Celestica Inc (CLS) 2014 Q3 法說會逐字稿

Good afternoon.

My name is Kelly, and I will be your conference operator today.

At this time, I would like to welcome everyone to the Celestica Incorporated third-quarter results conference call.

(Operator Instructions)

Thank you.

Manny Panesar, Director of Investor Relations, you may begin your conference.

Thank you, Kelly.

Good afternoon, and thank you for joining us on Celestica's third quarter of 2014 earnings conference call.

On the call today are Craig Muhlhauser, President and Chief Executive Officer; and Darren Myers, Chief Financial Officer.

This conference call will last approximately 45 minutes.

Darren and Craig will provide some brief comments on the quarter, and then we will open the call for questions.

During the Q&A session, please limit yourself to one question and a brief follow-up.

We will be available after the conference call for additional follow-up.

Copies of the supporting slides accompanying this webcast can be viewed at www.celestica.com.

As a reminder, during this call, we make forward-looking statements related to our future growth, trends in our industry, our intentions concerning the return of cash to our shareholders, our financial and operational results and performance, and financial guidance that are based on current expectations, forecasts and assumptions that involve risks and uncertainties that could cause actual outcomes and results to differ materially.

We also refer you to our cautionary statements regarding forward-looking information in the Company's various public filings, including the Safe Harbor statements in today's press release.

We refer you to the Company's various public filings, which contain and identify material factors that could cause actual results to differ materially from those contained in our projections or forward-looking statements, and which discuss material factors and assumptions on which such forward-looking statements are based.

These filings include our annual report on form 20-F, and subsequent reports on form 6-K filed with the Securities and Exchange Commission, and our annual information form filed with the Canadian Securities Administrators, which can be accessed respectively at SEC.gov and SEDAR.com.

During this call, we refer to certain non-IFRS financial measures, which include adjusted gross margin, adjusted SG&A, operating profit or adjusted EBS, operating margin, adjusted net earnings, adjusted EPS, return on invested capital, or ROIC, inventory turns, cash cycle base, and free cash flow.

These non-IFRS measures do not have any standardized meaning under IFRS, and may not be comparable with other non-GAAP or non-IFRS financial measures presented by our other public companies, including our major competitors.

We refer you to today's press release, which is available at celestica.com, for more information about these and certain other non-IFRS measures, including a reconciliation of the historical non-IFRS measures to the corresponding IFRS measures, where a comparable IFRS measure exists.

Unless otherwise specified, all reference to dollars in this call is to US dollars.

I will now turn the call over to Darren Myers.

Thank you, Manny, and good afternoon everyone.

Celestica delivered solid operating results in the third quarter, with strong operating margin and free cash flow performance, despite revenue softness, primarily from our communications end market.

Third-quarter revenue of $1.423 billion was at the lower end of our guidance range of $1.4 billion to $1.5 billion.

Third-quarter revenue decreased 3% compared with the second quarter of 2014, and decreased 5% compared with the third quarter of 2013.

Some highlights for the third quarter include non-IFRS operating margin of 3.9%, improved 70 basis points compared with the third quarter of 2013.

IFRS net earnings of $34.4 million, or $0.19 per share.

Non-IFRS adjusted earnings per share of $0.26, or $0.02 above the midpoint of our guidance range.

We generated $93 million of non-IFRS free cash flow, and we delivered 21% non-IFRS return on invested capital.

Looking at revenue from an end market perspective, relative to our beginning of quarter expectations, we experienced demand softness from our communications end market, while revenue performance from our other end markets was generally as expected.

Our diversified end markets comprised 29% of our total revenue for the quarter, an increase of 1 percentage point from the second quarter, and up from 26% in the third quarter of 2013.

Diversified revenue was up 2% sequentially, led by growth in our industrial business.

Compared with the third quarter of 2013, diversified revenue grew 7%, driven by new programs across our industrial, semiconductor and aerospace and defense businesses.

Revenue from our communications end market represented 40% of total revenue.

Communications revenue decreased 5% from the second quarter, as revenue in the third quarter came in lower than expected, with reduced demand from certain key customers.

Compared with the third quarter of 2013, communications revenue declined 15%, primarily due to demand weakness in the Japan market, and certain program completions related to the telecom build-outs for the North American carrier market in the third quarter of this year.

Storage revenue, representing 17% of total, was relatively flat on a sequential basis, as expected.

Storage revenue grew 18% compared to the third quarter of 2013, primarily due to new programs we launched in the first half of 2014.

Third-quarter revenue from our server end market, representing 9% of total revenue, decreased 10% compared to the second quarter, which was consistent with our expectations.

Server revenue decreased 7% compared with the third quarter of 2013, mainly due to the in-sourcing of a lower margin assembly program that we have previously disclosed.

And finally, our consumer end market, representing 5% of total third-quarter revenue, decreased 14% from the sequential basis, and decreased 25% compared with the third quarter of 2013, primarily due to program completions and the de-emphasis of certain lower margin business in our consumer business.

Our top 10 customers represented 65% of revenue for the third quarter, up 1 percentage point from the second quarter, and unchanged compared with the third quarter of 2013.

For the third quarter, we had three customers individually contributing greater than 10% of total revenue.

Moving on to some of the other financial highlights for the quarter, non-IFRS adjusted gross margin of 7.6% in the third quarter increased 30 basis points on a sequential basis, as a result of our strong execution, favorable program mix, and a net benefit from provisions.

Non-IFRS adjusted SG&A expense for the quarter was $47 million, which was lower than our expected range of $49 million to $51 million, mainly due to the timing of certain spend and a foreign exchange gain recognized in the quarter.

Non-IFRS adjusted operating profit, or adjusted EBIAT, was $56 million, or 3.9% of revenue, an increase of 40 basis points sequentially, as a result of the strong operating results and lower SG&A.

Compared with the third quarter of 2013, despite lower revenue, adjusted operating profit increased 17%, and adjusted operating margin increased 70 basis points, driven primarily by improved program mix and cost productivity.

Our adjusted tax rate in the third quarter was 14.4%, slightly higher than our expected annual range of 10% to 12%, as a result of the geographical mix of our earnings during the period.

Third-quarter IFRS net earnings were $34.4 million, or $0.19 per share.

Net earnings for the third quarter of 2014 were $23 million lower, compared to the same period last year, primarily due to legal settlement recoveries recorded in the third quarter of 2013.

Non-IFRS adjusted net earnings for the third quarter were $47.2 million, or $0.26 per share, compared to $41.5 million, or $0.22 per share, for the same period of 2013.

Turning to working capital performance, our inventory decreased by $7 million from the end of the second quarter to $775 million at September 30.

Inventory turns for the third quarter were 6.8 turns, unchanged from the second quarter.

Capital expenditures for the third quarter were approximately $10 million, or 0.7% of revenue.

Capital expenditures in the third quarter were lower than our expectations of 1% to 1.5% of revenue, mainly due to timing.

Year to date, our capital expenditures are 1.1% of revenue.

Cash cycle for the third quarter was 45 days, 1 day higher compared with the second quarter.

For the third quarter, we generated $93 million of free cash flow.

The strong free cash flow was mainly due to improved working capital performance and lower capital expenditures.

Moving on to our cash position, our cash balance increased $59 million from the end of the second quarter, to $578 million at September 30.

At the end of the third quarter, we did not have any outstanding debt, and our credit facility remains undrawn.

As an update to our share repurchases, in August 2014, we completed our Normal Course Issuer Bid program that we launched in 2013.

In September 2014, the Toronto Stock Exchange accepted our notice to launch a new Normal Course Issuer Bid, which allows us to repurchase for cancellation at our discretion during the following 12 months, up to approximately 10 million subordinate voting shares, representing approximately 5.8% of our total outstanding shares.

During the quarter, we repurchased for cancellation 2.4 million shares, at a weighted average share price of $11.51.

Of the 2.4 million repurchased in the third quarter, 1 million shares were repurchased for $11 million in the third quarter, and 1.4 million shares were funded from the $17 million program share repurchase, or PSR, in the second quarter.

In addition, we repurchased 2.2 million shares for $24 million for the future settlement of stock-based compensation.

At the end of the third quarter, we had 176.7 million subordinate and multiple voting shares outstanding.

Moving forward to our guidance for the fourth quarter of 2014.

For the fourth quarter, we are projecting revenue to be in the range of $1.375 billion to $1.475 billion.

At the midpoint, fourth-quarter revenue is expected to be relatively flat sequentially, and decrease 1% compared to the fourth quarter of 2013.

At the midpoint of our guidance, we expect to deliver non-IFRS adjusted operating margin of approximately 3.5%, an improvement of 20 basis points compared to the fourth quarter of 2013.

Fourth-quarter non-IFRS adjusted earnings are expected to range from $0.21 to $0.20 (sic - see Press Release "$0.21-0.27") per share.

Our non-IFRS adjusted SG&A expense for the fourth quarter is projected in the range of $49 million to $51 million.

For the fourth quarter, we expect an adjusted tax rate of 10% to 12%.

I would now like to turn over the call to Craig for some comments on the business.

Thank you, Darren.

Good afternoon to everyone on the call, and thank you for joining us today.

Celestica continued to deliver improvements in operating margin; return on Invested Capital; and free cash flow in the third quarter, despite lower than forecast demand, primarily in our communications end market.

Overall, our operational performance remains very strong, as we successfully manage through a challenging business environment.

We continue to strengthen our balance sheet and generate free cash flow.

We remain committed to plans for returning value to our shareholders through share repurchases, while continuing to use a disciplined approach to carefully evaluate a range of strategic alternatives for capital deployment, in order to accelerate our revenue growth and diversification.

To provide additional perspective on our end markets, for the fourth quarter, we are expecting year-over-year growth in our diversified business.

However, on a sequential basis, we are expecting revenue from diversified end markets to decline in the mid-single-digit percentages.

While we continue to launch new programs across diversified end markets, fourth-quarter revenue in our diversified business is expected to be impacted, in part, by seasonality; the timing of new program ramps; and the shift of a portion of our solar business from turnkey to a consignment model.

In our semiconductor business, we continued our efforts to accelerate the improvements in operational performance, ramp new programs, and improve cost productivity in the third quarter.

As forecasted, our semiconductor revenue in the third quarter grew modestly on a sequential basis, and in the double digits year over year.

As a result of the actions that we're taking to improve the operational and financial performance of our semiconductor business, the losses in the third quarter decreased sequentially by $2 million, resulting in an overall loss of $2 million at the gross profit level.

Consistent with our remarks during the July conference call, we expect to incur an operating loss for the balance of the year in our semiconductor business, as we continue to ramp new programs, absorb excess capacity, and drive further operational and commercial improvements.

Although we believe we're making progress, significant and sustained effort will be required in order to achieve our targeted levels of operational and financial performance.

For the fourth quarter, we expect semiconductor revenue to remain relatively flat on a sequential basis.

In our communications end market, we expect revenue to increase in the low single digits compared to the third quarter, with increases in enterprise and networking, partially offset by continuing weakness in our telecom business.

Our storage business continues to be very strong, and we're expecting double-digit growth in the fourth quarter, both on a sequential basis, as well as compared to the fourth quarter of 2013, driven by new programs with current and new customers.

While overall server end market demand in the proprietary space continues to be challenging, our server revenue is expected to grow sequentially in the mid-single-digit percentages, in part due to seasonality, and a new program launch with a current customer.

And finally, in our consumer business, we expect revenue to decline double digits sequentially in the fourth quarter, as we continue to rationalize our customer portfolio and deemphasize the lower margin business.

Overall, demand strength in our end markets continues to be volatile, with an increasing uncertain global economic environment.

While we are projecting sequential revenue increases in three of our five end markets, overall fourth-quarter revenue is expected to remain relatively flat at the midpoint of our guidance range.

Despite this environment, we are working to achieve continuous improvements in our quality, cost productivity, cycle time, and delivery performance; while investing in developing and delivering unique end-to-end supply chain solutions to accelerate our diversification.

During the third quarter, we are pleased to be recognized by two of our largest customers, Cisco and EMC.

We were awarded Supplier of the Year from EMC for the second consecutive year, as well as EMS Partner of the Year award from Cisco.

This recognition is a further proof point of our employees' passion to achieve industry-leading operational excellence and innovation in support of our customers, and our aspirational goal to be respected as a highly valued and trusted partner with industry leaders in our target markets.

In summary, our third quarter results and fourth-quarter guidance at the midpoint imply year-over-year adjusted operating profit and margin increases, despite lower revenue.

Our year-over-year improvements in operating results have been driven by diversification of our revenue base, higher value-added services, and our continued focus on achieving higher quality, increased speed, and improved cost productivity across all areas of the Company.

Consistent with our strategy to accelerate the diversification of our revenue mix and customer portfolio, we continue to make specific decisions to strengthen our customer portfolio, particularly by deemphasizing EMS manufacturing in our consumer end market, and by exiting lower margin programs.

These decisions have contributed to the higher operating margins this year, despite the lower overall revenue, as a result of improved revenue mix in our target markets.

We continue to focus our priorities, our resources and investments to diversify our revenue base and customer portfolio, and accelerate the new business wins and revenue realization with current and new customers.

We continue to be encouraged by our new business wins across all areas of our business, and are currently forecasting strong bookings in the fourth quarter of 2014.

We remain focused on our key priorities, including delivering on our commitments to our customers, while continuously improving our quality, our cost productivity, delivery performance, and speed to outcome across the business.

By accelerating the penetration of our JDM solutions across our customers and end markets.

By securing the near-term/long-term growth opportunities across target markets.

By accelerating our operational and financial improvements in our semiconductor business.

By flawlessly launching new programs and on-boarding of new customers, and reducing the time to target revenue and operating margin.

By continuing to improve our working capital performance and increasing our asset velocity, and continuing to leverage information technology and analytical tools to drive simplicity and cost productivity throughout our Company.

We believe our focus in these areas will further enhance our financial results, while generating continued value for our customers and our shareholders.

And before we conclude our formal remarks, I want to mention that we also issued a press release this afternoon announcing that I have informed our Board of Directors of my intent to retire as an officer and director of the company by the end of 2015.

Celestica has a strong leadership team and a talented and dedicated team of employees, and together we have significantly strengthened the Company's position in the eyes of our customers, our employees, and our shareholders.

It's with this positive momentum, I believe it is a good time to begin the transition to new leadership.

I am very much looking forward to continuing my role as CEO over the next year, and working with the board to ensure a smooth and successful transition.

The Board of Directors has formed a committee, and it gave Spencer Stuart to support a comprehensive search process, considering both external and internal candidates.

That concludes our prepared remarks.

Kelly, please open the call for questions.

(Operator Instructions)

Joe Wittine, Longbow Research

Hello, thanks.

Craig, congrats on the upcoming retirement, although I don't want to be congratulating you too early here.

It's a year out.

Yes, it's much too early.

(laughter)

Yes, work to do.

First question, in telecom.

Could you give any further details on the weakness you're seeing in wireless?

In your prepared remarks, you mentioned Japan and, I think, US carriers as at least driving the year-over-year change.

Are there any other regional details to point out?

And maybe you could delve into what has changed relative to 90 days ago.

Joe, it's primarily program buildouts and the impact of our market weakness in Japan.

Buildouts -- is it fair to say they were pulled out faster than what we were expecting 90 days ago or not necessarily?

These were expected wind-downs?

These were expected wind-downs.

Yes, it was also the strength last year of those builds.

Yes, we had accelerated buildouts; and then these are the wind-down.

But in general, it was expected.

Okay.

And maybe shifting gears to traditional hardware and storage.

I'm assuming you've seen the hard drive vendors, and they are growing aspirations toward assembling systems.

It seems mostly like they're targeting the white box market, but there are also some hints that traditional storage OEMs could potentially move some business to them, especially some very densely populated arrays.

So your storage business seems to be trending really well, based on the EMC award, et cetera.

But I'm curious if you've heard anything along these lines from your customer base, and your thoughts on this trend and how it could play out.

We think we have got a broad portfolio of JDM offerings, which is relevant to some of the changes that you have mentioned.

And some of the disk drive suppliers are looking at alternatives.

So we have a very strong portfolio through power packaging and cooling of some really exciting options that could offer them some advantages as well.

So we're still bullish on our relevance as these market changes continue to take place.

I'd say there are also similar trends, as you would know, in the flash business.

But very bullish -- we have got a portfolio; we have got a strategy; we have got an execution machine.

I think we're very bullish on the storage opportunity for Celestica.

Okay.

Thanks a lot.

One more quickly, if I could.

I think you glazed over, or I think you said you were evaluating new methods of capital deployment.

If you could just dig a little bit further into that, as far as what you are considering -- if I heard that right.

Yes, Joe.

It's in terms of really accelerating our investments in the business and as well, looking at potentially more aggressive buybacks.

And so the focus on the investments in the business is really on diversification of the Company and seeing how we can put the cash to use.

And the other alternative, of course, is to be more aggressive on the buybacks.

Thanks a lot.

Thank you.

Sherri Scribner, Deutsche Bank

Hello, thank you.

Just looking at the operating margin performance, very impressive.

It beats your typical -- I think you've said in the past that, at a $1.5 billion type of quarterly number, you should be hitting a 3.5% operating margin.

You were well ahead of that.

Can you give us some detail on what helped drive that performance?

Was it mix?

Was it the improvements in the semi business?

Just a little more detail on what drove that and also how sustainable that is.

Absolutely, and good afternoon, Sherri.

Yes, it was a great quarter from an operating margin perspective.

You saw it both in the gross margin and in the SG&A.

And I would say, Sherri, it really was a number of things.

It was mix, it was recoveries, a little bit of help from provisions, some spend deferrals, a little bit of FX.

It was a little bit of everything going one way, and generating a very strong quarter from all the actions that we had in place.

I think as you look forward, we are certainly pleased that -- and you can see in our guidance, we're at 3.5% at the midpoint.

That's at [1425] of revenue.

So we're pleased with the progress we've made, and the ability to drop the water level, you could say, from 1.5 down to the mid-[1400s] at this point.

So we continue to look for further opportunities.

And, obviously, there's a lot of mix involved and a lot of assumption.

But as we can improve semiconductor, we can keep working on that.

And how much does the strengthening of the US dollar help you?

I would say, generally, it helps us somewhat with some of our local labor spend but nothing material at this point.

Okay.

And just quickly on the communications segment, with the weakness in telecom and networking being a bit better, what is your mix of business within that segment between networking and telecom?

Thanks.

Yes, Sherri, we are not breaking that out at this time.

It's more on the networking side though than on the telecom side.

Okay.

Thanks.

Thank you.

Matt Sheerin, Stifel

Yes, thank you.

Just another question regarding the semiconductor capital business.

You talked about a $2 million delta to get you to breakeven.

What will get you to the EBIT margins at the Company level or around 4%?

Are we talking about, is volume growth, in order to get leverage?

Or are you also looking at additional costs coming out?

And will that get you there?

Matt, good afternoon.

Craig here.

It's the combination of volume growth, cost productivity, and then basically working on the commercial pricing for the products that we are producing.

Okay.

And beyond the next quarter, which seems flattish, what is your outlook there for that business, particularly given signs that the semi cycle, if not at peak levels, is certainly still relatively volatile?

It's really customer specific.

We been successful in securing a number of new customers in semi.

So it's going to be the combination of the mix of those customers and their success.

The timing of program ramps with their customers.

And then, I think right now, our visibility is limited to the fourth quarter.

We hear various scenarios for next year.

But it's a little too early for us to, I'll say, prognosticate on what exactly is going to happen at this point.

Okay.

And then regarding your consumer business.

The pruning of the business, focusing on more profitable segments certainly makes sense.

But could you tell us what is basically going to be left of that business -- the type of projects that you are doing, end markets?

And do you see that as a growth sector or just a segment that you will manage to profitability?

We have selective growth opportunities in servicing various product in the after-market space.

And we have, I would say, a major program in the area of supplies for one of the major companies in the printer space.

So it's after-market related.

I'd say it's relatively stable, once we get attriting some of the OEM manufacturing programs we have got.

But the number is not material on the overall revenue side.

But some of the short-term variances are to the overall growth of the Company, in terms of the --

So primarily on the logistics side and not so much on the assembly side.

It's logistics; there's some LCD repair; there's some product management; quality assurance on some of the consumer product side and then basically on the supply side -- so those types of areas.

And a bit on the repair and return area.

Okay.

All right.

Thanks a lot.

You bet.

Amit Daryanani, RBC Capital Markets

Thanks, good afternoon.

Couple of questions.

Just on the communications segment, 90 days ago you talked about this segment being down mid-single digits due to these two issues you were mentioning, which were program buildouts and continued weakness in Japan.

I'm curious.

What led to the 2x softness of the market?

It seems like things got worse than those two issues you're citing.

Could you maybe just talk a little bit about what else -- what had been worse which you talked about 90 days ago?

It was late in the quarter, and we had at least a couple customers, one of which pre-announced on the impact on their business.

But it was late in the quarter demand declines with certain customers and the softness in the service provider market.

Got it.

And then I guess it's fairly centered around telco CapEx centric customers versus more enterprising networking.

I thought that was implied in your December guide at least, right?

Yes.

That was the situation, Amit, but just a little bit more extreme than we anticipated.

Fair enough.

And then, maybe I missed this part, but what led to the OpEx to be down a whole lot more than you were thinking, at $41 million?

I think we were hoping for $49 million or something around there.

And you mentioned FX benefits that helped OpEx, I think.

So maybe just walk through what helped the OpEx.

And was FX a driver in that at all?

Yes, Amit.

In terms of our SG&A, it was $49 million to $51 million was our guidance.

We came in at $46.7 million.

So it was a combination of just reduced spend, some of that being deferrals as well as just under $1 million of FX gain.

So we did get some help there, and then we're guiding $49 million to $51 million.

So back to normalized levels for the fourth quarter.

Got it, that's helpful.

And finally, Craig, I was looking through my model.

And it struck me that if you hit the midpoint of your guide for December, it would be the 13th quarter of year-over-year revenue decline for the Company.

I realize you had some Blackberry issues for some part of those 13 quarters.

But when you look at that sort of revenue decline, what do you think Celestica can do to help turn that model around and drive growth?

Is it different acquisitions or maybe almost deemphasizing parts of the business that are dragging this thing down?

Just any thoughts on how you think you can get to revenue growth eventually would be helpful.

Let me say, it's portfolio for us.

We're trying to remix the portfolio of this Company to stabilize the outlook for revenue, to build the future around diversification away from our traditional IT enterprise markets while enriching those markets with the JDM.

Difficult to measure it on a quarterly basis.

We're moving in the right direction.

We're out looking -- some very strong bookings as we look at the fourth quarter.

I'd like to say, you have to bear with us here.

We're trying to do this in the public markets.

We're optimistic on the strategy, but we got to get the portfolio right.

We've got to continue to execute.

And we've got to have to make sure that we're winning business based on our differentiation and not using price as our primary lever.

Fair enough.

I appreciate the thoughts.

Thank you.

Thank you, Amit.

Jim Suva, Citi.

Thanks very much, and I have two questions.

One is on fundamentals, and the second one is on strategy.

When we think about fundamentals for the Company, I believe one of your top customers, maybe IBM.

And they publicly have talked about a lot of changes: selling the XAB6 business, selling the semiconductor business, and just basically deemphasizing hardware.

Can you help us understand that.

Is IBM still a top customer, which I think they are.

And if so, the type of exposure or comfort level or how do you work through that?

And then secondarily, Craig, when you look back over your tenure at Celestica, maybe if you can just update us on a couple of things -- I'm sure you have done a lot of self-pondering over this -- a couple or a few things that you are most proud of?

And then a couple of the most things that you feel were a little bit disappointing and maybe what the next leader you think could bring or their attributes.

Just me independently -- I would say that definitely your focus on cost cutting and operational improvement and margins is very impressive.

But it seems like maybe the revenue wasn't quite what you wanted for the growth.

I don't want to put words in your mouth.

But since you've done a lot of soul searching over the past few months, I'm sure you can line us up with a few things you are proud of and a few things that you'd like to see the next person step in the shoes to do.

Okay.

What I will say, Jim, is IBM is a top customer of Celestica; and we have a strong relationship.

But I won't comment on the specifics of some of the questions that you raise regarding the portfolio.

Suffice it to say, very strong customer; performing in the higher value-added segments of their business; and a very, very good relationship.

So we're very proud and fortunate to have them as a customer, and we anticipate to continue that going forward.

With regard to a little bit about me, I think I'd rather prefer to do that in a more private or personal session.

But the bottom line here is, this is a strong Company.

We've worked to manage a very challenging transition, and we are doing a very good job of delivering on our commitments.

And we look forward to that continuing.

Okay.

Thanks very much.

Thanos Moschopoulos, BMO Capital Markets.

Hello, good afternoon.

Craig, can you expand a little bit more in terms of what you're seeing on the macro backdrop?

You mentioned the weakness on the telecom segment.

But other than that, how would you say the rest of the business is tracking from a longer-term pipeline and visibility perspective relative to three months ago?

The funnel of opportunities is building.

The time to close those opportunities is challenging relative to driving this conversation on a quarterly basis, but the opportunities are growing.

I don't think there are overall demand increases in terms of any of our end markets.

The diversified market is going to be driven by customers moving to an outsourcing model.

The communications and enterprise markets are going to be driven by coming up with responsive solutions to this hardware commoditization trend and us providing a higher value-added offering to those customers that are faced with that trend.

So I think it's aligning your strategy with the forces in the market.

And market demand is going to be modest at best.

It will be higher in diversified than the enterprise space.

And it will be taking share based on your differentiation and your ability to execute and deliver on your promises.

But we're bullish about the changes, and we think they are aligned with the investments we've made, in some cases, five or six years ago.

And on the topic of differentiation, clearly, storage has been a bright spot based on your JDM efforts.

Where do you see other opportunities for your JDM capabilities (inaudible)?

We see higher levels of integration.

So as you see converged systems entering the marketplace, you had one of the analysts talk a little bit about disk drives and flash drives.

They are going to be looking for new options there.

So we see relevance across the entire stack, if you will, in the IT enterprise space.

And then obviously in business models around supply chain collaboration, fulfillment, configure to order capability.

And then, clearly, our execution of track record in markets like aerospace and defense are driving significant opportunities in healthcare.

And then our complex mechanical capability is opening up new opportunities in the industrial space.

So I think we've got a tremendous portfolio for the future.

It will take time to materialize.

But we're trying to do it in a measured way on a very disciplined basis.

And I think our margin performance speaks for itself -- our free cash flow generation.

And we're looking forward to continuing this as we look forward to 2015.

Great, thanks, Craig.

I'll pass the line.

Brian Alexander, Raymond James

Okay, thanks and good evening.

And just want to ask about the fourth quarter revenue guidance.

If I look at it sequentially flattish, it's actually better than the last few fourth quarters that you've guided to.

I think those were usually down low to mid single digits.

And on a year-over-year basis, I know you're not growing yet; but you're getting back toward being flat on a year-over-year basis.

So do you think that you could grow revenue in 2015, given everything you know today and your comments about being selective and pruning lower margin programs?

I know you are not guiding for 2015.

But I just want to get a sense for whether you thought that was possible.

And just directionally, what segments are you confident will grow?

Especially as we look at diversified, which looks to be decelerating toward low single digits from previously in the double digits.

Is it possible?

Yes, it's possible.

The question is, is the visibility we have and then the number of moving pieces in terms of the timing of program ramps, the revenue realization associated with those ramps, the qualification times, in some cases, in some markets that it takes to qualify us?

But we are winning business.

We are gaining share in these markets.

We are showing year-over-year growth this year.

But the visibility of the impact of all of that, I'd say we need certainly -- it's still no more than 90 days.

But certainly, the question is then the skew on that.

But sure, it's possible.

There's still three months in the year left to book new business.

Obviously, some of that can impact 2015.

And we've got major opportunities that we're bidding and that we're competing for right now.

If they come to bear with revenue realization that we think they have, it will be possible.

I would just add to that, Brian, there are programs we have won that we plan to ramp next year.

And as Craig mentioned, it's about revenue realization on those.

Yes.

And some of those programs we've won this year.

But they've had a rather protracted, I would say, revenue realization time line because of the impact of some of the -- for example, the IT systems and the conversions required to bring those programs online.

And just a follow-up.

When you talk about being selective, are you suggesting or finding that you have to be more selective then maybe you were six to nine months ago because of the pricing environment?

Or should we view this as similar level of selectivity and that you really haven't changed your discipline around return on capital thresholds, nor is the pricing environment forcing you to walk away from more business?

No.

I think the pricing environment because of the nature of the pressure on all of our competitors for revenue growth is intensified.

And we have to be not only more selective and more focused and targeted, but we have to be more creative in the value propositions we are putting forward to create the kind of opportunities or scope that we would like to execute for those customers to make this business attractive.

Manufacturing on its own is really something that does not look very attractive.

But our ability to bundle that and then create maybe a different playing field for us to play on is creating some real opportunities.

And I think JDM is a case in point.

But we've gone beyond that with some customers that have opened up some interesting opportunities.

But it's forcing a level of creativity and innovation that, frankly, is stepped up right now.

Okay.

Thanks for the thoughtful answers, Craig.

(Operator Instructions)

Todd Coupland, CIBC

Good evening, everyone.

Good evening, Todd.

Quick question on the margin, and then I had one follow-up.

So in the quarter, the 3.9%.

Did you say, in the gross margin there was a reversal of a cost or something like that in the quarter?

And if so, what was the impact?

Yes, Todd, there was some provisional release.

Call it 150 basis points (sic - see correction in later question "15 basis points"), in terms of margin impact in the quarter.

Okay.

The rest was mix and recoveries.

Okay, so if you normalized for that, it would be -- you would have to take that off the 3.9% and then off the $0.26 as well.

You didn't adjust for that, right?

That's right.

We did not adjust for that.

Fair enough.

And then I just wanted to understand a point on a previous question.

The observation was made there was potential in the current book of business to be at a 4% margin if semiconductors were at breakeven.

Is that statement in fact correct?

Yes, Todd, the straight math is that today's mix, with semiconductor at the gross margin level losing $2 million, that was at its target.

It's about a 50-basis-point improvement for the Company.

And so we're guiding at 3.5%, so that takes you to your 4%.

I see.

And that's $2 million a quarter?

Right now, this quarter, it was $2 million at the gross margin level.

Okay.

And does semi need to recover to some sort of volume level?

Or do you have plans in place to at least get that to breakeven so it's not a drag in 2015?

Yes.

As Craig mentioned, it's a number of things, both being commercial -- a lot of it on the revenue realization.

Remember, as we've talked about on previous calls, we have established a new facility in Johor.

The revenue level is below the two acquisitions we did due to some of the downturn in semiconductor.

And then we're also going to be ramping programs, and so we've got a cost associated with the ramping of programs and the excess capacity we have.

So it's a little bit about all of those.

We're working very hard to get to the breakeven but, frankly, better than the breakeven at the gross profit level.

But it will take us into 2015, certainly.

Sorry, it will take you through all of 2015 to get to breakeven?

No.

It will take us through 2015 and beyond to get to our target margins in the semiconductor area.

I don't think you should expect to see a lot of improvement in the fourth quarter; but certainly into next year, you will see more improvement there.

And sorry, one last question, if I could, on a follow-up.

The mix that you have in terms of your book of business for 2015.

If you were to exclude semi, does it also point to stronger margins; or is it about at the same contribution level as it is today?

Yes, Todd, I -- we can't give guidance on 2015 now.

Refer to the comments we have said before.

But I think for now, for your -- the way to think of the Company is, continue to be in the 3.5% to 4% range.

I think for gross profit, as you look at our Q4 guidance, it's around 7.3%.

And unless there's some big mix changes or changes in volumes, that's the world we are in right now.

Great.

Thanks a lot.

Okay.

Thanks, Todd.

Naser Iqbal, Salman Partners

Following up on what's the normalized operating margin.

If it was 7.6% gross margin in the third quarter, Darren, you said 115 basis points.

So would the margins on a normalized basis, excluding the benefit, be like the 6.5%?

Is that what the normalized level would have been?

Pardon me, I think I said 115.

I meant 15 basis points.

So apologies for that.

No.

At 7.3% is where we're guiding, so just think in that range.

I apologize for that error.

Okay.

So I guess my question was that, if you had the 3.9% in Q3, and you're looking at 3.5%, just what is the -- I guess the important delta?

Because your revenues are flat.

Is it just mainly the mix affecting the margins?

Yes, it was both gross profit and SG&A.

SG&A came in $3 million, and gross profit came in better from the mix recoveries, as well.

So it's the combination of the two.

Okay.

That's really helpful.

So I guess my question -- follow-up question would be that, if it's maybe too early for 2015.

But given your cost structure today, it would seem that you should be able to maintain these mid-3% margins, even -- that even if your revenues were to flat line for the rest of the four quarters in 2015, your margins should be relatively stable.

So I'm just trying to think, how should we be thinking about your margins versus your revenue growth?

Because it doesn't seem like you need to grow revenues like you did previously, like a year ago or even two years ago.

Yes.

At -- in the mid-1,400s, we're at current mix and everything, subject to no other big changes.

We're at the 3.5%.

So a lot of it becomes revenue dependent, and becomes the ramping of programs, timing, investments, and the mix that we have.

So it's hard to say every quarter.

But certainly if you maintain the current assumptions, you would burn that out at 3.5%.

Q1 is usually seasonally lower for us as a quarter, from a revenue point of view.

So that will obviously impact margins as we go into Q1.

But again, we're not providing guidance for Q1.

The visibility is just not there right now.

Right.

And -- but if we think about your OpEx level of the $49 million to $51 million that you mentioned earlier, is there some leeway also, such that if your revenues are not where you think they are going to be, you can adjust that?

Or is this like a fixed level?

We're always looking longer term on taking [cost out].

Usually the short-term is relatively fixed.

But I think we've shown a great track record of performance on the margin, 17% year-over-year growth in our operating margin.

So we will continue to focus on making the right decisions, the investments, and our cash and margin performance.

Okay.

That's very helpful.

Thank you very much.

Thanks, Naser.

One more question, operator.

Amit Daryanani, RBC Capital Markets

Just a quick follow-up, I guess.

I heard you talk about FX being a bit of a benefit from the operating side for you guys on the labor side.

But I'm curious, how does it flow out for you guys on the revenue line?

It seems to be a big topic these days.

Could you maybe just walk through if you have any FX issue on the revenue line, especially in the December quarter?

No, generally, we don't.

Most are US [denominator].

We did have some.

And part of our softness in Japan is the yen there, which we have been experiencing all year.

But generally, other than that, most is US dollars, so doesn't have that impact.

Perfect.

Thank you.

Okay.

I'd like to thank everybody for the call, and we look forward to continuing the dialogue.

And we are looking forward to 2015.

So thank you very much.

This concludes today's conference call.

You may now disconnect.