Celestica Inc. (CLS) Q3 2012 Earnings Report, Transcript and Summary

Good afternoon, my name is Megan, and I will be your conference operator today. At this time, I would like to welcome everyone to Celestica's 2012 Third Quarter Conference Call. [Operator Instructions] Manny Panesar, Director of Investor Relations, you may begin your conference.

Thank you, Megan. Good afternoon, everyone, and thank you for joining us on Celestica's Third Quarter 2012 Earnings Conference Call. We apologize for the delay today. However, as usual, we are available after the call for follow-up questions. On the call today are Craig Muhlhauser, President and Chief Executive Officer; and Paul Nicoletti, Chief Financial Officer. This conference call will last approximately 45 minutes. Paul and Craig will provide some brief comments on the quarter and then, we will open the call for Q&A. [Operator Instructions] Copies of the supporting slides accompanying this webcast can be viewed at celestica.com. As a reminder, during this call, we made forward-looking statements related to our future growth, trends in our industry, our financial and operational results and performance and financial targets 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 refer you to our cautionary statements regarding forward-looking information in the company's various public filings, including the Safe Harbor statement in today's press release. We refer you to the assumptions, risk factors and uncertainties discussed in the company's various public filings which contain and identify factors that could cause actual results to differ materially from those contained in our projections or forward-looking statements. These filings includes our Form 20-F and our subsequent reports on Form 6-K filed with the Securities and Exchange Commission, which can be accessed at sedar.com and sec.gov. During this call, we will refer to certain non-IFRS financial measures, which include adjusted gross margin, adjusted SG&A, adjusted operating margin or EBIAT, adjusted EPS, ROIC and free cash flow. These non-IFRS measures do not have any standardized meaning under IFRS and are not necessarily comparable with other non-GAAP financial measures presented by other companies, including our major North American competitors. We refer you to our press release, which is available at celestica.com for more information about these non-IFRS measures, including a reconciliation of the non-IFRS measures to the corresponding IFRS measures, as appropriate. I will now turn the call over to Paul Nicoletti.

Thank you, Manny, and good afternoon, everyone. Celestica delivered consistent profitability with solid returns and strong free cash flow in the third quarter despite the challenging environment. Third quarter revenue of $1.58 billion was slightly below our guidance range due to overall demand weakness. Revenue in the third quarter declined 10% sequentially, while on a year-over-year basis, revenue was down 14% with the majority of the decline due to the wind-down of our manufacturing services for RIM. Excluding RIM, third quarter revenue was down 1% sequentially and was down 5% compared to the same period of 2011. Some additional highlights for the third quarter include: non-IFRS operating margin of 3.3%, which was flat on a sequential basis despite lower revenue; adjusted earnings per share of $0.26, which was above the high end of our guidance range and included a onetime positive tax impact of $0.05 per share; IFRS net earnings of $44 million, strong free cash flow of $60 million. We repurchased and canceled 2.7 million shares in the quarter as part of our current stock repurchase program with total repurchases of 13.3 million shares this year. We completed the previously announced acquisition of D&H Manufacturing and ending cash balance was $598 million with no draws on our credit facility. From an end market perspective, while we experienced overall weaker demand in the third quarter across a number of our customers and end markets, we realized modest sequential growth in our Diversified and communications end markets. Our Consumer end market, representing 15% of total revenue, declined 35% sequentially, and was down 48% year-over-year predominantly due to the wind down of manufacturing services for RIM. Our Diversified end market was up 3% sequentially. On a year-over-year basis, diversified was up 14%, driven almost entirely by organic growth. While we experienced growth in Diversified, overall demand in this end market is, however, lower than what we expected particularly, in the Semiconductor segment. The Diversified end market now represents 21% of our total revenue, up from 16% in the third quarter of 2011. The communications end market comprising 37% of total revenue, was up 2% sequentially, which was lower than expected primarily due to the push out of a customer specific program. On a year-over-year basis, communications was down 9% due to demand declines across a number of customers. The Server end market, which represented 14% of total revenue for the quarter was down 17% sequentially, in part, due to a strong second quarter from one of our top customers. Revenue from the Server end market was down 9% compared to the third quarter of 2011 due to weak overall demand. The Storage end market, representing 13% of total revenue in the third quarter was down 6% sequentially, and was relatively flat year-over-year. Our top 10 customers represented 67% of revenue for the quarter, down from 70% for the third quarter of 2011. We had 1 customer in the quarter with greater than 10% of total revenue. RIM represented just under 10% of total revenue in the third quarter, down from 17% of total revenue in the prior quarter. We posted third quarter IFRS net earnings of $43.7 million or $0.21 per share compared to IFRS net earnings of $50.2 million or $0.23 per share for the same period last year. We recorded pretax restructuring and other charges at $8.9 million in the third quarter compared to a recovery of $2.6 million in the third quarter of 2011. Tax for the third quarter was a net recovery of $13.3 million compared to an expense of $8 million for the third quarter of 2011. The recovery for the third quarter was driven predominantly by 2 items: first, we recorded an income tax recovery of $10.6 million, arising from changes in our provisions relating to a certain historical tax uncertainty; and second, as a result of the D&H acquisition, we recognized $10.4 million of previously unrecognized deferred tax assets. We excluded the tax benefit relating to the D&H acquisition from our calculation of adjusted net earnings. Without the onetime tax recovery, this year's third quarter IFRS net earnings would have been $22.8 million or $0.11 per share. Adjusted net earnings for the third quarter were $54.8 million or $0.26 per share compared to adjusted net earnings of $57.4 million or $0.26 per share for the same period last year. Again, included in this quarter's adjusted net earnings of $0.26 per share was a onetime $0.05 per share benefit arising from the previously mentioned reversal of tax provisions. Without this onetime benefit, adjusted earnings per share would have been $0.21 per share this quarter. Our adjusted tax rate in the third quarter was negative 8%. For the 9 months ending September 30, our adjusted tax rate was approximately 6%. Looking ahead, we expect our tax rate to be in the 10% to 12% range. Third quarter non-IFRS gross margin of 7.2% was a sequential improvement of 30 basis points despite the lower revenue, primarily, due to favorable mix and onetime recoveries. Adjusted SG&A expense for the quarter was $55.9 million. Finally, pretax return on invested capital was 20%. As an update to the restructuring program previously announced at our July earnings call, we recorded restructuring charges this quarter totaling $8.3 million, comprised primarily of cash charges. Of the $40 million to $50 million restructuring cost, expected for the program, we have reported for $27.3 million to date, comprised of $12.3 million of cash and $15 million of noncash charges. Based on the projected timing of certain actions, we expect the restructuring program to continue into the first half of 2013. Moving on to working capital performance. Our inventory decreased by $73 million from the end of the second quarter, primarily due to the wind down of RIM manufacturing services. Inventory turns were 7.0 compared to 7.3 inventory turns in the second quarter. Consistent with the past few quarters, we negotiated cash deposits from RIM to fund higher working capital levels. As of September 30, our cash deposit was $30 million, which we expect to repay in the fourth quarter. Capital expenditures for the quarter were approximately $26 million or 1.6% of revenue. Cash cycle was 39 days, an increase of 5 days compared to the second quarter, predominantly due to lower revenue. We generated free cash flow of $60 million in the third quarter, driven predominantly by earnings. Moving to the balance sheet, the company's financial position continues to be strong. Cash balance at September 30 was $598 million, a decrease of $32 million from the end of the second quarter. While we generated $85 million in cash flow from operations during the third quarter, we paid $21 million to repurchase shares under our current share repurchase program, and we spent $71 million for the acquisition of D&H, which closed in September. At quarter end, we had no outstanding debt and our credit facility remains undrawn. As an update to our current share repurchase program, during the third quarter, we repurchased and canceled 2.7 million subordinate voting shares. We have repurchased and canceled 13.3 million shares this year, which concludes the current repurchase program per share that we intend to cancel. At the end of September, there were 186.2 million subordinated voting shares, and 18.9 million multiple voting shares outstanding. As a result of our strong financial position, continued cash generation and our commitment to delivering shareholder value, we're announcing our intent to repurchase and cancel up to USD 175 million of our outstanding subordinate voting shares through a substantial issuer bid. We expect to launch of the bid in the coming weeks and complete the offer during the fourth quarter of 2012. At the commencement of the offer, we will establish the maximum and minimum price that shareholders may select under the offer. We will fund the share repurchases using a combination of available cash on hand and cash from our credit facility. Moving on to fourth quarter guidance. With the wind down of the RIM manufacturing now substantially complete, we expect minimal revenue from RIM in the fourth quarter, and overall demand to continue to remain soft. As result, we are projecting fourth quarter revenues to be in the range of $1.425 billion to $1.525 billion. At the midpoint of this range, revenue would be down approximately 6% quarter-to-quarter. Excluding RIM, and again, at the midpoint of the range, revenue would grow by approximately 3%, primarily in our Diversified and Server end markets. For the fourth quarter, we expect our adjusted net earnings per share to range from $0.15 to $0.21 per share. Non-IFRS SG&A expense for the fourth quarter is expected to be in the $55 million to $57 million range. At the midpoint of our fourth quarter guidance, operating margin would be approximately 3%. I would now like to turn over the call to Craig, for some comments on the overall business environment and outlook, and an update on our key priorities.

Thank you, Paul, and good afternoon, everyone. As Paul mentioned earlier, the overall end market demand continues to be weak amid the current global economic slowdown. However, despite this challenging environment, Celestica continues to generate cash, deliver solid returns and continues to invest to strengthen our capabilities and accelerate the diversification of our revenue mix and customer base. For example, in September, we completed the acquisition of D&H Manufacturing Company, which has high quality and new product introduction and manufacturing capabilities, and supports our strategy to grow on the Diversified markets. D&H acquisition brings new capabilities and also compliments the strategic investment we made in June 2011, in acquiring the contract manufacturing division of Brooks Automation. Investments such as these are extremely important to accelerating generic growth and margin objectives. While we are facing demand headwinds, we remain very confident in our strategy and the opportunities for Celestica to gain market share in our target markets with industry-leading customers. Our financial position is very strong, as we continue to evaluate the various alternatives for effective deployment of our capital. While our #1 priority for investments continues to be the growth of our company, we are committed to generating short-term and long-term returns for our shareholders. Today's substantial issuer bid announcement allows us to distribute up to $175 million to shareholders who elect to tender while at the same time, increases the equity interest in Celestica for all other shareholders. We believe that a substantial share repurchase at this time is in the best interests of Celestica and our shareholders and it's an efficient and prudent deployment of capital. Over the last 3 years, and including this new issuer bid, we have returned over $400 million to our shareholders through share repurchases, while investing approximately $380 million back into the business through acquisitions and capital expenditures. Going forward, we expect to continue to use this balanced approach for the deployment of capital. In addition to generating value for our shareholders, we continue to be focused on providing value to make our customers successful. We continue to build further proof points of industry leadership and operational excellence, and sustainability throughout our global operating network as evidenced by a number of customer awards received this quarter. For example, CISCO recognized Celestica with 2 major supplier awards: the 2012 EMS Partner Operational Excellence and the Excellence in Partner IT Collaboration. We are very pleased to have received these 2 prestigious awards from Cisco that reflect the strategic and collaborative relationship we have fostered with this valued customer. We were also recognized as the winner of DMC's First annual Blue Sky Supplier Sustainability Award for our commitment to sustainability throughout our global supply chain and operational performance, and for our comprehensive global corporate social responsibility program and our contributions. We believe this customer recognition continues to reflect our commitment to setting the highest standards in our industry and for helping our customers meet the challenges of today's market. While we're honored to be recognized by our customers, we continue to be focused on raising the bar on operational performance and providing innovative supply chain solutions to enable our customers' success. Turning to our near-term outlook. Despite our lower revenue projection for 2012, we expect to achieve our target annual ROIC objectives of greater than 20% and our annual free cash flow objectives of between $150 million and $200 million. Based on our current customer forecasts, and the overall uncertainty in our end markets, we anticipate the first half of 2013 to remain challenging, with continuing downward margin pressures. While we're not providing formal guidance, we anticipate an operating margin in the range of 2% to 2.5% for the first half of 2013, with a reduced revenue outlook sequentially, for the first quarter. As we previously discussed, depending on a number of factors, including our product mix, we would anticipate achieving our operating margin target range of 3.5% to 4% with quarterly revenue of approximately $1.75 billion. While we continue to book new business across all of our targeted markets, the overall weak economic conditions, our limited visibility and the timing and production volume of new programs that we're currently launching, make it difficult to predict the precise quarter in which we will achieve this revenue objective. We are taking the necessary actions to adapt our cost structure, our capacity and resources to the reality of this current environment, while continuing to make investments to ensure that we remain strong and well-positioned for future growth and profitability. We remain committed to investing in our strategy and driving value for our customers and our shareholders. Our focus is on overcoming the external challenges we face today, and delivering on our revenue growth objectives at our targeted operating margins, while delivering on our ROIC and cash flow objectives. That concludes our prepared remarks. And now Megan, we're prepared to answer any questions.

[Operator Instructions] Your first one comes from the line of Joe Wittine from Longbow Research.

I was hoping you could just start with EBIT margins. First off, what drove the [indiscernible] expectations in the third quarter? And then secondly, what's going to drive things down, I guess, to 2.5 in the upcoming quarters?

Joe, it's Paul. I think, as it relates to Q3, we had some pretty favorable mix overall in the quarter, which just gave us a bit of margin strength. And second to that, as you can appreciate, as we were winding down such a sizable relationship with RIM, a lot of uncertainties around that and we just overall ends up a bit stronger than we expected as we completed that wind-down. As we look forward into the first quarter, certainly, we're feeling the impact of the overall absorption of losing such a sizable customer. In addition to -- as Craig mentioned, our expectations have some seasonal declines into first quarter. So those 2 things together are pressuring margins down.

Okay, makes sense. And then second, maybe, Craig, I was just hoping you can give some additional color on what you're seeing on, let's say, organically in the end markets right now? You mentioned challenging a couple of times in the prepared remarks. What type of organic growth, I guess, are you thinking that growth[indiscernible]?

Yes, let me take some time to just kind of give you some transparent -- I mean, within Diversified, we are experiencing sequential growth across all of our areas. As Paul mentioned briefly, our semi capital equipment -- our Semiconductor capital equipment business is going to grow with revenue contribution from our recent acquisitions, but the overall recovery due to the economic environment and the cyclicality of semi remains soft. Our healthcare are ramping, Aerospace and Defense continues steady, within Servers, we're ramping new programs and the strength of existing programs are expected to drive sequential growth into the mid- to high-single digits. Storage is relatively flat. Communications, slight decline sequentially, however, the trend is more customer and program-specific. And the current customer forecasts are challenging in the first half and were not providing guidance, and as we mentioned, we're going to be under some margin pressure, but we're very confident in our strategy. We're very strong, we continue to invest and obviously, it's not a question of if, it's just a question of when we get back to the targeted returns that we mentioned in the prior calls.

Great. Just a really quick follow up for the Consumer businesses. Is it still reasonable to assume that's going to be about 10% of Celestica, with RIM fully in the rearview now going forward or will it be a little bit under?

You should expect that Consumer would fall below the 10% as we go forward. So as I mentioned in my comments, RIM this quarter was slightly less than 10%. So in your modeling, take that to 0, with Consumer overall at 15%. So just pro forma this quarter, Consumer would be around 5%.

I thought RIM was going to stay around a little bit, is that not the case anymore?

No. As I said, we're done as far as our manufacturing operations with RIM. So revenues from RIM in the fourth quarter will be negligible.

So no more services either?

That's right, so while the overall demand in services have gone down, we'd expect that as we look forward that, that would also go to 0.

Your next question comes from the line of Sherri Scribner from Deutsche Bank.

I just had 2 quick questions. One, on the margin guidance for the first half of '13, I think you said, Craig, 2%, 2.5%, is that primarily related to volume and fixed cost absorption? Or -- and are you guys going to take some restructuring actions to sort of get that back on track?

Well, Sherri, it's Craig. And basically, the speed of the wind down, as Paul mentioned, we've had a very fast and efficient wind-down with RIM. So the absorption of costs, the rate at which we've been able to take out cost has not kept up with that. We've announced the $40 million to $50 million range of restructuring. We're continuing to make investments, and that's one of the major areas. We're not stopping investing. So we're looking for your support to continue to invest in our strategy, we believe it's the right strategy for the business. So we're not shortchanging our future. Structurally, we think we're strong. We've got a backlog of business, so it's primarily our cost structure, our investment philosophy that balance short-term and long-term, and then the timing of the ramp of new programs. So the volume uncertainty and the impact on the base, obviously, the speed and volumes associated with the newer programs are challenged. So a lot of moving parts, very solid operating platform and very solid investment strategy, very solid execution and we just, we're going through a period where we are trying to keep things in balance and at the same time, have this, I'll say, bottom, if you will, 2% to 2.5% as we rebuild the top line and gain momentum through the launch of the new programs.

Okay. That's helpful. And then, following up on the share count for the December quarter, and as we move forward with the substantial issuer bid, from the recent buyback, should we expect share count to go down a bit in December? And then, with the issuer bid, what are you assuming for share count in the December quarter that gets you to the EPS range?

So Sherri, the share count, as of the end of September is the share count minus any impacts from the bid we announced today. So in other words, the normal course that we had is essentially complete, as far as shares we plan on buying for cancellation. So where we will be now will depend, for the December quarter, will depend on how many shares are tendered. So I'll leave that to you as far as how you want to assume -- we haven't taken any of that benefit into account in setting our guidance, given the uncertainty around it. So the EPS range that we've provided does not assume any lower share count for where we ended the quarter.

Okay, so you assumed a flat share count, and you didn't incorporate that?

That's correct.

Your next question comes from the line of Matt Sheerin from Stifel, Nicolaus.

Just a couple of questions. As you look at the new program opportunities over the next few quarters, and clearly, organic growth is -- it's been weak for a lot of your competitors as well, there is industry capacity out there. So are you seeing any pricing pressure, are you seeing any of your competitors trying to fill capacity at lower prices which will put pressure margins even further on top of the issues that you're seeing now?

Well, yes, I mean -- Matt, it's Craig. We can -- certainly, it's a very competitive environment. Certainly, in the declining market, we see price pressure, we see customers making -- customers making decisions on consolidating their supply base. And then, we see them actually making a trade-off between value versus risks. So customers are smart enough to know that you almost -- you pretty much get what you pay for. And you kind of balance the value you get from the supplier with the risk specially, if it involves transferring programs and outsourcing in this environment, because certainly, no customers want to miss of their revenue targets. So it's balanced. It's -- continues to be competitive, but we're taking share, we're building capabilities. And as I said before, Matt, we feel very, really confident in our strategy and obviously, we have our return objectives. We did, once again this quarter, we're meeting our strong cash flow generation. So although there is price pressure, you've got our margin targets, you know what for, you know our targets. That's the path we're on. And we will manage the business to get there.

You've certainly been quite disciplined in terms of that strategy since you've been at the company, you've been running the company. So that's sort of my question, are you shifting off of that strategy given the weak demand environment?

No, actually, we're doubling down, actually.

Okay. And just question for Paul, in terms of the balance sheet. What cash level were you comfortable with in terms of running the business for working capital and, let's say, some M&A activity given particularly post the transaction that you're going to be doing in the next quarter?

Matt, generally, as a rule of thumb, we look at meeting around between 4% and 5% of revenues in cash to run the company. So if you take a $6 billion number then obviously, that will be around $300 million or so. So that would be the number that we would need, and that would ebb and flow depending upon where the growth is. But that's a good number to go with. So as far as we announced, $175 million off the $598 million will still keep us above that number. And we do expect to generate additional cash flow going into Q4 as well. So we feel pretty comfortable with the overall balance sheet even after this bid. We may -- as we commented on the call on the comments, we may draw on the credit facility for a period of time just as we work on moving cash around the enterprise. As we're sure you can appreciate, not all the cash is exactly in the spots that we need it when we need it. But if that were to occur, it will be for a relatively short period of time.

Your next question comes from the line of Brian Alexander from Raymond James.

Just to follow on Matt's question, to what extent is the revenue weakness, maybe, being driven by customer disengagements outside of RIM, due to the fact that you are very disciplined on pricing and margins and returns and, perhaps, some of your larger competitors that have more capacity are not as disciplined and they're pricing more aggressively? Or is that not really a big factor, you think it's really just more macro at this point?

It's more macro at this point. It's the rate of the new program introductions and timing of such.

Okay. And then just to the clarify, to get back to 3.5% to 4% I think you said earlier, Craig, you need to get the revenue back to $1.75 billion, or have you lowered that threshold because based on where we are now, I guess, that's about 25% above where the revenue could land in the next couple of quarters, so I just wanted to confirm that, and that you haven't lowered the revenue thresholds and that's where you need to get back to?

Brian, it's Paul. So we haven't lowered it. I mean, suffice to say, that we're looking at everything again. So even in respect of the restructuring program that we announced, as you know, we had a range on that expected cost. And so in light of the environment, we're certainly going back and taking another look at what we can do and utilizing some of that program that we had already announced. So at this point, we're not coming up with a different number from the 17.50, but suffice to say, we are looking to take out as much cost as we can given the environment.

Okay. And then, I think you said 1 10% customer which obviously wasn't RIM this quarter, should we assume that one came out of the communications segment?

That's a fair assumption.

You're next question comes from the line of Amit Daryanani from RBC.

Two questions for me. One, could you just talk about, for the December quarter, how much is D&H contributing to the model? And then excluding that, would the Diversified segment still be up in the December guidance?

So Amit, it's Paul. When we announced the acquisition, we talked about being around $80 million of revenue annualized. So as far as the quarterly impact is concerned, it's around that number. And yes, we still would expect some growth, even putting that aside into the fourth quarter.

Got it. And then, maybe, if I just kind of go back to your comment to -- in the first half of 2013 margins being the 2% to 2.5% range, maybe you can just give some more color over there because even back in the late '08, early '09, through the recession time period, you guys never got any closer to handling the margin structure. And you seem to have managed the RIM transition from margin level of 3.3% to potentially 3% and at December, so what is that -- what is so dramatic that's happened in the first half beyond the seasonal decline of 78%, potentially, that is taking margins down to the low 2% range?

I mean, certainly, if you go back from that time to today, I'd say, the overall mix of business and the pricing environment, would be more competitive today than it was back then, Amit. And then second, our level of investment today would be higher. So clearly, we are growing Diversified at a rapid pace. That's our goal. As you know, our intent was to get that to the, at least, 30% of revenues of the company. That was with our Consumer exposure. Clearly, today, Craig and I think more that 50% is where we want to get it to over the next couple of years. And so we're investing heavily to add capabilities, investing in new ramps to get there. So if I had to point to a few things, those will be some of the things that are holding the margin down. And as Craig emphasized, we're not backing off on the investments that we think are needed as far as driving net revenue growth longer-term.

And then just finally, when it comes to capital allocation, you guys have obviously been very aggressive on the buyback process, you announced one more today. Why the hesitance, I guess, to have -- not have a dividend policy as well? Because to me it seems that cash generation could handle both capital allocation processes fairly well?

So Amit, that's not something that we've dismissed as far as strategically. I'd say, today, as we look at our businesses and given some of the volatility, clearly, in the topline, both positive and negative. So we continue to look for acquisition opportunities. Our view is to be able to meter it with stock buybacks as a preferred method. That's not to say that over the strategic plan, we may not reassess dividends. But at this point in time, buybacks are how we choose to return that capital.

Your next question comes from the line of Jim Suva with Citi.

Focusing on the topic of capital allocation and the accelerated stock buyback of the $175 million, question is, can you help us understand the methodology or the logic behind that versus saving a lot more for accretive M&As. Celestica has been very attractive at finding tuck-in acquisitions, have the M&A pipeline slowed down? Or you still have sufficient force, can you just kind of help us understand the balance between M&A and stock buyback?

Jim, I think that-- it's Paul. So the comments Craig made around the last couple of years, again, with this announcement of this buyback being 50%, buybacks, 50% growth, is a good way to think about of it going forward. As far as, is this a signal of less acquisition opportunity, I wouldn't look at it that way. Certainly, the tepid growth environment is making our need for working capital investments, as an example, lower. So we need to step back and take that into account and then, also take into account that Celestica's balance sheet, as you know, continues to be unlevered. And that, as the right opportunity were to come along, we wouldn't hesitate to add some leverage again for the right deal. So I would not equate it that the pipeline of what we're looking at or aren't, and as far as M&A, that we're backing up that way. But certainly, our needs as far as the base business, clearly, will be lower given that the revenues are down. And we think right now given where Celestica is, it's just a premium use of capital.

Okay. And then, I think you made a directional comment about, from Q1 would be, I think you have said down [indiscernible] year-over-year and sequentially? And did I hear that statement correct for the sales for the March quarter?

So we didn't give a specific number, Jim. Certainly, year-on-year, it will be down given that RIM will no longer be in the revenue portfolio starting this quarter. So with certainty, it'll be down year-on-year. Sequentially, as Craig mentioned, we would expect it to be down as well. We're not dimensioning that for you here today. But we would expect it to go down and urge you to make your own conclusions based on history and what you think is happening on the end markets as far as seasonal declines are concerned.

Your next question comes from the line of Brian White with Topeka.

I'm wondering, could you talk a little bit about what the acquisition pipeline looks like, you've done some great deals here, how does it look over the next year?

So we continue -- and our priority for acquisitions are certainly, capabilities that are additive to our diversified markets. So as you mentioned, really feel like we've added some great capabilities with D&H, as far as precision machining is concerned which really rounded our offering for the semiconductor market. And also, the capability that we believe through time, we can leverage into others, the Diversified, particularly into the Aerospace market. Priority-wise from here, would be additional capabilities, be it on the services side, on the design side, that again, would be focused on us adding more value to the customers beyond just a manufacturing that we do in our facilities. So I think those will be some of the highlights that we would be focused on. Again, I think, anything that -- I would not say that we're looking at overall capacity, anything that adds capabilities or opens us up to new end markets that we currently don't have exposure to.

And when we think about market share in the first half, are there any market share shifts or is this purely, the end markets are weak in the first half?

Well, I think, generally, I'd say it's an overall end market weakness that we're seeing. I will say that programs come in and out of EMS suppliers all the time. So that's a normal course function of, as Craig mentioned, suppliers looking to consolidate and through time, we feel we get our -- we win and we lose. So I won't say that there won't be programs moving back and forth because that's normal course in our business. But overall, it's end market-driven, is the real factor.

Your next question comes from the line of Gus Papageorgiou with Scotiabank.

Most of my questions have been answered, but just on the gross margin, despite the fact that sales are down quite a bit year-over-year, the gross margin hung in there. Just how much was the gross margin impacted by overhead absorption from the RIM business in the quarter? And as you go into next year, where do you see the gross margin going?

Gus, it's Paul. As far as being able to answer the specific question, that's difficult to do, given that costs were coming out during the quarter, we executed some revenue. So I'll answer it more to that, where do we see it going forward. With operating margins in the 2% to 2.5% range, gross margins should likely be in the 6.5% to 7% range, that would be where you'd expect to see it. And then for it to build from there as revenue grows.

So in that -- you said that you can reach your target operating margins, 3.5% to 4% around $1.75 billion. So if you hit that, where would the gross margin fall roughly?

I think you'd, look, you'd be in the 7.5% zone at that --for that model.

Your next question comes from the line of Naser Iqbal from Salman Partners.

I'm just wondering if you could walk through, like, in terms of the first half of '13, the 2%, 2.5% margin, I mean, you're taking the restructuring charges of $40 million to $50 million, so I would've thought in -- given that the gross margins were 7.2 in the third quarter and you're guiding for 3% or so margin in the fourth quarter, but in terms of the restructuring charges offsetting some of maybe the under-absorption issues, I'm just trying to understand, like, why those restructuring charges wouldn't lead to higher margins or better than the 2.5% -- the 2% you're talking about?

Naser, it's Paul. I mean, in our previous restructuring programs, Naser, when you restructure and revenue stays flat, you see more of that savings fall into the bottom line. Certainly, in this case, we're restructuring but at the same time, the revenue is going away. Now that said, last quarter, we expanded our restructuring program to take a broader approach to overhead, which we are doing. But clearly, with the base end market revenue being weak and in some instances coming down, that's not helping us as far as overall absorption is concerned. If you look at things from a gross margin point of view, into the previous questions, things are a lot tighter. But as the company get smaller, the overhead or the SG&A impact becomes a larger impact to overall operating margins. So a lot of dynamics at play and as I said earlier, our continued investments in some of the growth areas. So again, as the company shrinks into the first half, those investments become a larger proportion of the total profit pool. So those are some of the factors at play as we look at the first half.

Okay. And just, Craig, I think, if we understand that 2014 -- you talked about it before that you expect some good program wins to kick in, in 2014. So where there's gap between 2012 and --2013 is this gap for those '14 programs come in. Do you think that in terms of what you need to win some more programs, is it just that you have everything in place and it's just the weakened demand environment, or do you think that, that would be investing in capabilities that's required to expand more of your capabilities in terms of winning more business?

Yes. So the -- 2013 for Celestica, as you know, is a year of transition. We've taken the impact of a 20% customer, we wounded down very effectively. We have done it at speed, part of the speed at which we've wound down has impacted our short-term cost structure. As Paul mentioned, we're investing. We're definitely investing for the future. Do we have everything in place? We're constantly investing in capabilities to strengthen our market position. We are winning market share, our Diversified business continues to grow. We're talking about the rate of growth and at the same time, balancing that against not getting into an era where we start destroying kind of the economic model we've built here where we give away price to get business that is not aligned with the strategy. So it's a year of transition, unfortunately, we're in a demand environment which makes it difficult to show the immediate benefit of everything we're doing. Obviously, as Paul mentioned, it's tough for us to predict the future but we know we got an operating model that we'll adjust and we'll adjust as fast as we can. And we'll -- certainly, we're building that foundation and transition from 2013 to 2014 and 2015 to realize the full benefit. I mean, now is the time for a company like Celestica to take advantage of the work we've done. Create the balance sheet and the strategy that's going to deal with not only a tough economic environment, but take market share not on the basis of not being price competitive or price only, but on the basis of the value we deliver.

Megan, we'll take one more question, and as a reminder, we are available for follow up questions after the call.

Your last question comes from the line of Todd Coupland with CIBC.

Just wanted to confirm, the share count you gave -- 1 technical question, the share count you gave of 204.9, that's the shares outstanding as of now? That's not an average number?

Yes, that's right, Todd. I think it's actually 205.1, so 18.9, 186.2 million. 18.9 multiple and 186.2 million for SVS.

Okay. And my second question is just thinking about the up margin for first half to 2.5, where would rather you need to be, to be at the low end of that range?

Todd, I mean, it's difficult to answer it right now. Because I'd say, we're making decisions dynamically here a bit on that just -- the next quarter forecast, but what we see -- and what we expect to see 3, 4 quarters out. So we're not going to be that specific at this point in time. I did -- we did, if you take the fourth quarter and where we're guiding revenue, we did give you an indication that we expect first quarter revenues to go down sequentially. So I'll let you come to your own conclusions on that. How much you want to take it down by to get to that 2%.

We just like to thank everybody for their interest and support, and we look forward to our continuing dialogue. Thank you very much.

Thank you.

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