Celestica Inc. (NYSE:CLS) Q1 2024 Earnings Call Transcript

Celestica Inc. (NYSE:CLS) Q1 2024 Earnings Call Transcript April 25, 2024

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Operator: Good morning, ladies and gentlemen, and welcome to the Celestica First Quarter 2024 Earnings 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] And this call is being recorded on Thursday, April 25, 2024. I would now like to turn the conference over to Craig Oberg, Vice President of the Investor Relations and Corporate Development. Please go ahead.

Craig Oberg: Good morning, and thank you for joining us on Celestica’s first quarter 2024 earnings conference call. On the call today are Rob Mionis, President and Chief Executive Officer; and Mandeep Chawla, Chief Financial Officer. Please note that during the course of this conference call, we will make statements relating to the future performance of Celestica that contain forward-looking information. While these forward-looking statements represent our current judgment, actual results could differ materially from a conclusion, forecast, or projection in the forward-looking statements made today. Certain material factors and assumptions are applied in drawing any such statements. We undertake no obligation to update these forward-looking statements unless expressly required to do so by law.

In addition, during this call, we will refer to various non-IFRS financial measures, including non-IFRS operating margins, 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, adjusted effective tax rate, and non-IFRS operating earnings. Additional information about material factors that could cause actual results to differ materially from a conclusion, forecast, or projection in the forward-looking information, as well as risk factors that may impact future performance results of Celestica, and reconciliation of such non-IFRS financial measures to their most directly comparable IFRS financial measures are contained in our public filings at sedarplus.ca and sec.gov, as well as in our press release that was distributed yesterday and which may be found on our website.

Unless otherwise specified, all references to dollars on this call are to US 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, and good morning, everyone and thank you for joining us on today’s call. We started off the year with a very strong first quarter, achieving revenue of $2.21 billion, while our adjusted EPS came in at $0.86, both exceeding the high end of our guidance ranges. Our non-IFRS operating margin was 6.2%, which was above the midpoint of our revenue and adjusted EPS guidance ranges. Our solid non-IFRS operating margins resulted in adjusted free cash flow of $65 million during the quarter. The strong performance to kick off the year was driven by the ongoing strength in our CCS segment, supported by continued demand strength from our hyperscale customers. This dynamic drove solid sequential and year-to-year growth in revenues across both our enterprise and communications end markets.

And resulted in CCS segment margin of 7%, 120 basis point improvement year-over-year. In our ATS segment, revenues were down slightly year-to-year, as anticipated, driven primarily by demand softness from customers in our industrial business, partially offset by growth across our other ATS businesses. Our A&D business continues to see solid double-digit year-to-year revenue growth, and the outlook for the year remains positive. And after several tough quarters in our capital equipment business, revenues appear to have stabilized, and customer forecasts are signaling that year-to-year growth will accelerate in the coming quarters. We are also pleased to share an update regarding a recent tuck-in acquisition. Following the close of the quarter, we signed a definitive agreement to require NCS Global Services LLC, a US-based IT infrastructure and asset manager business for $36 million.

This acquisition accelerates our IT services roadmap within our CCS segment by expanding our strategic capabilities and geographic footprint, and allowing us to enhance our service offerings across the entire lifecycle of our customers’ assets. This acquisition is strongly aligned to our strategic roadmaps and meets our financial hurdles, including being accretive to our adjusted EPS in 2024. Overall, we are very pleased with our start to the year. We are encouraged by our solid execution, our strong financial performance, and by the positive market tailwinds across a number of the businesses in our portfolio. I would now like to turn the call over to Mandeep, who will provide further details on our first quarter financial performance and our guidance for the second quarter of 2024.

Mandeep, over to you.

Mandeep Chawla: Thank you, Rob. And good morning, everyone. First quarter revenue came in at $2.21 billion dollars, above the high end of our guidance range and up 20% year-over-year. The increase was supported by stronger than expected growth in our CCS segment, partially offset by an anticipated modest decline in our ATS segment. Our first quarter non-IFRS operating margin of 6.2% was an improvement of 100 basis points year-over-year and marked the first time that our quarterly non-IFRS operating margin exceeded 6.0%. The margin expansion was driven by improved profitability in both segments as a result of favorable mix and production efficiency. Our adjusted earnings per share for the first quarter was $0.86, which exceeded the high end of our guidance range.

Our adjusted EPS was up $0.39 compared to the prior year period, driven primarily by higher non-IFRS operating earnings and a more favorable adjusted effective tax rate. Our first quarter adjusted effective tax rate expectation was 20%, assuming that global minimum tax would be enacted in Canada by March 31st. Given the legislation has not yet been enacted, our adjusted effective tax rate came in favorably at 15%, leading to a benefit of approximately $0.05 per share. Moving on to our segment performance, ATS revenue in the first quarter was $768 million, down 3% year-over-year, which was in line with our expectations of a low single-digit percentage decrease. The year-over-year decline in ATS segment revenue was driven by continued demand softness in our industrial business.

These declines were partially offset by solid year-to-year growth in our A&D business. In addition, our capital equipment business saw revenues stabilize on a year-to-year basis, registering modest growth compared to the prior year period. ATS segment revenue accounted for 35% of total revenues in the first quarter. Our first quarter CCS segment revenue of $1.44 billion was 38% higher compared to the prior year period, driven by strong growth in both our enterprise and communications end market. CCS segment revenue accounted for 65% of total company revenues in the quarter. Revenue in our enterprise end market was up by 72% year-over-year in the first quarter, exceeding our expectation of a high 60% increase. The growth is driven by continued demand strength for AI/ML compute products from our hyperscaler customers.

Revenue in our communications end market was higher by 17% compared to the prior year quarter, which was better than our expectation of a low single digit percentage increase. The return to growth in our communications end market was driven by increased demand for HPS networking products from hyperscaler customers, predominantly in support of AI/ML infrastructure. HPS revenue was $519 million in the quarter, up 40% year-over-year, and accounted for 23% of total company revenues in the quarter. The growth in the first quarter was driven primarily by stronger networking demand from hyperscaler customers, including new program ramps. Turning to segment margins, ATS segment margin in the first quarter was 4.7%, up 30 basis points compared to the prior year period, driven by favorable mix.

CCS segment margin during the quarter was 7.0%, up 120 basis points year-over-year as a result of improved mix and volume leverage which drove strong productivity. During the first quarter we had one customer that accounted for more than 10% of total revenues, representing 34% of sales for the quarter. We continue to support this strong demand with solid execution across a number of programs. And we remain comfortable with our current levels of concentration with this customer in our portfolio. Moving on to some additional financial metrics. IFRS net earnings for the first quarter were $102 million, or $0.85 per share, compared to $25 million, or $0.20 per share in the prior year period. Adjusted gross margin for the first quarter was 10.2%, up 80 basis points year-over-year due to more favorable mix and production efficiencies resulting from higher volumes.

Our adjusted ROIC for the first quarter was 24.8%, an improvement of 6.9% compared to the prior year quarter, driven by higher profitability and effective working capital management. Moving on to working capital. At the end of the first quarter, our inventory balance was $1.96 billion, down $150 million sequentially, and down $440 million year-over-year. Cash deposits were $719 million at the end of the first quarter, $185 million lower sequentially, and down by $91 million compared to the prior year period. Our cash deposits decreased as expected as a result of higher deliveries on a number of ramping projects. Cash cycle days were 69 during the first quarter, down three days sequentially, and six days lower than the prior year period. Moving on to cash flows.

Capital expenditures for the quarter were $40 million or approximately 1.8% of revenue, flat compared with the prior year period. Consistent with our discussion last quarter, we continue to expect our capital expenditures for 2024 to be between 1.75% and 2.25% of revenues. During the first quarter, we commenced operations at two of our new facility expansions, the first phase addition to our Thailand facility, and the 80,000 square foot expansion at our Kulim site in Malaysia. We remain on track to complete the second phase of our Thailand facility expansion by the first half of 2025, which will add more than 100,000 square feet of manufacturing floor space to support our programs with hyperscaler customers. Turning to our adjusted free cash flow, we generated $65 million in the first quarter compared to $9 million in the prior year period.

Moving on to some additional key metrics. At the end of the first quarter, our cash balance was $308 million. In combination with our approximately $600 million of borrowing capacity under our revolver. This provides us with liquidity of approximately $900 million, which we believe is sufficient to meet our anticipated business needs. Our gross debt at the end of the first quarter was $632 million, leaving us with a net debt position of $324 million. Our first quarter gross debt to non-IFRS trailing 12-month adjusted EBITDA leverage ratio was 1.0 turns, down 0.1 turns sequentially, and down 0.3 turns compared to the same period last year. As of March 31, 2024, we were compliant with all financial covenants under our credit agreement. During the first quarter, we purchased approximately 460,000 shares for cancellation under our normal course issuer bid at a cost of $17 million.

We intend to continue to repurchase shares on an opportunistic basis in 2024. Now turning to our guidance for the second quarter of 2024. Revenues in the second quarter are expected to be in the range of $2.175 billion to $2.325 billion, which, if the midpoint of this range is achieved, would represent growth of 16% compared to the prior year period. Second quarter adjusted earnings per share are expected to be in the range of $0.75 to $0.85, which, at the midpoint would represent an improvement of $0.25 per share, or 45% compared to the second quarter of 2023. If the midpoint of our revenue and adjusted EPS guidance ranges are achieved, non-IFRS operating margin would be 6.1%, which would represent an increase of 60 basis points over the same period last year.

Our adjusted SG&A expense for the second quarter is expected to be in the range of $67 million to $69 million. We anticipate our adjusted effective tax rate to be approximately 20% for the second quarter, excluding any impact from taxable foreign exchange or unanticipated tax settlement. Consistent with our approach last quarter, our guidance assumes that our income will be subject to global minimum tax. Now turning to our end market outlook for the second quarter of 2024. In our ATS segment, we anticipate revenue to be down in the high single-digit percentage range year-over-year, driven by demand softness in our industrial business, partly offset by growth in A&D and capital equipment. We anticipate revenues in our communications end market to be up in the mid 40 percentage range year-over-year, driven by strengthening demand for HPS networking products from hyperscaler customers.

Finally, in our enterprise end market, we expect revenue to be up in the low 20 percentage range year-over-year, driven by anticipated demand growth in AI/ML compute programs from our hyperscaler customers. I’ll now turn the call back over to Rob to discuss the outlook for each of our end markets and the overall business.

Rob Mionis: Thank you, Mandeep. Before discussing the outlook for our end markets, I would like to provide an update to our annual financial outlook for 2024. We are pleased to be raising our full-year outlook based on our solid performance in the first quarter and the positive momentum we are seeing across a number of our businesses. We now expect revenue of $9.1 billion in 2024 and adjusted EPS of $3.30, which would represent a growth of 14% and 36%, respectively, compared to 2023. Our non-IFRS operating margin is now expected to be approximately 6.1%, which would represent a 50 basis point improvement compared to 2023. Finally, we are raising our adjusted free cash flow outlook to $250 million for the full year. Now moving on to the outlook for our businesses.

Beginning with our ATS segment, within ATS we continue to anticipate a decline in the first half of 2024 compared to 2023 and for year-to-year growth to resume in the back half of the year. As a result, we are now expecting ATS segment revenues to be approximately flat for the full year in 2024 compared to 2023. In our industrial business, we believe that key sub-markets, including EV charging, smart energy, on-vehicle and factory automation will continue to be supported by favorable secular trends in our economy over the long term and will help drive robust and sustainable growth in our industrial business in the coming years. However, in the near term, the industrial business continues to experience softness across a number of our submarkets, driven in large part by EV charging as the industry works through an inventory backlog amidst a slowdown in demand for electric vehicles.

However, we do expect demand to improve as the year progresses and for revenues to show sequential improvement throughout 2024 with a return to year-to-year growth expected by the fourth quarter. In our A&D business, the recovery in air traffic continues to drive solid commercial aerospace growth. We expect broad-based demand strength in our commercial aerospace portfolio to persist throughout 2024. We also anticipate healthy growth in our defense business this year, supported by the ramping of new programs. In our capital equipment business, we are seeing early signs of a recovery, with revenue stabilizing both year-to-year and sequentially in the first quarter. The latest third-party forecasts are now calling for an improved demand outlook for the wafer fab equipment market in 2024, supported primarily by a recovery in the memory market.

Within our portfolio, stronger base demand and the ramping of newly-run programs are affirming our outlook for a return to growth in 2024. Market forecasts currently suggest that capital investments by chip manufacturers will continue to grow into 2025 in order to support demand for processes used in generative AI applications and increase silicon content in products within other sectors such as automotive. We anticipate that these trends will support continued momentum in our portfolio into next year. Now turning to our CCS segment. Based on the strong outlook in our CCS segment, we are raising our expectation for revenue growth to the mid-20s percentage range for 2024, supported by solid demand in both our enterprise and communications end market.

The demand strength from our hyperscaler customers continues to support very strong growth in our CCS segment. In 2023, hyperscalers accounted for 62% of our CCS segment revenues, and we expect that number to grow in 2024. As we have discussed in recent quarters and at our November 2023 Investor Day, the growth in demand for new AI and machine learning applications remains the primary driver underpinning this investment cycle. We continue to believe that this secular scene is durable in its nature and is likely to support continued demand strength for our CCS offerings into 2025. As such, we are continuing to make the necessary investments, including a capacity expansion and engineering capabilities in order to maintain our position as a leading provider of critical products and services for the data center.

Now moving on to our end markets. The demand outlook for our enterprise end markets remains very healthy, as we continue to benefit from the growing investment in AI/ML compute capacity by hyperscalers. We anticipate enterprise demand to remain strong in the coming quarters, supported by increasing AI/ML compute deployments and new program ramps. Our communications end markets saw stronger than anticipated demand to start the year, and we expect this momentum to accelerate in the coming quarters. We anticipate sustained growth throughout 2024, supported by strong demand from hyperscalers customers for HPS networking products and the ramping of new programs. Within our HPS business, the demand largely mirrors that of our communications end market.

Our outlook calls for sustained double-digit growth throughout 2024, supported by increased deployment of networking infrastructure from hyperscalers. That’s our period of inventory digestion in 2023. In addition, new program wins, including for our 800G platforms, are expected to ramp throughout the year and into 2025. We feel that our portfolio is well positioned for another very strong year in 2024. We continue to prioritize the fundamentals, adherence to our strategic roadmaps, solid execution, and prudent decision-making, and all of our businesses, regardless of the dynamics at play within the underlying markets. We remain confident in our ability to deliver on our financial targets and continue generating long-term value for our shareholders.

With that, I would now like to turn the call over to the operator for questions. Thank you.

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Q&A Session

Operator: Thank you, presenters. And ladies and gentlemen, we will now begin the question-and-answer session. [Operator Instructions] Your first question comes from the line of Robert Young of Canaccord Genuity. Your line is now open.

Robert Young: Hi, good morning. Congrats on the quarter. The first question I had was related to the full year guide. If we just simply take the Q1 and Q2 guide out of there, it implies a deceleration in the top line in the second half. And so, just curious if that’s visibility into the second half or is there something specific to call out there or any other factor?

Rob Mionis: Yes, good morning, Rob. Thank you. So hyperscaler demand remains healthy across multiple markets, and demand signals remain healthy, but really it comes down to visibility and you touched on it. So hyperscale customers generally provide about a 12 month outlook, but beyond six months, there are some demand dynamics at play. Demand continues to exceed supply, so as material availability improves, orders accelerate. And then secondarily, there’s some variability in customer deployment plans, driven by customers resource constraints or to some extent technology transitions. So our visibility into the fourth quarter is a bit murky. It should firm up in the next few months, but hence our view of a flattish relative to the first half [indiscernible] full-year outlook.

Mandeep Chawla: Yes. Hey, Rob. Mandeep here. Just to build on what Rob was mentioning. The [90, 100] (ph) reflects 14% year-over-year growth. And to your point the second half year-over-year is a little bit lower than the first half, but still a strong double digit set of numbers. I think the important thing to take away is that, the demand environment in CCS in particular remains healthy. We’re not seeing areas of concern, but we are being mindful of things such as material availability and going back to our customers and saying, look, Q2 came in stronger than what we had thought it was going to be, what are the implications for the back half of the year? And so those discussions are continuing.

Robert Young: Okay, thanks. That’s very helpful. Second question for me would be on the customer concentration. I think last quarter you suggested that networking recovery would maybe help that out a little bit and so with HPS returning to growth, I was surprised to see the concentration actually go up and so is that networking plus AI at that first — that largest customer or is there any other dynamic at play and then I’ll pass the line.

Rob Mionis: Yes. You hit on it Rob, which is, 34% with our biggest customer, at the same time we saw a very large level of growth happening in comms, and it’s continuing into the second quarter. And it just underscores what we had talked about last quarter, which is, we do a number of programs, 20 plus programs with this largest customer. And so not only are we seeing demand strength on the compute side with that large customer, but we’re also seeing an acceleration now on the switching side as well. And so we’re happy that our portfolio is able to support them in multiple areas.

Mandeep Chawla: And I’ll add that beyond that our top customer growth remains very healthy across a number of our hyperscale customers as well along those same platforms, the comms enterprise.

Robert Young: And just as a follow on there, the HPS growth I assume is driven by 400 gig switch. Is that spread across a larger number of customers? Is it broader than just that large customer? Maybe give us a sense of how many customers you have there or how broad that business is?

Rob Mionis: Yes, 400 gig is across a number of customers. We’re also ramping 800 gig switches this year and into next year. Next year, additional customers will come on on 800G switch ramps. On HPS, it’s also important to point out that HPS is not just limited to networking, there’s also a fair amount of HPS content in compute modules these days as well.

Robert Young: Okay, thanks. I’ll pass the line.

Operator: Thank you so much. And your next question comes from the line of Daniel Chan of TD Cowen. Please go ahead.

Daniel Chan: Hi, good morning. And maybe just to top up on that communications question. As you get more mix of 800G, how does that affect the financials? In other words, what is the price and margin profile difference between an 800G and a 400G program?

Rob Mionis: Hi, Dan. Thanks for the question. So the ASPs, of course, change a little bit as you go from 400G to 800G. They’re not necessarily twice as much. And so, it’s really a conversation of how many units are being shipped, et cetera. I think if we were to just up-level it and look at overall revenue, we expect revenue growth to be higher year-to-year as the 800G deployments happen. To the question that you’re asking, 400G demand has really — as you know, communications slow down because of an inventory overbuild. We’re now seeing customers not only work with us on program development around 800G products, but also taking 400G products in the meantime as well. And so, it’s nice to see that we’re actually shipping both products right now. We would expect naturally for 400G to start slowing down going into next year. That filled more than one-for-one on the 800G side.

Daniel Chan: Thanks, that’s helpful. When you talk to your cloud customers and you look at the AI data center architecture, do you get the sense that the mix of your products within an AI data center could be higher than what was done for a traditional data center?

Rob Mionis: That’s a hard one to discern, but what I do know is, we have all the solutions that our customers need that go into an AI data center, and we’re currently providing them, so hence we’re firing on all cylinders. We have HPS content across compute modules. We provide high-value EMS across compute modules. We have HPS content on 400 and 800 switches. And we’re also in advanced development on future generation network devices. And we also, as you know have storage solutions both the HPS and traditional as well. So our customers are really taking advantage of our full solutions.

Mandeep Chawla: Dan, as you know not all hyperscalers are created equal and there are some hyperscalers that lean towards more complex, challenging product deployments, and that really works out well for us. The reason that you’re seeing the amount of growth that we’re showing in HPS is because those are the solutions that really fit the demand requirements of certain hyperscalers. And so, as we see this shift towards more AI type of data centers, it implies more complex product, which is, what we want to see.

Daniel Chan: Great, that’s helpful. Maybe squeezing one more in on the enterprise, the enterprise growth is expected to decelerate next quarter. Have you been successful in diversifying your hyperscale customer base in AI compute, just giving your experience with servers using custom AI chipsets. And if so, what does that ramp look like? Or is this the new run rate for the remainder of the year? Thank you.