Celestica, Inc.

Thank you for standing by and welcome to the Celestica fourth quarter 2020 earnings call. At this time, all participants are in a listen-only mode. Please be advised that today's conference is being recorded. If you require any further assistance, please press star zero. Thank you. I'd now like to hand the conference over to Craig Oberg, Vice President, Investor Relations. Mr. Oberg, please go ahead.

Good morning, and thank you for joining us on Seleska's fourth quarter 2020 earnings conference call. On the call today are Rob Mayonis, President and Chief Executive Officer, and Mandeep Chawla, Chief Financial Officer. As a reminder, during this call, we will make forward-looking statements within the meanings of the U.S. Private Securities Litigation Reform Act of 1995 and applicable Canadian securities laws. Such forward-looking statements are based on management's current expectations, forecasts, and assumptions, which are subject to risks uncertainties, and other factors that could cause actual outcomes and results to differ materially from conclusions, forecasts, or projections expressed in such statements. For identification and discussion of such factors and assumptions as well as further information concerning forward-looking statements, please refer to today's press release including the cautionary note regarding forward-looking statements therein, our most recent annual report on Form 20F, and our other public filings which can be accessed at SEC.gov, and CDAR.com. We assume no obligation to update any forward-looking statement except as required by law. In addition, during this call, we will refer to various non-IFRS measures, including operating earnings, operating margin, adjusted gross margin, adjusted return on invested capital or adjusted ROIC, free cash flow, gross debt to non-IFRS trailing 12-month adjusted EBITDA leverage ratio, adjusted net earnings, adjusted EPS, adjusted SG&A, and adjusted effective tax rate. Listeners should be cautioned that references to any of the foregoing measures during this call denote non-IFRS measures, whether or not specifically designated as such. These non-IFRS measures do not have any standardized meanings prescribed by IFRS and may not be comparable to similar measures presented by other public companies that use IFRS or who report under U.S. GAAP and use non-GAAP measures to describe similar operating metrics. We refer you to today's press release and our Q4 2020 earnings presentation, which are available at Seleska.com under the investor relations tab for more information about these and certain other non-IFRS measures, including a reconciliation of historical non-IFRS measures to our most directly comparable IFRS measures from our financial statements. Unless otherwise specified, all references to dollars on this call are to U.S. dollars, and per share information is based on diluted shares outstanding. Let me now turn the call over to Rob.

Thank you, Craig. Good morning, everyone, and thank you for joining us on today's conference call. Lustica delivered a solid fourth quarter to end a year of unprecedented challenges. Fourth quarter revenue was within our guidance range, while operating margin and adjusted EPS were above the midpoint of our ranges. Within our ATS segment, we achieved strong revenue growth in health tech and capital equipment and reported sequential improvement in segment margins for the third consecutive quarter, as well as improvement in segment margin on a year-over-year basis. Despite these successes, demand weakness and commercial aerospace offset the strong growth in other businesses. Within CCS, we successfully concluded our Cisco disengagement in the fourth quarter. Q4 revenue decreased year-over-year and sequentially, with Cisco revenue declines more than offsetting growth in other areas. Despite the revenue decline, the segment posted expanded margin on a year-over-year basis for the fourth consecutive quarter and operated above our 2% to 3% target range. Our JDM business continues to experience impressive growth. JDM revenues were $211 million in the fourth quarter, up 53% year-over-year. JDM represented approximately 15% of our total company revenues in Q4. Many of you attended our JDM roundtable in December, where we discussed key elements of the business. For example, we noted that we have more than 500 JDM design engineers across the globe, working on current and next-generation hardware platform solutions. We have over 280 patents safeguarding our hardware technical advantage, and we drive a robust IP management process. Since the inception of JDM, we have launched over 150 programs and shipped more than 2.5 million units to our customers worldwide. The term joint design and manufacturing, or JDM, describes this offering as it began over a decade ago as a co-development model. However, we feel the term does not fully reflect the extensive evolution of our business over the last 10 years. It does not describe the breadth and depth of our current offering and roadmaps, the scope of our capabilities across the product lifecycle, nor the leading-edge solutions which have been fueled by more than 10 years of significant R&D investment. Therefore, moving forward, we will be referring to JDM as hardware platform solutions. or HPS. Said more simply, JDM is an engagement model and capability that we offer within our broader hardware platform solutions offering. We believe that HPS is a highly strategic offering within Celestica's portfolio, currently enabled by a comprehensive slate of more than 40 hardware platforms. Moreover, our HPS offerings support customers across the product lifecycle, and generates accretive margins, sharing many of the highly valued attributes of our ATS segment. Additionally, HPS has a diverse patent portfolio, comprehensive product roadmaps, and a deep ecosystem of partnerships with industry-leading companies. HPS revenue and ATS segment revenue together represent what we call lifecycle solutions. In 2020, lifecycle solutions represented more than half of our total revenue, and had an average growth rate of 8% over the last three years. We expect the revenue growth of lifecycle solutions to continue in the coming years and for it to represent a larger portion of our total revenues. This is in line with our diversification strategy and provides higher value added solutions to enable our customers. I will provide some additional color on our end markets and outlook shortly. But first, I will turn the call over to Mandip to give you some details on the fourth quarter and our first quarter 21 guidance.

Thank you, Rob. And good morning, everyone. For the fourth quarter of 2020, revenue of $1.39 billion was within our guidance range and decreased 7% year over year and 11% sequentially. Our non-IFRS operating margin for Q4 2020 was 3.6%, 10 basis points above the midpoint of our revenue and adjusted EPS guidance ranges, up 70 basis points year over year, and down 30 basis points sequentially. The year-over-year improvement was driven by improved productivity and mix across several of our businesses. The sequential decrease was due to mix in CCS, partly offset by improvement in ATS. Non-IFRS adjusted earnings per share were 1 cent above the midpoint, up 8 cents year-over-year, and down 6 cents sequentially. Fourth quarter IFRS earnings per share were 16 cents, up 21 cents year over year, and down 8 cents sequentially. Our ATS segment was 37% of our consolidated revenues during the quarter, down from 39% in the fourth quarter of last year. ATS revenue was down 12% compared to last year, and in line with our expectations of a low double-digit percentage year over year decline. Sequentially, ATS revenue was down 2%. The year over year and sequential decline was driven primarily by continued pressure in A&D specifically in our commercial aerospace and industrial businesses, largely due to COVID-19. This was partly offset by continued strength in health tech and capital equipment driven by new program ramps. Our CCS segment revenue was down 4% year-over-year, in line with our expectations of a low single-digit year-over-year decline due to the Cisco disengagement. Sequentially, CCS revenue was down 15%, As we look forward to the next few quarters, the disengagement from Cisco will continue to impact our year-over-year comparables. However, we are pleased with the growth we are seeing in the rest of the CCS portfolio. Revenue from our remaining CCS customers grew by 15% in Q4 2020 compared to the prior year period. Within our CCS segment, the communications end market represented 43% of our consolidated fourth quarter revenue, up from 39% in the fourth quarter of last year. driven by growth in HPS. Communications revenue in the quarter was up 2% year-over-year, primarily due to robust demand from service provider customers, offsetting the impact from the Cisco disengagement. Sequentially, communications revenue was down 15%, mainly driven by the Cisco disengagement. Our enterprise end market represented 20% of consolidated revenue in the fourth quarter, down from 22% in the same period last year. Enterprise revenue in the quarter was down 13% year-over-year and down 14% sequentially. Year-over-year and sequential declines were mainly driven by demand softness. Our HPS business continued to be an area of strength in the fourth quarter, with revenue up 53% year-over-year, driven by new program ramps and our ability to deliver on increased demand from our hyperscaler customers. For 2020, HPS achieved $862 million of revenue. up 80% compared to 2019, and accounted for 15% of our total company full-year revenue. As Rob mentioned, lifecycle solutions revenue is comprised of the revenues from our ATS segment and HPS business. For the full year 2020, lifecycle solutions represented $2.95 billion in revenue, up 7% year-over-year, and accounted for 51% of our 2020 consolidated revenues. Our top 10 customers represented 67% of revenue during the fourth quarter, down 1% from the same period last year and last quarter. Top 10 customers represented 66% of our 2020 revenue, up 1% from last year. For the fourth quarter, Celestica had two customers who represented 10% or more of our total revenue compared to one in the prior quarter and two in the fourth quarter of 2019. No customer represented more than 10% of 2020 revenues. Turning to segment margins. ATF segment margin continued on a positive trajectory, achieving a margin of 3.9%, up 90 basis points year-over-year, and up 20 basis points sequentially. The year-over-year improvement was driven by volume leverage in our capital equipment and health tech businesses, combined with our productivity actions, which more than offset the headwinds in our A&D business. The sequential improvement was driven by improved performance across a number of businesses. PCS segment margin of 3.4% was above our target range of 2% to 3%, up 50 basis points year-over-year, but down 60 basis points sequentially. Year-over-year margin improvement was driven by our productivity actions and favorable mix. The sequential margin decline, which was anticipated, was mainly due to normalizing demand and fewer one-time recoveries. Moving on to some additional financial highlights for the quarter. IFRS net earnings for the quarter were $20.1 million, or 16 cents per share, compared to a net loss of $7 million, or a 5 cent loss per share in the same quarter of last year, and net earnings of $30.4 million, or 24 cents per share in the third quarter of this year. Adjusted gross margin of 8.4% was up 140 basis points compared to the same period last year, and up 30 basis points sequentially. Year-over-year and sequential improvements were largely driven by improved mix and productivity efforts across the business, despite lower revenues. Fourth quarter adjusted SG&A at $56.5 million was up $4.1 million versus a year ago, primarily due to higher variable compensation. Adjusted SG&A was relatively flat sequentially. Non-IFRS adjusted operating earnings were $50 million, up $6.3 million from the same quarter last year, and down $10.1 million sequentially. Our non-IFRS adjusted effective tax rate for the fourth quarter was 19%, compared to 27% for the prior year period and 20% last quarter. We are pleased with the improvement in our overall tax rate, largely due to a normalization of profit mix. For the fourth quarter, adjusted net earnings were $33.3 million compared to $23.7 million for the prior year period and $40.9 million last quarter. Non-IFRS adjusted earnings per share of 26 cents were within our guidance range and up 8 cents year-over-year due to higher operating earnings, lower taxes, and lower interest expense. Sequentially, non-IFRS adjusted earnings per share were down 6 cents mainly due to lower operating earnings partly offset by lower taxes. Fourth quarter non-IFRS adjusted ROIC of 12.4% was up 1.8% compared to the same quarter of last year and down 2.8% sequentially. Annual adjusted ROIC for 2020 was 12.4%, up 3.2% compared to 2019. Moving on to working capital. Our inventory at the end of the quarter was $1.09 billion, down $114 million sequentially, and up $99 million relative to the prior year period, largely driven by investments in our HPS business. Inventory turns were 4.4 in the fourth quarter, down 0.3 turns sequentially, and down 1.1 turns year over year. Capital expenditures for the fourth quarter were $19 million, or approximately 1% of revenues. Non-IFRS free cash flow was $18.5 million in the fourth quarter, compared to $43.8 million for the same period last year. We are pleased to have been able to generate positive free cash flow for eight quarters in a row, despite the unprecedented challenges in 2020. Looking at the full year 2020, we generated non-IFRS free cash flow of $126 million, in line with our full year target of generating $100 million or more. Cash cycle days in the fourth quarter were 73 days, up 11 days year-over-year, and up 12 days sequentially. Our cash deposits at the end of December 2020 were $175 million, down $32 million sequentially. Moving on to some additional key metrics. We continue to maintain a strong balance sheet. Our cash balance at the end of the fourth quarter was $464 million, down $16 million compared to 2019, and up $12 million sequentially. Combined with our $450 million revolver, which remains undrawn, we have a very strong liquidity position of over $900 million in available funds. We believe we have sufficient liquidity to meet our current business needs. Our gross debt position was $470 million at the end of December 2020, while our net debt was $6 million, an improvement of $13 million versus the end of the third quarter of 2020. Our fourth quarter gross debt to non-IFRS trailing 12-month adjusted EBITDA leverage ratio was 1.6 turn, flat sequentially, and a 0.6 turn improvement from Q4 2019. The year-over-year improvement is the result of strong free cash flow generation, disciplined debt reduction, and improved operating profitability. At the end of December 2020, we were compliant with all financial covenants under our credit agreement. As we have shared previously, our capital priorities are to return 50% of free cash flow to shareholders and to invest the remaining amount in the business over the long term. We are pleased with our track record over the last 10 years, making strategic investments in the business while at the same time returning over $1.2 billion to shareholders through buybacks. When looking at investments, we are focused on both organic opportunities and capability-based acquisitions. When approaching an acquisition, Our approach and filter are well-defined. We look for investments that are aligned to our strategic roadmaps with a filter intended to ensure that they drive a creative EPS in year one and an ROI that exceeds our cost of capital by year two or sooner. We also weigh these investment decisions against alternative uses of cash, such as share buybacks. Recently, our stock price has been undervalued, having traded below tangible book value for the majority of 2020. In response to this undervaluation, and in order to opportunistically purchase shares, we launched a share buyback program on November 19th. In the fourth quarter, we incurred $7 million of restructuring charges to adjust our cost base to better adapt to fluctuating levels of demand, including in our A&D business, and as we completed the Cisco disengagement. For the full year 2020, we have recorded $26 million of restructuring charges against our earlier estimate of $30 million. Now turning to our guidance for the first quarter of 2021. We are projecting first quarter revenue to be in the range of $1.175 billion to $1.275 billion. At the midpoint of this range, revenue would be down approximately 7% year over year and down 12% sequentially. First quarter non-IFRS adjusted earnings per share are expected to range between $0.18 to $0.24 per share. At the midpoint of our revenue and adjusted EPF guidance ranges, our non-IFRS operating margin would be approximately 3.4%, an increase of 50 basis points over the same period last year, and a decrease of 20 basis points sequentially. Non-IFRS adjusted SG&A expense for the first quarter is expected to be in the range of $51 to $53 million. Based on the projected geographical mix of our profit in the first quarter, we anticipate our non-IFRS adjusted effective tax rate to be approximately 20%, excluding any impacts from taxable foreign exchange or unanticipated tax settlements. Turning to our end market outlook for the first quarter of 2021. In our ATS ed market, we anticipate revenue to be down in the mid single digit percentage range year over year due to sustained weakness in commercial aerospace as a result of COVID-19, partly offset by growth in our capital equipment and health tech businesses. For 2021, however, we are targeting ATS revenue to grow 10% year over year, largely driven by ramping programs in capital equipment and health tech. In CCS, We anticipate our communications and market revenue to be down in the high single-digit percentage range year-over-year, driven by our disengagement from Cisco. The remainder of our portfolio is growing, driven by strength in HPS. In our enterprise end market, we anticipate revenue to decrease in the low teen percentage range year-over-year, driven by weaker end market demand. I'll now turn the call over to Rob for additional color and an update on our business priorities.

Thank you, Mandeep. 2020 was an unprecedented year due to the COVID-19 pandemic. However, our entire global team mobilized quickly and stepped up to meet the challenges head on. As the number of COVID-19 cases rises again around the globe, we are seeing governments respond with additional restrictions to slow the spread of the virus. We continue to effectively manage COVID-19 related challenges and are currently experiencing minimal disruption to operations As circumstances evolve, we will continue to adapt to any new challenges and work to maintain operational continuity. Now turning to our segments. In APS, strong bookings momentum has us excited about our prospects to grow this portion of our business. We continue to see strong demand in our capital equipment business, driven by increased demand in our base semi-business, as well as new program ramps across a number of adjacent capital equipment markets. Industry sources are forecasting continued growth in wafer fab equipment in 2021. In our display business, we anticipate growth towards the end of the year as site utilization rates for small form factor displays are expected to drive increased demand. In A&D, headwinds continue in our commercial aerospace business as operators continue to work to reduce overall expenses in light of reduced demand. We continue to take cost productivity actions given that we anticipate market headwinds to persist through 2021. Demand in our defense business remains stable, and we continue to make investments to grow this business. We are encouraged by the booking momentum in A&D as we have added nine new customers, including major air framers and defense contractors. In industrial, we continue to experience a recovery of demand across our customer base, as the impact of COVID-19 begins to moderate. And within health tech, we continue to experience strong growth as we continue to ramp recent wins. We expect the strong momentum to continue into 2021. But turning to CCS, we continue to reap the benefits of our portfolio shaping efforts, resulting in improved revenue mix and margins. Our hardware platform solutions business hosted another quarter of growth, partly offsetting the impact from our Cisco disengagement. I'm pleased that we have achieved our back-fold target with a richer mix of programs. As I look back on our performance in 2020, we improved our operating results on a year-over-year basis, driving significant segment margin and adjusted EPS growth, while also generating strong free cash flow. Additionally, we made meaningful progress in a number of areas towards executing our strategy, First, our global team responded to the difficulties posed by the pandemic, maintained a high standard of service despite the challenges posed to operations. As a result of this effort, over 90% of the participating customers ranked Celesteca either number one or number two on their customer scorecards. Second, despite meaningful headwinds in some of our key markets, we improved ATS segment margin by 50 basis points in 2020, compared to 2019, and CCS operated above its target segment in the last three quarters of 2020. Non-IFRS operating margin of 3.5% improved 80 basis points in 2020 as compared to 2019, and non-IFRS adjusted EPS in 2020 was up 80% year over year. Third, despite the volatility seen in customer demand and the difficult macro environment, We successfully executed on a number of new program ramps which allowed for double-digit percentage revenue growth in our HPS business as well as other markets. Our HPS business saw impressive growth of 80% compared to 2019 as a result of investments made over many years. We believe HPS will continue to be a driver of growth for the company in the future. We strengthened our balance sheet by generating over $100 million of free cash flow, reducing our net debt position to $6 million, and launching an NCIB program to opportunistically repurchase shares. We believe that our transformational efforts over the last few years have positioned our business to capitalize on new opportunities and overcome challenges that might lie ahead. As we enter 2021, we remain committed to our strategy of diversifying our business, growing revenue in targeted areas, and improving margins. As such, we have set the following targets for ourselves. First, within our ATS segment, we are targeting 10% year-to-year revenue growth in 2021. And for the business to return to its target margin range of 5% to 6% by the end of the year, driven by growth in capital equipment, industrial and health tech, as well as ongoing cost productivity actions. Second, within our CCS segment, we are targeting high single-digit percentage growth in our HPS business, which will partially offset our non-HPS revenue decline, primarily as a result of the disengagement with Cisco. VCF segment margin is expected to be firmly in our target range of 2% to 3% in 2021. Third, we are targeting to generate $100 million or more of free cash flow in 2021, and we'll continue to have a disciplined approach towards capital allocation. And lastly, we expect lifecycle solutions revenue, which is comprised of APS segment and HPS business revenues, to grow in the high single digits, further enabling us to achieve our objective of materially diversifying our revenue in the next few years. To sum up, I am pleased with our performance in a very challenging environment. The last few years required some difficult decisions and focused efforts, but we believe that these decisions and our strong execution are paying dividends. We remain committed to executing on our strategy to drive long-term sustainable profitable growth. I would like to acknowledge and thank our employees for their hard work and dedication to our business. Their efforts have been tremendous. As a global team, we have overcome the unprecedented challenges faced in 2020. I have the utmost confidence that we will continue to deliver results and execute on our priorities for 2021. And finally, I would also like to thank our customers for their trust and loyalty and our shareholders for their continued support of Solastica. We look forward to updating you on our progress over the coming quarters. And with that, I would now like to turn the call over to the operator to begin our Q&A.

Certainly. At this time, if you'd like to ask a question, please press star 1 on our telephone keypad. To withdraw your question, press the pound key. Paul Steep with Scotia Capital, your line is open.

Great morning. Bob, maybe talking a little bit, like it's been a consistent theme across, I guess, almost the last year where your health tech business has been cited as, you know, new program ramps. Maybe talk to us a little bit more about what the outlook is for that business in terms of expanding it and, you know, how meaningful it is within the portfolio.

Hi, Paul. Good morning as well. Yes, the health tech business has been growing quite nicely for us over the last year and is expected to be a source of growth for us going forward. It is the smallest segment within our ATS business. That being said, you know, it grew by over 30% in 2020, and we're looking for very strong growth in 21. We've recently won lots of new programs in the areas of ultrasounds, PPE, diagnostic equipment, and frankly, all equipment related to combating this terrible virus that we have on our hands. On the flip side, some of the demand for surgical instruments is a little bit sluggish as well. But, you know, we continue to win new programs. We continue to have a very capable team, and we're very bullish on the outlook for the full year for our health tech business.

Fantastic. And then just maybe to clarify overall on the comments here, Mandeep or Rob, either of you, could you weigh in, I guess, one on what your expectations would be around CapEx, and then maybe help us frame how we should think about the working cap moves in the business, obviously with growth in, I guess, what we're now calling HPS. It seems like that's sort of held up, or is that unrelated in terms of maybe a little bit more upfront working cap demand?

Thanks, guys. Sure. Good morning, Paul. So, Maybe I'll start at the highest level, which is we're targeting to generate over $100 million of free cash flow in 2021. We continue to see improvements in our overall working capital, but there are dynamics happening, and you're hitting on a couple of them. Our inventory has been growing to support the HPS business over 2020, so we believe we have sufficient levels of inventory. But as that business continues to grow, and again, we're targeting high single digits growth in 2021, we'll proportionally build the inventory. But to help offset some of that, we still have inventory builds in other parts of our business that we still need to continue to unwind. And we're working very diligently towards doing that. The rest of the working capital is largely in line with our expectations. For CapEx, CapEx came in lower in 2020. We typically generate around 1.5% of our revenue in CapEx. Or maybe more simplistically, maybe around $80 million we spend per year we spent about $55 million in 2020. And a lot of that had to do with COVID and just putting projects that weren't of the highest priority on hold and some of them shifting into 2021. Our outlook right now is somewhere in the $80 to $90 million range for CapEx in 2021, so back to more normalized levels.

Great. Actually, in the last one, just to clarify, Mandeep, I know you've mentioned cost actions a few times. I'm assuming... All those are buried and baked into sort of the higher level commentary you guys provided this morning.

It is. So we've been taking restructuring actions, as you know, for a number of years. This year we took $26 million restructuring. We had an original estimate of $30 million. We were able to spend a little bit less because of the good progress that we made on ramping new programs and facilities where we were losing revenue. But we will be taking some tuck-in actions in 2021 as well. I would assume that the restructuring charges looking into next year will be more at our normalized levels, somewhere in the $10 to $15 million range.

Perfect.

Thanks, guys.

Todd Copeland with CIBC.

Your line is open. Great. Good morning, everyone. I also wanted to ask about a segment in APS, the semiconductor segment. You're calling it out as a growth area in 2021. Can you talk about the pace of growth in the semi-business and whether that forecast is locked in or could there be pockets of strength? And the reason I'm asking is investors often want to connect what appears to have been a surge in the semi-market and link that back to how it impacts your customers and your business. Thanks very much.

Thanks, Todd. Yeah, capital equipment has been strong in 20, and we expect it to be strong in 21. As you know, just from a broad market perspective, what we're seeing here is a long-term secular growth theme in the semi-industry, including the build-out of data centers, the expansion of high-speed communication networks, all being accelerated. I think if you're also reading the news of the auto industry saying that They're running out of chips. It's largely for the older 200-millimeter technology equipment. And they're also upgrading their designs, which is, again, bodes well for wafer fab equipment growth. UBS just raised their predictions for 21 from 8.5% to 12%. And on top of that, a good portion of our wins and our growth in 21 is coming from new program growth and share gains going into 21. So all that being said, you know, we're bullish on the outlook. We think capital equipment will get stronger as the year gets longer. In terms of our visibility, you know, customers typically provide us slot plans, I guess, out for six months, segment for a full year, slot plans for six months. And then inside of a quarter, they tend to firm things up. Things tend to wiggle around, obviously, but I would say that's kind of the visibility that we have. But broadly speaking, you know, industry analysts and our customers are bullish about the year and the secular trends.

Okay. And those slot plans, if you were to compare them now to where they were, I guess, at the end of September, can you sort of characterize the change from one quarter to the next?

Yeah, there's certainly increasing aligned with – the forecast for 21, it's been picking up a little bit relative to, you know, the September timeframe. Again, it takes a little time for the slot plans to turn into POs and, you know, it is capital equipment. So industry is certainly cyclical and somewhat dynamic, but the trends are certainly there.

One last question for me, if I could. The margin impact from this pickup in ATS, just talk about the rhythm over the course of the year and how it fits with that 5% to 6% outlook by the fourth quarter. Thanks a lot.

Great. Good morning, Todd. So we've been happy with the performance and the momentum that we've been seeing in ATS. As you know, we did 3.9% just this last quarter, and we are expecting to continue to see improvement going into 2021. We're targeting to get back into the target margin range of 5% to 6% by the end of the year. And really the drivers to get us from where we are to there is continuing growth in capital equipment. That'd be the largest driver. We expect continuing performance from the health tech business as we ramp programs and have a strong margin profile. But capital equipment, because of its heavy fixed cost structure, as we continue to grow the revenue, but we will see disproportionate benefits. And so we expect that we will see some margin improvement, especially as we go towards the second half of 2021. Great.

Thanks a lot. Thanks, Doug. Robert Young with Canaccord. Your line is open.

Hi, good morning. I think you said that the revenue from customers outside of Cisco and the CCS business had grown, I think it was 15%. Maybe if you could reconfirm that number. And if you could talk about that relative to the capacity that's left unused by Cisco, how is that backfilling? Are these new customers, are you part of this, you're backfilling some of that capacity? And where are you in backfilling the Cisco business?

Great. Good morning, Rob. I'll take the first part, and I'll let Rob take the second part. So, yes, CCS did grow, excluding the Cisco disengagement. We grew by 15% in the fourth quarter when you exclude Cisco. And, you know, another KPI, if you look at it on a full-year basis, CCS actually grew by 9%, excluding the Cisco disengagement. And I'll let Rob touch on the second piece.

Yeah. Hi, Rob. So, as you previously mentioned, We're not looking to backfill the Cisco revenue dollar for dollar, but we're going to focus on revenue that has a higher value add content. We put a target in place for ourselves at the end of last year, and we fulfilled that target. I would say the mix is largely on our HBS business in terms of backfilling that target. And, you know, we're very pleased that we're able to achieve that goal and very pleased with how our portfolio shaping initiatives are coming along.

Okay, great. And then the way that you're going to go forward reporting the JDM or HPS business, it's still going to be reported under the CCS business, so the margin target of 2% to 3% in 2021. That includes HPS. Am I correct with that?

That's correct, Rob. We continue to have two operating businesses, ATS and CCS. But when we just talk about the revenue as lifecycle solutions, we're putting the revenue of HPS and ATS together. just to highlight the fact that they have very similar attributes. But our HPS business is firmly in the CCS segment, and the 2% to 3% margin target range is inclusive of that.

Okay, great. And then, I mean, the growth in the JDM business since 2020 is very strong, and you're declining now to single digits, which is still good, but is there any potential for upside there? Or, like, why is it declining? Why is the growth declining so much? And then is there potential for the growth to be higher than what you're guiding today based on, you know, opportunity in front of you?

Hey, Rob. Yeah, we had some very strong growth, 80% growth year over year with JDM. It is still, or HPS, I should say, it is still growing. In 21, and there is certainly opportunity for upside. It all just depends on the long-term secular trends, you know, in terms of switching edge compute and the expansion of data centers around the world. We have a very healthy portfolio of products. So we'll have to see how the year plays out. But, you know, right now we think, you know, high single digits is where it's going to land, but it certainly could be higher.

I guess part of what I was asking is that the HPS business has the cycle time. Is it the type of business where you could book and then convert business in 2021 that you don't have in your plan today?

Yeah, absolutely. It's a business we can actually book and do have book and build inside the year, no question about it.

Okay. Maybe last question for me, I'll pass the line. The margin recovery and the ATS business, would you say that that's more driven by the cost takeout and efficiencies that you guys are looking for, or would you say it's more driven by the strength in the other areas, the semi-cap, like you were talking about earlier, and other areas of strength?

Yeah, Rob, I would say it's a combination of the two. On the A&D side, we are needing to take cost actions to align to the demand outlook. And so we've already taken a number of actions and we'll be prepared to continue to take some if we need to. But in the areas of health tech and capital equipment, we're seeing good revenue growth, very strong revenue growth, frankly, in 21, which is giving us the benefit of scale. And then on the industrial side, we are experiencing some sequential improvement. And again, because we've already taken cost productivity actions, a lot of that growth does help come to the bottom line.

Okay, great. Thanks for answering all the questions.

Thanks, Rob. Paul Treiter with RBC Capital Markets. Your line is open.

Thanks very much, and good morning. I just wanted to delve in a little bit more into the outlook for 21 on the ATS segment, the 10% growth. What do you see when you're looking at that forecast and building up to it as a potential upside opportunity and, conversely, potential downside risks when you go to an outlook?

Hey, Rob. Yeah, so we look forward, you know, I would say, you know, first we have a comprehensive roadmap and engagements across all the core technologies in the data center this past year and also going into We see 400G as a key driver of service provider growth. We have strong positions with market leaders in other speeds and also a healthy white box business. We see the edge as being a source of growth. We have developing edge programs such as MEC, multi-access edge compute servers, that are resonating with emerging customers and will continue to focus on enabling these customers with the right edge solutions as their requirements evolve. We're seeing some strengths from our communications customers on the wired side, given by expansion of 4G to 4G plus to 5G. And we also have, you know, a strong data center cloud offering and portfolio positions across, you know, the broader edge. And then lastly, I would say computers is a source of growth for us. We have a healthy business as data centers continue to expand AI and ML applications. They continue to grow. And we also have healthy compute positions with our enterprise customers and service provider customers as well. So I would say the broader trends is just, you know, additional growth by, you know, web scale demand strength. The downsides could be, you know, just over buffering perhaps or, you know, a broader slowdown in some of these secular trends. You know, these tense trends, Service providers tend to buy equipment and consume their own demand. So sometimes we may have a built out to have a little bit of a pause demand until the next technology products hit. So I would think that would be on the flip side.

I think you're referring to HPS there. Is that correct?

Yeah, I was talking about HPS. I'm sorry, did you say APS or HPS?

Yeah, I mean, I was talking about APS.

Oh, APS, I'm sorry. Well, hopefully that was helpful for you on HPS for APS. I'm sorry about that. For APS, we see growth in capital equipment, as I mentioned before. Again, good long-term circular trends in terms of, you know, build out of data centers, expansion of high-speed communication networks, things like that. We certainly see health tech expanding in 21 as the need for diagnostic equipment. continues to be very strong, PPE, ultrasound, things on those lines. We see aerospace still being sluggish, but, you know, I mentioned during the call that we won nine new customers. Those programs should be turning into revenue programs. in the back half of 21 and helping out our commercial aerospace business. And then lastly, our industrial business is flattening out and fully starting to turn the corner. We're expecting some growth from our industrial business in 21 as well as COVID-19 subsides.

And just delving a little bit more into commercial aerospace, I mean, typically, how long are the lead times in that segment? And are you I mean, you mentioned that there's new programs maybe to revenue in the second half of the year. In terms of your other programs, the existing programs, I mean, do you see them normalizing by the end of the year, or is there still likely headwinds on the existing programs in that segment?

Yeah, it comes along. I mean, that's a good thing and a bad thing. The programs that are ramping in the back half of the year, we actually won those programs in early in 2020. So they'll start ramping in the back of 21. I would say commercial aerospace still has a little bit of ebbs and flows, but I would say it's flattening out right now at trough levels.

Okay. Thank you for that. I'll pause the line. Okay. Oh, sorry.

Dino Simskopoulos with BMO Capital Markets. Your line is open.

Hi, good morning. Just to come back on ATS margins, I mean, if your message is you can get back to 5% to 6% with what sounds like only a modest improvement in commercial aerospace, does that imply that as we head into 22, there might be upside to that range as commercial aerospace has more of a recovery?

Hi, Thanos. Good morning. Yes. So as you know, before the pandemic, aerospace and defense was our largest segment within ATS and had very strong margins overall. And frankly, we're the largest contributor of profitability within ATS. That's not the case right now. And so working towards getting back to the 5% to 6% range, we're expecting a nominal contribution from A&D. And so when A&D does return, and it will, and we continue to have the capabilities to support the market when that demand does come back, that would be a positive thing for overall ATS. Okay.

And then if you could expand on your comments for display equipment. You mentioned the uptick you're expecting later this year with small screens. Should we think of that as kind of a gradual ramp, or might that be more of a step function as new capacity is slated to come online?

Are you talking about capital equipment, Thanos?

Display equipment, display equipment specifically.

Display equipment. Yeah, thanks. I have to check twice now before I answer. Yeah, display, I would think it's, it would be more of a gradual ramp. I think It will be a tale of two halves. You know, I think it will be a sluggish first half and a stronger second half. But as we go from half to half, it will build as the year gets long. What we're seeing in the second half of the year is hopefully growth by mobile orders and new program ramps coming from China, Japan, and Korea-based OEMs. We've also seen some improvements in panel prices, and panel makers' profitability, which bodes well to them spending additional capex.

As far as new large fabs coming online, that might be more of a 22 possibility?

Yeah, I think display will get stronger as time goes on. I think we're expecting the back half of 21 to be much stronger than the first half of 21, but we're also expecting 22 to be much stronger than the back half of 21 as well. The long-term trends for display are positive, but I think 22 will be much stronger than 21 for display, all things considered.

Great. Thanks, Sal. That's fine.

Okay. Rupal Bhattacharya with Bank of America. Your line is open.

Hi. Thank you for taking my questions. The first one, just to clarify – The CCS segment revenues for fiscal 21, are they still expected to decline double digits year on year? Because you've guided HPS to grow high single, then that would mean the rest of the CCS segment would be declining somewhere in the mid-teens year on year. Would that be all Cisco? I'm just trying to reconcile this because I think you said in 2020, CCS ex-Cisco grew high single digits. So, I mean, is Or maybe just to clarify, I mean, is CCS revenues, I mean, do you expect them to decline double digits year on year in fiscal 21?

Yeah. Morning, Rupaloo. We're not giving specific guidance on overall CCS revenue, but I'll tell you the dynamics to think about. The first one is we are targeting HPS, again, to grow in the high single-digit range. It's an $850 million business right now. And so that will generate growth. Cisco will be coming out, and Cisco is going to come out for the entire year. So that is going to be a headwind for the remainder of the portfolio. And then for the rest of CCS, we're expecting right now for it to be relatively flat going into 2021. There was a very strong level of demand that took place in 2020 because of all the dynamics that we've been talking about. And so some of that will subside, and that will be offset by programs that we're ramping. So growth in HBS, Cisco comes out, and the rest of the portfolio to be slashed.

And the only thing I would add, Rupalu, is that most importantly, CCS is growing in our targeted areas is what we're focused on.

Okay. Okay. Thanks for the clarification on that. And then just on the ATS side, you're guiding a mid-single-digit decline for the first quarter, and the full year is still up 10%. So any comments on the seasonality we should expect throughout the year? Can we expect, like, from 2Q onwards, year-on-year revenue growth, or would you expect that, you know, the growth to be more in the second half versus the first half?

Yeah, hi, Rupalu. So, yes, we are showing a decline in the first quarter, and then we are expecting a full year of 10% growth. A lot of that growth is going to be back-half oriented, although it could lead to year-to-year growth even in the second quarter. We know we're not going to give quarterly guidance at this point. But what I would say is that we think that the first quarter will be, in terms of growth rates, be the largest headwind for the full year. And then where that growth is coming from is, Rob's touched on a few of them. Within A&D, we have been winning some new programs, and so we should see some growth towards the back end of the year. We are already seeing strong demand on the semiconductor side, which will continue, but we think could accelerate towards the end of the year. And then display is also expected to come online a little bit more at the back end of the year. So first quarter, we expect to be a drag and then some growth coming after that.

Okay, thanks for that. And for my last question, I think you're guiding SG&A to $51 to $53 million for the first quarter. What were COVID-related expenses in the quarter? How should we think about that going forward? And should we think about SG&A at this level for the rest of the year, at least, or maybe in terms of percent of revenue? Can you maintain that for the rest of the year? Thank you.

Yeah. So to answer both questions, Rupaloo, we did have COVID costs in the quarter. It was in the range of around $8 million, some in SG&A, some in COGS as well. We did generate a number of recoveries, both from customers as well as from various government programs in the countries that we're in, which mostly offset that. So we had about $10 million of recoveries. But when you look at the full year, we had a negative impact. We ended up having far greater COVID costs than we did overall recoveries. In terms of our SG&A going into next year, we are looking to maintain our SG&A at dollar levels that are similar to 2020. We're driving productivity in a number of areas, but we're also taking the opportunity to invest in some of the areas where we're seeing very rapid growth. We will be making further investments in the HPS business. We are making engineering investments within the ATS business. And those are really aligned with roadmaps that we have where the businesses are showing good, strong growth for a number of years. And so we want to maintain our capabilities in 2021 because we are bullish on the longer-term revenue outlook.

Great. Thanks for all the clarifications. Appreciate it.

Thanks, Rupal. Jim Suva with Citi. Your line is open.

Thank you. You have been very clear with the Cisco disengagement. Now that that's behind us and we look more forward positively to the future, is your book of business, you know, pretty stable with those customers as well as your profit profile going to additional disengagements or pruning or realignments to products that we should be mindful of, you know, as you look ahead?

Hi, Jim. Good morning. Yeah, I would say overall things are generally stable. You know, as I mentioned on the call, one of the things we do measure is how we rank on our customer scorecard. And, you know, we either rank number one or number two in over 90% of our customer scorecards. We're keeping cost effective networks and taking the appropriate actions to stay that way. I think we've proven that we're quite disciplined. So we're not pursuing revenue for revenue's sake. We're staying aligned to our strategy. So, you know, at times we might feel that it's better to step away from very low margin business, but we do that. to a strategic lens. And our goal really is to grow our business profitably in the right segments and across CCS specifically. I think we're doing that and we're happy with the progress we're making in HPS and also because of the value adds that we're providing to our customers, the margin profile of that incremental business that we're booking.

Great. Thank you so much for the details and clarifications.

Kurt Swartz with Stifel, your line is open.

Hi, good morning. I'm hoping to get a little bit more color on the supply environment, given all the headlines regarding component shortages. I'm hoping you can talk about any constraints you may be seeing and how you're responding from an inventory procurement perspective.

Yeah, hi. Yeah, it's certainly very dynamic out there. The situation is fluid. What we're seeing is a demand increase coupled with the impact of COVID. We've been preparing for this. We've probably saw this coming a couple of quarters ago, so we've been preparing for one or two quarters of uncertainty. You know, just across the market, we're seeing, which bodes well for our semi-capacitors, that foundries are reaching capacity. The 8-inch wafers are running tight in 21. High-end semiconductors, logic, MOSFETs, transistors, memory, all commodities are having increasing lead times. We're seeing auto levels spike for chip resistors and even MLCCs again. And several manufacturers have started to implement order entry controls based on customers' historical consumption to make sure we don't get into, you know, too much buffering. You know, that being said, we've opened up our windows, ordering windows and placing our orders, you know, at the anticipated lead times and paying very close attention to the dynamics in the marketplace and working with our customers to make sure we secure We've also, you know, increased our resources in this area to make sure we stay on top of the dynamic situation.

Understood. Great. And then on the health tech side, I'm hoping you could maybe elaborate a bit more on where we stand with COVID product-related ramps versus elective product demands and how those two should sort of reconcile in the coming quarters.

Yeah, COVID-related products and more diagnostic-related products are the ones that are certainly driving the majority of our growth. Ultrasounds, PPE, diagnostic equipment, anesthesia, respiratory, patient monitoring, imaging devices, things like that. Surgical instruments, things that require elective surgery has been sluggish. We expect that to uptick in the back part of the year. But time will tell. It's really going to be a function of how quickly COVID subsides.

Understood. And then maybe one more, if I could.

Sure.

Just on the defense business, given the new U.S. administration and maybe any expectations for defense budgets, I'm wondering how that should sort of factor into the long-term ATS growth profile of roughly 10%.

Yeah, so, you know, within our A&D business, about 60% is commercial, about 40% is defense. Our defense business is stable. We're looking to grow that more. We've recently doubled the size of our New Hope Minneapolis facility, which was part of the Atron acquisition from 50,000 square feet to 100,000 square feet. It is now open for business. We have a full funnel. A lot of the that we have booked is headed into that facility. So, you know, we're looking to, you know, increase our defense business, you know, moving forward. And also, you know, the Biden administration recently defined the Buy America Act as well. And, you know, that bodes well for having IRTAR facilities in the U.S., especially as it relates to providing the U.S. government, you know, products for their use.

Thank you so much.

We have one more question from Daniel Chan with TD Securities. Your line is open.

Yeah, thanks for squeezing me in. Your net debt position is getting to break even here, and if you hit your $100 million target this year, you'll be in a nice net cash position throughout the year. So just any thoughts on how you want to deploy that capital? You did talk about the NCIP and the share price. Are you kind of leaning towards that versus acquisitions, or maybe any comments you have about the acquisition pattern would be helpful? Thanks.

Yeah, good morning, Dan. So, you know, to your point, we're at almost a break-even level right now. We are looking to generate strong free cash flow going into next year. We have the NCIB program at this point open to be opportunistic. As you know, we have a track record within the industry of buying back, frankly, the most shares relative to the rest of the peer group. And so we are willing to act opportunistically when we believe the share price is undervalued. It was undervalued for the majority of 2020. But we'll take an opportunistic approach as we go through the year because we're going to continue to weigh that against organic and inorganic alternatives. Alternatives such as continuing to build dry powder by paying down some more debt, reducing our interest expense, working towards expanding our EPS, investing in other types of growth programs and capabilities, But we do continue to have an active M&A pipeline, but we're just very disciplined with our filter. We've looked at a significant amount of transactions through 2020, and for one of the few reasons that we have in our filter, it didn't get our support. So we'll continue to do that. We're looking to invest in areas where we have good, solid strategic roadmaps and where we know that we can plug in the capabilities and do something really good with it, whether that's in our ATS business or in our HPS business. So we'll continue to take a similar approach. But it is nice when you have a net debt position that it opens up a lot of alternatives.

There are no further questions at this time. I'd now like to turn the call back over to Robert for final remarks.

Thank you, Jack. After a strong finish to 2020, our focus is on continuing to execute for our customers in 2021. Our margins in ATS are expanding, and we anticipate entering back into our target margin range by the end of the year on the back of strong forecasts of growth. And in CCS, we expect hardware platform solutions to continue growing, and for CCS to deliver margins firmly in their target range for this year. I'd like to thank our global team for remaining vigilant and keeping themselves safe and each other safe. And thank you for joining today's call. I look forward to updating you as we progress throughout the year. Please stay safe.

This concludes today's call. We thank you for your participation. You may now disconnect.