Celestica, Inc.

Good morning ladies and gentlemen and welcome to the Celestica Q1 2023 earnings conference call. At this time, all lines are in listen only mode. Following the presentation, we will conduct a question and answer session. If at any time during this call you require immediate assistance, please press star zero for the operator. This call is being recorded today, Thursday, April 27th, 2023. I would now like to turn the conference over to Craig Oberg. Please go ahead.

Good morning, and thank you for joining us on Seleska's first quarter 2023 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 meetings of the Private U.S. 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 yesterday'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 financial measures, including ratios based on non-IFRS financial measures consisting of non-IFRS operating margin, adjusted gross margin, adjusted return on invested capital or adjusted ROIC, adjusted free cash flow, gross debt to non-IFRS trailing 12-month adjusted EBITDA leverage ratio, adjusted earnings per share or adjusted EPS, adjusted SG&A expense, lifecycle solutions revenue, and adjusted effective tax rate. Listeners should be cautioned that references to any of the foregoing measures during this call denote non-IFRS financial measures, whether or not specifically designated as such. These non-IFRS financial measures do not have any standardized meanings prescribed by IFRS and may not be comparable to similar measures presented by other public companies who report under IFRS or who report under U.S. GAAP, and use non-GAAP financial measures to describe similar operating metrics. We refer you to yesterday's press release and our Q1 2023 earnings presentation, which are available at Foleska.com under the Investor Relations tab for more information about these and certain other non-IFRS financial measures, including a reconciliation of historical non-IFRS financial measures to the most directly comparable IFRS financial measures from our financial statements. and a description of modifications to specified non-IFRS financial measures during 2022 and Q1 2023. 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. Celestica is off to a solid start in 2023. Our first quarter revenue was 17% higher compared to the prior year period, while our non-IFRS adjusted EPS was at the high end of our guidance range. First quarter non-IFRS operating margin was 5.2%, exceeding the midpoint of our revenue and non-IFRS adjusted EPS guidance ranges, and was the third consecutive quarter with non-IFRS adjusted operating margin greater than 5%. The current economic environment remains highly dynamic and presents a host of challenges that we are navigating. We believe that our first quarter results are a testament to the strength and diversity of our commercial portfolio. Our financial performance in Q1 is built on the exceptional momentum we generated in 2022 as we continue to show solid year-to-year progression in our key performance metrics in a difficult environment. Across some of our businesses, we are seeing near-term volatility in customer demand. However, on an aggregate basis, our portfolio remains highly resilient as our strategic diversification has allowed us to deliver on our financial objectives and remain on track towards achieving our near and long-term financial goals. The results of our portfolio's strategic diversification are evident as both ATS and CCS posted strong year-over-year revenue growth of 14% and 20% respectively in the first quarter. Lifecycle Solutions revenues of $1.16 billion accounted for 63% of total revenues in the first quarter and generated 10% growth compared to the prior year period. The continued solid performance of our Lifecycle Solutions portfolio underscores the benefits of our strategic exposure to diversified high value-end markets with what we see as attractive long-term growth prospects supported by strong secular fundamentals. Before I provide further detail on the outlook for each of our markets, I would like to turn the call over to Mandeep, who will discuss our financial performance in the first quarter and our guidance for the second quarter of 2023. Over to you, Mandeep.

Thank you, Rob. And good morning, everyone. First quarter revenue came in at $1.84 billion, exceeding the midpoint of our guidance range, and 17% higher year-over-year, supported by double-digit revenue growth in both our ATS and CCS segments. We achieved first quarter non-IFRS operating margin of 5.2%, 80 basis points higher year-over-year. This performance was driven primarily by improved volume leverage, and in particular, very strong profitability in our CCS segments. supported by our HPS business. Non-IFRS adjusted earnings per share were $0.47 for the first quarter. This was at the high end of our guidance range and was $0.08 higher year-over-year, driven by higher revenues and improved mix. ATS segment revenue was up 14% year-over-year in the first quarter, higher than our expectations of a low single-digit percentage increase. Year-over-year growth in ATS segment revenue was driven by a strong performance in our industrial, A&D, and health tech businesses, supported by new program ramps, secular demand tailwinds, and improved materials availability. This helped to offset expected softness in our capital equipment business. ATS segment revenue accounted for 43% of total revenue in the first quarter. Our CCS segment continued to deliver solid growth. with quarterly revenue up 20% compared to the prior year period, driven by strong demand and improved availability of materials in both our enterprise and communications end markets, as well as new program ramps in our enterprise end markets. Our HPS business recorded revenues of $371 million in the quarter, up 3% year over year. As anticipated, growth in HPS revenue moderated in the first quarter as a result of tougher comps from the prior year period, after an exceptionally strong 2022. HPS revenues were 20% of total company revenues in the first quarter, compared to 23% in the prior year period. Communications and market revenue for the first quarter was up 11% year-over-year, compared to our expectation of a high team percentage increase. Growth was driven by demand strength with service providers, as well as improved materials availability. Enterprise and market revenue in the quarter was up 38% year-over-year, above our expectation of a mid-30s percentage increase, driven primarily by the ramping of new programs, strong demand in compute, and improved materials availability. Turning to segment margins. ATS segment margin was 4.4% in the first quarter, 60 basis points lower year-over-year. The decline in ATS segment margin was driven by anticipated softness in capital equipment. which more than offset profitability improvements driven by growth in our other ATS businesses. We expect ATS segment margins to remain dampened in the second quarter, driven by continued softness in capital equipment and ramping programs in industrial. However, we anticipate improvements in the second half of the year as new program ramps are expected to stabilize and our costs in capital equipment are further aligned with lower volumes. CCS segment margin of 5.8% was up 190 basis points year-over-year. The increase was driven by strong volume leverage and favorable mix. Moving on to some additional financial metrics. IFRS net earnings for the quarter were $25 million, or 20 cents per share, compared to net earnings of $22 million, or 17 cents per share in the prior year. Adjusted gross margin for the first quarter was 9.4%, up 60 basis points year-over-year. primarily due to greater volume leverage, productivity improvements, and favorable mix. Our first quarter non-IFRS adjusted effective tax rate was 22%. Non-IFRS adjusted ROIC for the first quarter was 17.9%, an improvement of 4.0% compared to the prior year quarter. Moving on to working capital. Our inventory at the end of the first quarter was $2.4 billion, up $53 million sequentially and up $468 million year-over-year. Our customers continue to display their commitment to working collaboratively with us by helping fund these higher inventory balances, which is reflected by our $811 million in customer cash deposits at the end of the quarter, an increase of approximately $350 million year-over-year. When offset by cash deposits, Inventory levels are higher by $119 million compared to the same quarter last year, while inventory turns of 4.3 turns in the first quarter improved compared to 4.2 turns one year ago. Despite end market demand volatility and continued elevated material lead times, our inventory balance has stabilized and we expect working capital efficiency improvements over the course of the year. Cash cycle days were 75 during the first quarter, 11 days higher sequentially, but one day lower than the prior year period. Capital expenditures for the first quarter were $33 million, or approximately 1.8% of revenue, compared with 1.0% in the first quarter of 2022. The increase in our capital expenditures conforms with our previously communicated expectations for increased investments in our Southeast Asia, Europe, and Mexico facilities in support of new program wins. Non-IFRS adjusted free cash flow in the first quarter was $9.2 million, compared to $0.5 million in the prior year period. Consistent with our long-term annual target, we expect to achieve $100 million or more in non-IFRS adjusted free cash flow in 2023. Moving on to some additional key metrics. Our cash balance at the end of the first quarter was $319 million. down $28 million year-over-year, and down $56 million sequentially. The lower cash balance is primarily a result of stock-based compensation. Our cash balance, in addition to our approximately $600 million of borrowing capacity under our revolver, provides us with liquidity of approximately $900 million, which we believe is sufficient to meet our anticipated business needs. At the end of the first quarter, our gross debt was $623 million, down $5 million from the previous quarter, leaving us with a net debt position of $304 million. Our first quarter gross debt to non-IFRS trailing 12-month adjusted EBITDA leverage ratio was 1.3 turns, flat sequentially, and down 0.5 turns compared to the same quarter of last year. At March 31, 2023, we were compliant with all financial commitments under our credit agreement. During the first quarter, we purchased approximately 800,000 shares for cancellation at a cost of $11 million. We intend to continue to opportunistically deploy capital towards repurchases under our NCID throughout the year. Now turning to our guidance for the second quarter of 2023. Our second quarter revenues are expected to be in the range of $1.75 billion to $1.90 billion. Revenue would be up 6% year over year if the midpoint of this range is achieved. Second quarter non-IFRS adjusted earnings per share are expected to be in the range of $0.44 to $0.50 per share. If the midpoint of our revenue and non-IFRS adjusted EPS guidance ranges are achieved, Non-IFRS operating margin will be 5.2%. This would represent an increase of 40 basis points over the prior year period and flat sequentially. Non-IFRS adjusted STD expense for the second quarter is expected to be in the range of $64 to $66 million. We anticipate our non-IFRS adjusted effective tax rate to be approximately 21% for the second quarter, excluding any impact from taxable foreign exchange. Now, turning to our end market outlook for the second quarter of 2023. In our ATS end market, we anticipate revenue to be up in the mid-teen percentage range year-over-year, driven by continued growth in our industrial, health tech, and A&D businesses, partially offset by anticipated continued market weakness in capital equipment. In our CCS segment, we anticipate revenues in our communications end market to be down in the mid-teen percentage range year-over-year, driven by tough comps and lower anticipated demand from certain programs in networking and routing. Finally, in our enterprise end market, we anticipate revenue growth in the high 20% range year-over-year, supported by anticipated continued demand strength in proprietary compute, as well as new program grants. I'll now turn the call back over to Rob to provide additional color on our market and our overall outlook.

Thank you, Mandeep. As mentioned earlier, uncertainty has complicated the global economic outlook. We believe that recessionary pressures are tempering demand in some of our end markets, while others continue to show resiliency and experience strong growth. However, given these dynamics, we remain confident in our outlook for the overall company, which continues to be validated by our strong results and continued operational execution. As such, We are pleased to raise our full-year 2023 revenue outlook. We are now anticipating full-year revenues of at least $7.6 billion, and we are tightening our anticipated range for non-IFRS adjusted EPS to between $2 and $2.05. We are also tightening our anticipated 2023 non-IFRS operating margin range to between 5% and 5.5%. Achievement of our updated revenue outlook would represent year-over-year revenue growth of at least 5%, and achievement of the midpoint of our tightened non-IFRS adjusted EPS range would represent year-over-year growth of 7%, which would illustrate solid progression on our very strong financial results from 2022. Now, I would like to turn to our outlook for each of our businesses. Overall, we expect our ATS business to be up in the low double-digit percentage range in 2023, as softness in capital equipment is anticipated to be more than offset by strength in all of our other ATS businesses. Our industrial business continues to experience strong growth, with revenues up more than 30% year-over-year in the first quarter of 2023. Demand from green energy projects remains very strong, supported by a number of new program ramps and strong secular tailwinds in vehicle electrification and energy storage and generation. Additionally, PCS performance continues to be solid. The outlook for our industrial business remains healthy, and we continue to expect strong and sustained growth throughout 2023. In our capital equipment business, the overall wafer fab equipment market is still expected to be down materially in 2023 compared to 2022. While our capital equipment business is also expected to be down year over year, we continue to anticipate our business to outperform broader market expectations due to the benefits of our business mix, market share gains, and new program wins. Looking beyond 2023, we are encouraged that the current market outlook anticipates the wafer fab equipment market to return to growth in 2024. Moving on to A&D, Our commercial aerospace business is experiencing a strong recovery in demand. This has been supported by the normalization of commercial air traffic and new program ramps, which we anticipate will drive continued revenue growth at rates accretive to our ATS segment throughout 2023. The most recent industry estimates and customer outlooks calls for commercial air traffic to return to pre-COVID levels by 2024. Our defense business also continues to see demand growth, supported by higher customer spending on military equipment from Western governments amid rising global geopolitical tensions. Our health tech business is seeing accelerating growth, supported by new program ramps in the areas of surgical instruments, imaging, and patient monitoring devices. We believe the demand outlook for our health tech business is strong and stable, given our view of its lower sensitivity to recessionary pressures. Now turning to our CCS segment. For 2023, CCS revenues are expected to be flat to slightly up compared to 2022. Our 2023 enterprise end market revenue is expected to increase compared to 2022, fueled by strength in proprietary compute. This anticipated increase It's expected to be partially offset by demand softness in our communications end market and to some extent in our HPS business. Our HPS business has more than tripled in size since 2019 on the back of very strong market share gains from ODMs and substantial investments in data center expansion from hyperscalers. Due to very tough comps, we expect HPS growth to moderate this year, but continue to be a large and stable portion of our CCS business and overall revenues. Although HPS growth rates are expected to moderate this year, we expect hyperscaler customer growth to be robust in 2023, largely driven by new program ramps and proprietary compute, supporting our customers' artificial intelligence and machine learning investments. Demand in our enterprise and market remains healthy. As mentioned earlier, within our portfolio, we are seeing very strong demand from customers, including hyperscalers for proprietary compute, which is more than offsetting softness in the storage market. Finally, the outlook for our communications and market is soft. After an exceptional 2022, we expect difficult year-over-year comparisons for the remainder of the year. With our strong start to 2023, I remain optimistic regarding our prospects for the year ahead. We believe that our strategic decisions over the past several years and the exceptional efforts of our team have positioned us to continue to execute on all of our key objectives and navigate the potential hurdles presented by the broader economic environment. And while we are focused on the near-term challenges at hand, we are also mindful to maintain perspective keeping sight of our long-term targets. With that, I would now like to turn the call over to the operator for questions. Thank you.

Thank you, sir. Ladies and gentlemen, we will now begin the question and answer session. If you would like to ask a question, please press star followed by the number one on your telephone keypad. If your question has been answered and you would like to withdraw from the queue, please press star followed by the number two. And if you are using a speakerphone, please lift your handset before entering any keys. Your first question will come from Rob Young at Canaccord Genuity. Please go ahead.

Good morning. First question for me would be on pricing environment in 2023. I know you talked a little bit about this last quarter and just maybe an update there as supply chain normalizes. Are you able to... sort of keep pace with the inflation on your cost side wages and materials are able to pass that along and maintain strong pricing in 2023. Yeah.

Hi, Rob. Nice to talk to you. I'd say overall, the pricing environment is stable and we're able to pass on the vast majority of the increases that we're seeing. As you know, in many cases, we do quarterly repricing. And so when we are seeing spikes in inflation on costs that we control. We very quickly have those conversations with our customers. There are some longer-term agreements where we don't have quarterly repricing. Sometimes it flips into a year. In those cases, there's sometimes a little bit of a catch-up, but the vast majority of our business is not that. The other thing I would say is that there continues to be a lot of emphasis on securing materials, and our team has been doing an exceptional job And being able to secure materials in still a very volatile environment does give us an advantage when having pricing conversations.

And I would also add, Rob, on the supply chain side, the material pricing premiums are subsiding as the inventory buffers are being consumed and lead times are being reduced. So we're seeing less material inflation moving forward.

Okay, great. And then second question, maybe just a little more precision on HPS. If you could just talk a little bit about the growth expectation there relative to the ATS and lifecycle growth of 10%-ish. I think you've shared the past. Is HPS still supportive of that, or should we expect it to be a drag on that this year?

I'll start off on what Mandeep said. So, from an HPS perspective, HPS growth is moderating, but frankly, it's largely due to tough comps. You know, recall HPS grew 59 percent last year. So, this type of growth obviously is not sustainable over the short term. You know, that being said, hyperscaler growth has been robust, and we believe that it will be in the double digits this year. And that's on the back of some strong growth in the areas of proprietary compute. You've seen a lot of the buzz in the marketplace regarding AI and ML investments that the hyperscalers are making, and we have been and continue to be the benefactory of that. So, while this is not strictly HPS revenue, it is what we call high-value EMS, you know, given the complex nature of the products and the high amount of process expertise that we add to deliver this product. And typically speaking, what we see is this high-value EMS work migrates to HPS products over a period of time. And I'll turn it over.

Maybe just to answer the lifecycle solutions question, Rob, I think the way I would think about it is the $7.6 billion or more that we have given as an outlook is implying 5% year-over-year growth. That 5% growth is going to be relatively consistent between lifecycle solutions and non-lifecycle solutions. And it's for the reasons that Rob mentioned, which is there is CCS business that sits outside of lifecycle solutions where we're seeing some pretty strong demand strength, primarily in proprietary compute with the cloud providers. They're not necessarily buying HPS gear at this point, but they are buying gear that has a lot of engineering content to it, so it has favorable pricing, and it is growing. Overall, if I was just to go by end markets, ATS is expected to have strong double-digit growth this year for the reasons we mentioned. All markets are growing with the exception of capital equipment. HPS growth we're moderating, as we talked about. But then also, just looking from a cons and enterprise perspective, a lot of strength in proprietary compute offset by some softness that we're seeing in the networking side.

Okay. Thanks for all the color. I'll pass the line.

Thanks, Rob.

Your next question comes from Thanos Scopolis at BMO Capital Markets. Please go ahead.

Hi. Good morning. Just on the macro, if we think now about your outlook for the various segments versus where it would have been 90 days ago, are there some in particular where you're seeing more macro apprehension and reduction in your prior forecasts versus what you would expect in the starting year?

You know, macro backdrop is certainly starting to impact portions of our business. And if you just take them, you know, overall within ATS, it's really just the capital equipment business. The other segments within ATS are growing nicely. Our industrial business is growing like a weed, you know, largely driven on the backs of green energy projects, energy storage, energy generation. Our health tech business is growing very nicely. Our aerospace and defense business is growing very nicely, led by commercial aerospace recovery and, to some extent, defense. So within ATS, I would say, you know, aside from capital equipment, the macroeconomic backdrop hasn't really impacted us. And within CCS, we are seeing some moderation, but it's really in HPS driven by tough comps. and also consumption of some of the strategic inventory buffers that are being consumed as material constraints ease. But on the flip side, we're seeing very strong growth in proprietary compute driven by AI and ML investments. So net-net, we're getting the benefit of a very diversified portfolio in our results.

And on capital equipment, to clarify, it sounds like you're optimistic for that segment returning to growth next year. Just from a quarterly perspective, where do you think we might hit the bottom? Would that be in the second half or when?

Probably, you know, it's hard to always call the bottom. That's always Aaron's fool. But we see growth coming out of the year and going into next year. Whether the bottom will be Q2 or Q3, time will tell. But we see us coming out of it towards the back of the year. And that is largely driven by new program ramps that are starting now, which we'll add to put some fuel on the fire, if you will, towards the back end of the year.

Great. Thanks for the last one.

Your next question will come from Maxim Matyshansky at RBC Capital Markets. Please go ahead.

Yeah, good morning. You mentioned the strength in ATS was from new program ramps, the overall market demand, and also the improved materials availability across ATS and industrial AT and health tech. Given that you increased the ATS outlook for Q2 and you had no adverse revenue impact from supply chain constraints, I'm wondering how much of the strength in the ATS was from new program ramps versus the improved materials availability?

I would say, Maxim, the large majority of the improved growth is driven by new program ramps, especially in our industrial business. You know, our industrial business has great exposure to some of these green energy projects. A lot of what the U.S. government is doing on the Inflation Reduction Act is adding fuel to the fire with respect to demand. We have very strong backlogs of these programs. And these programs are material constrained. So while material constraints are easing in some of the other areas in the ISC area, industrial area, we still have a fair amount of material constraints given the very strong demand that we have.

Okay.

And just wanted to circle back on the hyperscaler demand issue. Now that we're approaching the midpoint of the year, I'm curious whether you're seeing any changes in that demand for your customers. You mentioned that some of that has shifted to potentially proprietary compute. Can you just comment on the changes in the demand from hyperscalers and anything new from those conversations over the last few quarters?

Yeah, so hyperscaler segment is still continuing to grow. As I mentioned, we believe that hyperscalers will grow about double digits this year. But they are shifting their spend. They do have inventory in the pipeline, largely in the areas of networking. Those strategic buffers were put in place last year, and they're consuming those down. And once those buffers are down, they'll probably return to growth. but they are shifting their CapEx spend more towards these AI and ML investments, which will be ramping out through the year and into next year. So that's where we, in CCS, we see a large portion of our growth coming from proprietary compute. And we're serving multiple customers there, not just hyperscalers, but OEMs as well.

Great, thanks. I'll pass the line.

Your next question comes from Daniel Chan at TD. Please go ahead.

Hi, good morning. So the communications segment came coming at 11%. That's a little bit lower than the high teens you were expecting. Just wondering if you can give us a few details on what happened in the quarter that came in different from what you're expecting.

Sure, Dan. So in the comp side, As the material constraints are starting to ease, our customers and comms are starting to consume some of those strategic inventory buffers, and that's really what happened in the first quarter. That was partially offset with some new program ramps that we have going on in Optical. That dynamic will also repeat itself in the second quarter as well. Still more consumption on the networking side, partially offset with some new program ramps that we have in Optical.

Okay, thanks for that, Rob. And then you're talking a lot about AI helping you on the hyperscale customers. What has to happen to get those programs to HPS? It seems like it would be very conducive to the specialized kind of services that you provide there. How long do you think that would take, and what's the potential uplift when that happens?

Yeah, for those types of products, it would probably be the next generation of those products. So I would say 18 months or so. But we call it high-value EMS because the level of intellectual capital, I would say, that goes into building these products is very, very high. So the margins, given the high-value add, is somewhat synonymous or very close to HPS margins. So it is a natural migration. We've seen this migration happen in the past. And we expect this to migrate into HBS, you know, moving forward as the next generation products kick in.

Great. Thank you.

Ladies and gentlemen, once again, if you would like to ask a question, please press star 1 now. There are no other questions from the phone lines, so at this point I will turn the conference back to Rob Mayonis for any closing remarks.

Thank you, Michelle. I'm pleased with our performance in the first quarter and encouraged by our continued momentum. Revenue increased by 17% year-over-year, and we posted over 5% operating margin for the third consecutive quarter. As the majority of our end markets are poised for growth in 2023, I'm also pleased we're able to raise our 2023 revenue outlook. Thank you all for joining today's call and we look forward to updating you as we progress throughout the year.