our ATS end market in 2017 increased compared to the prior year, as a result of increases in each of our semiconductor and former solar businesses (the latter as a result of lower provisions recorded in 2017), offset in part by the completion of consumer programs which benefited gross margin in 2016. The gross margin for our former solar business was negatively impacted in 2016 by higher provisions (accounting for 15 basis points in 2016), primarily to write-down the carrying value of our solar panel inventory to then-recoverable amounts). SG&A for 2017 decreased $7.9 million to $203.2 million compared to 2016 , primarily due to lower foreign exchange losses, stock-based compensation expense, and variable expenses in 2017 (described under “Operating Results” below). Other charges for 2017 increased $11.5 million to $37.0 million compared to 2016, primarily due to $12 million of recoveries of damages related to a legal settlement in 2016, and $3.1 million in higher acquisition-related costs in 2017, offset in part by the costs to settle a legal matter during 2016. Net earnings for 2017 of $105.0 million decreased $31.3 million compared to 2016 , primarily due to $9.8 million in lower gross profit and $11.5 million in higher other charges in 2017 as discussed above, as well as $14 million of refund interest income that benefited 2016 .

New tax legislation was enacted in the U.S. in December 2017. In connection therewith, in the fourth quarter of 2017, we recorded a one-time, non-cash increase to our deferred income tax expense of $2.0 million, to re-value our recognized net deferred tax assets. Net income tax expense for 2016 was favorably impacted by a reversal of $45 million Canadian dollars (approximately $34 million at the exchange rate at the time of recording) in provisions previously recorded for tax uncertainties related to the resolution of a transfer pricing matter for one of our Canadian subsidiaries, offset in part by withholding taxes, deferred tax expense relating to the anticipated repatriation of undistributed earnings from certain Chinese subsidiaries, and negative impacts related to taxable foreign exchange. See “Operating Results — Income taxes” below for further details.

We made the decision in the fourth quarter of 2016 to exit the solar panel manufacturing business. As part of this exit, we terminated (prior to its scheduled expiration) a supply agreement with an Asia-based solar cell supplier under which we had made specific cash advances. All such cash advances were repaid in full by the end of the second quarter of 2017 ( December 31, 2016 — $12.5 million). Under this supply agreement, we also manufactured and sold completed solar panels to this supplier as a customer (discussed below). In connection with our exit from this business, we wrote down the carrying values of our solar panel manufacturing equipment (by $19.0 million) and inventories (by approximately $10 million) during 2016 to then-recoverable amounts, and completed production of the final solar panels in the first quarter of 2017. During 2017, we incurred operating losses related to the wind-down of our solar panel manufacturing operations, and recorded additional provisions of $0.9 million to further write down the carrying value of our remaining solar panel inventory (to reflect lower prices obtained in then-current purchase orders), a provision of $0.5 million to write down the carrying value of our solar accounts receivable (primarily as a result of a solar customer's bankruptcy) to recoverable amounts, and net impairment charges of $3.8 million (through restructuring) to further write down the carrying value of our solar panel manufacturing equipment (which was classified as assets held-for-sale) to its estimated fair value less costs to sell, based on executed sale agreements. Such equipment was valued at $2.6 million as of December 31, 2017. We currently expect the sale of such equipment to be completed by the end of the first quarter of 2018. A substantial portion of our solar panel manufacturing equipment was subject to finance lease agreements. As of December 31, 2017 , our outstanding lease obligations for this equipment totaled $11.1 million. In anticipation of the sale, we terminated and settled these lease obligations in full in January 2018 . During the third quarter of 2017, we shipped all of our remaining solar panel inventory to customers, including to the former solar supplier described above. As of December 31, 2017 , we had $6.7 million of outstanding solar accounts receivable, all from the former solar supplier described above, which we expect to collect in the first quarter of 2018. If we are unable to recover the carrying value of these amounts owed to us, we will incur additional write-downs to these receivables in future periods.

Our cash and cash equivalents at December 31, 2017 were $515.2 million ( December 31, 2016 — $557.2 million ). Our cash provided by operating activities of $127.0 million for 2017 decreased $46.3 million compared to $173.3 million for 2016 , primarily due to $52 million of income tax refunds which benefited cash in 2016 and the decrease in net earnings in 2017 compared to 2016, offset in part by lower working capital requirements in 2017 as compared to the prior year (discussed below).

At December 31, 2017 , we sold $80.0 million ( December 31, 2016 — $50.0 million ) of accounts receivable (A/R) under our A/R sales program and sold $52.3 million ( December 31, 2016 — $51.4 million ) to a third-party bank under a customer's supplier financing program, all of which have been de-recognized from our accounts receivable balances. We utilized this customer's supplier financing program to substantially offset the effects of extended payment terms required by such customer on our working capital for the period. See “Capital Resources” below. We increased the amount of A/R sold under our A/R sales program in 2017 compared to 2016 as an alternative to drawing on the revolving portion of our credit facility (Revolving Facility).

At December 31, 2017 , we had $187.5 million outstanding under the term loan portion of our credit facility (Term Loan) ( December 31, 2016 — $212.5 million ) and no amounts outstanding under our Revolving Facility ( December 31, 2016 — $15.0 million ). We repaid the remaining $15.0 million outstanding under the Revolving Facility in the first quarter of 2017, and made four scheduled quarterly principal repayments totaling $25.0 million under the Term Loan in each of 2016 and 2017 . See “Liquidity and Capital Resources — Liquidity — Cash requirements” below.

We have repurchased subordinate voting shares in the open market and otherwise for cancellation in recent years pursuant to NCIBs and substantial issuer bids (SIBs), which allow us to repurchase a limited number of subordinate voting shares during a specified period. The maximum number of subordinate voting shares we are permitted to repurchase for cancellation under each NCIB is reduced by the number of subordinate voting shares purchased in the open market during the term of such NCIB to satisfy delivery obligations under our stock-based compensation plans. We enter into program share repurchases (PSRs) from time to time as part of the NCIB process (if permitted by the TSX), pursuant to which we make a prepayment to a broker for the right to receive a variable number of subordinate voting shares upon such PSR's completion. Under such PSRs, the price and number of subordinate voting shares to be repurchased by us is generally determined based on a discount to the volume weighted-average market price of such shares during the term of the PSR, subject to certain terms and conditions. The subordinate voting shares repurchased under any PSR are cancelled upon such PSR's completion.     

In November 2017, the TSX accepted our notice to launch the 2017 NCIB. See “Overview — Recent developments” above. Since the commencement of this NCIB through December 31, 2017, we paid $19.9 million (including transaction fees) to repurchase and cancel 1.9 million subordinate voting shares at a weighted average price of $10.58 per share. In addition, we repurchased 1.4 million subordinate voting shares during 2017 (0.3 million of which were repurchased under the 2017 NCIB) to satisfy delivery obligations under our stock-based compensation plans.    

See “Overview — Recent developments” above for a discussion of our recent acquisition activities.

    

Summary of 2016

    

Revenue of $6.0 billion for 2016 increased 7% compared to 2015 . Compared to 2015 , revenue dollars in 2016 from our Communications end market increased 12%, primarily driven by demand strength and new program wins. Revenue dollars from our ATS end market increased 8% from 2015 primarily due to new program ramps in our smart energy business (including new solar programs prior to our exit from that business), and a new “operate-in-place” program outsourced to us from one of our aerospace and defense customers in April 2015, offset in part by completion of programs with one of our then-largest Consumer customers. Revenue dollars from our Enterprise end market in 2016 decreased 3% compared to 2015 , primarily due to customer demand softness.

Gross profit of $427.6 million ( 7.1% of total revenue) for 2016 increased 9% compared to $391.1 million (6.9% of total revenue) for 2015 , primarily driven by higher revenue levels in 2016 and margin improvements in our ATS end market, including our semiconductor business and our then-solar business, partially offset by changes in program mix as some of our 2016 programs contributed lower gross profit than past programs. Our solar margins for 2016 improved compared to 2015 despite the higher provisions recorded in 2016 (accounting for approximately 15 basis points) primarily to write down the value of our solar panel inventory in the second half of 2016 to then-current market prices (see discussion above). SG&A for 2016 of $211.1 million increased compared to $207.5 million in 2015 . Net earnings for 2016 of $136.3 million were $69.4 million higher compared to 2015 , primarily due to higher gross profit, lower other charges (driven by $12 million of recoveries of damages related to a legal settlement in 2016 ) and a net benefit of approximately $32 million related to income taxes, comprised primarily of income tax

recoveries and related refund interest income attributable to the resolution of certain previously disputed tax matters in Canada, offset in part by withholding taxes and income tax expense related to taxable foreign exchange. See “Operating Results — Income taxes” below for further details.

In connection with our decision in the fourth quarter of 2016 to exit the solar panel manufacturing business, we recorded restructuring charges in the fourth quarter of 2016 to close our solar panel manufacturing operations at our two locations, including $19.0 million in impairment charges to write down the carrying value of our solar panel manufacturing equipment to recoverable amounts. We also recorded inventory provisions of approximately $10 million in 2016, primarily in the third quarter of 2016, to write down our solar inventory to recoverable amounts as a charge through cost of sales.

Our cash and cash equivalents at December 31, 2016 were $557.2 million ( December 31, 2015 — $545.3 million ). Our cash provided by operating activities was $173.3 million for 2016 compared to $196.3 million for 2015 , primarily due to higher working capital requirements in 2016 , offset in part by the increase in net earnings for 2016 described above and the cash income tax refund of $52 million we received during the fourth quarter of 2016 , representing the refund of cash previously deposited on account with the Canadian tax authorities and related interest income resolution of previously disputed tax matters. See “Operating Results — Income taxes” below for further details.

 

At December 31, 2016 , we sold $50.0 million ( December 31, 2015 — $50.0 million ) of accounts receivable (A/R) under our A/R sales program and sold $51.4 million to a third-party bank under a customer's supplier financing program that we joined in the fourth quarter of 2016 . See “Liquidity and Capital Resources — Liquidity — Capital requirements” below.

At December 31, 2016 , we had an aggregate of $227.5 million outstanding under our credit facility, including $212.5 million outstanding under the Term Loan ( December 31, 2015 — an aggregate of $262.5 million outstanding under our credit facility, including $237.5 million outstanding under the Term Loan). During the first quarter of 2016 , we borrowed $40.0 million under the Revolving Facility, partly to fund the PSR described below. During 2016 , we repaid $50.0 million of the amount outstanding under the Revolving Facility and made four scheduled quarterly principal repayments totaling $25.0 million under the Term Loan. See “Liquidity and Capital Resources — Liquidity — Cash requirements” below.

On February 22, 2016, the TSX accepted our notice to launch an NCIB (2016 NCIB) which was amended in March 2016 to permit PSRs. The 2016 NCIB allowed us to repurchase, at our discretion, until the earlier of February 23, 2017 or the completion of purchases thereunder, up to approximately 10.5 million subordinate voting shares (representing approximately 7.3% of our total outstanding subordinate voting and multiple voting shares at the time of launch) in the open market or as otherwise permitted, subject to the normal terms and limitations of such bids. During 2016, we paid an aggregate of $34.3 million (including transaction fees) to repurchase and cancel 3.2 million subordinate voting shares under the 2016 NCIB at a weighted average price of $10.69 per share, including 2.8 million subordinate voting shares repurchased at a weighted average price of $10.69 per share under a $30.0 million PSR funded in March 2016. We did not repurchase any subordinate voting shares for cancellation in 2016 prior to the launch of the 2016 NCIB, and we did not repurchase any shares for cancellation under the 2016 NCIB during 2017. The maximum number of subordinate voting shares we were permitted to repurchase for cancellation under the 2016 NCIB was reduced by 1.6 million subordinate voting shares we purchased in the open market during 2016 to satisfy delivery obligations under our stock-based compensation plans.

In November 2016, we acquired the business assets of Lorenz, Inc. and Suntek Manufacturing Technologies, SA de CV, collectively known as Karel Manufacturing (Karel) for a cash purchase price of $14.9 million. Karel is a manufacturing services company that specializes in complex wire harness assembly, systems integration, sheet metal fabrication, welding and machining serving primarily aerospace and defense customers. This acquisition supported our strategy to accelerate our growth in the aerospace and defense market through the addition of value-add capabilities and services.

Other performance indicators:

 

In addition to the key operating results and financial information described above, management reviews the following measures (which are not measures defined under IFRS):