Celestica Inc. (NYSE:CLS) Q4 2023 Earnings Call Transcript

Celestica Inc. (NYSE:CLS) Q4 2023 Earnings Call Transcript January 30, 2024

Celestica Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good day, ladies and gentlemen, and welcome to Celestica Q4 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 on Tuesday, January 30, 2024. 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 fourth 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 sedarplus.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, adjusted effective tax rate and operating earnings.

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 Q4 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 recent modifications to specified non-IFRS financial measures.

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. We ended the year with a very strong fourth quarter, achieving revenue of $2.14 billion, which is towards the high-end of our guidance range, while our non-IFRS adjusted EPS came in at $0.76, exceeding the high end of our guidance range. Our non-IFRS operating margin was 6% exceeding the midpoint of our revenue and non-IFRS adjusted EPS guidance ranges. The outperformance in the fourth quarter relative to our guidance was driven by continued strength in our CCS segment, supported by the sustained growth of our hyperscaler portfolio. We continue to see the benefit of improved mix in our CCS segment margin, which reached yet another new high of 6.7% in the fourth quarter.

In our ATS segment, revenues were down slightly year-to-year as incremental demand softness in our industrial business and continued demand headwinds in our capital equipment business more than offset strong growth in our A&D business. Our solid performance in the fourth quarter capped a stellar year in 2023. Throughout this past year, we continued to execute on our strategic firm, enhanced our competitive presence in key markets and consistently delivered on our financial objectives. In 2023, our business generated revenue of approximately $8 billion, 10% higher than 2022, driven by strong growth in both our CCS and ATS segments. Our non-IFRS adjusted EPS of $2.43 was up 28% versus the prior year, while non-IFRS operating margin of 5.6% was higher by 70 basis points, with both results marking the highest in the company’s history.

Our strong profitability and working capital management allowed us to generate non-IFRS adjusted free cash flow of $194 million, exceeding our full year target of $150 million. Before I provide an update on the market outlook for each of our businesses, I would now like to turn the call over to Mandeep, who will provide further details on our fourth quarter financial performance and our guidance for the first quarter of 2024. Mandeep, over to you.

Mandeep Chawla: Thank you, Rob, and good morning, everyone. Fourth quarter revenue came in at $2.14 billion, towards the high end of our guidance range. Revenue was up 5% year-over-year, supported by solid growth in our CCS segment, partially offset by a modest decline in our ATS segment. Our fourth quarter non-IFRS operating margin of 6.0% was 70 basis points higher year-over-year and marked the highest quarterly results in the company’s history. Our margin expansion was driven primarily by higher profitability in both segments, as a result of improved mix, production efficiencies, and higher volumes in our CCS segment. Non-IFRS adjusted earnings per share for the fourth quarter was $0.76 exceeding the high end of our guidance range.

This result was $0.20 higher year-over-year, driven primarily by higher non-IFRS operating earnings, as well as lower interest costs, a more favorable non-IFRS adjusted effective tax rate and lower shares outstanding. Moving onto our segment performance. ATS revenues in the fourth quarter were $803 million down 2% year-over-year, slightly below our expectations of a low-single digit percentage increase. The year-over-year decline in ATS segment revenue was driven by demand softness in our industrial business, primarily as a result of slowing demand in certain programs, as well as continued demand headwinds in our capital equipment business. These declines were partially offset by solid performance in our A&D business, which saw growth of more than 20% compared to the prior year period.

ATS segment revenues accounted 38% of total revenues in the fourth quarter compared to 40% in the same period last year. Our fourth quarter CCS segment revenue of $1.34 billion was up 10% compared to the prior year period, driven by very strong growth in our enterprise end market, partially offset by anticipated demand softness in our communications end market. CCS segment revenue accounted for 62% of total company revenues in the quarter compared to 60% in the prior year period. Enterprise end market revenue in the fourth quarter was up 46% year-over-year, meaningfully above our expectation of a high-20s percentage increase. This growth was driven by ramping programs and strengthening demand for AI/ML compute from our hyperscaler customers.

Revenue in our communications end market was lower by 10% compared to the prior year period, better than our expectation of a mid-teens percentage decrease. Similar to last quarter, the decline was driven primarily by tough comps, as some of our customers continue to digest inventory purchased in the prior year. HPS revenue was $484 million in the quarter, 1% lower year-over-year. HPS revenues were 23% of total company revenues in the fourth quarter compared to 24% in the prior year period. Turning to segment margins. ATS segment margin in the fourth quarter was 4.7%, up 30 basis points year-over-year, driven by strong productivity and favorable mix. CCS segment margin during the quarter was 6.7%, up 80 basis points year-over-year, driven by higher volumes and improved mix, including significant growth with our hyperscaler customers.

During the fourth quarter and for 2023, we had one customer, which accounted for more than 10% of total revenues, representing 29% for the quarter and 22% for the year. Celestica has a long standing relationship with this customer, a global hyperscaler that we have been supporting for well over a decade. We support this customer across 25 programs covering HPS and non-HPS products in the areas of networking and compute. The products we build are highly complex, and as a result, the majority of these programs are single sourced. In addition, we are pleased that as a result of our strength in engineering and solid operational execution, we continue to win new programs with this customer and expect to see demand strength continue through 2024 and into 2025.

Moving onto some additional financial metrics. IFRS net earnings for the fourth quarter were $84 million or $0.70 per share compared to net earnings of $42 million or $0.35 per share in the prior year period. Adjusted gross margin for the fourth quarter was 10.4% up 100 basis points year-over-year, due to improved mix and production efficiencies. Fourth quarter non-IFRS adjusted effective tax rate was 20% in the quarter compared to 23% in the prior year period. Non-IFRS adjusted ROIC for the fourth quarter was 23.3%, an improvement of 2.6% compared to the prior year quarter driven by strong profitability and working capital managements. Moving on to working capital. At the end of the fourth quarter, our inventory balance was $2.11 billion, down $155 million sequentially, and down $244 million year-over-year.

Cash deposits were at $905 million at the end of the fourth quarter, up $30 million sequentially, and higher by $79 million compared to the prior year period. When accounting for cash deposits, inventory at the end of the fourth quarter was lower by $323 million on a year-over-year basis and lower by $185 million sequentially. Inventory days, net of cash deposit days were 62 in the fourth quarter compared to 79 in the prior year period. We are pleased with the improvements we are seeing in inventory as material constraints continue to improve and [indiscernible] lead times normalize. Cash cycle days were 72 during the fourth quarter, flat sequentially, and 8 days higher than the prior year period. Capital expenditures for the quarter were $33 million or approximately 1.5% of revenue, compared with 1.6% of revenue in the fourth quarter of 2022.

For the full year, capital expenditures were $125 million or 1.6% of revenue as we continue to invest in growth across our network to support customer demand. As we look to 2024, we expect our capital expenditures to modestly increase to between 1.75% and 2.25% of revenues, with a higher level of spend in the first half of the year. Our increasing level of capital expenditures is geared towards capacity expansions at key sites in support of demand for AI/ML compute and HPS programs. In Thailand, we are currently building out over 100,000 square feet of additional capacity, with the first phase expected to be online in the first quarter of 2024, and the second phase expected to be completed in the first half of 2025. This expansion is being partially funded by a co-investment with one of our hyperscaler customers to facilitate demand for highly specialized data center products.

And in Malaysia, we are building more than 80,000 square feet of capacity to support strong demand from customers in our CCS segment, including our HPS business. This edition is expected to be online in the first half of 2024. Turning to non-IFRS adjusted free cash flow. We generated $84 million in the fourth quarter compared to $43 million in the prior year period, marking our 20th consecutive quarter of positive non-IFRS adjusted free cash flow. This result brings our total free cash flow for the year to $194 million ahead of our full year outlook of $150 million and approximately double our results from 2022 of $94 million. The out performance was driven by strong profitability and working capital management. Looking forward to 2024, we are expecting $200 million or more of non-IFRS adjusted free cash flow, $25 million higher than the outlook we shared in our November Virtual Investor meeting.

Moving on to some additional key metrics. At the end of the fourth quarter, our cash balance was $370 million, higher by $17 million sequentially. In combination with our approximately $600 million of borrowing capacity under our revolver, this provides us with liquidity of approximately $1 billion, which we believe is sufficient to meet our anticipated business needs. Our gross debt at the end of the fourth quarter was $609 million, leaving us with a net debt position of $239 million. Our fourth quarter gross debt to non-IFRS trailing 12-month adjusted EBITDA leverage ratio was 1.1 turns flat sequentially and down 0.2 turns compared to the same period of last year. As of December 31, 2023, we were compliant with all financial covenants under our credit agreement.

During the fourth quarter, we purchased approximately 400,000 shares for cancellation under our normal course issuer bid at a cost of $10 million. For 2023, we repurchased a total of 2.6 million shares for cancellation, or approximately 2% of our shares outstanding at year end, at a total cost of $36 million. In December, the TSX accepted our normal course issuer bid, which is in effect until December 2024. Under this new NCIB, we are authorized to purchase up to approximately 11.8 million shares, or approximately 10% of the public flow. We continue to believe that investing in our share buyback program is a good use of capital and intend to repurchase shares on an opportunistic basis in 2024. Now turning to our guidance for the first quarter of 2024.

First quarter revenues are expected to be in the range of $2.025 billion to $2.175 billion, which, if the midpoint of this range is achieved, would represent growth of 14% compared to the prior year period. First quarter non-IFRS adjusted earnings per share are expected to be in the range of $0.67 to $0.77 per share, which at the midpoint would represent an improvement of $0.25 per share or 53% compared to the first quarter of 2023. If the midpoint of our revenue and non-IFRS adjusted EPS guidance ranges are achieved, non-IFRS operating margin would be 6.0%, which would represent an increase of 80 basis points over the same period last year. Non-IFRS adjusted SG&A expense for the first quarter is expected to be in the range of $62 million to $64 million.

We anticipate our non-IFRS adjusted effective tax rate to be approximately 20% for the first quarter, excluding any impact from taxable foreign exchange or unanticipated tax elements. Our first quarter guidance assumes that our income will be subject to global minimum tax, as legislation that has been introduced in Canada may be approved before the end of the quarter. If this legislation is not substantially enacted in the first quarter, our estimate for our first quarter non-IR4S adjusted effective tax rate would be approximately 15%. Now turning to our end market and outlook for the first quarter of 2024. In our ATS segment, we anticipate revenue to be down in the low-single digit percentage range year-over-year, driven by demand softness in our industrial business and ongoing market softness in capital equipment, partly offset by continued growth in A&D.

We anticipate revenues in our communications end market to be up in the low-single digit percentage range year-over-year, driven by strengthening demand and networking from hyperscaler customers, including in our HPS programs. Finally, in our enterprise end market, we expect revenue to be up in the high-60s 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, Mandy. Before discussing the outlook for our markets, I would like to reaffirm the following metrics from our 2024 financial outlook that we provided at our Virtual Investor meeting in November. We continue to expect revenue of $8.5 billion or more, non-IFRS adjusted EPS of $2.70 or more, and non-IFRS operating margin to be in the range of 5.5% to 6%. In addition, as Mandeep mentioned, we have raised our non-IFRS free cash flow outlook for the year to $200 million or more. We are pleased with our strong performance in 2023 and continue to see very positive momentum in the first quarter of 2024. As such, we are currently undertaking discussions with our customers and suppliers in order to obtain better visibility into the remainder of the year.

And we look forward to providing an update on our 2024 outlook with our first quarter results. Now moving on to the outlook for each of our businesses. Beginning with our ATS segment, our industrial business recorded annual growth of 29% in 2023, driven by ramping programs in smart (ph) energy and EV charging. However, we began to see signs of market softness towards the end of the year, due in part to pockets of weakness in the broader economic environment, higher interest rates, as well as some delays in new program ramps. As such, we expect to see lower revenues in our industrial portfolio through the first half of the year before seeing a return to year-to-year growth in the second half, which should result in modest growth in our industrial business for all of 2024 when compared to 2023.

We continue to believe that the structural trend in markets such as EV charging, smart (ph) energy, and telematics, amongst others, remain intact and are supportive to growth in our industrial business over the long term. In our A&D business, the sustained recovery in commercial aerospace has seen domestic air travel surpass pre-pandemic levels in many economies, resulting an annual revenue growth of more than 30% in 2023 compared to 2022. Looking ahead, we expect to see strong demand across our commercial aerospace submarkets to continue in 2024. Our defense business is also expected to see solid growth in the year ahead, supported by new program wins, and increased government investment in military capabilities. Overall, we anticipate the sell demand to drive low-double digit percentage growth in our A&D business in 2024 compared to 2023.

In our capital equipment business, market forecasts continue to suggest that the underlying market demand is operating close to trough levels, and we should see flat to slightly higher demand in 2024. We are maintaining our outlook for modest revenue growth in our capital equipment business in 2024, supported by the ramping of new program wins and our assumption of base demand holding flag for 2023. We anticipate that the year-to-year growth will largely be in the back half of the year, setting up for a stronger recovery and demand in 2025. In our Health Tech business, we anticipate our revenue to grow in 2024 compared to 2023 as we wrap new programs. So for our overall ATS segment, we currently anticipate that revenue will decline slightly in the first half of 2024 compared to 2023 to the pockets of macro weakness affecting some of our markets.

However, we anticipate that segment revenue will resume year-to-year growth in the second half of the year. Overall, we are maintaining our expectation for ATS revenue growth in the mid-single digit percentage range in 2024. Now turning to our CCS segment. The demand backdrop for our CCS segment continues to be very strong. Investments from hyperscalers and data center infrastructure are fueling significant CapEx spending, driven by growing demand for artificial intelligence and machine learning applications. In 2023, our portfolio with our hyperscalers saw revenue growth of 32% compared to 2022, recording nearly $2.9 billion in revenues. This accounted for 62% of our total CCS segment revenues in 2023, up from 51% the prior year. At our recent Virtual Investor meeting in November, we delved further into this dynamic, which we believe is long-term and structural in nature.

We anticipate this solid growth to continue in 2024 and believe that this investment cycle has the potential to support several years of strong demand for our CCS segment. The demand outlook for our enterprise and market continues to be impressive as the beneficiary of hyperscaler’s growing deployment of AI/ML compute capacity. We’re seeing the strong momentum from 2023 continue, and as mentioned earlier, we anticipate significant growth within our AI/ML compute portfolio as we enter 2024. We expect additional growth in our storage business to materialize in the latter half of the year, driven by demand from new programs. After experiencing some softness in 2023, demand in our communications end market is anticipated to resume year-to-year growth in the first quarter, driven by a resumption of strength in networking demand from hyperscalers, which is expected to persist throughout the year.

Within our HPS business, we anticipate to resume year-to-year growth in the first quarter of 2024 and for the full year. This growth is being fueled by a number of new program loans in both networking, supported by growth in our 400G and 800G platforms, and to some extent AI/ML compute. For 2024, we are maintaining our previously communicated expectation of low-double digit percentage revenue growth in our CCS segment, supported by solid growth in both our enterprise and communications end markets. Although, we are seeing some divergence in the short-term demand dynamics underlying our various end markets, we believe that the fundamentals supporting our overall business are very constructive due to the benefits of our strategic portfolio diversification and our consistent execution.

We feel that our positioning for 2024 remains positive, as we remain confident in our ability to meet our financial outlook and improve on our very strong performance in 2023. With that, I would now like to turn the call over to the operator for questions.

Craig Oberg: Thank you.

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Q&A Session

Operator: Thank you, sir. Ladies and gentlemen, we will now begin the question-and-answer session. [Operator Instructions] Our first question comes from the line of Robert Young from Canaccord Annuity. Please go ahead.

Robert Young: Hi. Can you give us a little bit of color on the hyperscale business and CCS, given the large customer accounting for 29%, it’s a pretty significant chunk. Maybe if you could talk about the business outside of that large customer, is that driven by the high level of AI compute currently, and there’s one customer or a small number of customers there, or is there some other dynamic going on there?

Rob Mionis: Well, hi, Rob. So with this particular customer, it’s a hyperscale of customer, they’re making significant investments in AI/ML compute, as well as networking. As you mentioned on the call, we have over 25 programs with this customer and it’s comprised of everything from hardware platform solutions to high value EMS to even services. They’re an industry leader. We’ve been doing business with them for over a decade. And they’re also co-investing with us on some CapEx facility investments over in Thailand, so a very healthy relationship. Across the broader hyperscaler business, we’re also seeing strong growth from several others in the same area and we expect the concentration to improve over time as ebbs and flows in people’s investment cycles.

Mandeep Chawla: I would just add to that, Rob that, as a reminder, we do business with the top five hyperscalers and while we are doing a lot of AI/ML compute with the large customer that Rob just talked about, we’re starting to see some return and demand coming on the networking side, which is helping us across the customer base and we’re really encouraged that as we go into the first quarter now, we’re seeing growth resume in communications, we’re seeing growth resume in hardware platform solutions, and those are offerings that we provide across the customer base.

Robert Young: Okay. Thank you. Yeah. And then the second question, maybe I’m getting ahead of myself. You said you’re going to revisit the full year outlook, I think in Q1, but the outlook for 5.5% to 6% operating margin seems conservative given, you’re doing so well in the enterprise business in CCS at 6.7% and you’re entering at 6% and the guide looks like 6%. So it looks as though it’s going to decelerate in the back half of the year. Maybe if you could discuss that and I’ll pass on.

Mandeep Chawla: Yeah, Rob. I’ll talk about two things. one is the outlook for the full year and then I can talk to your point on margin specifically. So, when we look at full year 2024, we’re really pleased with the way we ended ‘23. And clearly, we’re off to a really hot start now into the first quarter. And again, encouraged by where we’re seeing the demand signals come through, both on comms and HPS, but also the demand signals from the hyperscalers continue to strengthen. As you know, in November, we provided the outlook of $8.5 billion or more and $2.70 of EPS or more. And right now, we really do see that as being the floor. What we are looking to do, as Rob mentioned in his prepared remarks is, we’re going back out to the customer base and revalidating the second half outlook.

We’re seeing that increased strength happening in the first half and now what we want to do is go and validate whether or not those increasing level of demand signals are going to be added to the second half as well. And so, in April, we’ll come back with an updated forecast. To your point on the margin profile itself, as we talked about, ATS is expected to see some very minor levels of declines in the first half of this year before resuming growth in the back end of the year. ATS, again, we’re expecting across all of our end markets to have some level of growth in 2024. But because that growth in the back half is going to be off the back of ramping programs, there is going to be a little bit of margin challenges around there as well. Again, 6% for the first quarter, I believe the 270 is the floor.

And obviously, we’re going to be working towards the high end of that 5.5% to 6% range as best we can.

Rob Mionis: And one other thing, I would add, Rob, I think by the end of the first quarter we’ll have better visibility into capital equipment markets. We are seeing some signs of recovery. We’re cautiously optimistic. Some of our customers are starting to restock consumables and spares, which is a good sign. So I think as capital equipment gets better, so will some of the ATS margins as well.

Robert Young: Okay. Thank you. I’ll pass on.

Rob Mionis: Okay.

Operator: Thank you. We have our next question coming from the line of Maxim Matushansky from RBC Capital Markets. Please go ahead.

Maxim Matushansky: Hi, good morning. Just on the Communications segment, has there been any changes to your expectation for the networking growth to resume in Q1, or is it just the OEM business that’s offsetting the hyperscaler strength? I think I see that the guidance implies a core record deceleration. So is that to mean that, that is primarily because of the OEM business softness?

Rob Mionis: No. As we head into Q1, we expect communications and networking to actually be up, driven by a hopper scalers, both on 400G and 800G programs and there’s also, HPS driven programs. So, as we head into last year, we had some tough comps. Some of those tough comps are lapsing, and now we’re seeing comps return to growth.

Maxim Matushansky: Got it. And on the hyperscalers, is there any changes from your last update, I guess, in November on your hyperscaler customer programs and your expected demand over the next few quarters? And I know you talked about a new program wins with your largest customer, is that something that you anticipated in previous quarters or is that something that’s new?

Rob Mionis: Yeah. We’ve been on our hyperscaler programs. We’ve actually been winning incremental share. That on top of increased demand strength has both been positive for us and some of the reasons for some of the improved outlook that we’re seeing into Q1 and potentially for the full year, hence, that’s why we’re going to take a quarter to revisit with our customers and take a look at what the full year has to be. But we have been winning some incremental share and been booking a really significant amount of 800G programs.

Maxim Matushansky: And just finally for me. Just to revisit, ATS, I think some of your peers have also been seeing a slowdown in their end markets over the last little bit based on customers working through their inventory buffers. Is that what you’re seeing as well this quarter and can you maybe speak to within industrial and capital equipment end markets specifically, and what is causing you to expect demand to return by the second half? Is it primarily kind of those new program ramps?