Celestica Inc. (NYSE:CLS) Q3 2023 Earnings Call Transcript
Celestica Inc. (NYSE:CLS) Q3 2023 Earnings Call Transcript October 26, 2023
Operator: Good morning ladies and gentlemen. And welcome to the Celestica Q3 2023 Earnings Conference Call. At this time, all lines are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session. [Operator Instructions] This call is being recorded today, October 26, 2023. I would now like to turn the conference over to Craig Oberg, Vice President of Investor Relations and Corporate Development. Please go ahead.
Craig Oberg: Good morning. And thank you for joining us on Celestica’s third quarter 2023 earnings conference call. On the call today are Rob Mionis, 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 yesterday’s press release, including the cautionary note regarding forward-looking statements therein, our most recent annual report on Form 20-F and our other public filings, which can be accessed at sec.gov and sedar.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 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 that 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 Q3 2023 earnings presentation, which are available at celestica.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 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.
Rob Mionis: Thank you, Craig. Good morning, everyone, and thank you for joining us on today’s call. Celestica’s third quarter revenue of $2.04 billion was towards the high end of our guidance range, while our non-IFRS adjusted EPS came in at $0.65 exceeding the high end of our guidance range. Our non-IFRS operating margin of 5.7% was our 15th consecutive quarter of year-to-year non-IFRS operating margin expansion. Our CCS segment continues to benefit from improved business mix, due to the strength of our hyperscaler portfolio reflected by segment margin of 6.2% for the third quarter, the highest ever. We also saw meaningful sequential revenue growth in our HPS business. Our ATS segment delivered solid double-digit year-to-year revenue growth, as we continue to see tailwinds from new program ramps, as well as demand strength in our aerospace business.
Celestica’s strong results in the third quarter are reflective of the bullish secular trend underpinning our portfolio and our team’s solid execution. Before I provide an update on each of our end markets and some color on 2024, I would like to turn the call over to Mandeep who will provide a detailed review of our third quarter financial performance and our guidance for the fourth quarter of 2023. Mandeep, over to you.
Mandeep Chawla: Thank you, Rob, and good morning, everyone. Third quarter revenue came in at $2.4 billion towards the high end of our guidance range. Revenue was 6% higher year-over-year, supported by higher revenues in both segments, including double-digit growth in our ATS segment. Our third quarter non-IFRS operating margin of 5.7% was 60 basis points higher year-over-year. This margin expansion was driven primarily by strong profitability in our CCS segment, supported by solid operational execution. Non-IFRS adjusted earnings per share for the third quarter were $0.65, exceeding the high end of our guidance range and were $0.13 higher year-over-year, driven primarily by higher operating profits. Moving on to our segment performance, third quarter ATS revenue was $859 million, up 12% year-over-year and in line with our expectations of a low double-digit percentage increase.
The year-over-year increase in ATS segment revenue was driven by the ramping of new programs in our industrial business, improving demand in A&D and solid growth in our HealthTech programs. This growth was partly offset with ongoing market related softness in our capital equipment business. ATS segment revenue accounted for 42% of total revenues in the third quarter, compared to 40% in the same period last year. Our CCS segment revenue of $1.18 billion were up 2% compared to the prior year period and accounted for 58% of total company revenues in the third quarter, compared to 60% in the prior year period. Year-over-year dynamics were largely unchained from last quarter, as very strong growth in our enterprise end market, supported by strong demand for proprietary compute, was largely offset by anticipated demand softness in our communications end market.
Enterprise end market revenue in the quarter was up 31% year-over-year, higher than our expectation of a low double-digit percentage increase. Revenue growth was driven by program ramps and continued strength in demand for proprietary compute from our hyperscaler customers in support of artificial intelligence applications. Revenue in our communications end market for the third quarter was lower by 10% year-over-year versus our expectation of a high single-digit percentage decrease. The decline was driven primarily by tough comps from a strong prior year period. HPS revenue was $493 million in the quarter, 5% lower year-over-year, but up 39% sequentially in line with our outlook provided last quarter. HPS revenues were 24% of total company revenues in the third quarter, compared to 27% in the prior year period.
We expect HPS revenue to return to year-to-year growth in 2024, as we anticipate networking customers demand to increase. Turning to segment margin, ATS segment margin in the third quarter was 4.9%, 10 basis points lower year-over-year as the benefits of volume leverage and ramping programs in our industrial business were more than offset by softness in the capital equipment business. CCS segment margin during the quarter was 6.2%, up 100 basis points year-over-year, marking the first time one of our segment margins has exceeded 6%. The increase was driven by higher volumes with our hyperscaler customers, as well as production efficiency. Moving on to some additional financial metrics. IFRS net earnings for the third quarter were $80 million or $0.67 per share, compared to net earnings of $46 million or $0.37 per share in the prior year period.
Adjusted gross margin for the third quarter was 9.8%, up 90 basis points year-over-year due to higher volumes in both segments and improved mix. Third quarter non-IFRS adjusted effective tax rate was 20%, compared to 21% in the prior year period. Non-IFRS adjusted ROIC for the third quarter was 21.5%, an improvement of 2.3% compared to the prior year quarter. Moving on to working capital. At the end of the third quarter, our inventory balance was $2.26 billion, down $85 billion sequentially and down $65 million year-over-year. Cash deposits were $875 million at the end of the third quarter, up $65 million sequentially and higher by $251 million compared to the prior year period. When accounting for cash deposits, inventory continues to improve meaningfully, lower by $316 million on a year-to-year basis at the end of the third quarter and lower by $150 million sequentially.
Inventory days net of cash deposit days were 72 in the third quarter, compared to 85 in the prior year period. We anticipate a further improvement in inventory days over the coming quarters as material lead times continue to normalize. Cash cycle days were 72 during the third quarter, one day lower sequentially and nine days higher than the prior year period. Capital expenditures for the quarter were $27 million or approximately 1.3% of revenue, compared with 2.0% in the third quarter of 2022. Non-IFRS adjusted free cash flow in the third quarter was $34 million, compared to $7 million in the prior year period. This represents our 19th consecutive quarter with positive non-IFRS adjusted free cash flow and brings our year-to-date figure to $110 million, more than double our performance of $51 million from the same period last year.
Given our strong year-to-date performance and positive outlook for the fourth quarter, we are raising our non-IFRS adjusted free cash flow expectation from $125 million to $150 million for 2023. Moving on to some additional key metrics. Our cash balance at the end of the third quarter was $353 million, which, in combination with our approximately $600 million of borrowing capacity under our revolver, provides us with liquidity of approximately $1 billion. We believe this is sufficient to meet our anticipated business needs. Our gross debt at the end of the third quarter was $613 million, leaving us with a net debt position of $260 million [ph]. Our third quarter gross debt to non-IFRS trailing 12-month adjusted EBITDA leverage ratio was 1.1 turns, down 0.1 turns sequentially and down 0.4 turns compared to the same quarter of last year.
At September 30, 2023, we were compliant with all financial covenants under our credit agreement. We did not purchase any shares for cancellation under our NCIB during the third quarter. We do, however, intend to continue to be opportunistic on share repurchases under our current NCIB for the remainder of the year and intend on renewing our NCIB program in December, subject to necessary approvals. Now turning to our guidance for the fourth quarter of 2023. Fourth quarter revenues are expected to be in the range of $2.0 billion to $2.15 billion, which, if the midpoint of this range is achieved, would be slightly higher compared to the same quarter last year. Fourth quarter non-IFRS adjusted earnings per share are expected to be in the range of $0.65 per share to $0.71 per share, which would represent an improvement of $0.13 per share or approximately 23% compared to the fourth quarter of 2022 if the midpoint of the guidance range is achieved.
If the midpoint of our revenue and non-IFRS adjusted EPS guidance ranges are achieved, non-IFRS operating margin would be 5.7%, which would represent an increase of 40 basis points over the prior year period. Non-IFRS adjusted SG&A expense for the fourth quarter is expected to be in the range of $67 million to $69 million. We anticipate our non-IFRS adjusted effective tax rate to be approximately 20% for the fourth quarter, excluding any impact from taxable foreign exchange or unanticipated tax settlement. Now turning to our end market outlook for the fourth quarter of 2023. In our ATS segment, we anticipate revenue to be up in the low single-digit percentage range year-over-year, driven by expected double-digit growth in our industrial and A&D businesses, partly offset by ongoing market softness in capital equipment.
We anticipate revenues in our communications end market to be down in the mid-teen percentage range year-over-year, driven by tough comps from the prior year period. Finally, in our enterprise end market, we expect revenues to be up in the high 20% range year-over-year, driven by anticipated continuing demand strength in proprietary compute programs from our hyperscaler customers. I will now turn the call back over to Rob to provide details on the outlook for our end market and business overall.
Rob Mionis: Thank you, Mandeep. Based on our solid performance this quarter and our strong guidance to close out the year, we are pleased to raise our preliminary 2024 outlook. In the coming fiscal year, we are maintaining our expectation of non-IFRS adjusted EPS growth of 10% or more compared to our 2023 outlook, which has increased from $2.25 to $2.36 based on the midpoint of our fourth quarter guidance. We expect this growth to be driven by a combination of higher revenue across each of our end markets and solid non-IFRS operating margin. I would now like to provide some detail on the outlook for each of our businesses. Beginning with our ATS segment, our industrial business has continued to experience very strong growth in 2023, driven by ramping new programs.
We expect this momentum to continue into the next year as these green programs continue to ramp. Our PCI business also achieved solid revenue growth in 2023 and we are pleased that they are on track to achieve the synergy objectives establish at the time of acquisition. We anticipate continuing growth in 2024, supported by our investment to expand capacity in Indonesia, which is expected to be online by year end. The recovery in commercial aerospace demand continues to fuel solid growth in our A&D business, supporting a greater than 30% increase in revenues year-to-date compared to the prior year period. Our defense business is also experiencing solid double-digit growth in 2023, supported by a number of new program ramps and we anticipate this momentum to continue into next year.
With commercial air traffic now approaching more normalize levels, we anticipate our overall A&D revenue growth rate moderating in 2024, though remaining relatively strong as we continue to have a healthy backlog. Moving on to capital equipment, demand continues to be soft across the broader wafer fab equipment market, which has been compounded by the recent U.S.-China trade restrictions affecting the semi industry. We continue to be encouraged by our ability to execute in a challenging market and remain profitable despite a material year-over-year reduction in volume. Overall, our capital equipment portfolio is benefiting from a combination of favorable mix and the ramping of new program wins. Looking ahead, we believe that our capital equipment business is operating at trough levels and while we expect the underlying market demand to be relatively flat year-over-year in 2024, we do expect our business to grow based on new program wins.
In our HealthTech business, the ramping of new programs in surgical instruments and imaging devices are supporting solid growth during 2023. Overall, the demand outlook for our HealthTech business remains healthy with growth into 2024. Now turning to our CCS segment, the broader environment continues to be positive for our CCS segment as hyperscalers are making significant investments in data center capacity. Market observers have suggested that we may be in the early days of this long-term secular trend accompanied by a major hardware upgrade cycle to support artificial intelligence applications and the resulting increase in data center traffic. We believe that the different stages of this investment cycle will be synergistic and support demand for our entire suite of data center offerings at various times throughout the entire cycle.
Demand in our enterprise market is showing significant strength benefiting from the tailwinds of hyperscalers investments in data center compute capacity to support the growth in artificial intelligence applications. Our medium-term outlook for this business also remained very positive, with expectations for continued strong demand and proprietary compute, as well as ramping programs and storage. We anticipate that these factors will support double-digit revenue growth rate in our enterprise business through 2024. The near-term outlook for our communications end market remains soft into the end of the year, primarily due to tough comps. However, we do expect that this business will resume year-to-year revenue growth in 2024 as customer investments in compute begin to pull through demand for networking.
We are encouraged by our medium-term outlook for our communications end market, supported by our leading position in 400G and recent wins in 800G. We are also encouraged by the sequential growth in our HPS business in the third quarter and believe that it is poised to return to annual growth in the coming year as customer inventory levels are expected to normalize and new networking and compute programs ramp in 2024. Finally, I am pleased to announce that being a Virtual Investor Briefing on November 29th, we are looking forward to walking the investment community through an overview of our CCS and ATS portfolios, including a more thorough look at the opportunities we see in our hyperscaler business. We also intend to provide further details on our 2024 outlook, as well as our long-term financial targets and capital allocation framework.
We will be releasing the details of the event shortly and we hope that all of you can join us on that day. We have much to look forward to as we aim to close with a strong finish to the year. We are on track to achieve the highest ever non-IFRS adjusted operating margin and non-IFRS adjusted earnings per share in the company’s history, eclipsing both of the previous highs set last year. I have the utmost confidence and trust in our team to execute on our long-term strategy, continue to deliver on our targets and set us up for another great year in 2024. With that, I would now like to turn the call over to the Operator for questions.
See also 20 Most Popular Business Hashtags on Instagram and 15 Best US Cities for Public Transportation.
To continue reading the Q&A session, please click here.
