Celestica Inc (CLS) 2002 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

Welcome to the Celestica Second Quarter 2002 Financial Results Conference Call.

During the presentation, all participants will be in a listen-only mode.

Afterwards, we will conduct a question and answer session.

At that time, if you have a question, please press the ?1? followed by the ?4? on your telephone.

As a reminder, this conference is being recorded Wednesday, July 17, 2002.

I would now like to turn the conference over to Mr. Eugene Polistuk, Chairman, and Chief Executive Officer, Celestica.

Please go ahead, sir.

Good afternoon and thank you for joining us on Celestica?s Second Quarter 2002 Conference Call.

Since you have access to our detailed financial results, Tony Puppi will summarize -- our Chief Financial Officer -- will summarize the second quarter and I will conclude with some comments per our outlook.

Also, joining Tony and me today is Marv MaGee, President and Chief Operating Officer.

And between the three of us we?re going to be very happy to answer any of your questions.

Let me turn it over to Tony.

Thanks, Eugene.

Before we begin, let me express to you that there are statements that are made today which may be forward-looking and not historical fact.

They involve risks and uncertainties, which could cause actual results to differ materially from those expressed in the forward-looking statement.

Despite the continued challenges faced in technology and markets, Celestica was able to expand margins and generate very solid improvements in working capital efficiency.

Revenue in the quarter was $2.25 billion, up 4.5 percent sequentially and in line with our range of $2.1 to $2.4 billion guidance announced in April.

Base business levels were flat and the increase, quarter over quarter, was driven by our NEC Japan acquisition, which closed on March 31.

Asia now represents close to 25 percent of company sales, compared to less than 10 percent a year ago.

End market segmentation for the quarter was essentially unchanged from the prior quarter and broke out as follows: communications revenue was 46 percent of sales; server business was 27 percent; storage and other was 20 percent; while workstation and PC's was seven percent.

The communication segment was affected by weaker base telecom sales offset by the NEC Japan edition.

During the quarter, SUN, IBM and Lucent were each over 10 percent of sales.

Our top five customers represented 67 percent of revenue compared to 72 percent in the first quarter of 2002.

Providing a little more color on the top line, the second quarter continued to show increasing stability in order patterns.

On the back of new customer ads and new program editions, we have started to see some growth and accounts not in our top 10, which grew as a group, 12 percent sequentially.

So even in an overall flat environment, these are some positive signs of life.

00:3:18 Lastly, utilization was between 40 and 45 percent for the quarter, which was about the same as the first quarter of 2002.

Nonetheless, we were pleased that we?re able to continue to realize some margin improvement.

Our operating margins came in at 3.6 percent, up 10 basis points sequentially based on higher gross margins and within our 3.5 percent to 3.7 percent range.

The key driver for margin expansion in the quarter was the effect of the restructuring program previously announced.

Adjusted net earnings defined as net earnings less amortization of intangible assets, integration costs related to acquisitions and other charges, net of tax, were $69 million in the quarter or $0.28 per share, and up approximately 10 percent sequentially from the first quarter.

This result was also in the middle of our guidance range.

On a GAAP basis, net earnings were $40 million, up 150 percent from $16 million last year.

Moving over to our balance sheet, I?m pleased to say the company continues to show strong improvements in all operating metrics.

Cash flow from operations was $237 million and represented the fifth consecutive quarter positive cash flow.

Over that five-quarter period, total cash flow generated has been $2.1 billion.

Cap ex in the quarter was $49 million, higher than the first quarter as we continue to make IT investments associated with our supply chain initiatives, as well as investments in our low-cost facilities.

Cash cycle continued to improve.

Total cash cycle, defined as inventory days plus receivable days, less days of trade payables including accruals, improved from 28 days in the first quarter to 21 days this quarter.

Strong improvement in inventory management drove this result as inventory levels decreased $121 million from the first quarter with turns increasing to 7.1 times compared to 6.1 times in the first quarter.

00:5:44 As a result of these efficiency gains, our total cash position grew by an additional $200 million, ending the quarter with $1.7 billion in cash.

The company also continues to be undrawn on its approximately $1 billion in credit facilities and conservatively capitalized with a debt-to-capital ratio of 21 percent, and that is treating the convertibles as debt.

By building this financial strength and with our confidence and our ability to continue to prove on it, we have facilitated additional opportunities to generate economic value for our shareholders.

One of these opportunities is to redeem our outstanding 10.5 percent Senior Notes.

This redemption will be financed at the company?s existing cash balance and will result in a reduction of $130 million, or virtually all of the company?s long-term debt.

On an annual basis, this initiative will be [accretions] earnings by about 4 cents.

We also plan on launching a normal course issue, or bid, or stock repurchase plan.

The plan will give us the option and flexibility to use our strong cash position to purchase up to five percent of the company?s outstanding subordinate [holding] shares.

Importantly, this plan stock repurchase program is a reflection of the confidence we have in our company going forward and the commitment we have to using our solid cash flows and strong balance sheet to generate additional shareholder value.

Let me now turn to our guidance and capacity reduction plans.

Our revenue guidance for the third quarter is approximately $2.1 billion to $2.4 billion.

This guidance, again, reflects a flat tone in an environment where our customers continue to feel their end markets are challenged and lack visibility.

We expect offering margins to continue to improve to between 3.6 percent and 4 percent.

At the mid-point, this reflects a positive bias of 20 basis points achieved through our ongoing cost reduction and our previously announced restructuring program.

The result in adjusted earnings per share guidance for the third quarter is between 26 cents and 33 cents per share.

Additionally, we expect to see continued gains and working capital efficiency, including improvement in inventory turns and cash cycle in the third quarter.

Let me now move to our decision to undertake further restructuring, which will result in a total pre-tax charge of between $300 and $375 million to be recorded in the third and fourth quarters of this year.

Despite our confidence and our ability to further improve our profitability, at current utilization rates, as our third quarter guidance suggests, we believe it is important to accelerate these gains given the prolonged, difficult end-market environment and continued lack of visibility by our customers.

We remain committed to our 5 percent operating margin objective, and return on invested capital target of greater than 30 percent, and believe this action accelerates progress towards these goals without compromising our growth opportunities or limiting our customers? flexibility.

We are not providing details of the restructuring plan at this time, as we have employees and customer sensitivities to address first.

However, we do expect the restructuring upon completion will: first, increase our utilization rates from the current 45 percent level to levels between 55 and 60 percent; second, further align our capacity footprint in low-cost geographies from about 55 percent to 65 percent, or roughly two thirds; and importantly, achieve operating earnings benefits that pay back the cash cost of the program within one year from when the actions take place.

Our goal is to fund the maximum cash cost of $150 million of this restructuring program from the operating cash flow generated in the upcoming quarter.

I?ll now turn it to you Eugene for his closing comments.

Thank you, Tony.

With the end markets remaining challenging, we [are being] focused on solid execution and driving operating efficiencies.

As we move forward though, I?m getting pretty excited about some of the things we are accomplishing and the very robust business models we are building.

Some of you may have heard me speak about us being at the start of what I refer to as the ?third stage of outsourcing.? Industry is evolving from a point where we were once simple contract manufacturers to today?s global EMS companies and now to a new phase.

In this phase, I see the potential to take the business model to a new level where greater and more consistent returns on capital are generated.

Let me expand on this.

During the first stage of our industry, we were contract manufacturers where we were ? which really represented off-load capacity for the OEM.

We had limited capabilities and a small global footprint.

We weren?t doing anything that an OEM couldn?t do or achieve itself.

But we provided the OEM's with a very important service.

More recently, in stage two, we became the EMS industry where we invested in capabilities, footprints and supply chain processes to provide a full set of services on a global basis to a set of global OEM customers.

We changed how OEM did business and we got very good at managing an extremely complex manufacturing network and an explosive growth environment.

We have now evolved to where we are today, entering a third stage over the next few years, where we will start to fully mine the benefits of those previous investments and capitalize on what remains a significant growth opportunity ahead.

And yes, there will be growth again as we move forward.

During this stage, you should expect to see an incredible focus on efficiency, not only in our company, but throughout the industry.

We already have an industry that?s materially more efficient than the traditional OEM manufacturing model.

But not because they weren?t good at manufacturing but more because our model is more effective with multiplicity of customers, efficiency of supply chain, unconstrained parts sourcing and being intensely and singly focused on manufacturing.

There is a still significantly greater opportunity for increased efficiency during this next phase and capturing the benefits of these gains will ultimately generate more returns for us, our customers, our suppliers and our shareholders.

We expect that during this phase we will increasingly move towards our longer term goals, which approach zero days working capital structures.

I think it?s already starting to happen.

When I said earlier that we were pretty excited about some of the things that were going on in the company, this is one of the areas where our past investments are starting to pay off.

Pilot projects in the company are running very close to those levels already.

You can see how this direction really starts to redefine the nature and the characteristics of the business.

Of course, to do this you need fully deployed, interconnected and advanced IT systems run by superb professionals utilizing very robust business processes.

We feel [advantaged] in that regard.

One of the byproducts of achieving this efficient working capital model is a core building block for the future: a very robust balance sheet.

You should expect this from us and you should expect it from the industry, as it will be necessary to participate in the growth ahead.

Growth in the future should not require significant, incremental working capital like it did in the past.

And that proposition will create a very attractive value proposition for everyone.

So our longer-term view of the potential model is quite compelling to us.

Attributes of this model include the 5 percent operating margin that we?ve talked about -- much less than the 25-day cash cycle.

ROIC is at 30 percent or greater, a robust balance sheet with the potential for high growth and positive cash flow at the same time.

In essence, you create a business model event not unlike Dell has in their space.

And when you apply this economic model to a multi-billion dollar electronic [caused] opportunity that?s out there for us, this is a meaningful opportunity to generate shareholder value.

Long-term, we?re extremely positive on this future opportunity.

In the medium-term, we see the potential for some pretty exciting gains with this model.

In the near-term, we?re all frustrated by the economic environment, but we?re also not going to simply wait for a turnaround.

Instead, we will drive to achieve our financial goals even in a slack environment.

When growth does resume, and it will, the evolved model should benefit us even more as the increase in volumes materializes.

With that, I?m now going to ask the operator to open up the call for questions.

Thank you.

Ladies and gentlemen, if you would like to register a question, please press the ?1? followed by the ?4? on your telephone.

You will hear a three-tone prompt to acknowledge your request.

If your question has been answered and you would like to withdraw your registration, please press the ?1? followed by the ?3.? If you are using a speakerphone, please lift your handset before entering your request.

One moment please, for the first question.

Our first question is from Ellen [Chay], Prudential Securities Incorporated.

Please proceed with your question.

Congratulations on a great quarter, gentlemen.

Could I just ask you, in terms of any sort of commentary, I know that you haven?t provided any official guidance for your fourth quarter, but have you gotten anything qualitatively that could give us some sense as to how your fourth quarter may look?

Well, we?re not providing any guidance for the fourth quarter, given the lack of visibility.

I would say that, as in prior years, we do expect some seasonality.

That?s certainly in the market segments where we play the quarter that represents the highest seasonal sales pattern.

Could you give us a sense of what you would consider to be kind of a normal seasonal sequential growth pattern?

Well, that's very difficult to predict, given all the all the volatility that?s in the market, Ellen.

Okay.

And then, one thing that I did notice was HP dropped off as an over 10 percent of revenue customer.

If you could give us a little bit of inside on what happened there, that would be appreciated.

Well we don?t disclose anything about customers, particularly those that are under 10 percent.

Suffice it to say that our base business remained relatively flat but overall, the business grew on the back of the NEC transaction, which could at times change the percentages and mixed between the top 10 and not.

So there?s no event occurring underneath that -- just the way the number worked above 10 and above 9.

They?re very close.

Is there any way that you could give us a little bit more insight to some of the IT investments that you?re making?

You did make some mention of it.

Could you provide a little bit more detail?

Well, we?ve been making those IT investments as we?ve integrated the company, deploying certain very strategic platforms. [Tap] is part of it, but there?s a lot of other ones that go along with it.

And that?s really the core of it, is making it common right across the whole company, interconnecting it and putting the best possible applications with it.

That said, it?s not just the software, it?s the software plus the business processes plus the professionals that go with it.

And we think with the kind of world that?s possible, and the leverage you get out of it, it?s a very good investment indeed.

What percentage of your suppliers are on BMI with you?

In terms of supplier base, over a quarter of our suppliers would be already on DMI-type programs.

But in addition to that, there?s other electronic, or system based interconnects, as Eugene mentioned.

Okay, Thank you.

Our next question is from Jerry [Lebowitz], Merrill Lynch.

Please proceed with your question.

Yes.

Could you tell me how long do you expect it to take to fully implement the restructuring that you?re talking about today?

Well, we think that [indiscernible] will implement it over the course of the next year, Jerry.

So it will be in phases, given the amount of migrations of programs and various executions underneath that and customer sensitivities.

It?ll take us about that time to implement this phase.

Okay.

And it will fully implemented a year from today?

That?s correct.

So we?ll see the full benefit the following year.

That?s correct.

Okay.

One other quickie.

Pricing of components this past quarter -- components and other purchase materials?

Generally, on the material side we continue to see take-down rates at a general rate around 3 to 5 percent per quarter.

Thank you.

Our next question is from David [Parish], RPC Capital Markets.

Please proceed.

Yes.

Good evening.

Tony, what?s behind the 80 basis point sequential decline in the operating margin in Europe for the quarter?

Well, Europe is undergoing some program transitions, as we are wrapping up our low-cost facilities in the Czech Republic.

And that?s driving most of the change on the sequential basis.

Even though sales were, as you saw, pretty flat.

Okay.

And can you talk about the acquisition pipeline and whether we should expect to see any additional transactions materialize here on the second half of the year?

We don?t make comments relative to what might happen, but I will make the comment that there is a pipeline of opportunities and we continue to evaluate them, and they?re fairly broad relative to geographies and sectors.

But, you know, we?re going to pick the ones that really work for us -- and in this environment, you want to be even extra selective.

Okay.

And can you give us some color regarding the segments for new customers that you mentioned that actually added to the stability in the order patterns in the quarter?

Well, essentially, they came across the board.

I think we?ve had a good, healthy mix of both communication customers and some IT's, as well.

And I?ll go one step further here.

I?m mean, we?ve typically had about 70 customers.

We?re probably running more like 100 customers in our core business.

And a lot of wins.

You know, that's one of the areas that [I'll] make a little feature on.

The fact that we don?t put out press releases doesn?t mean nothing?s happening.

We have a steady stream of wins with our existing customers and with new customers.

And it?s a case of, you know, not misleading or hyping things.

So, we?ve got a lot of momentum and I think we?re having a lot of successes.

How did the linearity of the quarter compare to last quarter?

It was quite similar -- maybe with a touch of better linearity or stability between the three months.

But pretty similar.

David Parish.

Okay.

Great.

Thanks.

Nice job on the balance sheet.

Thank you.

Our next question is from Gus [Pupagorgus], [Gosha] Capital.

Inc.

Please proceed with your question.

Thanks.

Tony, question for you.

Could you give us an idea of what the head count was in the quarter and also the square footage?

And Eugene, could you just expand a little bit on -- you said that going in the future, growth should not require working capital commitments.

Can you just expand on that and tell us what?s going to be different in the future from what?s happening now?

Well, let me answer the second question first.

As we drive down our cash cycle, obviously, that has a very real implication on our working capital, and at a point in the past when we?ve had higher cash cycle and growth, we ended up in an environment where we had negative cash flow.

As we improved the efficiency of our cash management, it creates an environment where we start to spin off cash and we?re not just as capital intensive -- or working capital intensive.

And I think that significantly improves our balance sheet.

It improves our return on invested capital.

It becomes attractive to our customers because they have less risk in our pipeline.

There?s no downsides to it.

It just requires the proper infrastructure to properly implement it.

But in an environment when sales are decreasing, you know, it?s easier to milk the working capital.

But when we?re getting back to an environment where sales start to move up--?

And that?s precisely what you want to do is not get into an environment where we have to add gobs of working capital.

So you think it?s sustainable even as sales start to move up?

Exactly.

And that?s the beauty of it.

And it?s for us to prove it?s possible.

We have working examples inside the company and that?s why we?re excited about it.

I think it moves us to another stage.

And that?s why that little speech on what?s possible.

Our vision, [indiscernible] our dream of how the business model can move forward.

Now in the totally -- in a difference space, Dell perfected that.

We?re not saying we?re going to do the same thing Dell did, but in a lot of ways in our space, I think it has a similar effect.

And it?s really all about efficiency, whether it?s efficiency in working capital or any other form of efficiency.

It has a very real effect.

Tony, are there [any other parts]?

Gus, the employee levels above 40,000 and the space was 10 million square feet.

Thank you.

Our next question is from Louie [Misiosa], Lehman Brothers, Inc.

Please proceed with your question.

Okay.

Thanks.

Thank you.

Just to touch again, I guess, on the cash flow issue -- so it sounds like that for the foreseeable future, you look to be positive from cash flow operations and, I guess, even given growth, you don?t expect that to go negative.

At what growth top line level would you expect, maybe, to run into difficulties?

Above, let?s say 20 percent, above 30 percent on a year-over-year basis?

We model it out at, you know, 20 percent growth rates.

We should at, between 20- and 25-day cash cycle, be very close to not requiring additional cash.

And as the cash cycle drops further, then you can have even higher growth rates without adding capital.

It?s a very important element to the [indiscernible] of how we can improve the business.

As I say, if you look at the models and work it out yourself, you can see it.

And as I say, we?ve gone beyond that.

We?ve started out -- this is rather an insight here -- we started down this path two years ago because we were concerned about the significant growth that was materializing in front of us; the amount of capital we?d have to generate to fuel it.

Ironically, it?s also a gateway for helping us in a flat environment and helping us for growth later on.

It?s just a pure win-win.

So, we?re very, very happy that we started down that path and I think, as people get to appreciate it more, they will embrace it too.

And I should make a comment, and I may be speaking for the industry here.

Many of our competitors are now talking up cash cycle more and more, and they?re supporting the concept of how this helps the economic model, and some of them are even putting in targets of 28, 25 days.

One of our competitors is already down to nine days.

You know, so there?s a momentum here that the industry sector wins at.

Okay.

Great.

When we now just look out to the September quarter, a lot of the customers that you have usually see pretty strong seasonality in that it?s a summer and usually a lot of people in both Europe and U.S in IT-land are taking holidays.

What would lead to the environment where you?d be able to get up-revenues quarter to quarter?

It would just be that tech really starts to rebound?

Meaning the fourth quarter?

No.

The guidance that you gave for the September quarter could imply that you could see up-revenues quarter to quarter.

That?s correct.

And basically, based on our view of the order book and order patterns today, that?s kind of the range that we feel comfortable with.

In terms of it being on the growth side, again, the success of certain programs, the speed at which new programs are introduced and successful in the marketplace, the resiliency of some of the programs that were [at the end of life].

It?s a whole combination of things and that?s what we typically try to embrace and look at very carefully when we provide the guidance.

But those are the same areas of potential upside, looking at the quarter ahead of us.

Would it be, though because your customers are growing organically on a sequential basis?

Or is there other new wins that you haven?t put out press releases that are really driving that -- sort of, as we had some help from NEC in the last quarter?

We put out press releases on major acquisitions.

We typically don?t put out press releases on wins.

And as I mentioned earlier, that does not mean we?re not having wins.

We would be spending a lot of our time writing press releases and I don?t think that would provide valuable clarity or anything.

So that?s why it?s important that those wins are happening and they are happening.

Does that answer your question?

No.

I?m just trying to understand -- let?s say if you hit the high end of your number for -- of guidance range -- $2.4 billion; that would be up on a quarter-to-quarter basis.

Is that because your current customers are growing on a sequential bases?

It could.

Or it could mean some of the programs we have are successful, and some of the competitive wins may be more successful.

So, it could be a variety of factors.

Okay, then.

But [indiscernible] in there are any acquisitions that might happen in the third quarter.

Correct.

Then my last question is just that, if you could just give us a little more view.

You did say that it seems like things are starting to firm up in IT-land.

Are you getting also that impression that that will continue into the September quarter?

We have been saying for the last couple of quarters that things have firmed up and I think, you know, there is that element of stability.

What there isn?t, is a big uptick.

So, I would say it isn?t a stability that's unique to this quarter. [I'd say it's] been around for a few quarters.

Okay.

So nothing as a second-half rebound really materializes.

We have not seen the second half rebound.

That?s a more frontal way to say to say it.

Okay.

Great.

Thank you.

Good numbers.

Thank you.

Our next question is from Alexander [Blanton], [Ingles & Snyder].

Please proceed with your question.

Thanks.

I?d like to go to what you were talking about before -- effectively zero working capital.

And I?ve used a rule of thumb since I started following this business about ten years ago, that it would take -- normally it has taken in the past, for a dollar of sales, about ten cents of working capital and ten cents in plant and equipment.

And what you?re talking about is removing half of that investment.

Is that correct?

For a dollar of sales you?d need ten cents of plant and equipment.

Incremental sales.

I think it?s less than that.

I think -- and this is why, you know, we?re sort of putting this label of new model.

The old models -- I?d throw them out, relative to where we?re going.

It says if you get to zero working capital, you need zero cents for working capital.

Right.

We haven?t said we?re getting to zero yet but that's certainly in our -- where we want to end up.

And we?re working towards it.

And we said at one time we would get the 25-day cash cycle sometime next year.

We?re already at 21 days and we?re continuing to work it.

Relative to the equipment investment, I think it?s significantly less than that and certainly not in the near term as we deal with these levels of utilization.

Well, not in the near term but I?m talking incrementally, if you had to build new capacity -- normally that?s been what it is.

And --

I believe that this focus on efficiency in this third stage, not just working capital ? overall -- will probably drive that number down and you?ll basically -- you will fund anything you need out of your cash flow.

Well, it has some very interesting implications, what I?m saying is, for incremental returns.

Because, let?s just assume, for the sake of argument, 10 cents of investment for a dollar of sales and you?re planning to earn 5 cents pre-tax on that dollar of sales.

So that means you have a 50 percent return on the incremental investment required to get that dollar of sale.

A 50 percent return.

So, that?s well over 30 percent after tax.

Your arithmetic is correct and on the incremental it?s probably even higher than 50 percent.

And overall, you take your entire business to levels of over 30.

Absolutely.

Yeah.

So, that?s about double of what it?s been in the past, which is accomplished by removing half the investment.

But, however, in view of the competitive environment in the industry, would this mean that in the future, margins might be lower.

Because returns go up to a certain point, and then it does have an effect on pricing -- you know, competitive pricing in the industry.

What?s your reaction to that?

Not necessarily.

We don?t think so.

And, you know, I think efficiencies drive through and you significantly reduce the material liability to the OEM -- that has a lot of value.

When you significantly improve the pace at which cost reductions and materially flow through to the customer, like Dell, in their model.

There?s a lot of other corollary benefits that works out the economics in a positive way.

Now, I just want to caution everyone -- we?re talking about the third stage and where the leverage is.

I don?t want anyone to walk away from the call saying, you know, it?s a done deal, it?s all in place and, you know, you see it next quarter.

This is where we think it can take us.

We?re working very hard on it.

We started two years ago and we think that the object should be to get there.

But your fascination on what the returns can be is exactly why we?re excited about it. [We think that] there?s a lot of potential that the whole industry should strive for and stay tuned.

We now have to prove it.

Well, what I?m saying is if the whole industry does this and achieves these high returns, maybe it does drive the margins down because --

Well, now, the problem is, not everyone will be able to do it, because they won?t have the attributes.

So this isn?t something that anybody can pick up.

What I would like to do is, because we?re trying to cover ? we have quite a few people on the call back log, if I could move on to another caller.

If you?d like to call us separately, we?ll be happy to discuss it further.

I have just one more thing, if you have all this cash, what are you going to do with it?

Well, we already made some announcements today.

Okay.

Thanks.

Next question.

Next question is from Steven [Savis], Goldman, Sachs.

Please proceed.

Mr. Savis, your line is open.

Please check the mute button on your phone.

Hi.

Thank you, and congrats on the quarter.

Can you hear me?

Yes, we can.

Great.

Just wanted to follow-up.

I think last quarter you had indicated that you are assessing some intangibles for impairment charges and I was wondering what the progress on that is -- if you?re still in the process of doing so?

We have assessed the impairment according to new accounting pronouncements of goodwill, which we were required to do, and to complete that assessment by the end of the second quarter.

That assessment has been completed and we?ve determined that no write-offs of that goodwill is required.

Okay.

Great.

That?s it.

Thanks.

Thank you.

Our next question is from Todd Copeland, CIBC World Markets.

Please proceed.

Good evening, everyone.

If we could just go to the restructuring for a moment.

Had that restructuring been in place in the current quarter or the September quarter, what might the operating margin look like?

In the second quarter?

Yeah.

I don?t think we would have got any mileage in the quarter we?re implementing.

In fact, the guidance for the third quarter does not anticipate any benefit from that restructure.

Okay.

Sorry.

I didn?t ask the question smoothly enough.

What I was interested in is, I guess, what is the incremental operating leverage to go from 40 to 45 percent utilization to the 55 percent level?

What would be the earnings power of the company once this restructuring program is fully executed?

Would you be at your 5 percent operating margin goal?

Just give us a little color on that.

Sorry, Todd, for not fully comprehending the question.

I think we could clearly add, you know, 60 to 70 basis points in margin on the back of a 10 percent increase -- an absolute 10 percent increase from 45 to 55.

And so then, we should get that at a bare minimum, assuming flat markets starting in the September quarter.

No, again in the second -- in the September quarter -- you mean the September quarter of next year?

Correct.

Yes.

Yeah.

Okay.

Great.

Secondly, IBM was -- had a tough server quarter in Q1.

Did that change any in Q2?

Can you give us any color on how your server business did?

We don?t discuss any customer programs.

But you saw in aggregate it was flat.

Okay.

Finally, there?s been a lot of discussion of ODM's on the low-end of the EMS environment.

Can you just give us a sense on how you?re seeing that play out with Celestica?

Is this pushing this restructuring, this resizing of the footprint to Asia?

And if you are seeing ODM's, what part of your business are you seeing them in?

Thanks.

The ODM's obviously are presenting a bigger problem with people -- high concentration in the PC sector, or as you say, the low end.

So they?re [less than] that for us.

ODM's have been built up in a lot of ways, and they're certainly part of the outsourcing solution.

We believe ourselves as a CDM, you know, a contract design manufacturer, that offers a lot of design capability and does not present any risk from an intellectual property point of view to our customers.

And you know, that's a component in our overall solution.

So I think they're there;

I don't think they represent a massive threat to us with our portfolio.

Presents a bigger problem with people that have high percentages in, you know, consumer or low end.

But you know, we always watch; we're a paranoid group.

Just one follow-up.

Percentage of your business where you are currently going head to head with the ODM's?

Very small.

Okay.

Wouldn't be much, really, off the PC and workstation end market segment.

Less than 10 --

Aggregate, yeah.

Probably ? certainly [indiscernible] 10 percent.

I'd say closer to 5.

Okay, thanks very much.

And we have repeated very effectively some of the ? with all the hype here of Taiwanese, in many cases we're competing very aggressively and effectively with them.

So a little bit of hype on this topic.

Next question is from [Mark Lucy], [PDC] Securities.

Please proceed with your question.

Hi.

Maybe one point of clarification.

And another more general question.

First of all, the restructuring charges that you expect ? you're saying they'll max out from a cash basis at about $150 million, and the remainder, of course, by definition is non-cash.

What kind of categories would you expect that to be in?

Would that be write-offs of PP&E?

Are you expecting any kind of inventory write-downs, or any other write-downs of intangibles?

I guess goodwill is ? just to clarify, was goodwill ruled out by your answering the question a little bit earlier?

Maybe I'll let you answer that and I'll just ask my second question after.

Okay.

The restructuring beyond the $150 million including the $300 and the $375 would include property, plants and equipment.

Probably for about $100 to $125 million.

And the balance will be for intangibles associated with any closures that are undertaken, okay?

So these are intangible assets other than goodwill.

I understand.

Thanks.

That's exactly what I was looking for.

Just in terms of the industry dynamics, if I got the quote correctly ? I think it was Tony who said it earlier, that of your top ? the customers below your top ten, if I got that right, were growing, I think, sequentially, on a 12 percent clip.

Is that -- just in terms of painting a picture there, in terms of industry dynamics, are you perceiving your great effect benefiting from a consolidation of EMS customers that these people use, that say, let's say, in this group, you may be a secondary supplier or a tertiary supplier, and you're now moving into a solid number two or maybe even moving further up the pecking order with these vendors.

So, in effect, a market share gain in this particular segment?

Well, they're mostly displaced ? not, you know, existing lower tier going up.

Displacing.

Nevertheless, in aggregate, a market share gain amongst that group by definition.

Yeah.

Essentially, they're the new customers that we have been winning, and those new programs being introduced to our revenue stream.

Thanks.

I appreciate that.

Okay.

Next question is from Roger Norbert, J.P.

Morgan Security Inc.

Please proceed with your question.

Good afternoon.

Just a couple quick ones.

Tony, did the margin compression in Europe have anything to do with ? was there any currency impact around that at all?

No, there was no currency impacts in Europe.

Okay.

If you looked out over the next twelve months, is there a high or low likelihood that your top five customer list will change at all?

Well, they're pretty good customers so ? you never know.

Okay.

Along those same lines, what about your current mix in terms of your work station communications and stores.

Do you expect any significant changes around the mix as it stands right now?

Well, the interesting observation, when we look at what we've been winning and some of the new programs as well, on existing customers -- they're across the board, so it kind of suggests to us that the kind of mix that we have won't change too much.

And remember, that I think about 75 percent of the entire electronics cost of goods sold, if I'm not mistaken, falls into IT and communications, and those are the two primary segments that we have.

So we won't see a material change in the other.

Okay, and just a last question.

Regarding Asia, you've had Omni now for a few quarters and a bigger footprint in Asia.

Can you maybe help me understand a little bit more how that's shaping up, in terms of your marketing and relationships with new and existing customers?

Is Asia eventually going to be used more or is it starting to be used more to shift manufacturing on some of your core platform business with existing customers, or is it being used more to expand a down market with those same customers?

And how far down market do you want to go?

I think [there are] a couple of parts to your question there.

Certainly the work that we've been doing with the new addition with Omi has been very positive.

And I think it's added to the very solid capability that we had prior to that acquisition.

Relative to the type of work, it's attractive to both areas that you mentioned, so certainly for existing customers, it does present some sourcing opportunities.

But it's attractive to new customers as well.

Okay, and last question.

On your working capital ambitions, what would you describe right now as, say, an upper boundary on inventory turns, and what would you describe as a lower boundary on DSO's?

On the inventory, it's [usually described] as, you know ? kind of crazy here, but the deal is, looking back a few years, we were able to get 12 to 15 turns.

And I think there's no reason why some of our modeling and some of our pilots, and their success, gets us [indiscernible] on that kind of a range.

And in terms of a receivable base, you know, efficiency and collection -- we're pretty efficient at it.

So it's probably not a huge opportunity on that line, say, between 40 and 45 days.

And ultimately maybe closer to 40.

Okay.

Thanks very much.

Okay.

Our next question is from Thomas Hopkins, Bear Stearns.

Please proceed with your question.

Yes, good afternoon.

Congrats on a good quarter.

I won't belabor the cash conversion point, but I will say the reason there's so many questions is because if investors really believe that you guys could do sub-20 or 10, or sub-10 days, you know, these stocks will probably double or triple.

Gene, could you tell us about a couple of new sectors that are starting to outsource?

And specifically, how you guys are positioned?

We've got a lot of data on them.

Semi-conductor capital equipment, automotive electronics, and medical electronics.

And they're all smaller sectors, compared to, obviously, IT and then communication.

Probably the most difficult in there is the automotive.

Because that's a totally different model, where you can end up supplying to a second tier or even a tier 1, because it's a different tiering business.

That's probably short term, least attractive.

Relative to going into medical and some the of the other spaces, those are all ? I don't think there's great barriers of entry.

I mean, there are certain things you have to do, and if we want to go into them, I think we can.

But I remind everyone that they're a small percentage of the overall available market.

We look at the total electronics cog ? space ? as available market to us, with very little barriers of entry to get into those.

There's things you have to do, but they're all things we think we can do quite well.

I think there's a great barrier of entry, of creating new tier 1 EMS players, on a global basis.

So it's kind of a big barrier to become what we are; very little barrier to go into those incremental spaces.

If you go into them, you've got to make sure you go into them to win.

And we're not going to, you know, go in to play in it.

We'll go in to win when we go into some of those.

Okay.

So following up on the other question, when we look out a year from now, we really should still expect to see, in your customer lists, a wireline, a wireless enterprise telecom equipment, LAN and WAN enterprise networking, and enterprise computing should still dominate.

No, remember I said we have about a hundred customers.

It's pretty well spread out.

In fact, it even includes semi-conductor companies in there.

So we have a fair amount of diversity.

We have a concentration [relative to the] customer base that touches many, many of the spaces you're talking about.

Okay.

Great.

Thanks.

Our next question is from Tony [Bowes], A.G.

Edwards & Sons, Inc.

Please proceed with your question.

Thanks.

On the restructuring, was there a specific event or series of events that prompted the new round of restructuring?

Because I guess last quarter it sounded like you were pretty satisfied with your footprint at the time, given the environment.

Well, just to sort of recount the history ? Chief Historical Officer here.

We said that we had a 40, 45 percent utilization.

We did in the first quarter; we've done it in, in fact, the previous quarter; we're running at that level.

Some of the people on this very call, last quarter said, 'Why are you tolerating that level of low utilization?'

And we said, We're holding until we're sure there isn't a massive turnaround in the second half.

What we're basically saying is, we're concluding there's isn't a massive turnaround in the second quarter, and we're now making the adjustment.

So that was really ? it was all an issue of what was going to happen in the second half.

And you know, we're making a statement.

Now, we think with the efficiencies we've garnered, the efforts that we're doing, we still have a lot of elasticity and capability to take on any meaningful upside, but not the kind of upside that, you know, we thought might be coming at one time.

But it's more a correction; we're waiting.

We were criticized that we were waiting maybe longer than we had; we're cautious.

And we're just catching up on it, that's all.

Has your long term view of what kind of growth this industry can generate changed at all?

No, it hasn't.

And every cross-checking we do, whether it's with various industry analysis or whether it's with customers, and many other ways to check ? there is still a lot of latent outsourcing to come, and we see that there is a massive correction relative to the level we have today and what we'll have downstream.

And that's why, you know, we're so obsessive here about working towards a very efficient cash cycle, because when the time comes, we will be in a very robust position to respond to that upslide, and not have to consume or do a lot of dilution or any of those items.

And I think that does change the business model.

Just a couple of housekeeping questions.

What did NEC contribute in the quarter?

When do you expect the redemption of the 10.5 percent notes to be completed?

And what was the securitization in the quarter?

Okay.

In terms of NEC, the amount was about $100 million dollars of sales in the quarter.

The redemption will take place in the third quarter.

And the last question was on securitization and I think you --

[Inaudible] the receivables --

The [inaudible] that we had done; we're maintaining that line at $400 million.

There was no augmentation of that facility.

Great.

Thanks a lot.

Okay.

Next question is from Jim Savage, Thomas Weizel Partners.

Please proceed with your question.

Hi, my congratulations as well.

Thank you.

It seems that in communications and servers, that there is a fairly high percentage of outsourcing that's been done with many of your customers already.

Can you give us some idea, or detail, in what you think are the incremental opportunities, other than gaining share from other suppliers?

Well, there is a share gaining from the lower tiers.

I still think there's a significant amount of Wave 5, which is where companies get out of manufacturing altogether; even people like IBM, for example, still have a lot of factories.

You know, I still believe ? and we've verified that there's still [an amount] -- a lot of outsourcing yet to be done in Europe.

We conclude that there is just starting in Japan, which we call Wave 4.

So I still think there's a lot more.

We've cross-checked and done it 16 different ways, and we can debate a lot about how much.

But it's significant with whatever analysis we do.

And you know, we've even gone down to counting all the factories that are out there.

So it's out there, but a portion of it will be from Europe and Asia.

A portion of it will be taking people to full virtual.

You think that many of these customers are likely to just shut down their facilities and outsource?

Or will they be looking to sell their facilities?

Well, that's a good question.

I see a definite trend where, [while it's one] I mentioned before, the prices are dropping.

But in some ways, we're doing an acquisition anymore.

What we're really talking about it transition agreements.

And it's ? yes, we've decided to outsource; yes, we've picked you; we have this residual problem. [If the plant], the bulk of the dollars, are in inventory, how do we transition?

Can we mitigate, you know, the fact that we have this equipment and their people?

In the majority of cases now, I'd say the factories end up getting closed.

In some cases they get shrunk significantly.

And I think, you know, people are taking a very different attitude.

And we're very, very sensitive now about, for example, [anything] we've picked in higher cost geographies; then we have to look at what are the downstream implications, and how sustainable is it, etc.?

But I think it's ? the most effective cost solution for our customers in most cases is just a pure shutdown.

That's the way they'll realize the most.

I guess that way, they also get ? you don't have to charge them as much.

That's right.

I think the reality is, customers are now realizing this isn't a source of cash; it's a case of, I'll get something up front and I'll have to pay for it over the next two to three or four or five years.

And in the present environment, people want to get to the cost reductions as soon as fast as possible, and are looking at things that used to concern them, in very much a secondary way compared to the past.

So the industry is really evolving from where it once was.

A couple of other things.

One is, you had about 12 percent sequential improvement or growth with non-top 10 customers.

Is that mostly new programs that were ramping up?

And what would you be anticipating for the next couple of quarters in terms of those non-top 10 and what the trends are going to be?

It was new programs.

And [they're] hard to project.

You know, we start getting into second quarter projections.

So ? [technical difficulty].

You could accelerate.

Yes.

And is that accelerating because of additional new programs or the ramping of the programs that have already started up?

Both.

More additional customers, more new programs, realization of things that have already started up.

And as I said - you know, some days I sit here and have a big soul search relative, should we release a press release for every event that happens to us?

And I think, you know, we understate how we're doing in the marketplace.

But I think it's misleading to have isolated press releases.

[Inaudible] to be valid, you know, the non-top 10 are not a significant part of the revenue stream.

So the point in discussing it is, there is light there.

There is outsourcing happening.

And what is constraining it, to a very large extent, is depressed end markets.

Right.

Do you think that any of those customers could turn into top 10 customers over the next 12 [inaudible] months?

Absolutely.

Absolutely.

That means multiple hundreds of millions of dollars of revenues?

That's correct.

Okay.

And just to change a little bit ? in terms of getting to the zero working capital, today there aren't too many component shortages.

Do you feel that because you're able to ? that you have essentially complete access to components when you want them at this point, and your suppliers are certainly willing to give you that, do you think that there is any reason to believe that when components start to tighten again, when demand rises, that there could be a reversal, in terms of the working capital for you?

I don't think so.

I think in some ways, [these things] are very attractive to the suppliers.

There's less risk with us, because it means there's less in the pipeline that can surprise them.

There's less risk for our customers, because it means the liability they carry on that agreed-to inventory is less.

I think it ends up translating into higher flexibility and it's better for everyone down the road.

I mean, it still boggles my mind that as an industry, you know, we turn, say an average of 6 or 7, you know, say in that bandwidth ? and that represents like two months' average inventory, or a little bit less.

And most of our products get assembled in days.

And in an environment where we have a depreciating commodity in the form of parts, it's not where an industry needs to be.

So that's why Dell's been so successful.

They solved that issue.

And I think we have to solve it in our industry.

Well, I mean, to some extent they solved it by being pretty tough with their supply base.

In this case, the question is, after this last cycle, when so many of the semi-conductor companies ended up with excess capacity or with their foundry's commitments for excess capacity, do you think that they are more willing to hold the inventories themselves in order to maintain management control over the supply base?

Over the supply chain?

Yeah, are you talking about the OEM's?

I'm saying the IDM's.

Do you think that they want to have more control over what they see out there, so that they aren't surprised that one of their customers ends up with six months of inventory?

[Inaudible] we have that now, with more and more advanced planning tools, and the less you have in that pipeline, the better the quality of your visibility.

I've been in the business for 32 years, and having inventory ? whether it's OEM or whether it's EMS, or anywhere in the pipeline, does not offer any comfort or flexibility.

Invariably, you end up with the wrong [stocks] in wrong place, and there's a financial liability.

My belief, and certainly it's being demonstrated by people like Dell, is the faster your pipeline works and turns over, the more accurate your information, the less waste there is, the higher flexibility there is, on a downside and on an upside.

And it does translate into even more flexibility, because you become a reliable consumer relative to your suppliers.

And they will work with you and satisfy your requirements.

Because they know you know what you're doing; you're able to provide them the information, and there isn't this ambiguous lump of stuff there that surprises people.

And we don't have any components in allocation today, either.

That's true, that's true.

But I think that if anyone thinks they're going to have flexibility by having huge inventories ? in 32 years, I've never seen it translated that way.

All that people end up with is a big huge surprise and, you know, write-offs.

Especially in an environment where material continues to change tactically and costs keep dropping.

So you buy a whole pile of material; tomorrow it's obsolete.

So the fact you had it ? what did it do for you?

It's an interesting point.

I honestly believe that there's only ? that it only gets better going down this path.

And do you feel that your suppliers feel the same way at this point?

They have been very positive relative to that, and - you know, we work with them.

And as the quality of tools go up, then their comfort level keeps going up.

So the answer is yes.

Okay, great.

Thanks.

Okay, I want to suggest we have two more questions, please.

The next question is from Michael [Moore], Solomon Smith Barney.

Please proceed.

Thank you.

Good afternoon.

I'm interested in following up on your continued rationalization of your footprint.

And you've made a number of comments today that have led up to my question.

It's clear that you, historically and still, play in the upper end of complexity in technologies; [you have suggested that] a low double digit or high single digit percentage of your sales are exposed to ODM competition; yet, you're moving to a 65 percent low cost footprint.

So I was just hoping you could shed some light on what we could infer from that about commoditization; about what your future needs may be.

And may you could comment on whether you feel you're getting ahead of your customers' needs in doing this, or whether you're being driven by your customer to continue to shift to the low-cost geographies.

That's my first question.

I think in terms of ? the way I would look at it is, it's increasingly independent of the commoditization aspect.

We've tried to grow our capabilities, as Eugene mentioned earlier, both in IT as well as operating capability to be consistent around the world.

So it does, by working with our customers, to move some of their products to low-cost geographies present an obvious cost opportunity for them.

But at the same time, there are other opportunities, perhaps some smaller customers in different industries that are looking for presence in the high-cost geographies, and some of the Wave 5 type products that we spoke about earlier definitely are, because of logistic complexities, more suited to the high-cost geography.

So, you know, it?s not a black and white kind of answer.

I think from our perspective, it's important to have the full operating capabilities around the world, and that's both supply chain and the manufacturing and technical side of our business.

And with that capability, we can optimize for what makes sense for the particular set of products that our customers are looking at.

So two things ? first of all, if you have the right infrastructure, it makes it easier to do.

And we do.

And second of all, we're always striving to get the lowest possible cost solution for our customers.

So, you know, we're probably pushing even more than our customers are.

Okay.

And you have referenced, Eugene, the virtual opportunity, or moving customers to virtual; being part of the opportunity.

And I don't know that ? maybe I just have missed it ? but have you given us an update as to what level, or percentage of your revenues, are coming from full system integration, where you're having the final software loading shipment out of your dock?

About 30 ? just over 30 percent of our business is boxed [in] final assembly.

Most of it's final [configed].

So that's up from prior quarters.

Great.

I just have one other question.

I think you've already answered it.

But I know in past forums, and other members of the supply chain, we've heard say the same thing.

Celestica has said you have actually a concern that you may not be able to scale to meet upside in the future, if you contract too much.

And I'm inferring from your additional reductions that you have less concern about scaling to meet upside in the future, or is that an inappropriate inference?

I think that's a correct conclusion.

We think we've got the recipe to accommodate a pretty significant upside.

You know, in a way that doesn't mean we have assets tied up and we have costs up there.

So we have a way to dial it off as we need to.

That's great.

Thanks very much.

One more.

Okay.

Today's final question is from Gary Baker, of Raymond James Limited.

Please proceed with your question.

Good afternoon, guys.

One last question on the working capital efficiency.

I model sort of if you get 10 times inventory turns, you drive your cash cycle down to, like, under 10 days [indiscernible].

Are you going to give a new objective now, to get it down to 10 days, 15 days?

I mean, we've talked about 20 to 25, but you're already there.

We're not going to announce another number.

We said we're going to be 25; we have; and we want to get to or as close to zero as possible.

And you know, we'll make announcements of how we've done quarter by quarter.

And Eugene, when you talk about having ? is the infrastructure in place now to do - you know, you talked about upper end 12 to 15 times on your turns; this would obviously drive your cash cycle down to zero.

Is there still more you have to do in terms of infrastructure, in terms of the spending, to get to the level that you can do that?

I should correct ? I said 12 to 15 times.

Eugene actually believes it should be closer to 25.

But yeah, as we continue to redeploy globally our IT infrastructure, we continue to get mileage and confidence in improving the turns [indiscernible].

And a quick housekeeping.

On NEC, are you fully ramped at $100 million, or is there more to come this quarter as you ramp that up?

No, that was in for the full quarter.

Okay.

And last question: I'm just interested in your views on the [expense options] with the publicity that's getting these days, if that does in fact [become a] [indiscernible] in companies that are required to expense options.

Does that in any way impact how you would compensate employees going forward?

Well, first of all, we indicate how much [it's worth] in our notes.

We're not going to make any grand pronouncements until we see what we're supposed to do.

I don't think we can do it in isolation.

I'll make an interesting point: the bulk of our options go to the employees, not to the executive [indiscernible].

So I think that's an interesting aside.

But we're watching the debate.

There's so much being said about so many things all at once.

We think we conform to just about everything people are wanting to do.

And that one is - you know, we'll watch it.

It all depends on what everybody is doing.

It may be not only that it will be an accounting issue, but maybe the numbers will start to drop over time, too.

So that could be another different --

I think what we're most concerned about is, you know ? definitely we won't change our approach without a clear and definitive policy.

You know, where -- full disclosure, on a level playing field, and the accounting is level playing field for everyone.

At the same time, being sensitive to who we compete for, in terms of our resources -- human resources.

So we have to be calibrated with those industry dynamics.

Okay.

Last question.

In terms of China, I just wondered, Eugene, if you could comment; if you're happy with the current footprint Celistica has there, given the opportunities that market presents, and if you want to expand your footprint print there?

Are there acquisition opportunities?

Or is [Greenfield] the most likely?

I think, in terms of [time], I guess I'd say we're certainly happy with the capability we have today.

We are making ongoing investments to expand the operations that we have in China; certainly it's an attractive market for many of our customers, as well as an obvious cost opportunity.

So you know ? the future looks bright in that particular country.

And at the same time, we're making sure we have capability in low-cost geographies outside of China, too.

So that, you know, we're hedged there, too.

Because things could change there.

So we have capabilities in Malaysia; we have capabilities in Thailand; capability in Indonesia.

And we have it in China and, you know -- we're in about four or five different locations there, and we continue to invest and expand there.

And as acquisition opportunities come that add to it, we would evaluate it like any other acquisition opportunity.

Okay, I think that answers all the questions.

I'd like to thank everyone for calling in.

As I said, we're going to work on making this a successful model in any kind of environment, even a flat environment, but we're also preparing for the future.

We feel positive relative to the results we have, and we look forward to showing you our progress to where we want to, quarter by quarter.

Talk to you all next quarter.

Thank you.

Goodbye.

Ladies and gentlemen, this does conclude the conference call for today.

We thank you very much for your participation, and we ask that you please disconnect your lines.