Celestica Inc (CLS) 2006 Q3 法說會逐字稿

Good evening, ladies and gentlemen.

Thank you for standing by.

Welcome to the Celestica third quarter 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 on Thursday, October 26th, 2006 at 5:00 p.m.

Eastern time.

I will now turn the conference over to Ms. [Donna Sing], Director, Investor Relations.

Please go ahead.

Thank you.

Good afternoon, everyone, and thank you for joining us on Celestica's third quarter conference call.

On our conference call today will be Steve Delaney, Chief Executive Officer, and Tony Puppi, Chief Financial Officer.

Steve and Tony will provide some brief comments on the quarter, and then we'll open up the call for Q&A.

Copies of the support slides accompanying this webcast can be viewed at celestica.com during this conference call.

During the Q&A session please limit yourself to 1 question and 1 follow-up to ensure everyone on the call who would like to ask a question has the opportunity to do so.

You are welcome to get back in the queue after you ask your question.

Before we begin the call I would like to remind everyone that during this call we will make forward-looking statements related to our future growth, trends in our industry, and our financial and operational results and performance that are based on current expectations, forecasts and assumptions involving risks and uncertainties that could cause actual outcomes and results to differ materially.

We refer you to the risk factors and uncertainties discussed in the Company's various public filings which contain and identify important factors that could cause the actual results to differ materially from those contained in our projections or forward-looking statements.

These filings include our form 20-F and subsequent reports on Form 6-K filed with the Securities and Exchange Commission, which can be accessed at www.sedar.com, and www.sec.gov.

Please note that we will refer to certain non-GAAP financial measures during this call.

The corresponding GAAP information and reconciliation to the non-GAAP measures are included in our press release, which is available at celestica.com.

I'll now turn the call over to Steve Delaney.

Thanks, Donna, and good afternoon, everyone.

Before Tony takes you through the specific details of the quarter, I would like to comment on a few highlights.

Revenue for the Company for the third quarter was strong, and came in above the high end of the guidance, with adjusted EPS above the mid-point of our guidance.

Revenue growth was 8% sequentially and 20% compared to third quarter 2005, fueled largely by the growth in our consumer auto medical segment which posted a 36% sequential increase.

Our traditional segments grew at a moderate 3% sequentially, but note that this is considerably stronger than we saw in each of the previous 2 years in the third quarter, indicating a stronger overall demand environment.

The growth in the consumer auto medical segment helped our diversification efforts, bringing our non-com and non-IT revenue to 30%, up from 27% last quarter and 24% a year ago.

In terms of bottom line, operating margins were up sequentially by 50 basis points to 2.7%, and adjusted EPS improved by $0.05 to $0.18 in Q3.

Working capital also showed some improvements during the quarter.

Return on invested capital continued to improve, with a 290 basis point sequential increase, free cash flow was $51 million in the quarter, while inventory turns improved slightly to 7.1.

Our balance sheet continues to be strong.

As we entered the third quarter, we were looking to improve our output and efficiencies from our high growth sites, benefit from the ramp-up of some major new programs, improve working capital, and make additional progress on improving margins.

We were able to make progress in each of these areas in the quarter, but we have more work to do.

As we discussed our Q1 and Q2 calls, we have been addressing some operational issues in Mexico and Europe.

From a profitability standpoint, improvements in both Mexico and Europe regions have been progressing slower than anticipated.

We made improvements in Mexico's operational performance, but we continue to experience efficiency shortfalls caused by the growth and complexity introduced there.

Our team is methodically improving the processes to ensure that we get strong execution for our customers as the first priority.

Stabilize first, then optimize for efficiency.

I see this taking place over the next few quarters.

Europe showed no improvements in operating earnings this quarter over last, due to weaker demand in the region.

Restructuring should help improve profitability in the fourth quarter, and our efforts over the next several quarters are focused on bringing more growth to this region, which is now highly concentrated with an excellent offering in low-cost eastern Europe.

In terms of restructuring, we're entering the important final phases of a major program that we announced in January 2005.

The sale of our Italian site during the quarter gave us the opportunity to take a significant portion of underutilized capacity in a high cost geography.

Furthermore, with our new partner, Bartolini Progetti, we continue to have available to us capacity, service capability, and skills in Italy to support our global customers as required.

The actions taken this quarter get us the key ingredients necessary for us to achieve our goal of having a robust and low-cost EMS network, capable of supporting a diversified customer base, while generating returns greater than our cost of capital.

For the fourth quarter, we're going to continue to focus on improving our performance in our high growth sites, working capital performance, and flawlessly completing the actions of the previously announced restructuring program.

That concludes my remarks.

And now let me turn the call over to Tony.

Thanks, Steve.

Revenue for the third quarter was $2 billion $392 million, an 8% sequential increase, and above the high end of our guidance.

On a year-over-year basis, we're up 20%.

Sequential growth was driven primarily by new programs in the consumer space, which seasonally peak in the third quarter.

In terms of revenue by segment, we continued to experience solid increases in our diversity, with most segments showing sequential growth.

Segmentation was as follows: Enterprise communications represented 26% of total sales, up 3% sequentially; telecom was 19% of revenue, also up 3% quarter-to-quarter; server segment represented 15% of sales, down marginally; storage was 10%, up 12% on the quarter; industrial, aerospace and defense was 9%, down 6%; while consumer, auto and medical segment continued to experience considerable growth of 36% sequentially, with the segment coming in at 21% of sales.

Growth in this segment was driven by the new programs, which ramped in the second quarter.

Our customer concentration was fairly consistent with the second quarter, top 10 customers represented 59% of sales.

On a geographic basis, we saw sequential growth in Asia and the Americas.

Asia grew 14% sequentially, and represented 54% of total sales.

Americas grew 4% sequentially, and came in at 34% of sales.

Europe's revenue declined 9% sequentially, to come in at 12% of sales.

Moving to profitability, Company posted a GAAP loss of $42.1 million, or a loss of $0.19 per share for the third quarter.

Included in this loss was an $82 million pretax charge associated with our previously announced restructuring program.

The largest component of this restructuring charge was $61 million related to the sale of our Vimercate, Italy operation. $42 million GAAP loss compares to a loss of $19.6 million, or a loss of $0.09 per share last year.

Adjusted net earnings continued to show improvement and came in at $40.5 million or $0.18 per share, $0.02 above the midpoint of our guidance.

Gross margin was 5.6%, and operating margins came in at 2.7%, compared to 5.6% and 2.2% respectively in the second quarter.

Our gross margins were adversely impacted by a $6 million inventory charge, relating to a physical inventory variance at one of our sites in the Americas.

We have made various process and systems changes to mitigate reoccurance, and should finalize corrective actions this quarter.

Excluding this item, our gross margins for the quarter would have reflected a 30 basis point improvement.

SG&A was $70.6 million in the quarter, or 3% of sales.

This compares with SG&A in the second quarter of 3.4% of sales, or $76 million.

Lower SG&A was due to savings from our restructuring programs and reduced variable pay accruals.

Segmenting our operating margins by geography, Asia continued to perform extremely well, with operating margins of 4.8%.

Margins in the Americas were up 40 basis points to 1% of sales, but this was disappointing, given the inventory charge and the lower than expected improvement in our Mexico operation, which is still incurring losses of approximately $7 million.

Q3 losses in Europe remain flat, at roughly $6 million.

Lower demand, offset expected improvements from restructuring in that region during the quarter.

In terms of the restructuring update, as of the end of the quarter, during the quarter we completed the sale of our Vimercate, Italy operation to Bartolini Progetti and entered into a strategic alliance with that firm to provide certain EMS, after market, new product introduction, and support services on a subcontract basis.

This allowed us to maintain excellent skills in Europe, while making the necessary reductions in our high cost profile in the region, and avoiding significant potential charges in the future.

We have recorded approximately $280 million of restructuring charges related to the program announced in 2005, with cash charges of approximately $180 million paid to date.

We have a few smaller closures and restructuring actions that will be taken in the fourth quarter.

We expect on the back of the higher than originally estimated accounting charges for the Italy restructuring and a few additional actions, that our total charge will now approximate $300 million.

We expect the cash element on the program to be approximately 80%, or $240 million.

As of the end of the quarter, approximately 3,800 employees have been released from the business.

On completion of the restructuring, we continue to expect this program to generate approximately $150 million of annual cost savings.

To date, we are running at approximately 75% of that rate.

Moving to the balance sheet, cash at quarter end was $779 million.

Cash flow from operations was $88 million in the quarter.

Included in this was the collection of a $57 million income tax receivable in the quarter.

Our cash cycle for the quarter was 16 days, reflecting a 2 day improvement in receivables, days sales outstanding, and a slight improvement in inventory turns, from 7 to 7.1 turns sequentially.

Capital expenditures were $37 million for the quarter.

Let me net out our third quarter performance.

We had solid growth in top line quarter-to-quarter and year-over-year, both from base products and new programs, with added diversity in terms of end markets and customers. [inaudible] margin and EPS expansion amidst continued operational transformation associated with restructuring.

Operating leverage from increased sales offset by the inventory charge taken, and the slower than expected progress in our low-cost site efficiencies.

Finally, our balance sheet remains very healthy, with better than expected growth in cash, solid liquidity and a conservative debt to cap of 26%.

Let me now summarize our guidance for the fourth quarter.

On top line, we expect revenue to be $2.25 billion to $2.45 billion, and adjusted EPS of between $0.15 and $0.23 per share.

Reflected in the revenue guidance is a sequential seasonal decline of our consumer business, which is only partially effected by growth -- or partially offset by growth in our traditional segments.

At the midpoint, our fourth quarter guidance would reflect a 13% growth year-over-year, and a 2% sequentially -- sequential decline.

Earnings guidance reflects the volume or revenue change, as well as benefits from the restructuring programs.

That concludes our remarks, and Steve and I would be happy to answer any questions.

Operator, we'll take over our first question, please.

[OPERATOR INSTRUCTIONS] Tom Dinges, JPMorgan.

Just a quick one on Mexico.

In looking through it -- last quarter got a little bit of benefit from that, a little lower loss than you were expecting.

This quarter it sounds like things kind of turned the other direction a little bit there.

You obviously have some plans in place along the lines of further streamlining the operations.

But maybe just some incremental color there as to what was the really big swing factor this quarter that caused that to be a bit more of a drag than maybe you guys were expecting?

Okay, hey, Tom.

Yes, I would say in the third quarter we saw quit a bit of churn here in the quarter, in terms of demand fluctuation and things got, I would say, very intense as we attempted to get all of the parts cleared and get the production through the plant towards the end of the quarter.

Now given that we're in a bit of an unstable condition still, as I had mentioned in my comments, our ability to do this efficiently was hampered by all of this churn that was taking place.

I think that's probably one of the biggest factors of why we didn't get what we expected to get out of this.

We continue the efforts, in terms of just a fundamental stabilizing of all of the complexity through a number of actions in our logistic areas.

Those will help as we go forward.

And frankly, I think the churn in the fourth quarter seems like it might subside a bit.

I think third quarter, people were a bit nervous in the customer base as maybe a general rule around the overall supply environment in the industry.

But I think that was one of the contributors, as well.

Okay.

And then just another quick one on the restructuring.

You are running at about 75%, as you guys said, of the cost savings that you were expecting.

Is it fair to say that probably 2 more quarters sort of what you guys were talking about last quarter, and then you should be getting to about, pretty close to the full run rate on those cost savings as we kind of exit the March '07 quarter?

Tom, I think you're right.

I think we'll get the full benefit by the end of the first.

But in terms of the balance to go, I think we'll get a meaningful improvement here in the fourth, with the announcements that we have made.

Okay.

Thank you.

Paras Bhargava, BMO Capital Markets.

Just a couple of longer term questions.

Guys, there's some talk that some of your bigger customers are looking at other manufacturers as -- to balance off -- to balance or to shift some business.

How do you see the '07 revenue base?

And what kind of mix might you see?

It looks like the mix may be hurting some of the operating margin expansion, too.

What kind of mix would you see in '07?

And if you could comment on your top customer relationships, are there any reasons for stability or instability?

And maybe just as a housekeeping item, Tony, you didn't give us 10% customers.

I wonder if you could?

Okay.

In terms of -- obviously we wouldn't talk about specific customers.

I would say in the environment, overall, I still consider it an opportunity-rich environment for outsourcing and growth as we look into the future.

So clearly, our performance in some of our high growth sites has been below even our standards, and our customers in some cases have been impacted by it.

We're working very diligently to recover that with those customers, and I think we're seeing very progress in that.

As we look into 2007, there's -- the opportunities with existing and other customers continue to be quite rich.

I think our customers are enjoying some growth in their markets, as well as the introduction of some of these new diversified markets brings new opportunities to us, as well.

So we're going continue on the -- with the growth initiatives that we have had in the past around those areas.

And you wouldn't expect any major shift in your existing top customers?

No.

In terms of 10% customers, Tony?

We don't have any.

And that's reflective of the growth we have had with a couple of new customers, and a couple of new programs in the consumer space.

And the top 10 were how much?

59%.

Thanks a lot, Tony.

Thanks, guys.

Steven Fox, Merrill Lynch.

Just getting back to the $7 million loss in Mexico, was that where the inventory issue arose?

Or was that some other part of the other operation.

It was not in that operation.

And then looking forward, Tony, so are you saying that break-even for Mexico is not possible until sometime early next year?

Or how would you describe the timing of that now?

That's exactly what I would say.

More work to do in that site.

We expect improvements, but we won't get there this quarter.

And when you look out to next -- the December quarter given your guidance, if you just -- I don't know if you want to look around the midpoint of the range, does the SG&A dollar level stay around her?

And if so, what would happen to gross margins in the middle of your range?

Well, usually we have a higher level of SG&A in the fourth quarter.

And as we refer in the conference call script, we actually got a pick up in terms of compensation expense in the third quarter on a retroactive basis.

We actually had a, let's say a one-time improvement in the third quarter.

So looking forward, I do expect the SG&A will grow.

And if you took the midpoint of the guidance, that would-- in terms of the fourth quarter, we continue to expect some improvement here.

And then last question just on Europe.

I don't know if there is any other color you can provide in terms of why it's not improving as quickly this quarter?

And again, same question with Mexico, how quickly before we could see some material improvements?

I think the key lever in our European operations, particularly now, as we've largely completed our restructuring, is our top line performance.

When you look at our European operation on a sequential basis, we were down.

And the operational -- or operating leverage effect of that decline in sales in Europe basically offset the restructuring benefits, leaving us with essentially the same loss.

So as we look at the fourth quarter, we completed those restructuring actions, or we'll complete all of the restructuring actions in that geography, we expect some improvement there.

Great.

Thank you.

Amit Daryanani, RBC Capital Markets.

Just looking at your EPS expectations for Q4, looks like margins should improve a bit from here to about 2.8, 2.9% on an operating basis.

From there, we're still about 60, 70 basis points shy of the 3.5% target you have.

Can you talk about what we need to do to capture the remaining 60 basis points or so?

And the flip side of that is, maybe we don't need to get there, given the increased consumer revenues and better asset velocity to hit your ROIC levels.

The first thing we have to do, Amit, is change the $7 million number in Mexico.

So when that turns positive, that would have had a very material effect on the guidance that we would have shown here.

So I mean, that's the first and very important lever.

And in addition to that, when you look at our top line for the quarter, when we were looking at a target of 3.5%, we were thinking between 2.4 and $2.5 billion at the level that would do that.

And if we took that leverage and applied it to the guidance that we have, and even got to a break-even in the Mexico environment, we would be damn close to the 3.5%.

All right.

So it's really Mexico starting to turn profitable and incremental revenues should get you to the 3.5% number?

Is that a good way to look at it?

That's where we feel we have disappointed in the fourth quarter.

All right.

And then just the $6 million inventory charge that you took, could you just provide some color on what exactly happened there?

And are there any residual charges that you foresee taking in Q4 for that?

We don't foresee taking any more of those charges.

We've certainly taken a lot of actions to prevent reoccurance.

But in essence, we had a particular site ramping some new business with inadequate inventory controls, and so we have corrected that.

We have made series of changes.

We have got a few more changes to fully affect this quarter, and we don't anticipate any further charges in that department.

All right thanks.

Matt Sheerin, Thomas Weisel Partners.

I just want to focus on the top line again in your guidance.

Midpoint of the guidance gets us to around 10% or so year-over-year growth, and that's sort of decelerating from very strong September number.

So could you be more specific about business pipeline, and what shall we be thinking specifically about new projects, any business going away, and what sort of near-term growth targets do you have for the business?

Is it 10, 15%, what we should be looking at, or anything else?

I think in terms of near term guidance, I think it's important to recognize that it was a pretty substantial decline from third to fourth quarter in the demand related to our consumer customers.

This is normal -- a normal thing going on.

Throughout the rest of the segments, I would say by and large there's the normal fourth quarter seasonal pick up that you might expect.

I would say IT might be a little bit weaker than we expected, just in terms of some products that we're involved with.

And then there were a couple of communications customers, that over the past couple of years, or in fact quite sometime ago, had announced some changes.

One was related to a divestiture, and another one related to a sourcing strategy change, that has been taking effect over a long period of time, from which this quarter is probably the most substantial effect that we have seen.

So that's sort of one of the other headwinds hitting here this quarter.

So are you hoping to get some of that back, then, with other business?

Could you just talk about your business pipeline, what you see out there, opportunities?

Well, sure.

There's-- I mean, we have a backlog of new wins that are set to launch here over the next several quarters.

And the normal, Matt, the normal thing that takes place in this business all the time, products come and products go, and we're launching new business, and things get pushed and pulled, and all of that stuff that is typically happening.

So, no, the new business pipeline is adequate right now.

The opportunities are rich, as I said in the past.

And I think there's some exciting things available to us for 2007.

Okay.

And just a follow-up, regarding Cisco and its lean initiative.

Are you expecting to see revenue drop off, and then come back at any point in the future, like Solectron and Jabil have seen?

Well, let's not talk about any particular customer's name.

But we're a customer that has been talked about in some of the previous calls.

We don't have an implementation happening in this quarter, so there will be no effect of that.

Okay.

Thank you.

Bruce Krugel, Blackmont.

Just with regards [inaudible] of your operations, if I look at your 20-F and I add up all of the properties that have been highlighted for closure, that amounts to about a 15% reduction in square footage in '06 over the beginning of '05.

Obviously, Vimercate, or your Italy operation was the biggest.

Are there any other large outstanding facilities that still need to be closed?

Everything that -- all of the large facilities that are closing have been announced, and in fact, are done.

There are some smaller [inaudible].

Great.

Thanks.

Jim Suva, Citigroup.

A follow-up question on that inventory write-down.

Is that inventory just written down on the books and still in your plants, and we can expect it to flow through next quarter?

That was a physical inventory variance, so we obviously couldn't find the inventory.

I got you.

Okay.

And then as a follow-on, can you discuss about Mexico, when you really expect -- I know it has been problematic, and I know it has a tremendous amount of business, which is a great thing.

The problem with getting the efficiencies, when can we really expect to see that 7 million turn to break-even, and turn to profitability now?

Well, I think that's the one thing I don't want to state at this point.

I have disappointed myself and you guys over the last little while here.

The point that I wanted to make is that, we're going to do what it takes to make sure that the customers are served well by that plan, first, and drive the efficiencies from there.

We are seeing improvements in the output and all of that.

There's a lot of moving parts in this equation.

And so for that reason, I don't want to talk about specifically when we'll be at a point like break-even.

But expect us to improve our performance over the next few quarters.

Okay.

And last question regarding the inventory.

That variance, does it have any impact to your Sarb-Ox controls and being able to report your SEC filings?

No, we have remediated the issue, so that will not be a factor.

Great.

Thank you, gentlemen.

Kevin Kessel, Bear, Stearns.

I just wanted to understand a little bit better the comments you are making about consumer, in terms of having a material decline in December.

I think you are correct, a lot of consumer programs do peak in September.

But this seems somewhat unusual to see such a steep decline in the December quarter.

Is there something to do with the product types you dealing with?

Or are certain products coming to end of life?

Could you help explain that?

Quantify it maybe?

No, Kevin, it's related to the demand on us from the customers for these products.

And I think a common thing going on in consumer is stocking of things before the -- stocking the channel really for Christmas.

So we get into a low-volume situation here as we enter November and into December.

Okay.

And Steve, I think last year around this time you mentioned your backlog, I think you even quantified it as being $500 million, at a minimum going into calendar 2006.

Can you give us a similar sense in terms of what you guys have booked, and what you expect to help grow the top line in 2007?

I don't have a number for you, Kevin.

And I don't remember if I -- what I gave last year, to be honest with you.

Our bookings progress for the year has been certainly adequate to support the objectives that we have had for revenue in 2006 and early 2007, and we continue to drive the opportunities that we show on our radar screen [inaudible] more 2007 growth.

And then, just Tony, in terms of cash flow, you guys were able to throw off free cash flow in the quarter.

What is your expectation for maybe the fourth quarter and for 2007?

Well, we would expect with the operating earnings and the full completion of the cash charges on restructuring, that will probably keep things sort of flattish here in the fourth quarter.

And as we look forward, it will be really the operating earnings, and as well improvements in our inventory management.

We still feel we have got about $200 million in there that we consider inefficient.

And when that releases, particularly as we work with our customers here, that that will generate some good cash flow into next year.

Thanks.

Louis Miscioscia, Cowen and Company.

Haven't been able to model all of the numbers yet, but it sounds like, obviously, since you hit your EPS number, that there was an offset to Mexico which was going to be a benefit of 7 million, and ended up-- not coming in as a 7 million benefit.

What was the offset that actually got you to your EPS number?

What offset the inventory charge?

Last quarter, I think that you had said that you had a 7 million loss.

Right.

And then you expected, I thought you said, to get to Mexico to break-even this quarter.

And you actually didn't, it was another 7 million loss.

Well, to hit your EPS number, there must have been some upside that offset this?

It is the revenue upside that we had in the third quarter.

Okay.

And as we look to, I guess, going into the fourth quarter, do you expect Mexico is still going to be about 7 million?

Or do you think it's going to be -- get halfway there or, do you have any projections, or -- ?

We-- firstly, we had a bit of improvement.

It wasn't much, but we'll take them as they come, in the third quarter.

So it was about $1 million.

We expect some improvement there in the fourth quarter.

But it's not anywhere near to getting to what we think is a break-even point for the quarter.

So there will be some, and that's reflected in the guidance, but it's a nominal impact there.

Okay.

And then on Europe-- so I think you mentioned that all of your restructuring is basically done.

So it really just comes down to a demand issue.

And if that is the case, I guess, what are the prospects for I guess, the pipeline or bookings for Europe as you look forward over the next of quarters?

There are a number of opportunities that we are chasing right now for Europe to improve it.

They'll work in, depending on the gestation period of the opportunities, but I'm not going to give a quarter at this point.

Okay, but it sounds like it's probably going to take a number of quarters, as there is always a sales cycle associated with this -- ?

Sure.

Okay.

Thank you.

Carter Shoop, Deutsche Bank.

Wanted to talk a little bit about restructuring.

It sounds like we're getting pretty close to wrapping up the current phase, and I was curious if you guys had started thinking about a new incremental phase of this restructuring, other areas to target, possibly cutting some more fat in Europe and North America?

Carter, the point of this restructuring program was to get us to a point where we have basically 85%, or north of 85% of our capacity in low-cost geographies.

And this is accomplishing just that.

I think right we have 88% of our people in low-cost geographies, and probably something slightly less than 85 of our SMT lines, as an example, or Space.

So we're getting right about that point.

And I like the offering, in terms of where we have our capacity, that the ability to serve through very efficient delivery models into Europe and North America, as well as Asia.

So I don't see a need for any kind of huge announcement.

Having said that, there's always adjustments that you make from time to time, based on what is happening just in a dynamic revenue environment.

And so I would never say never on anything.

But I don't see any big things going on.

And then also, kind of following-up with a string of quarters where we have seen some pretty poor operational control.

What are you guys going kind of in the big picture, maybe up 10,000 foot level, to fix this?

Obviously, we have had several disappointments, and it's in Mexico, or it's been meeting demand fluctuations, et cetera.

Are you guys taking a bigger picture look at what needs to be done, possibly rearranging some of the supply chain management control positions?

Yes, of course we're looking at the root cause of all of these issues.

I would say that the $6 million inventory control problem that Tony talked about, was a different problem t than the one that caused us the problems that we have right now in Mexico, and we have talked about for the last few calls.

But certainly the processes that lead to us getting into those kind of problems are the things that have been rectified.

Now, we have to dig our way out of the problem subsequently caused.

In the case of the inventory control problem, that has been mitigated -- or, remediated, I guess maybe is a better way to say it at this point in time.

And we're still digging out of the problem that we created in Mexico through all of the complexity that we put in place, without the appropriate planning for that site.

Okay.

Last question.

When you look at the gross margin line, and the midpoint of revenue is down about 2%, not that material.

And then you also have the reversal of the 7-- or the inventory charge, and then also, Mexico is going to be improving.

On top of all of that, you're going to have a positive mix shift on the margin side with consumer down and everything else up.

Why aren't we seeing more gross margin improvement in the fourth quarter?

What is the other drag here that I'm missing?

Well, when you look at the margin improvement, we were referring to operating earnings.

So we do expect at the midpoint, at least 20 basis point improvement.

More than all of that improvement will be in the gross profit line, so you are absolutely right.

We won't have another inventory charge-- or certainly I pray we don't.

And that would certainly release some operating earnings and margin expansion on the gross profit.

We've got the restructuring benefits that are largely going to hit that line.

So we expect more than all of the improvement, sequential basis in margin to come at that line.

And recall what I also said about SG&A, that it will be higher in the fourth quarter, as we normally have in the fourth.

But if you take out the inventory charge from this quarter, you will actually be looking at a decline in gross margin, correct?

No, we're look at a growth-- the mid-point right now, my view is we'll have at least a 40 basis point improvement on gross margin on a sequential basis.

Excluding the issue with inventory this quarter?

Adjusting for it.

In other words, we do get a pick up on a sequential basis, because that won't happen again.

Exactly.

But if you exclude that, then they'd be going down, right?

Yes, well -- .

That's what I'm asking, why would they be going down if we're getting an improvement in Mexico, improved mix shift, et cetera?

That's a 30 basis point impact, is the inventory, so we do pick up a little bit normalizing for that.

I got your question now.

Okay.

So after that, you've got to look at the overall volume reduction and the impact on the operating leverage of the Company.

Try that again, Carter?

Yuri Krapivin, Lehman Brothers.

On previous calls, you talked about the supply chain tightness.

Has the situation improved at all?

Yes, Yuri, it has.

I think third quarter probably was, at least through part of third quarter, at least was probably the peak of it.

And I certainly have seen things ease a bit.

There's always components here and there that wind up in short supply, for one reason or another.

But I'd say, the general market has eased a bit.

Okay.

And then, a comment on your capacity position, please?

I'm sorry, could you repeat the question.

What is your current capacity utilization?

About 65%.

And, finally, quite a few questions have been asked already about the seasonal decline in your consumer business.

But, I just want to quantify it.

Should we be thinking about a drop off somewhere between 15% and 20% quarter-over-quarter?

About 15% on that segment's revenues.

Okay.

Thank you.

Chris Umiastowski, TD Newcrest.

Question for you guys on the total impact of the charges that you say -- or not charges, but the misses that you are having right now.

Just tell me if I got this right. 6 million on inventory.

About 7 million in Mexico.

And then if I take the 25% remaining for the restructuring plan, that works out to about 9 a quarter.

Is that correct?

We figure around 7 to $9 million of restructuring benefit.

Yes, that's correct.

Okay.

So that adds up to 20 to 22.

I did my math on the 22 number, because I took your 25% of restructuring of a total of 150.

So that's 37.5 divided by 4.

So, on that, that looks like about pretax $0.10 a quarter.

So my question is, in Q3 of next year, if your business is flat with Q3 of this year, and those problems are gone, does that really mean you are going to be looking at an EPS number that, after-tax is about $0.08 higher?

If all of those things happen, that's exactly right.

Everything else being equal.

Everything else being equal, that's good math.

Okay.

Perfect.

Then question for you, Steve.

I'm not going to let you off the hook that easy on your Mexico response to the earlier guy.

Every quarter, we have to make estimates on your Company, and put our names down with a recommendation.

So. on a view on the stock, I would like to hear your view on when you think Mexico is going to get better.

Look, Chris, Mexico is getting better every day.

And it's going to continue getting better every day.

But in order to get this things completely stabilized to get -- there's, like I said earlier, there's a lot of moving parts.

In fact, there's literally a lot of moving in the plant.

And with all of the rearrangements and everything we're doing relative to fixing some logistics issues and other things, it's going to take us the next few quarters to get it completely sorted out and stabilized.

In the meantime, we're in containment mode to make sure that our customers don't suffer from any of this.

So, are you talking more like, in terms of waiting in to the benefit, are you looking at this dragging on at its current level for another 1 or 2 quarters and then, sort of disappearing in a 1 quarter period?

Or are we going to look at a linear improvement over a certain number of quarters?

No.

It's probably -- there'll be -- it's probably going to look more linear, I guess, over time, but there will be some non-linearities, I'm sure.

Okay.

And you expect some of that in Q4?

I hope to see some of that in Q4.

But it sounds like you are not sure at this point?

Right.

Okay.

Thanks very much, appreciate it.

Michael Walker, Credit Suisse.

Just a really easy modeling question.

Your interest expense has been climbing steadily over the course of the year on a flat total debt amount.

Is that entirely due to higher interest rates?

And what should we be modeling there going forward?

Yes, the T was up in the quarter.

And we also drew more on our receivables [inaudible] program of $20 million.

So that drove the interest expense up.

So what should we be thinking for the next couple of quarters?

It is going to run roughly flat to what it is, depending on the T.

I guess just I'll throw 1 in on inventories.

They were basically flattish, down a little bit this quarter.

What is your expectation for what inventories do on a day's basis in the next couple of quarters?

I would-- on a days of supply basis?

Yes.

Yes, I would expect it to go down over the next few quarters.

I think we were impacted by a few things in the case of inventories.

Certainly the performance problems that we have been having in Mexico affected us there that in that category.

And I think frankly, all of the supply constraints that we were seeing just as a general rule worldwide in the second and the third quarter, I think caused a bit of conservatism maybe, in terms of demand planning and stuff by customers.

And I think that has driven to a bit more churn, as I mentioned earlier in the third quarter, and stuck us with a bit more inventory.

So we're trying to correct all of that here over the next few -- well, as quick as possible.

But I still hope to get meaningful progress this quarter.

Okay.

Thanks.

Brian White, Jefferies.

Yes, you talked about the consumer market declining sequentially in the December quarter, and your outlook on the revenue seems just a little bit soft relative to expectations.

What other market do you think will decline in the December quarter sequentially?

I think what we normally see is the storage area is a little bit down.

But I would say what we -- in both the IT we have seen some softness.

And part of it is some programs moving -- or 1 program in particular, moving to a right with a particular customer.

And I would say that even in the communications we had a pretty good quarter here in the third.

And that looks about the same as the overall IT.

Okay.

The one that is coming down is probably the storage one.

Storage.

Okay.

And just, one of your competitors announced a new relationship with Cisco today.

Cisco is notorious for decreasing their suppliers, not increasing their suppliers.

Can you comment on your relationship with Cisco, and give us comfort that in 12 to 18 months we won't be looking at a decline in the Cisco business at Celestica?

I won't give any comments on any customers, that one, or any others.

They are certainly a customer of ours, and an important one.

Okay.

Thank you.

Robert Dennison, UBS.

Thanks for taking my question.

I'm -- it sounds to me like the core IT and server and telecom business seems to be holding relatively stable.

And at least with the customers.

And the consumer business you are ramping some new wins there.

Do you get the impression that you are at least maintaining market share, relative to your competitors?

Depends on the quarter you are talking about.

We increased in second quarter.

Last quarter, I guess I haven't seen all of the numbers.

I would imagine we're pretty close, as an average.

And so do you expect to continue to at least maintain your market share, or even increase it as you ramp new consumer programs?

I would certainly hope so.

I mentioned the environment for opportunities to bring revenue growth in consumer and some of these other areas are out there, certainly.

And we hope to be successful in those.

Okay.

And so given the numbers that are being thrown around, the market growing at around 10 to 15%, and you guys maintaining your market share, is that kind of longer term, what we should be thinking about in a longer term sort of idea for top line growth?

Yes, as Steve says, we don't expect to lose share here.

And the 10 to 15% seems like a reasonably accurate market growth assumption.

Is that correct?

I don't know about 15.

That's a bit higher than I've been seeing.

But that's the range of some of the analysts' estimates out there, so.

Okay.

And based on your perception, that seems reasonable?

I'm not going to nail you down to 15, and I understand if that's a bit high.

But in that range there seems reasonable, based on what you guys are seeing?

Look, I'm not going to be forecasting 2007 revenue at this point.

But those are the kind of numbers that [inaudible] high single-digits to low double-digits in terms of revenue growth as an industry.

We certainly hope to grow with the industry or better.

Great.

Thank you very much.

[OPERATOR INSTRUCTIONS] Paras Bhargava, BMO Capital Markets.

Gentlemen, in the past you have said that you are going to try to get in the longer term, operating margins of 4 to 4.5.

Now I know that's a long way from where we are today.

Is that still your longer term target?

Or does the mix changes away to consumer and maybe some of the complexity in the business and your footprint make you temper that?

And then what kind of time frame are you putting on that?

I would probably temper it a little bit, at least in the medium term at this point, especially as we introduce more consumer business.

It's obviously [inaudible] margin.

So I like the consumer business in terms of return on invested capital opportunities are there.

I think there's good business there.

And we certainly want to enjoy the growth and bring that diversity into our portfolio.

But certainly, 3.5% is not where we plan to stop in terms of margins.

And then is that something we should see next year?

I mean in terms -- or is that something that's '08 and further away?

I mean, given that we're not yet at our 3.5% target, I certainly am not going to start talking about 4% in the next year time frame yet.

And a question for you, Tony.

Capacity utilization is at 65%.

Is that before Vimercate was shut down and Telford is reduced?

Or does that include those at the Q3 capacity levels?

And then, if it isn't, what happens when those 2 things are taken away?

That includes the entire network.

Right?

So the overall utilization factor would have been very low in those facilities anyway to begin with in the third.

So it's not going to move -- those particular actions won't move the needle much going into the fourth quarter.

But they do take out cost, and that's important.

So what are you going to do to get -- is it volume?

Or what do you need to do to get the capacity into the low 70s?

Or can you get there with your mix?

Maybe it's just not possible, given the mix and how much of it happened in the last part of the quarter?

I think probably a big factor still in our operation in Mexico, utilization is affected by some of our logistic problems, as well.

So we're probably over-invested in the capital required really to do that output at this point.

That's what's driving some of the cost there.

So some of those improvements will help us over time, as well.

In addition, Paras, we have been expanding in eastern Europe and we've been expanding in China, and in Thailand.

We have been making those investments and we have got that capacity, so volume is an important part of it.

Thanks.

Amit Daryanani, RBC Capital Markets.

Just looking at your performance in Asia, which has been fairly impressive, with margins about 4.8% this quarter, despite some pretty good growth.

Can you talk about what is the key -- what is the reason for the success you are having there?

Is that just the fact you have a steady revenue growth, or you have the right people there?

Could you talk about what is driving the continual performance there?

And just also what the utilization rates in Asia are specifically?

Okay.

Just in terms of the formula, why it's working so well.

We certainly had a lot more stability in Asia, especially of late.

And so the growth has been, I think, better managed and we haven't introduced -- or overwhelmed any kind of plant with complexity, something that we won't be doing again anyplace, let alone a place like Mexico or some other ones.

So I would say that's probably one of the biggest contributors, is the team there is able to control growth kind of environment, just deliver improved efficiencies.

In some cases we had certainly the launch of our consumer products there.

Have helped Asia a bit as we start to get some utilization out of our new Songshan Lake plant, and the team is executing very well.

Utilizations there were nicely above the overall average, so they are in the 70s, high 70 kind of area.

I mean, essentially, if you can get the whole of Celestica on a corporate level more stable, better managed, hit mid 70 utilization, there is nothing to say corporate Celestica-wide margins should be close to what Asia is today?

No, I don't know about that.

Some of what you wind up having in western market geographies is more fulfillment-related kind of products.

So there is really less margin and should be higher turn in some of those areas.

So that combines -- it depends on really how much that combines with the ultrahigh mix stuff that's in the high-cost geos.

I mean, essentially, a 4.8% number in Asia might be subsidized a bit because of negative margins in Europe, call it?

I don't know about subsidies.

I think the performance is very good, given the utilization, and when you really think about it, the stability that Steve mentioned.

Not a lot of change and just ramping programs, and consistency in what they are doing.

And so our belief is, that yes, there might be more fulfillment kind of content in our North American and European.

But we'll also have after-market services, which has higher margins, and we'll have a bigger profile of higher mix, lower volume, more custom, if you will, EMS business, that also describes a higher level of margin.

So my belief is longer term, we should be continuing to target our business north of 4.5% overall.

And that is a sign that we can get there.

We're there today, in a well run and stable environment.

Operator, we're just going to take one more question.

[Maryann Dillon], Moon Capital.

I was just wondering, can you just describe a little bit what this complexity that you keep talking about, was introduced complexity, or complexity overwhelmed in Mexico.

What exactly are you talking about, when you talk about this complexity?

It comes -- probably the easiest form to think about is the number of part numbers -- active part numbers introduced into the site.

It was an extremely large number that we introduced, along with a lot of product complexity and there's a lot of mix in the product, so there's a lot of churn in the demand.

It really overwhelmed our supply chain processes and logistics processes.

And when you say churn in the demand, do you mean the customer started getting upset because things were getting messed up down there?

Is that what you mean by churn in demand?

I mean churn in demand as in the demand changed as you often have happen in a high mix environment, where at one point in the quarter or during the execution cycle, the customer is ordering SKU A, and what finally gets shipped is SKU B, and it has some different parts associated with it.

Oh, that's interesting.

So do you have to rethink what you send to Mexico and what you send to other areas, or what not, to try to get -- is it something to have to with the region?

Absolutely, our improvements for the process has been to create a much more thorough manufacturing readiness review process to ensure that before we put any kind of program into a plant like this, that we wind up thoroughly reviewing all the factors that govern the performance of the site.

And this one clearly wasn't done well, with all of the work that we loaded into Mexico.

I guess the one other point that I would say, Maryann, is that one of the things I think that we didn't properly plan for was the amount of part number expansion that happened from the [Rojas] initiatives in the middle of the year.

And this was done based on how customers decide to solve the Rojas problems.

And we saw a material increase in the number of part numbers, [inaudible] the amount of complexity that the site had to manage as they were going from non-Rojas to Rojas line of products.

Thanks.

I may have misinterpreted this, but did I get the impression that this complexity -- the issues that you have in Mexico cost you some relations with your customers at all?

I mean, are they feeling some of the impact?

Or are you pretty much absorbing it all?

Well, we're trying to absorb it all, for sure.

But during -- certainly during the first half of the year, we had impacted customers.

And all of our efforts since then have been to try and contain that to things that -- where we could deliver adequately for the customer and take the cost problems ourselves.

So would you say that satisfaction is pretty much improving?

Improving, yes.

Yes.

And I have one last question.

What would be the normal sequential revenue for the consumer business, Q4 going into Q1?

Would it normally be flat, or down again?

Q4 to Q1 typically has been down 5% to 10%.

Okay.

Great.

Okay.

Great.

Thanks, I appreciate it.

Great.

Well thanks, everyone, for joining the call today.

And we will look forward to talking to you next quarter.

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

Thank you for participating.

Please disconnect your line.