Oct 28, 2008
Executives
Paul Carpino – VP, IR Craig Muhlhauser – President and CEO Paul Nicoletti – EVP and CFO
Analysts
Amit Daryanani – RBC Capital Markets Brian White – Collins Stewart Jim Suva – Citi Kevin Kessel – JP Morgan Joe Witten [ph] – Longbow Research Todd Coupland – CIBC World Markets Lou Miscioscia – Cowen and Company William Stein – Credit Suisse Edward Lee [ph] – Pacific Majority Capital [ph] Alex Blanton – Ingalls and Snyder
Operator
Good afternoon, ladies and gentlemen. Thank you for standing by.
Welcome to the Celestica’s third quarter results conference call. (Operator instructions) I would like to remind everyone that this conference call is being recorder on Thursday, October 23, 2008 at 4:30 Eastern Time.
I will now turn the conference over to Mr. Paul Carpino, Vice President of the Investor Relations.
Please go ahead.
Paul Carpino
This call will last approximately 45 minutes, but we can be reached for follow-up questions after the call as well. During the Q&A, please limit yourself to one question and one 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 asked your question. Before we begin, 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 operational result and performance that are based on current expectations, forecasts, and assumptions involving risks and uncertainties that could cause actual outcome and results of the different material.
We will refer you to the risk factors and uncertainties discussed in the company’s various public filing which contain and identify foreign factors that could cause actual results to differ materially from those contained in our projections or forward-looking statements. These filings include our form 20F and subsequent reports on form 6K filed with Security and Exchange Commission, which can be accessed at 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 nonGAAP measures are included in our press release which is available at www.celestica.com.
I will now turn the call over to Craig Muhlhauser.
Craig Muhlhauser
Thanks, Paul and good afternoon everyone. In an environment of economic uncertainty, Celestica had very strong results in the third quarter.
On the topline revenue came in slightly above the midpoint of our guidance, driven primarily by our consumer segment which benefited from seasonally strong quarter as well as additional revenue from ramping new programs. Our industrial aerospace and defense segment also provided double-digit sequential and year-over-year revenue growth as established customer relationships continue to expand and new customers begin to ramp.
Our focus on diversifying our end markets, strengthening our customer base and improving our operating performance have been the cornerstones of the company’s improved results. Three years ago, we had very little revenue in either of these segments.
And our other category, which represented all revenue outside of our communications and IT infrastructure segments, represented only 21% of our business. Today, our consumer in industrial aerospace and defense end-market segments now represent 36% of our business.
In order to further diversify into these end markets and ensure we could participate on a sustainable level, we have build our engineering and supply chain capabilities and established a robust global footprint to support the unique needs of these markets. To further strengthen our position for future growth and end market diversification, we’ve invested in our operating network.
We begin to focus in disciplinary approach to increasing our market share in these segments and the steady ramping of current and new customer programs. Our increasing and overall profitability during this growth is a proof point that our strategy of focusing on key industries, target customers, and operational excellence is delivering consistent, sustainable results.
Profitability improved this quarter as evidenced by our gross margin which climbed to 7.4%, our strongest performance since 1999. This was achieved as the company continued to deliver strong operational performance and improvements throughout our global network in the areas of quality, cycle time reduction, delivery, and cost productivity.
Operating margins were 3.2%. This represented the second consecutive quarter with operating margins within our 3% to 3.5% midterm target range.
This is also achieved despite SG&A being $15 million higher on a sequential basis due to unprecedented currency fluctuations during the quarter which Paul will take you through in more detail. Inventory turns are 9.1 times, another solid performance, which also included the impact of ramping several new programs in the quarter.
The combination of these solid inventory turns and better operating margins, I’m very pleased to report that our return in invested capital, including intangibles, was 13.9% as compared to 11.8% in the second quarter and 9.1% in the third quarter of last year. At this level of return, the company is now generaing a return in excess of its weighted average cost of capital.
This achievement meets one of our key midterm financial targets that we set at the beginning of our transformation in January of 2007 and represents the first time the company has generated this level of return since 2000. This result is also a confirmation that our strategy of focusing the company’s resources on working capital and operational efficiency at every level of the supply chain not only provides customers with the lowest total cost of ownership for their products but also generates improving returns for our shareholders.
We have longer term goals to generate higher returns, but reaching this midterm target demonstrates that we can set our sights for higher returns over time. While the quarter was very strong, our journey has only just begun and we now turn our attention of all of Celestica’s business leaders to understanding how the current economic crisis will impact our business and how we will capitalize on the opportunities that lie ahead.
We are operating on unprecedented times, and today’s economic financial crisis is clearly something not seen in decades, if ever, and the full impact of this situation is still unclear. In our outlook for the coming quarters, some of our customers have reduced demand, delayed new program introductions or expressed the more cautionary tone and this is reflected in our guidance.
Although, these are volatile times, we recognize that the most significant changes in market share tend to change hands during economic downturns. With our strong operating performance, our cash position, and our strong balance sheet, we are working aggressively with customers to offer that unique solution and to capture these opportunities created by this uncertainty and liquidity crisis.
In terms of new business winds, Q3 was our strongest quarter this year for this company with key wins coming in consumer, industrial, and the IT enterprise base. We are also securing new business and ramping new programs with new customers and key growth industries such as healthcare and alternative energy.
These customers are looking to take advantage of our strong technical capabilities, our global operating performance and to expand their outsourcing activities, to capitalize on their market opportunities, and to meet their competitive challenges. In this environment, our traditional nuance [ph] are also looking for brighter solutions to reduce cost, increase speed, flexibility, and time to market.
This includes more solutions that encompass a full-product life cycle of activities, (inaudible) from design engagements right through the day after market support. These challenging economic times will drive major companies to look for innovative solutions and strong financial partners that have the ability to offer breakthroughs and quality, time to market, cost, and increased asset velocity.
Celestica has now demonstrated the track record that I believe makes us the best choice for taking on the most technically demanding challenges and delivering in these tough times. Today, our clear imperative is to capitalize and execute on the new opportunities for future growth and profitability, continue to build on the improvements we made with Celestica, thus far, and to prioritize the company to meet the investment challenges that we have in this current market environment.
On the financial side, Celestica is very strong. The cash position for the company is in excess of $1.26 billion.
We have the highest net cash position among the North American EMS providers; our net cash is a positive $500 million, compared to a negative net cash position for most of our North American peers. We have built this balance sheet on a steady track record of generating free cash flow.
After generating free cash flow of $307 million in 2007, we have generated an additional $144 million in free cash flow in the first nine months of 2008 and expect to generate additional free cash flow on the fourth quarter. Financial strength is an imperative in this environment and is clearly a strong attribute that Celestica has the ability to invest in our existing customers and new customers during these challenging economic times.
Today’s global business environment is more complex and competitive than ever, but also filled with many opportunities. We are confident that Celestica continues to be very well positioned with our customers and are very confident that we will have the ability to leverage our financial strength and our global capabilities to capitalize on the opportunities in the market today.
That concludes my remarks, so let me know turn the call over to Paul Nicoletti.
Paul Nicoletti
Thanks, Craig and good afternoon to everyone. Revenue of the third quarter was $2.03 billion, up 8% sequentially from second quarter, and down 2% from the third quarter of last year.
The strong sequential growth was driven by both near program wins and seasonal strength in our consumer business and as Craig noted, growing programs in our Industrial Defense Aerospace segment. Looking at our revenues by end markets, our consumer segment represented 28% of our business, Enterprise Communications represented 25% of total sales, the Server segment represented 15%, Telecom was 14%, Storage was 10%, and finally, Industrial, Aerospace, and Defense came in at 8% of sales.
Five of our six segments were flat or showed some sequential growth while the Server segment declined. Moving to our customer concentration, our top ten customers represented 62% of sales for the quarter.
Our top five were 38% of sales and no customers were greater than 10% of sales in the quarter. GAAP net earnings for the third quarter were $32 million or $0.14 per share, compared to GAAP net earnings of $51.5 million or $0.22 per share for the same period last year.
GAAP earnings from third quarter of 2008 included restructuring charges of approximately $17 million compared to $3 million for the same quarter last year. Year-to-year GAAP earnings were also impacted by a favorable tax recovery achieved in 2007, not repeated in 2008.
Adjusted net earnings for the quarter were $54.3 million or $0.24 per share compared to adjusted net earnings of $29.3 million or $0.13 per share for the same period last year. The stronger earnings were driven primarily by year-over-year improvements in our Mexican and European operations.
As Craig noted, all major regions in the company were breakeven or better in the third quarter as previously targeted, and we expect that to continue into the fourth quarter. Adjusted net earnings also benefited from a lower tax rate, and we now expect our adjusted tax rate for 2008 to be 10% compared to our previous rate of 15%.
Gross margins this quarter, we’re adding nine year high of 7.4% compared to 5.9% for the same period in 2007. This increase was primarily due to operating improvements in Mexico and Europe, as well as continued benefit from cost reductions, restructuring actions, and the impact of exiting unprofitable accounts and overall, the streamlining and simplifying the processes throughout the company.
SG&A in the third quarter, excluding option expenses, was $85.3 million or 4.2% of revenue. The volatile in exchange rate for certain foreign currencies, particularly in the month of September, resulted in foreign exchange losses of $12 million for the quarter, more than giving back the $8 million of gains we experienced in the fist half of 2008.
Most of the foreign exchange losses were unrealized and resulted from the translation of foreign currency-denominated assets and liabilities to U.S. dollars of September 30, 2008.
Approximately, one-half of these losses resulted from the precipitate devaluation of the Brazilian reais, which fell 18% compared to the U.S dollar in the month of September alone. This occurred at the same time revenue was growing in the region.
Although, the bulk of our local currency cost are hedge, the swing in the Brazilian reais was well in excess of any volatility we have experienced in that region over the past several years. Despite the impact of higher SG&A, operating margin came in at 3.2%.
Excluding the impact of foreign currency loss this quarter, SG&A would have been in our more typical range of between $70 and $75 million. In terms of our restructuring update, we record the charges at $17 million in the third quarter.
Here today, we recorded $24 million of the anticipated $50 to $75 million restructuring charges that we had announce at the beginning of this year and we expect to complete this restructuring program during the second half of 2009. Moving to working capital and the balance sheet, Celestica is delivering excellent results and enjoys one of the strongest financial positions in the industry.
Working capital, cash flow, and balance sheet metrics all continue to perform well this quarter. CAPEX in the quarter was $31 million and free cash flow was $57 million.
The cash cycle for the quarter was 11 days, a two-day improvement from the second quarter, primarily on the back of inventory days, declining to 40 days, compared to 42 days in the second quarter. During the quarter, we further reduced the use of our AR sale program to $75 million, representing an additional $50 million reduction from the second quarter.
This is the lowest level this program has been since the program started in 2001. A reduction in usage of this program reflects the company’s ability to self-fund its working capital, our consistency in generating free cash flow, and the overall strength of our balance sheet.
During the quarter, we extended the maturity date of the program to the fourth quarter of 2009 on similar terms while we do not foresee utilizing this liquidity given our balance sheet strength. The program is committed and is available to us if we choose to use it.
Rounding up the balance sheet, our debt to capital was 26% and our credit facility of $300 million remains undrawn and is fully available. And as a reminder, the company has no debt maturities until the middle of 2011.
Overall, our balance sheet is in exceptional shape and gives us the opportunity to deal comfortably with the weaker revenue environment and to invest in future growth opportunities. Looking ahead, visibility is low and forecasting is a challenge.
As a result, we are being prudent in our outlook for the December quarter. We are providing a wide range for our guidance targeting revenue of between $1.75 billion to $2 billion and adjusted that earnings per share between $0.16 and $0.24 per share.
On the top line, we anticipate our communication that IT infrastructure business can aggregate to show declines in the fourth quarter with other segments being relatively flat, reflecting a slower growth environment. At the midpoint of our revenue and EPS guidance, the implied operating margin is 3.2%, which is flat to the third quarter’s operating margin levels, despite an approximate $150 million sequential decline in revenue from Q4 to the midpoint of the Q4 guidance.
We also expect the balance sheet to continue to strengthen as we generate additional pre-cash flow, further reduce the size of our AR program, and maintain strong inventory performance. Although we are seeing some impact to our topline in this environment, our efforts on deriving ways and efficiency of the business is paying off.
We believe we can hold profitability levels, maintain returns, and generate additional free cash flow despite the challenging revenue environment. That concludes our remarks, and now I ask the operator to start the question and answer session.
Operator
Thank you. Ladies and gentlemen, we will now conduct the question and answer session.
(Operator instructions) Your first question comes from Amit Daryanani from RBC Capital Market. Please go ahead.
Amit Daryanani – RBC Capital Markets
Thanks. Good afternoon, guys.
Just a question, I guess looking into your guidance policy, talking about your expecting call could be down a little sequentially and the other segments to be flat and (inaudible) the consumer report – why do you expect that to be flat, although some consumer ramp, they were offset and market softness, even the core market is to be flat as well.
Paul Nicoletti
Amit, so just to clarify your question. Are you asking as to why we expect the consumer to be relative flat?
Is that your question?
Amit Daryanani – RBC Capital Markets
.
Paul Nicoletti
Generally, you note the composition of our consumer business, Amit, you see some customers to – the peak really happened in Q3 and as Q4 unfold particularly, that is where the middle of November, the channels are full and revenue falls off for the quarter, so just giving the mix of what we have. We generally think consumer overall will be flat, so some customer and consumers will be down from Q3 levels, other customers will be up, overall relatively flat.
Amit Daryanani – RBC Capital Markets
This is – I cannot see any incremental (inaudible) are signs of – essentially that business potential being down sequentially in December somewhere on that figure?
Paul Nicoletti
Well, I mean, as you see, we widen our range this quarter and we think we are being prudent to state the obvious. The visibility is relatively low, I think more than usual.
I think, of note, particularly some of our consumer or customers, I think, the question mark will be more in the first quarter one as essentially the channels are being full – being filled and if there are sales issues, I think that would reflect itself more in the first quarter. So, overall, as I’ve said, we have given a pretty wide range, and we think we have captured the volatility that we are seeing right now.
Amit Daryanani – RBC Capital Markets
Got it, and my followup would be, you guys have done a really good job on cash and ratio, I think, both you and Craig talked about debt how well if that is going? With $500 million in net cash at this point and given by your stock is rating, can you just talk about how do you look at all the net cash you have fit in to the debt buyback or share repurchase, or issue a dividend yield potentially.
Paul Nicoletti
So Amit, first, just as a reminder, for the terms of our notes, we are subject to restrictions with regards to the amount of debt, pardon me, the amount of stock that we could buy back or any dividends. And that is really as a result of the significant GAP losses that we incurred early on several years ago.
So our basket is a $50 million basket in regards to those two categories. We have talked on this call about looking at debt buyback in the past and I would say right now with a conscious decision on our part, given the volatility in the debt markets that we would hang on to that cash and quite frankly, we think that this is going to be an opportunity-rich environment for companies who have cash and be able to capitalize on that and so our perspective was that given that we recognize that if you can take the debt out, you’re likely not going to get it back.
We consciously have held on to it. Now, as the market unfolds, we are obviously generating some pretty solid cash flow here every quarter if we do see a window opportunistically takes some debt down we will, and you’ve been seeing us manages in a fairly scene this way through the reduction of AR program and as I’ve said you can expect to see us reduce that even further.
Amit Daryanani – RBC Capital Markets
Fair enough, thanks a lot and congratulation on a good quarter.
Paul Nicoletti
Thank you, Amit.
Operator
Your next question comes from Brian White from Collins Stewart. Please go ahead.
Brian White – Collins Stewart
Yes, I’m wondering if you could talk a little bit about some of the trends you saw in September linearity of the month and what you saw in October.
Craig Muhlhauser
In September, this is Craig Muhlhauser, in September, obviously, it’s the third month of the quarter, I mean, what we are seeing is at least in the case of our third quarter, it was – demand stayed relatively constant and a few surprises, I think, what the trends we are seeing are really around the mixed changed within the month roughly 46% of our volume shipped in the month. So the benefits of our supply chain strategy gives us, we think, added flexibility now – we meet those short-term requirements.
So in October – October is within the guidance we have given for the quarter. So, overall, we have seen ups and downs, we have seen cautious down for many of our customers that is reflected in both the range we have set for the forth quarter as well as the overall midpoint.
So, obviously as Bob mentioned, the visibility is weak, but we think, we’ve got the flexibility and we are showing the ability to generate improved returns every quarter so the way we’re managing today allowed us to deal with this environment with no material changes, ups and downs, but overall growth basis slightly down from what we have hoped to be but nonetheless continue to maintain flat margins.
Brian White – Collins Stewart
And what is the outsourcing pipeline look like right now? Are things kind of soften?
Craig Muhlhauser
I think in terms of the opportunities actually our funnel of new business opportunities strengthened quite significantly in the third quarter so we are optimistic, obviously, as Paul mentioned, our cash position gives us a unique advantage where we’re able to make investments and selective opportunities. Our third quarter was the strongest new bookings quarter we’ve had in a full year.
We’re up on the funnel of opportunities we’ve got in the company today, so we are feeling it’s going to be tough with the base business but obviously with these times come opportunities. So we’re taking an approach that we’ve worked hard to get to this position, and we are going to work hard to capitalize on the opportunity.
Brian White – Collins Stewart
Okay, thank you.
Craig Muhlhauser
Thank you.
Operator
Your next question comes from Jim Suva from Citi. Please go ahead.
Jim Suva – Citi
Great, thanks very much. In the past, you’ve talked about earning the right opportunity to now grow the business but in your preferred remark, you didn’t talk a lot about growth.
Is that because the overall environment has become deteriorated so much? And as we’ve look at 2009, do you actually think Celestica could grow the year or it is just the economic environment too challenging, and specifically, for the March quarter, when consumer typically seasonally declines, can you give us a little bit of primer of how would you think about 2009 as well as the March?
Paul Nicoletti
Jim, its Paul, I mean, I think to state the obvious, we are not going to give guidance here today on 2009. I think, as Craig mentioned, we are booking new business.
Third quarter was a very good quarter for us. The question mark is obviously around the base, and so I commented in my former remarks, around some of the IT enterprise bases, which for us you would have expected to see a 10% seasonal up in forth quarter from third, we are seeing them come down.
The point there is we are not sure what normal means anymore. Clearly, when we look at our revenue numbers, our objective would be to grow from where we are in ‘07, but I have said earlier and you’re aware.
I think visibility is certainly the lowest I’ve ever seen it and so the ability to forecast is pretty low. Our vise is to plan that revenue will be slightly lower than – let’s say what our rollups are and to set the cost structure accordingly and then we’ll chase revenues there, we will put some structure back in, but we are taking a pretty cautious tone as the way I characterized it.
Jim Suva – Citi
Okay. And as a followup, can you talk a little about your tax rate.
If I look at this quarter, it looks like your tax rate was about 2%? Which helped EPS by about 2 pennies, and your guiding to – I believe is 10%, what is the disconnect there?
And what allowed you to beat your taxes by 2% or $0.02, was that just conservative guiding or something in that quarter because, typically, I think you have preformed things out to make it more effective apples to apples.
Paul Nicoletti
Yes, so Jim, first the 10% adjusted rate out is consistent in the past, I mean, that is what we forecasted for the full year. You will see aberration through the quarter as tax expenses is an annual event and not a quarterly event.
What’s driving it is the composition of the earnings in the countries where we have lower taxes and where we have tax losses that we can benefit that is the fundamental driver. So, you have seen some volatility in our tax rate through over the last year.
We have been working to stabilize that, so if you recall, we are up at 25, rather down to 15. We think the 10% here is the sustainable level for where we are seeing the earnings and the predictability by region.
So, essentially, it is just where we earned our money and a little bit of –maybe a little bit of conservatism in the 15% earlier in the year.
Jim Suva – Citi
For the September quarter, it seemed like some income came in from low tax areas or that are something you’re not expected, if I remember, you guided specifically to about 15% for September.
Paul Nicoletti
Yes, we did Jim. So again, that is timing – it just timing within the quarter that our guidance on tax has always been an annual guidance.
And so our adjusted earnings tax rate is we are guiding 10% for the year and previously, it was 15% for the year.
Jim Suva – Citi
Okay, great, thank you.
Paul Nicoletti
Thanks Jim.
Operator
Your next question comes from Kevin Kessel from JP Morgan. Go ahead.
Kevin Kessel – JP Morgan
Thank you very much. Craig, I was just wondering if you could maybe talk a little bit about the consumer business.
Obviously, it was strong and you mentioned both existing as well as new customers. Is there anyway you give us a broad sense for how you’ve diversified that segment of your business in terms of – or maybe from a high level of these product lines?
Craig Muhlhauser
I’ll do my best. Thanks, Kevin.
Clearly, I cannot comment on there – we don’t comment on specific customers, but the majority of growth in this segment is with customers that are leaders in their field. So, first of all, we have been targeting leaders in their field segments that we are doing business in that today are gaining; smart phones, flat screen TVs, and what I call the printer-type segments.
So, those would be broadly the segments that we are participating in today.
Kevin Kessel – JP Morgan
Okay, and then also you are mentioning that it is one of the better bookings quarters, I didn’t hear that you said it (inaudible) or if this going back even further, is there anyway you to give us – to quantify that or give some context.
Craig Muhlhauser
Yes I said for the year? As we look back, it obviously was one of the highest booking quarters that we’ve had in the last three years.
Kevin Kessel – J Morgan
Okay, then, you obviously don’t want to quantify.
Paul Nicoletti
Kevin, we are not going to quantify, I mean, as we’ve discussed in past –you going to look us for the total revenue which is the sum of the new bookings and the base and we are managing both. As what Craig mentioned, we booked new business in these segments, (inaudible) particular industrial pretty exciting opportunities and you are seeing that turn into revenue which is the best part.
Kevin Kessel – J Morgan
Okay, I got and then just housekeeping, Paul, I think last quarter you made a comment that, on a combined basis in Mexico and Europe, were just slightly below breakeven. Can you just give us a sense for this quarter where they are about breakeven?
Paul Nicoletti
Yes, they were both profitable.
Kevin Kessel – J Morgan
Individually?
Paul Nicoletti
Yup, individually and together – is about that way.
Kevin Kessel – J Morgan
Great, thank you.
Operator
Your next question comes from Joe Witten [ph] from Longbow Research. Please go ahead.
Joe Witten – Longbow Research
Hi this is Joe on the line for Shawn Harris [ph]. My first question is that – and if you look at the revenue guidance, the midpoint of the guidance implies about $150 million sequential decline.
You’ve mentioned that you expect the IT communication market to be in the weaker side, but that would be a pretty significant decline just for that market. I mean, are there any other market looking across your spectrum that could also see a potential decline or at least a little bit worse than difficulty in seasonality?
Paul Nicoletti
Well, Joe, it’s Paul. So I think as I said earlier that the typical part is the interesting word in this environment, as I can say.
We would have – instead of [ph], we would have typically expected to see server and enterprise com go up from third quarter to fourth. And so again, in going back through history, generally a 10% increase, I’m not seeing that this year; we’re seeing declines.
Those would be the two that are just, I would say, are not performing consistent with history. Those would be the two; they are really the bulk of the reduction that you referenced.
Joe Witten – Longbow Research
Okay, and then with the restructuring charges that were incurred during the quarter year. When do we expect to see the benefits in that, I guess?
I think you originally said way back when the program was announced that in the 12, 18 months, a full payback. But how about the start to see some benefits in this piece now that the charges that have begun?
Paul Nicoletti
So, Joe, I think you’re seeing some pretty significant benefit today. Highest gross margins in almost ten years, and so you’re seeing the benefit.
Directionally, just to help you with your thinking in your model, I think when you see a restructuring charge in one period, you generally see a lag and see the benefit in two quarters forward. So a charge today would generally lead to full benefits one plus one quarter-end.
Joe Witten – Longbow Research
Okay, great. And then just lastly, with the currency issues that impacted the SG&A line.
Do you expect for us to continue or should we be modeling relatively flat SG&A dollars right now?
Paul Nicoletti
So I mean, I think from my elaboration [ph] in Q3. Having said that, as I said earlier, we were – we both had some gains; I think about $6 million in first quarter, $3 million in second, obviously took a big hit here in third.
I expect us to be marginally down in the fourth quarter but not anything in the magnitudes that we saw in third. So that’s captured in our guidance range.
Overall, I expect the SG&A in the mid-70’s.
Joe Witten – Longbow Research
Great. Thanks a lot and congratulations in the quarter.
Paul Nicoletti
Thanks very much.
Operator
Your next question comes from Todd Coupland from CIBC World Markets. Please go ahead.
Todd Coupland – CIBC World Markets
Hi, good evening everyone. If I could just talk a little bit about 2009 for some color.
When you think about what you did Q4 to Q1 last year and what you’re seeing at this point, is that a reasonable benchmark to be using, in particular, the 20% decline that you saw in consumer or should we be widening that out given what you’re seeing in the young markets?
Paul Nicoletti
Well, Todd, so I think – plans are this way. If you go back, you really have to look at what happened from Q3 to Q4 in ’07 to begin with.
So specifically, we saw a 6% increase versus seeing the decline of almost 8% that you’re seeing this year. So differently, we came down 7% from fourth to first but that was on the back of having gone up 6% from Q3 to Q4.
So we’re not going up from Q3 to Q4, so conversely I would not expect us to fall this hard into Q1. Now where that ends up, as I said earlier, visibility’s never been poor but what I look at right now, I’m not seeing the same historical reduction that you would’ve saw in Q1 of ’07 where we came down 18%, Q1 ’08 where we came down 17%.
No, I would not expect us to come down that hard because we’re not going up as high in fourth quarter.
Todd Coupland – CIBC World Markets
And do you make those comments with sensitivity to the channel stills and not really knowing what kind of sell-through the customers ultimately will get?
Paul Nicoletti
Yes, I mean, Todd, listen. You could expect – we’re talking to our customers pretty often here and asking them what they’re seeing and down-judging what they’re saying.
I mean, except the obvious, guys just don’t know. I think a lot of our customers just don’t know what they’re going to sell, so we’re putting our judgment on the numbers that they’re giving us.
So as I said, visibility, we’re not going to guide here for Q1 at this point; but all I can say is the 17% decline was on the back of an increase that we’re not seeing this year, and so logically suggest that we should not fall as hard.
Todd Coupland – CIBC World Markets
And just to clarify a comment you’ve made before, you said you’re planning below the roll offset you’re seeing. I mean, from our modeling purposes, should we assume that that’s flat with 2008 or is there any color you can provide on that?
Paul Nicoletti
Todd, we’re not going to give any real, any color on 2008 right now. I will say that we’ve made some good fraction on operating margins and overall, our goal is to hold the margins despite the revenue decline.
So if you look at our revenue range this quarter and the guidance range and translate what that means with the high and the low from an operating margin point of view, at the low end, we’re pretty darn close to 3% on 17.50% of our revenue. So that’s our goal, we’ve set a watermark for where we want to keep things above 3%, and that adds with everything [ph] to do.
As you know, obviously, there’s fixed costs in the business and it gets harder and harder to do, but that’s what we’re driving towards.
Todd Coupland – CIBC World Markets
Okay, great. Thanks very much.
Paul Nicoletti
Okay, thank you.
Operator
Your next question comes from Lou from Cowen and Company. Please go ahead.
Lou Miscioscia – Cowen and Company
Okay, great. I guess my question is on the same line, your comment on margins that you just made.
Is that going to take us through, I guess, ’09? And that’s obviously the goal that you’re setting, to stay above 3% operating margins even with some variability in revenue as you’ve obviously had in a lot of benefits cost setting.
Craig Muhlhauser
Yes, Lou, this Craig Muhlhauser and yes, that is our goal.
Lou Miscioscia – Cowen and Company
Okay. Can you give us a comment as to what are the things that tend to build up a bit when things do slow as just the inventory?
Returns on a year-to-year basis were good but actually picked up just a tad quarter-to-quarter. Just how are you feeling about inventory?
You think that you’re going to be able to keep it at reasonable level as you finish up the fourth quarter?
Craig Muhlhauser
Well, we think the opportunity to continue to improve inventory is there. We had a slight build in this quarter due to ramping new programs; those should flow through in the fourth quarter.
Obviously, we’re staying close to our customers, as Paul mentioned, to make sure that we don’t get caught with any excess inventory. But our inventory balances in terms of our, I would say, our non-performing inventory or the inventory that we’re holding for orders is the lowest it’s ever been, so the age of our inventory has improved dramatically.
The velocity has improved dramatically. We’re optimistic and we have plans to achieve further improvement in the fourth quarter, and these are the benchmarks we’re going to hold for the future.
So, I mean, this is a new model and you finally see the Celestica operating model kicking in. You see the benefits of our restructuring, you see the velocity improving.
You see the cash flowing, and we are developing, hopefully, credibility with you and other people that this is a model that we can keep going and we’ll eventually win.
Lou Miscioscia – Cowen and Company
Okay, and in just the last clarification, is that – Paul, I think you mentioned a 50 million basket that had to do with the buyback. Can you buyback, I guess, only 50 million of shares because of the debt covenant that you have?
Or did I misinterpret that?
Paul Nicoletti
No, you interpreted it correctly.
Lou Miscioscia – Cowen and Company
Okay, and that’s something you would all consider given where the stock is?
Paul Nicoletti
I mean, Lou, as we said all along, our priority is to invest into the business and grow the company, and that’s what we want to do. So I’m certainly not in the business of trying to second-guess what investors think the company is worth.
But suffice it to say, when I look at our balance sheet and I look at our stock price, it’s – I have a hard time making those numbers work. So right now, our goal is to use that cash frankly as a competitive weapon to take advantage of opportunities that I think are going to come down the pipe and that we’re not seeing yet because I think companies are still figuring out how to get through their own liquidity issues.
I think it’s going to create opportunity for us and that’s what our focus is.
Lou Miscioscia – Cowen and Company
Okay, thanks. Till next quarter, guys.
Paul Nicoletti
Thank you.
Craig Muhlhauser
Thank you.
Operator
Your next question comes from William Stein from Credit Suisse. Please go ahead.
William Stein – Credit Suisse
Thanks. First question, on the level of visibility we have today.
I think, Paul, you mentioned earlier worst that it’s been in years, perhaps ever. Can you compare it to 2001?
Paul Nicoletti
I think the difference between now and 2001 is the inventory in the system, so we had a lot more inventory back in the whole pipeline. Generally speaking, Celestica, as you know, you’re seeing it in the numbers and certainly in the competitors, full inventory performance sustain relatively good through this environment.
I think, 2001 is a long time ago, I would say probably a little bit worse right now, overall is probably good characterization.
William Stein – Credit Suisse
So the visibility is worse now?
Paul Nicoletti
Yes.
William Stein – Credit Suisse
And then with regard to the haircut you’ve given to the roll-up of customer forecast, is that – should I assume that it’s a deeper cut relative to what you normally do? Do you normally – I would assume you normally haircut that as well with the kind of history [ph], I think?
Or is that not the case? Any comments on that?
Paul Nicoletti
So we typically down-judge what our customers give us. And you’ve seen us come up here and pull some numbers over the last couple of quarters which end up being better than the midpoint, and so I’m happy to have been wrong in those scenarios.
Right now, what we’ve done to deal with the uncertainty is, as you see, we’ve widened the range, so I think taking a more pessimistic view and at the same time, widening the range of what we’re seeing.
William Stein – Credit Suisse
Great, thank you very much.
Paul Nicoletti
Thank you.
Craig Muhlhauser
Thanks.
Operator
Your next question comes from Edward Lee [ph] from Pacific Majority Capitals [ph]. Please go ahead.
Edward Lee – Pacific Majority Capitals
Thank you. The question I have is with respect to your cash balances.
Could you just give us a little bit of color as to what your cash is invested in these days?
Paul Nicoletti
Sure, good question. So through the quarter, I mean, we took a very hard look at all the money market funds we were invested in, better than any other market funds that have the ability to get into any asset back type of security.
I’d say the majority of our cash is invested directly in the US Treasury, second to that invested in direct deposits with highly-rated banks. So if you look at our banking group, you’ll see it’s a pretty strong syndicate of banks.
So that’s essentially what we’re doing, direct investments in those banks and/or – deposits, I should say, and/or in US Treasuries.
Edward Lee – Pacific Majority Capitals
US Treasury. And just a quick question.
In terms of the two bond issues you have outstanding, are the covenants in there any different just with respect to the restricted payments basket?
Paul Nicoletti
The covenants are the same. They’re different notes but the prevailing one, you have to solve both; one essentially, so they both give you the same problems, so to speak.
Edward Lee – Pacific Majority Capitals
One less restricted because it was issued a little bit before?
Paul Nicoletti
Yes, I mean, that may work a little bit different on the timing but it’s – essentially, they’re both the same.
Edward Lee – Pacific Majority Capitals
Right. Okay, thank you.
Paul Nicoletti
You’re welcome.
Operator
(Operator instructions) Your next question comes from Alex Blanton from Ingalls and Snyder. Please go ahead.
Alex Blanton – Ingalls and Snyder
Good afternoon. Just quickly, once this crisis is over and things return to normal, if ever, how high do you think your gross margin can go?
It was 7.4% in the quarter. Is that the ultimate or do you think it can go meaningfully higher eventually?
Paul Nicoletti
Hey, Alex, it’s Paul. I think, as usual, it’s somewhat depending upon the mix of the business.
And so I’ll answer the same, we talked about a near-term goal of between 3% and 3.5% operating margin that we believe our model with the current mix was a 3.5% to 4% overall margin profile. We think the SG&A overhead we have in place for the company can support a lot more revenue than the $8 billion annualized that we have today.
So I think 7.4% gross margin and 7.5% range is probably a good way to think about it overall SG&A dollar amounts in the zone that you’re seeing today.
Alex Blanton – Ingalls and Snyder
Okay, thank you very much.
Paul Nicoletti
Welcome.
Alex Blanton – Ingalls and Snyder
And now, I guess we all have to get off and get on our foot to end this call.
Paul Nicoletti
All right.
Alex Blanton – Ingalls and Snyder
All right. They promised not to do this again.
Paul Nicoletti
Okay, great.
Alex Blanton – Ingalls and Snyder
All right, thank you.
Paul Nicoletti
Thank you.
Craig Muhlhauser
Well, with that, I guess I’d like to thank everybody for joining and appreciate your continued support and interest in Celestica. Thanks, everybody.
Paul Nicoletti
Thank you.
Operator
Ladies and gentlemen, this concludes the conference call for today. Thank you for participating.
Please disconnect your line.