Celestica Inc (CLS) 2003 Q3 法說會逐字稿

Welcome to the Celestica third quarter financial results conference call.

At this time, all participants are in a listen-only mode.

Following the presentation, we will conduct a question-and-answer session.

Instructions will be provided at that time for you to queue up for questions. (OPERATOR INSTRUCTIONS) I would like to remind everyone that this conference call is being recorded, and I would now like to turn the conference over to Mr. Eugene Polistuk, Chief Executive Officer and Chairman of the Board.

Please go ahead, sir.

Thank you for joining us on Celestica's third-quarter 2003 conference call.

Tony Puppi will briefly summarize our third-quarter result and then I will provide a few comments before we go to your questions.

Also joining Tony and I today is Marv Magee, President and Chief Operating Officer.

Before we begin, let me express you that any statements that are made today, which may be forward-looking and not historical fact, may involve risks and uncertainties which could cause actual results to differ materially from those expressed in the forward-looking statements.

We will refer to certain non-GAAP financial measures during (technical difficulty) the corresponding GAAP information and reconciliation to the non-GAAP measures is included in our press release, which is available at our Website, www.Celestica.com.

For third quarter, revenue was 1,635,000,000, down 17 percent from 1,959,000,000 in the third quarter of 2002, but up sequentially 2 percent from the second quarter.

Despite weaker demand from some of our largest customers, the sequential growth was encouraging, particularly with our non top 10 accounts, which grew 18 percent sequentially.

The growth was primarily driven by ramping of new (technical difficulty) from both existing and new customers, as well as some pickup in demand.

Sales in the Americas represented 43 percent of total revenues, down 7 percent sequentially.

Europe was 19 percent of total revenues, down 6 percent from Q2; and Asia now represents 38 percent, which was up 18 percent sequentially.

Revenue by end market included Enterprise Communications at 26 percent, Telecom was 23 percent, Server was 21 percent, Storage at 13, Workstation and PC at 7, and other came in at 10 percent of sales.

During the quarter, IBM, Sun and Cisco were each over 10 percent of revenue.

Our top 5 accounts represented 50 percent of revenue, down from 54 percent last quarter.

And our top 10 represented 75 percent.

We are encouraged that as we see growth resuming, customer diversification is also improving.

Net loss on a GAAP basis for the third quarter was 64.8 million, a loss of (ph) 30 cents per share, compared to a net loss of 91 million, or 40 cents per share, for the same period last year.

Included in the quarterly loss was a pretax restructuring charge of 49.1 million.

Adjusted net earnings, defined as net earnings before amortization of intangible assets, gains or losses on the repurchase of shares and debt, integration costs related to acquisitions and other charges, net of tax, was a loss of 3.8 million, or 4 cents per share, compared to adjusted net earnings of 50.9 million, or 20 cents per share, for the same period last year.

These results compare with our guidance for the third quarter for revenue of 1.55 to 1.7 billion, and adjusted net loss per share of 5 cents, to a gain of 2 cents per share.

In terms of profitability, our operating margins were slightly below breakeven, but up 70 basis points from the prior quarter.

Gross margins were at 3.9 percent, up 80 basis points from the second quarter.

Improved gross margins were driven from the benefits of the restructuring activity, although these gains were dampened by the startup cost of new products and programs, (technical difficulty) product mix and overall pricing pressure.

SG&A remained basically flat from the second quarter at just over 60 million and down 12 percent from a year ago.

R&D doubled to 8.4 million (ph) compared to the second quarter, reflecting an increased investment in our reference design initiatives for 64-bit servers, workstations and other products.

This growing investment will certainly precede revenue over the next few quarters, but we believe the longer-term benefit of higher margins from these products targeted to our (indiscernible) strength will not only diversify our participation in these markets, but also provide healthy returns.

Let me step you through our operating performance by geographies, starting with our European operations.

In Europe, our operating margins showed a $13 million sequential improvement, with an operating loss of just under 21 million.

This improvement was achieved despite revenues declining 6 percent sequentially from our second quarter.

Our overall sales levels here versus our expectations are clearly delaying our track to breakeven, as are product mix and transfer activity.

Our restructuring in Europe continues, with resource reductions through to the end of the year and into the first quarter of 2004.

The margins in the Americas declined to just above breakeven, as revenue dropped by about 54 million sequentially.

This region incurred the majority of additional costs of investments and R&D spending on the new products.

Asia margins showed sequential improvement of 30 basis points, as revenue increased 18 percent.

The region continues to benefit from new wins and transferred programs, offset by program ramps and a tough pricing environment.

We incurred $49 million in restructuring charges.

Two sites in Europe were closed and 1200 employees were released on a global basis.

We have approximately 1000 employees remaining to be released as part of our planned restructuring.

We expect to incur between 90 and 95 million in restructuring charges in 2003 versus our prior expectation, which was between 50 and 70 million.

Additional detail on our restructuring is given in our notes and financial statements.

Moving to the balance sheet, we continue to preserve our very conservative and highly liquid capital structure.

Debt to cap decreased further to a very healthy 17 percent, the best among the majors in our space, and cash came in at $1.21 billion.

During the quarter, we continued with our share and convertible debt buyback programs.

We purchased over 4 million shares for 65 million at an average price of $15.88 per share.

We purchased $70 million in LYONs.

The total of all of this repurchase activity was $135 million in the quarter.

Since the Company began its share and debt repurchase program in the third quarter of 2002, Celestica has spent $143 million to buy back stock and retire debt.

The Company has been authorized by the Board to purchase up to an additional $100 million of LYONs, subject to market conditions.

Cash cycle, defined as inventory days plus receivable days plus days of trade payable, including accruals, increased by 4 days to 7 days, driven primarily by higher inventory levels.

Inventory turns of 7 points eroded slightly quarter-to-quarter, primarily as a result of increased orders into the fourth quarter and some late quarter supply constraints.

Correspondingly, we expect improvement in the fourth quarter.

Our cash flow from operations was a -$71 million in the quarter, again due to our lower operating earnings and the growth in inventory levels.

Let me now turn to our forward guidance.

On the top line, we are encouraged by organic revenue growth as we head into the fourth quarter.

We are expecting revenues to land in the range of 1.7 billion to 1.85 billion, representing a 4 percent to 13 percent sequential increase.

This view is based on a mix of stronger demand, new programs and new customers.

We believe our diversity efforts and our new program win rates are starting to produce results.

On the bottom line, we see an adjusted earnings per share in the range of a loss of 1 cent per share to a loss of 9 cents per share.

This bottom line is reflective of the increased investment in our growth initiatives, including continued R&D in our reference design activity, as well as some short-term startup losses in these areas.

Furthermore, we expect Europe to improve significantly in the fourth quarter, driven primarily by higher seasonal volumes and the benefit of continued restructuring.

At this time, however, we expect Europe to still produce a loss in the quarter.

Finally, difficult pricing conditions and product mix volatility continue to prevail and cause us to remain cautious (technical difficulty).

Let me now turn it back to Eugene.

Before we open up things for questions, I would like to take a couple of minutes to update you on what I have been referring to as our fix, optimize and growth initiatives.

We have been talking about these initiatives over the past few quarters, and we believe the benefits are starting to materialize.

On our fix initiatives, we've been progressing steadily with our overall cost reduction and restructuring activities.

Europe continues to improve through benefits, although those benefits are not quite as high as we would like at this time, given the significant drop in revenues in that region.

Nevertheless, the improvements continue and we expect additional meaningful reductions in operating losses in the fourth quarter.

Our shift to 70 percent low-cost geography is on track, going from what was at one time 19 percent.

This is on track for year end this year end.

New operations and expansions have come online in places, for example, like China.

The short-term challenges we face is to not compromise potential customer upside in our zeal to adjust our critical mass further for the near-term.

Are their opportunities to take out further cost?

Yes, and that brings us to our optimize phase, where we have an intense focus on optimizing our costs and working capital efficiency.

While we have done well in these areas during the downturn, our objective is to be even more effective now that growth is resuming.

We feel that SG&A should remain relatively flat or at least grow much slower than revenue.

We have some growth initiatives underway that will incur additional expenses in R&D and will drive further growth.

Our optimizing the working capital, we have near-term objectives of getting our inventory turns over 10 and long-term over 12, and expect to be showing improvement in the fourth quarter.

We are starting to see growth in our overall business, and as transfer activities are completed and new programs ramp to normalized volumes, the improvements in turns should fall and be sustainable.

We also continue to optimize the balance sheet, and in addition to the repurchasing of another 4 million shares this quarter, we have spent another 71 million for LYONs repurchases, as Tony had mentioned, and to date have spent 308 million reducing this convertible.

In keeping with this optimization initiative, the Board continues to support spending an additional 100 million for the repurchases of LYONs.

So a lot of focus on growth, a lot of focus on optimization, and probably even more focus on the growth side.

We are seeing results from our growth initiatives, both in our diversification (technical difficulty) addition of efforts with new customers.

In the past 7 quarters, we have added 80 new customers, with our customer list growing from 63 to 143.

Of those customers, I think very important, 33 -- a third of them are noncommunications, non-IT, the areas we have traditionally participated in, obviously giving us a much broader diversification base.

We have also diversified by expanding our service offerings by enrichment in such areas as repair, logistics, order fulfillment, design and other areas to offer and continue to offer an ever-expanding spectrum of services to our customer.

In design, we have seen wins with companies like IBM and Telematics, Agere in communications and many others.

There are reference design activity, we have launched and shipped reference products including 64-bit workstations based on Intel's Itanium microprocessor, on 64-bit servers, based on AMD's Opteron processor, and other reference products such as graphics cards based on ATI's Radeon architecture.

And there are other activities in addition to these.

We expect that these investments will continue to contribute to the growth at least the ahead of us.

We also remain committed to supplementing these extensive organic activities with key acquisition, such as our recently announced acquisition of MSL, which adds diversity and expands our growing capabilities in the area of build-to-order, logistics and orderbook fulfillment.

We are also becoming more positive with what we are seeing in terms of opportunities in the OEM space, both for divestiture and transition agreements.

We do see OEMs continuing to look very seriously at all areas of outsourcing, and we anticipate to participate in all of those opportunities.

That concludes our remarks.

I would like to now ask the operator to open up the lines for questions.

(OPERATOR INSTRUCTIONS) Scott Craig from Morgan Stanley.

Just a quick question on the guidance going forward.

If you were to handicap the high end and the low end, where do you think that the biggest swing factor's going to be from a segment point of view?

So where some of the risk and opportunity to move it around in the range?

Like I said, I think we're trying to be cautious, given all of the parameters in place, the expectation of growth that we have.

At the end of the day, I think we are not seeing any -- outside of the new program wins, many of which are in sectors outside of IT communications, I think the other sectors are pretty much staying where they are, or at least behaving in a regular seasonal pattern.

So in the new spaces, it is driven by the fact we have new wins.

Cumulative new wins that have been happening since the first quarter of last year and are now starting to come into fruition, and we continue to add to that win rate.

On the cash flow, Tony.

Can you give us your expectations -- are we going to continue to use working capital here in the near-term as you're ramping up some of these new programs?

From the operations, I don't think so.

I think we have got a real opportunity here, as I mentioned, in terms of our inventory performance.

We could have done a better job there at the end of the quarter, given some of the supply constraints.

But I think we have a good handle on that and with a stronger and more robust fourth quarter, we should be generating some cash.

Okay, thanks, guys.

Thomas Hopkins from Bear Stearns.

Just want to think more broadly.

What do you see contributing this kind of late in the downturn to the performance relative to, say, some of your peers when we look at them starting to recover in revenue and earnings, and you guys still here struggling a little bit?

What lessons have you taken from that?

What is the plan in the near-term for the margin recovery?

I think diversity is probably our first lesson and that is what we have been very much focused on.

As you know, we do intend to have a higher concentration in the higher end, certainly in the infrastructure products, telecommunications, which I think have not had the kind of growth characteristics that maybe some of our competitors have had in other market segments.

I think that is one differentiator -- we're very focused on that.

And Eugene alluded to some of the new programs into the fourth quarter and beyond.

In terms of our margin, we are just going to stick to the path of executing our restructuring activity and focus on removing cost in all parts of our business.

Managing SG&A diligently and using that kind of operating leverage, which we do have -- it is maybe not as clear as you think from the guidance -- but using that operating leverage as the business expands.

What is your overall perspective on Unix and if you could give us your exposure.

As a platform, obviously, there is a lot of concern that Unix is under structural multiyear deterioration from open platforms.

You guys have historically had a lot of Unix exposure, and it is not that difficult to diversify in the short-term.

So as a Company, what is your perspective on Unix, what is your perspective on open platforms and how are you going to improve that mix?

A lot of people have speculated on Unix, and it should have died a long time ago based on all the stuff that people wrote.

But the fact is it still is a significant portion of people's high-performance offering.

We have a high concentration in there, but our total service base participation is just over 20 percent.

That includes both Intel-based and risk-based Unix.

What we try to do there is have maximum diversity.

We have complemented that with our ODM, if you will, with 64-bit processors, both with AMD and Intel.

I think that is probably the main -- one is to diversify across the broader set; second is to participate on the Intel side and to participate in the 64-bit side.

So we are trying to maximize our installation, if you will, for that trend.

But I would comment on the fact that that is -- everyone is predicting it, but it tends to go much slower than people realize.

I think in the short run, it really has no material effect on us.

It's a long-term trend rather than a short-term trend where we are parked (ph) right now.

Just want to be clear on what impact future acquisitions might have on stock repurchases.

Specifically, what maybe using the stock for acquisitions -- that kind of stuff?

We will continue to monitor the marketplace.

Depending on our acquisition opportunities, we will look at what our choices are and act appropriately.

We clearly have the flexibility to have considerable choice in that regard.

The best word to use for us is we're opportunistically optimizing in every possible way.

So every opportunity we have for an acquisition or a merger opportunity, we have different options, we'll pick the one that works best for our shareholders.

And relative to buybacks, it will depend on what the price is and what our other options are.

But I think the best way to look at what we're going to do in the future is to look at what we have done in the past.

And I think we have made relatively wise choices to date and you should anticipate we will continue to do that.

Great.

Thanks.

Alex Blanton from Ingalls & Snyder.

Most of your peers and yourselves are reporting that nearly every metric is positive except sales and earnings.

And this is becoming, I think, a little bit discouraging to investors as shown by yesterday's selloff in the group.

But I would like to ask this.

When do you think that the restructuring programs and the new customers that you have talked about are going to result in a really significant change in the top and bottom line and margins getting back to where they have been in the past?

I mean, what is your realistic thinking on that time frame?

Also, your current restructuring efforts and transfers of products, how much cost is embedded in your cost of goods sold or other parts of your operating or adjusted earnings that you can't report as a separate item, but that will be going away when those restructuring activities are finished?

There is a lot of cost that reflects back into -- and it would show into the GP line, relative to basically having all of the backfield in motion if you will.

We moved a lot of product between factories.

We reconfigured a lot of factories.

We moved things from high-cost to low-cost factories.

It has been a tremendous level of activity, which inherently has inefficiencies associated with it.

It should start dissipating -- most of it dissipates this year; it dribbles into next year.

So that has had an effect.

We have not put out an exact number of that, but it is something that we do know and that gives us confidence going forward on the improvements we will get as all that gets pub behind us.

Relative to your earlier question on revenue and profitability, certainly on the revenue I think that we have booked a lot of business over the last seven quarters.

We have gone from very cautious to cautious to stable to being more optimistic, and that trend continues.

I think that that will start reflecting more and more as we go into next year.

There is an environment here where there is really no motivation for anyone to sort of talk up what the revenues going to be next year prematurely because of the governance environment.

Our enthusiasm continues to build up.

We have been building the business up.

We have seen our (technical difficulty) stabilize.

Other indicators that I think our complementary is we see component supply getting more restricted.

We see components suppliers hitting up against some capacity points.

All of the different indicators are there relative to people asking for increases, so there is more and more momentum.

So I think in your question, the revenue side, certainly from the way we perceive based on all we have been winning -- especially a third of it being diversification areas beyond our traditional space -- we see momentum on revenue building up.

We have seen -- it's come slowly, so we see first quarter, second quarter, 1 percent, second quarter, third quarter 2 percent -- you can see a percentage even increasing going into fourth quarter.

And the missing part of the puzzle that we are not sharing is what we see in 2004.

I think revenue is building up.

I think some of our peers have been sending out signals on their growing optimism, and we would be -- we are kind of conservative folks so we'll probably subdue that commentary.

But we definitely see a trendline there that says that part of the equation is going up.

Relative to the earnings side, that is lagging and we are a little bit -- we are lagging some of our peers.

We recognize that.

But we are very confidently doing what I think are all the right things to improve that trend, and would have preferred that some of that showed up a little bit sooner.

But it is on the right trendline, and I think that will start to reflect.

And I think some of our peers are showing that in some of their results too.

So I think the sector is going to show improvement as we go into 2004, 2005.

And certainly from an industry point of view, the trend towards outsourcing, as I talk to many, many of our OEM customers, they are very committed to this.

It is going to happen.

We have had to go through the worst tech depression I have ever been through or any of us have been through, and we're --

Are you saying that a great deal of the higher revenues represented by the 80 new customers you have signed up will be reflected next year rather than this year?

Because apparently your sales were down 17 percent year-over-year and they were up -- I guess they were up -- they're going to be up 4 percent sequentially in the fourth quarter, but it is a seasonally strong quarter, so that is not --

I understand that, but you have to look at the underlying dynamics.

And to give you some way to look at it, look at that sector that is with the new customers, the non-top 10, and you see that area growing, and Tony mentioned sequential growth of 18 percent.

That is the buildup in momentum over there.

We have had probably a disproportionate effect on some of our top customers.

A lot of that is public.

No surprise to, as they make announcements, obviously some of that ripples into us.

Some of that is starting to stabilize and so I think that roughly answers your question.

Okay, thank you.

Paras Bhargava from BMO Nesbitt Burns.

I am looking at your guidance, gentlemen, and I am -- this next quarter, if you hit the midpoint of revenue, should it be the midpoint of EPS or will there be a similar effect as to what you were talking about last quarter?

I think that is one way you could interpret it.

If I do that, it is hard to reconcile that with the increasing -- with the sort of revenue -- geographic revenue mix and the shift in EBITA margins you're talking about.

It looks to me like Europe probably isn't going to get any better, if it is midpoint of revenues, midpoint of earnings.

Am I missing something or if you could just give a clarification on that?

As I tried to allude to, given the granularity of all of the dynamics, because we don't have a crystal ball as you know, we are going to benefit from restructuring -- in Europe, we will benefit.

There is going to be some volume pickup, the top-line guidance, or certainly we are forecasting that.

And that will drive some profit improvement.

On the other side of the coin, we will continue to invest in some of these new product ramp-ups and investments in some of our new products.

We are still within a pretty challenging pricing environment, and so what I would like to do is just make sure that we are being cautious with some of the dynamics.

Again, we are at a point where --around breakeven, where you have tremendous amount of operating leverage from an earnings perspective.

That's what makes (multiple speakers) be a little more cautious.

I'll tell you where I'm coming.

It is obviously hard to lay people off in Europe and reduce downsides -- there are a lot of regulatory issues.

The problem is, initially we thought it was going to be Q3 and then some time this year, and now it looks like it is bleeding into next year, and there may be some things that aren't completely in your control.

I'm just trying to reverse engineer this and say, what kind of EBITA margins should we expect from Europe next year?

Is it something that you can get under control next year or (technical difficulty) going to lag?

I also noticed your restructuring charges increased a little bit, and maybe you're taking in a little bit faster than expected.

I'm just trying to piece those three together.

I think the first and foremost thing we are reacting to is certainly relative to our prior expectations, some of our biggest customers in Europe have seen demand reductions, and obviously the path goes on to us.

That is certainly what we're trying to adjust to.

When you look at restructuring and trying to determine how far you go, if you have to achieve a delicate balance between what you know is your critical mass and still trying to maintain some flexibility for your customers, and that is the challenge we have.

Going forward, our growth in sales will leverage that critical mass.

That will be the key driver as we complete restructuring.

So would Europe, before including the manufacturer servicers acquisition, in Q1 would we expect Europe to be profitable then?

We are certainly targeting to be profitable as soon as we can.

Thanks very much.

Our view of what the revenue levels will be in 2004 obviously would be part of our thinking on how we go forward.

That is the part of the equation you don't have, which is, what are we anticipating the volumes will be in 2004.

And we're just not prepared to make forecasts that far ahead, but it certainly is something that is in the back of our thinking.

Keith Dunne from RBC Capital.

The R&D, it went up 4 million in this quarter, you're investing in 64 -- you talked a little bit about that.

Can you give us a little more quantification?

Is it going to double again in the fourth quarter and then hold at those kind of levels?

It sounds like you're clearly doing a lot more in that area.

I think we are going to stabilize that line item.

Relative to that, with the 64-bit architecture, I assume that there is some sales coming by the fourth quarter?

If so, can you talk about that?

And with this combination, will this keep America from going into losses or do you expect Americas to fall just below the breakeven line at some point here?

That's proceeding, as I said, the revenue.

And the acceptance of (indiscernible) 64 in the marketplace is certainly moved to the right, as everybody knows.

That is certainly a factor as we look at the fourth quarter.

But we are very optimistic that we have got the right positioning in that environment.

What I'm trying to dovetail that back into is your end markets.

Your workstation business has been very volatile; it was obviously down in this quarter.

I was wondering if that was, if you will, some clearing out in anticipation of 64-bit intros or is there something else going on or is that related?

No, I don't think there is a relationship there.

Second question is Europe.

What else can you do there?

We just basically lay off this 1000 people.

There is no more plants you can shut and wait for volume.

Can you give us a little more specificity about things that you can do beyond laying off 1000 people that you talked about?

The biggest item there really is business we have won and the revenue ramping up as we go forward.

And your cash utilization by geography at this point?

In terms of utilization, sequential improvement on average for the Company, it is in the 50 to 55 percent range -- obviously higher in Asia.

But that is sort of where we are parked now.

Typically over the last four years, you had about a 15 percent gain third quarter to fourth quarter in sales.

At the midpoint, this is looking more like an 8ish percent kind of gain, so less than typical.

Can we suggest then that this first quarter seasonal downturn, which has typically averaged 13 percent over the last four years, would also be less because the upturn was less?

Yes, I think both of those quarters from a seasonal perspective will be more muted than in the past.

Thanks very much.

(multiple speakers) diversification of our product.

Thank you.

Matt Sharon from Thomas Weisel and Partners.

I just want to focus on the restructuring charges again, which have gone up.

Just try to understand what has gone into that, what is the reason for the increase there.

Are the cost cutting efforts in Europe more deeper than we expected?

Is the manufacturing transfer more expensive?

What is going on there?

The manufacturing transfer costs wouldn't be in that line item.

What is driving the additional restructuring charges is primarily the difficult conditions that do exist in the marketplace for things like buildings and leases and our ability to sublet.

So some of our assumptions that we made in the past have changed in that regard.

So that is the key driver, not a cash impact.

On inventories, you talked about trying to increase inventory turns going forward, but given the component environment where we are getting into potential leadtime stretching and more constrained capacity at the suppliers, what is your thinking there and are customers asking you to build inventories or to have some inventory buffer as we get into that environment?

I think on the inventory, as customers are looking at increasing demand in Q4, they are placing that demand on us close in.

And we had to bring inventory -- more inventory in the Q3 to support Q4 output than we had expected.

So how is that going to affect the turns going forward then?

We feel that there is room for improvement there as we go through the quarter.

Again, it is all based on the revenue forecast that we have.

Okay, thank you.

Louis Miscioscia from Lehman Brothers.

I guess what I'm still struggling with a little bit -- maybe you can give me just the two top reasons as to why quarter-to-quarter earnings are down.

You're getting so much additional revenue in the December quarter.

If that is from core customers, you generally would think that that is going to then help leverage.

So just point to the top two reasons why I guess we are looking at modestly down earnings, whereas most of (indiscernible) expect to get back to profitability in the December quarter?

The key drivers are the startup costs on the new programs and overall mix of our products and general pricing.

In terms of -- Celestica is driving the sequential.

The way I would look at it in terms of what maybe our expectations would have been going into the fourth quarter, I would say that surely we would have thought Europe would have been breakeven by then, and that is not going to be the case, so that is clearly a factor underneath this.

That is volume, but offset by volume elsewhere, maybe at a lower mix.

I don't want to complicate the story too much, but those are the key drivers, sequentially, the program and product investments and startup.

So overall, the pricing and mix that we see versus what we saw in the prior quarter.

And a lot of that mix and pricing was largely expected, so what has changed is more our expectations of performance of Europe, and again, the ability to defray the startup costs in the time frame that we initially wanted --

And give us a percent of total revenues that has actually been new programs, because when you're looking at just a normal kind of tech seasonality into the December quarter, all of that business that you have had say for years or at least for 12 months should be reasonably profitable stuff, or is the pricing on that also very challenged right now?

The new programs are more execution challenged than they would be priced challenged.

In other words, as you (indiscernible) and as you get the experience in your manufacturing process to drive the profitability that you want, you always have an element of timing -- timing to profit as we call it.

That is the key there.

In terms of other factors, more of a seasonal pattern, I think it is our other base business that is much more price challenged and with in that business environment there is a lower margin mix profile of work that we are doing.

When we look now to 2004 -- I'm not really looking for guidance, just sentiment or thoughts -- will there be a step function in 2004 where it clicks like a light switch or is it more likely going to be a gradual, more or less, increase?

Because as we do get into the seasonal (technical difficulty) quarter, so if you still have some starter (ph) programs there, then it might obviously take us a little bit longer to get back to profitability here as opposed to -- I guess many of us had thought that restructuring would start to kick in and really help in '04.

But if you're not getting leverage and help with pricing capacity utilization, then should we take a little bit more of a cautious approach into the earlier part of '04 -- maybe into the first half?

The part of the puzzle that you don't have, and it's awkward for us to talk about, is exactly how much business have we won.

So all you have to deal with is a tip of the iceberg indicator relative to how much the mix has change.

So, obviously, we are I think dealing with a ramp-up that may be bigger than you perceive.

How would it flow through 2004?

It obviously isn't going to be a step function.

Maybe the annual number will be, but certainly not right out of the chute for the first quarter.

That implies a fair amount of activity that we're starting to digest.

I think a good indicator is just looking at the sheer number of customer growth that we have had over a relatively short period of time.

We have very aggressively been engaging new customers, new sectors and with some existing customers.

It is starting to appeal -- it has been dampened and there has been an underappreciation of that based on what I call some erosion on four of our top five customers that makes it sound like there is very little happening, but it is masking what is underneath.

Okay, thank you.

Steven Fox from Merrill Lynch.

Could you talk about your R&D expenditure expectations for the fourth quarter in dollars?

I think I mentioned that we're going to try to stabilize that level of investment to what it was in the third quarter (indiscernible).

No material increase there.

And that is a good run rate to carry into next year, I assume?

(indiscernible) depending on if products click and we're turning the cycles a lot faster, we may want to invest more of that.

There will be good revenue to support that.

But I would say -- looking at it right now, I would say that that would be a good level going forward to assume.

Let's follow up on Europe.

I guess you're not willing to talk about when breakeven is going to come?

Is that correct?

Are the charges going to be focused more on people than facilities, I guess, the additional charges going forward?

The additional charges I already referenced are more in terms of assumption changes on buildings and leases and those kinds of things.

I think, again, we've -- our restructuring efforts have targeted a level of critical mass that we need in Europe.

Recovery to breakeven will be predicated primarily on our revenue growth there.

Okay, thank you very much.

Michael Morris from Citigroup Smith Barney.

Good morning everyone.

I just wanted to touch back on your reference design initiative.

I haven't heard so much direct discussion of it before, and I guess I want to focus on the sales channel for that initiative, if you could talk a little bit about if it is different than the rest of your operation, if there are investments in your sales channel that we might expect?

I guess that is my first question.

First of all, we are talking an ODM/CDM kind of model, so we're not talking about logo product with the Celestica logo on it.

In getting people, obviously, we have sort of a classical sales getting OEMs to pick up these designs and then for us to manufacture them.

So there is (technical difficulty) incremental sales effort associated with it.

In some cases, it is different.

You are selling the product and the manufacturing, rather than just selling the manufacturing.

We think that is largely reflected in our comments on SG&A and our comments on R&D.

Over the strategic period, we expect that will be a growing aspect of our business as the whole industry tends to broaden its service offering and have it to grow not just in the manufacturing but all the services associated with the manufacturing, including design.

So there will be some incremental cost, but I don't think it is material.

I think the bigger thing that shows up is on the R&D side and, quite frankly, it is showing up in a time that we are most vulnerable, but we feel so committed about this being an appropriate initiative that we're willing to make that investment with the downstream positive effect that that will have for us and the strategic positioning it will have for us.

I don't know if you can share this with us, but can you tell us when did you begin this initiative, because maybe I have just been not aware, but I hadn't heard direct discussion of this before?

We had put out press releases.

We have been at various presentations, like when Intel introduced its Itanium (ph), we were up there on stage as one of the first ones with reference design.

Certainly when AMD came out with its Opteron, we were too.

We have been doing progressively more and more, know the visibility here is most of our action is with the OEM groups as we show them what's in our product menu and how does it fit in with what they need on their product menu.

Typically, what happens in this space is you're filling in parts of their product menu.

So they have their set of designs, we fit in certain niches, and then that is how the thing unfolds.

I think we have been fairly open about it.

I think that it is showing up on the numbers now and, therefore, looks more vivid, but we have been talking about this direction.

My second question is just regarding your shift to the lower-cost geographies, and it looks like you're on track to be around 70 percent by year-end.

If we pencil out MSL, it appears to not be at 70 percent in low-cost geographies.

So my question is, will the addition of the MSL assets shift your intention and objective to be in 70 percent low-cost geographies, or will we see some shuffling of the portfolio resulting from the acquisition?

Thank you very much.

I think if you (technical difficulty) at the day of combining it, it might degrade slightly, but I think the strategic direction there is so pervasive that I don't think it materially changes it over time.

Okay, thanks very much.

Michael Walker from Credit Suisse First Boston.

First question is on if we can revisit the PC workstation (indiscernible) -- it's been a place where you have been picking up a lot of new wins.

You had a couple good numbers there in March and June and then we saw a reversal here in September, which is not in line with what the end market is doing overall.

I wonder if you could clarify that a little bit?

I think most of the dynamics there in the workstations are quite specific, so we can't discuss that.

The second question is, it seems pretty clear that the macro sort of environment in Europe, the kind of weakness we have had all year long is still presenting a bit of a headwind towards your progress in restructuring that region and getting it back to profitability.

So I'm wondering if you can give any color at all on how you feel the macro trend in Europe is, if demand is recovering at all or is does it still seem in the doldrums?

The word that comes to mind, sluggish, is probably the best way to describe it.

And as I mentioned maybe in the last call, as we hover around the breakeven, we are disproportionately sensitive to being above the line or below the line on that.

And there are different dynamics there relative to -- we had probably a higher concentration of North American based OEMs in Europe versus European based OEMs, and that is something obviously we're trying to correct.

Did you see any signs of a seasonal upturn at a macro level there in Q4?

A little bit.

Okay, thanks.

Jim Savage from Wells Fargo.

First, do you have any design wins yet that will result in revenues in '04 on your reference designs in the 64-bit arena?

Not in a material way, from the point of view of how it would show up on the revenue line.

Obviously, the process here tends to be you start off with your prototypes, then ramping up.

It won't show up in 2003.

Okay.

I'm still trying to get my arms around the level of your losses or expected losses in '04 in the fourth quarter, considering that you are going to have higher revenues, so there should be better absorption, there is progress in restructuring in Europe, even though it is not completed.

SG&A, you are expecting to be flat.

Is it specifically the startup costs for new programs?

And when do we expect revenues to follow these startup costs so that they end up being amortized more effectively?

That is an element to this and that should start slowing in 2004.

Some of it is already in there in 2003, and as I had mentioned earlier (ph), it is being masked by what has happened with some of our top five customers.

But in addition, Jim, the product mix and pricing heading into that quarter is challenging.

Okay.

Should we expect then that some of these major programs that I assume that you are spending for at this point will actually start up in the first part of calendar '04?

Sure hope.

Okay.

Thank you.

Start up or in ramp-up?

Starting to ramp during the first quarter.

First and second quarter, third quarter, yes.

Great, thank you.

Steve Savas from Goldman Sachs.

I guess two different things related to outlook for fourth quarter, because I think most of us are scratching our heads a little bit on how it ends up that way.

I think if -- you mentioned R&D increased to 4 million sequentially.

Just looking at the midpoint of guidance and what is going on with revenues, I think it implies that gross margin is probably going down in the fourth quarter.

Is that a fair interpretation, maybe not by much -- but what is your outlook there?

I think that is a fair assumption.

Again, that is driven by the dynamics of the startup element to those programs, as we keep R&D roughly where it is today -- maybe a slight increase.

So it is a startup element as we build the business structure to support that business.

And in addition, the mix and pricing effects that affect our GP level.

Again, underneath, a lot of that is our desire to have a more cautious approach to that, given some of the dynamics we have.

Given those startup costs do we think that that is a one quarter phenomenon in terms of that gross margin trend?

If we go back a couple of quarters ago, I think you were expecting that -- the bottom in gross margins last quarter?

In terms of these new product type businesses, we had a little bit of an impact in material in the third, a bigger impact as we build the business structure in the fourth.

And as with any new business venture, you do expect some degree of chasing the top line in terms of profitability.

So over the next couple of quarters, we will probably be again recognizing a lower level of profitability as a result of that.

On SG&A, is it -- given your ODM investment or reference design investments, any change to your long-term goal of 3 percent SG&A, and if not, what do you think -- when do you think you get there?

Is it a straight line from 4 and change right now to 3 percent over the course of the next year -- what are your thoughts there?

Our view is that we still have a lot of work to do, and over time, the absorption of the same structure on a bigger base of revenue will help improve our base SG&A.

Certain product related businesses certainly have the higher profile of sales and marketing expense and other costs.

So certainly -- and those all flow into the SG&A line.

So we do expect that.

But we expect that we have an opportunity still to stay on track with our targets on an aggregate basis.

Our long-term target was 2 present.

Related to SG&A, in terms of restructuring that remains, what is the allocation between SG&A versus cost of goods sold?

It is pretty proportionate to our cost.

Obviously, we are attacking all structures.

Okay, thank you.

Thomas Dinges from J.P. Morgan.

Gene, one question on the new customers you've had there and so forth -- you reverenced that a third of those are in the non-IT area.

How many of those are currently at or close to volume, and how many will be at that point or near that point in the fourth quarter and then as you look into the first quarter of '04, and then I have a follow-up for Tony.

I think the key point there is most of them are not near volume.

And won't be in the fourth quarter, either.

There will be some.

Clearly, the 13 customers we won in the third quarter will have some but more of a 2004 effect.

Tony, on the balance sheet, inventory has been taking up a little bit these last few quarters, and I am assuming that inherent and in your outlook for improving cash flow and so forth that that should start to tick down.

As the increase in inventory, as you look at it maybe this quarter over last quarter, help us understand how much of that is related to you have program transfers and you need to build product in two areas, and how much of it is just simply because of the environment?

Because as you alluded to, components are getting a little bit tighter, and OEMs are asking you just to stock more stuff into the fourth quarter, both for seasonal and also just because OEMs are a little worried about shortage of supply?

I think in terms of the revenue program, what (technical difficulty) happened in there to support what our demands are in the fourth quarter.

Part of it is, even within that, is making sure it is brought in early such that there aren't any shorts.

On top of that we do have -- we did have shorts at the end of the third quarter, which is another way of saying that we probably had some limitations to the amount of shipments we can deliver in the quarter.

In other words, how much more inventory we could have reduced.

I think those two factors are the key explanation and they are about 50-50.

Okay, thank you.

Pierre Terrisse from DesJardins Securities.

Tony, first of all, going back to Europe, can you give us a sense on how your loss is spread in the quarter -- was it higher in July and lower in September?

Can you give us a sense of that?

It was spread largely in the first two months.

So an improvement in the third quarter.

A significant -- ?

(indiscernible) of the quarter, excuse me.

So you would qualify September as a significant improvement over July?

An improvement over July, yes.

Looking at the U.S., your EPS margin has been trending down for the last couple of quarters.

What are your expectations going into 2004 in that regard?

Certainly the level of margin that is in the U.S. is not something we would deem as acceptable.

So that would be something, given our growth expectations and our focus on optimizing the business, we expect an improvement.

That's what we're focused on -- across the board.

In terms of inventory, can you split it up in Q4 between raw material (ph) and finished goods?

I can.

Let me just rustle some papers here, as I look for it.

About 65 percent in the raw material category; about 12 percent (indiscernible) and the remainder in finished goods.

And that compares to what in Q2?

Pretty much the same levels.

Same level?

Okay.

I think the raw material was a little (technical difficulty) and that is about it.

I just missed the first portion of the call.

Des your forecast for Q4 includes MSL at all?

No.

Thank you very much.

I would like to thank everyone for dialing in and we'll talk to you next quarter.

Thank you very much.

Ladies and gentlemen, this concludes the conference call for today.

Thank you for participating.

Please disconnect your lines.