Good morning, ladies and gentlemen, and welcome to the Celestica Q3 2022 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, Tuesday, October 25, 2022.

I would now like to turn the conference over to Craig Oberg. Please go ahead..

Good morning, and thank you for joining us on Celestica’s third quarter 2022 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 earnings, 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 net earnings, 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 that report under IFRS or 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 2022 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.

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. In the third quarter, Celestica achieved revenue of $1.92 billion above the high end of our guidance range on the back of strong demand across the majority of our businesses combined with solid execution by our team.

Our ability to deliver on this demand in the face of continued macroeconomic challenges resulted in our highest ever non-IFRS operating margin of 5.1%. And our quarterly non-IFRS adjusted EPS of $0.52 was our highest result in more than 20 years. Our strong third quarter results reflect Celestica’s continued execution of a long-term strategic plan.

Because of our strong performance and the momentum we are seeing continue into the fourth quarter, we are pleased to raise our full year 2022 revenue and non-IFRS adjusted EPS guidance ranges. At the midpoint, our revenue guidance of $7.16 billion would represent an increase of 27% year-over-year if achieved.

Also, a non-IFRS adjusted EPS guidance of $1.86 at the midpoint would represent an increase of 43% year-over-year if achieved. The new Celestica marked by nearly 70% of our revenue concentrated in high value markets is providing us with the foundation to navigate through ongoing macroeconomic challenges.

We continue to execute on the many growth opportunities we see in front of us, supported by strong bookings, customer backlogs, and enabled by our diversified portfolio. On the back of a strong 2022, we are also taking this opportunity to provide a full year 2023 outlook.

For the coming fiscal year, we expect to achieve revenues of at least $7.5 billion. And our outlook for non-IFRS adjusted EPS is $1.95 to $2.05, which if achieved, would mark another record high for our company. Additionally, we are pleased to increase our company’s target non-IFRS operating margin range by 50 basis points to 4.5% to 5.5%.

Before I provide further color on the outlook for each of our businesses, I would like to turn the call over to Mandeep, who will provide a detailed overview of our financial performance in the third quarter as well as our guidance for the fourth quarter..

Thank you, Rob, and good morning, everyone. Third quarter 2022 revenue came in at $1.92 billion, exceeding the high end of our guidance range. Revenue was up 31% year-over-year and up 12% sequentially fueled by double-digit revenue growth across the majority of our businesses.

We achieved non-IFRS operating margin of 5.1%, 30 basis points higher than the midpoint of our guidance ranges driven by strong profitability in both our ATS and CCS segments. Non-IFRS operating margin was up 90 basis points year-over-year and up 30 basis points sequentially.

This represents the first time Celestica has achieved non-IFRS operating margin above 5%. The non-IFRS adjusted earnings per share were $0.52, well above the high end of our guidance range, and up $0.17 year-over-year and up $0.08 sequentially.

ATS segment revenue was up 30% year-over-year in the third quarter, meaningfully higher than our expectations about high-teen percentage year-over-year increase.

The year-over-year growth in ATS segment revenue was driven by the continued strong performance of our Capital Equipment, Industrial and A&D businesses supported by solid demand, new program ramps and improved material availability. Sequentially, ATS segment revenue was up 10%.

ATS segment revenues accounted for 40% of total revenue in the third quarter. Our CCS segment delivered another quarter of strong growth with revenue up 32% year-over-year driven by strengthen our Communications end market, primarily due to the strong performance in our HPS business. CCS segment revenue was 13% higher sequentially.

Our HPS business continued to exhibit very strong growth, delivering revenue of $517 million in the third quarter, up 72% year-over-year. The growth in HPS was driven by strong demand from service providers, as they continue to invest in data center expansion.

We are pleased that our HPS business continues to gain market share, helping us outpace anticipated underlying market growth rates. HPS revenues were 27% of total company revenues in the third quarter. Communications revenue was up 42% year-over-year ahead of our expectations of a mid-teen percentage increase and was up 22% sequentially.

As noted, the year-over-year and sequential growth was driven by our HPS business and improved material availability. Enterprise revenue in the quarter was up 13% year-over-year, close to our mid-teens percentage expectations driven by increased customer demand and new program ramps. Sequentially, enterprise revenue was 3% lower.

Turning to segment margins. ATS segment margin was 5.0% in the third quarter, up 70 basis points year-over-year and up 50 basis points sequentially. The year-over-year margin increase was driven by improved profitability across the segment as a result of stronger demand and maturing program ramps.

CCS segment margin of 5.2% the highest CCS segment margin ever reported was up 110 basis points year-over-year and up 20 basis points sequentially. The year-over-year margin increase was driven by volume leverage and improved mix within our HPS business.

Moving on to some additional financial metrics, IFRS net earnings for the quarter were $46 million, or $0.37 per share compared to net earnings of $35 million, or $0.28 per share in the same quarter last year, and net earnings of $36 million, or $0.29 per share last quarter.

Adjusted gross margin was 8.9%, up 10 basis points year-over-year and down 10 basis points, sequentially. The year-over-year improvement was driven by the benefit of operating leverage due to higher volumes in both ATS and CCS. Non-IFRS operating earnings were $98 million, up $37 million year-over-year and up $15.5 million sequentially.

Our non-IFRS adjusted effective tax rate for the third quarter was 21%, 2% higher year-over-year and 1% lower sequentially. For the third quarter, non-IFRS adjusted net earnings were $64 million, up $20 million year-over-year and up $9 million sequentially.

Third quarter non-IFRS adjusted ROIC of 19.2%, the highest in over 5 years was up 4% year-over-year and up 3% sequentially. During the third quarter, our top 10 customers accounted for 67% of our total revenue compared to 68% in the second quarter and 66% in the third quarter of 2021.

We had 2 customers that individually accounted for 10% or more of total revenue, compared with 1 customer in both of the second quarter of 2022 and third quarter of 2021.

Both customers individually comprising greater than 10% of our revenues are in our CCS segment, and in aggregate operate across 20 separate programs, which is a testament to the breadth of our product offering. Moving on to working capital.

Our inventory at the end of the third quarter was $2.3 billion, up $218 million sequentially, and up $920 million year-over-year. Higher inventory balances have been a focus within our industry in recent quarters, driven by the persistent challenges in the supply chain environment.

So let’s get higher inventory levels, the results of longer lead times and strong demand, which are partially mitigated by customer cash advances have enabled us to grow at exceptional rates, while generating strong non-IFRS adjusted ROIC. As the material environment improves, we expect inventory balances to reduce over time.

Cash cycle days were 63 during the third quarter, 9 days lower than the prior year period, and the lowest since the third quarter of 2020. Our team continues to work diligently to manage our working capital balances, including working closely with our customers and suppliers.

Capital expenditures for the third quarter were $39 million, or approximately 2% of revenue. As we noted in our previous earnings call, we expected capital expenditures to be higher during the second half of 2022 after having lower levels of CapEx investment during the first half of the year.

The increased capital investment is primarily to support program growth in our Lifecycle Solutions business, including expansions in our Southeast Asia and Mexico footprint to support a number of new program win.

Non-IFRS adjusted free cash flow was $7 million in the third quarter, compared to $27 million in the prior year period, and $43 million last quarter. As of September 30, non-IFRS adjusted free cash flow was $51 million and our fiscal year outlook continues to be $75 million as we make strategic working capital investments in 2022.

Moving on to some additional key metrics. Our cash balance at the end of the third quarter was $363 million, down $114 million year-over-year and down $2 million sequentially.

Our cash balance in combination with approximately $600 million of borrowing capacity under a revolver, provide us with liquidity of approximately $1 billion, which we believe is sufficient to meet our anticipated business needs.

We ended the quarter with gross debt of $647 million, down $4 million from the previous quarter, leaving us with a net debt position of $284 million. Our third quarter gross debt to non-IFRS trailing 12-month adjusted EBITDA leverage ratio was 1.5 times, down 0.2 turns sequentially, and up 0.1 turns compared to the same quarter of last year.

At September 30, 2022, we were compliance with all financial covenants under our credit agreement. During the third quarter, we repurchased approximately 500,000 shares for cancellation at a cost of approximately $5 million. We ended the quarter with 122.6 million shares outstanding, a reduction of approximately 2% from the prior year period.

During the fourth quarter, we intend to launch a new NCIB program subject to necessary approvals, after our current program is set to expire in early December. Return of capital to shareholders remained a priority within our capital allocation strategy.

We continue to aim to return 50% of our non-IFRS adjusted free cash flow to shareholders and reinvest 50% into the business over the long-term. However, as noted in previous earnings calls, our short-term priority is to focus on reducing our net debt, while remaining opportunistic with our share repurchases under our NCIB.

We currently believe our share price is trading at a material discount when considering our strong operating performance, and as such, we have recently been active in the market. Now turning to our guidance for the fourth quarter of 2022. Our fourth quarter revenue is expected to be in the range of $1.875 billion to $2.025 billion.

If the midpoint of this range is achieved, revenue would be up 29% year-over-year and up 1% sequentially. Fourth quarter non-IFRS adjusted earnings per share are expected to be in the range of $0.49 to $0.55 per share. If the midpoint of this range is achieved, non-IFRS adjusted earnings per share would be up 18% year-over-year.

If the midpoint of our revenue and non-IFRS adjusted EPS guidance ranges are achieved, non-IFRS operating margin would be approximately 5.1%, which would represent an increase of 20 basis points over the prior year period and flat sequentially.

The non-IFRS adjusted SG&A expense for the fourth quarter is expected to be in the range of $64 million to $66 million. We anticipate our non-IFRS adjusted effective tax rate to be approximately 21% for the fourth quarter. Now turning to our end market outlook for the fourth quarter of 2022.

In our ATS end market, we anticipate revenue to be up in the mid-20% range year-over-year, driven by double-digit growth in all of our ATS businesses.

In our CCS segment, we anticipate revenues in our Communications end market to be up in the low-30% range year-over-year, driven by new ramps and continued strong demand from service provider customers supported by our HPS offering.

In our Enterprise end market, we anticipate revenue growth in the mid-20% range year-over-year supported by new program ramps in storage and strong demand in compute. I’ll turn the call back over to Rob to provide additional color on our end markets and overall business outlook..

Thank you, Mandeep. Before I move on to our end market outlook, I want to take a step back and provide some commentary on the sustainability of our ongoing success given the current macroeconomic backdrop. As we noted, our non-IFRS operating margin in the third quarter surpassed 5% for the first time in our company’s history.

As we recorded our 11th consecutive quarter of year-over-year non-IFRS operating margin improvement. We are also poised to achieve a new record high in non-IFRS adjusted EPS in 2022, and if the outlook we provided is achieve surpass that mark in 2023.

While Celestica is by no means immune to the impacts of cyclical changes in demand, we believe that we have made some important structural changes to our company, as well as key strategic decisions which have helped us evolve into a more diversified, resilient and profitable business.

67% of our revenues are now coming from more diversified markets with higher barriers to entry, what we call a Lifecycle Solutions business. As we continue to grow Lifecycle Solutions, we expect benefits from both volume leverage and mix providing additional support to our already strong margins.

Moreover, our exposure to consumer markets is minimal, and a fixed cost structure is lean and does not require significant investments. Therefore, we believe we will outgrow the broader market in 2023 due to our end market exposure, new program wins and market share gains. Now, I would like to turn to our outlook for our businesses.

Starting with our ATS segment, our Capital Equipment business continues to exhibit strong growth driven by secular demand, new program ramps and market share gains. We anticipate the strength will continue through the fourth quarter as the short-term impacts of China export controls are mitigated by our existing backlog.

The wafer fabrication equipment market has experienced significant growth over the past 3 years. End market estimates are calling for a moderation and spending in 2023.

Our business, however, is primarily focused on pockets of the wafer fab equipment market, where we anticipate demand remaining strong, such as investments in new capacity to support on-shoring, and our focus on leading edge technologies of less than 7 nanometers.

Based on our strong order backlog, new wins and market share gains, we expect to continue to outperform the broader wafer fab equipment market expectations in the coming quarter. New program ramps and robust demand in our Industrial business continue to be supported by favorable long-term secular trends.

Investment in green technologies such as energy storage and generation, and growth in the electrical vehicle market, supporting demand for EV charging projects are expected to sustain growth in demand for the next several years.

Our Industrial business has grown 18% organically in the first 9 months of the year, and we expect these trends to support double-digit organic revenue growth into 2023. Now turning to A&D, we continue to see improvements in commercial aerospace highlighted by new program wins.

Commercial aerospace demand driven by business jet and single-aisle aircrafts is projected to continue to strengthen through 2023. Market estimates now suggests that commercial air traffic should return to near pre-COVID levels in 2023, which we believe should support further demand for new deliveries.

Our Defense business is also anticipated to continue its solid growth track, as governments continue to strengthen their militaries, particularly in the EU. In our HealthTech business, new project ramps in surgical devices and sports medicine are expected to drive sequential and year-over-year revenue growth.

We are also seeing solid demand for imaging and patient monitoring devices, and anticipate contribution from new projects beginning next year. Strong demand and new wins in imaging and patient monitoring are expected to more than offset and anticipated softening in COVID-related demand for diagnostic equipment. Now turning to our CCS segment.

Our HPS business remains the primary driver of the strong results in our CCS segment, recording $1.34 billion in revenue for the first 9 months of the year, a 67% growth rate compared to that of the prior year period.

The remarkable growth we are seeing in our HPS business is supported by significant capital investments from our service provider customers, as they scale their data center capacity, coupled with our gains in market share from ODMs.

As we have noted in prior calls, it is our view that this trend is likely to continue for at least the near-term, though, we expect growth rates will moderate into 2023, as comps become tougher with each subsequent quarter.

New ramps and strong demand from existing programs continue to support growth in our Communications end market with a significant portion of that demand strength coming from hyperscale our customers for HPS offering. We anticipate demand to remain healthy into 2023, as we ramp new wins.

And finally, in our Enterprise end market continued growth in storage demand is supported by new program ramps, which we anticipate will continue through the end of the year. Demand for compute is also expected to remain strong into the end of the year.

Across Enterprise, despite double-digit year-over-year growth during 2022, we remain cautious in our outlook, as potential signs of slowing demand in the broader economy have typically had a more pronounced impact on demand from our Enterprise customers. I am incredibly pleased with what Celestica has accomplished thus far in 2022.

Despite a challenging environment, our team has done an admirable job of managing the factors within our control. This is reflected in our results this quarter, and a strong outlook for the year ahead. We are confident that our focus on our strategic plan and consistent execution will drive value for our shareholders over the long-term.

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. [Operator Instructions] Your first question comes from Thanos Moschopoulos of BMO Capital Markets. Please go ahead..

Hi, good morning. Rob, if we look at the upside of the quarter relative to your prior expectations, you said it was a combination of both stronger demand and better component availability.

Just qualitatively, if we think about the relative weighting of those 2 factors, was it more weighted towards demand upside or more towards supply chain doing better than you thought?.

Hi, Thanos. I would say, it was more along the lines of supply chain constraints improving, our clear-to-build was better than original expectation. So it was enabling us to convert our backlog and fulfill our strong demand, if you will.

Demand, it really not moderate in the quarter, but our fill rates ability to convert, it was actually better than anticipated..

Okay. As far as 2023, you’re introducing fiscal 2023 guidance for 2022 is even over.

Presumably, does that speak to the strong level of visibility in the backlog that you currently have?.

Correct. As we look forward to 2023, we continue to see strong growth coming from many of our verticals. We do see a little bit light demand in some areas, as in China and our Enterprise business. But, net-net, we feel confident that we’re able to provide – good, I think, given the macroeconomic backdrop, good growth going into 2023..

Great.

Finally, for Mandeep, how should you think about cash flow and CapEx over the next year? We did see a bit of a reduction inventories sounds like you think that might continue, so presumably, as you drive some cash generation in 2023?.

Yeah, Good morning, Thanos. I would say that we’re pleased with the cash generation we’ve had so far this year. But we always want to do more our outlook for this year of $75 million, because we have decided to make a number of investments in working capital, as you’ve highlighted.

As we go through 2023, we do anticipate that there is going to be improved clear-to-build on the material side that should help us unwind some of the working capital. And so, our goal continues to be over $100 million, and we think that that’s a safe floor for next year..

Great. Thanks, guys. Congrats on the quarter, and best of luck..

Thanks, Thanos..

Your next question comes from Rob Young of Canaccord Genuity. Please go ahead..

Hi, good morning. You already talked a little bit about visibility on the semi cap space, so I want to dig in a little deeper there. The highlight of your exposure to leading process note is probably a little safer. But I’m just curious if you could talk a little bit about the visibility over the next 12 months.

How much of that is covered by ramps that are already in progress? Or how much of that is business has locked in? Maybe just give a sense of the level of visibility there?.

Sure, Rob. So just take a step back in 2022, we’re on track to grow much faster than the market, we should be growing north of about 20%.

And to your comment that’s on the back of new program wins and expanding market share, we have a very competitive footprint that being in North America and Malaysia and Korea, and we also have some fantastic vertical integration capabilities that’s a large reason for our growth.

As we look into 2023, the broad market is certainly seeing some headwinds, some of the more pessimistic, analysts are predicting as much as 15% to 20% decline in wafer fab equipment spending. On top of that, we’ve all seen the news on this China export controls that could have up to an 8% additional impact if that is not resolved.

That all being said, we should fairly well relative to the market for a couple of reasons; the first reason is mix. From a mix perspective, we’re focusing on the high end node, so that less than 7 nanometers is 80% of our business.

Demand is more robust, their exposure to China is typically limited; second is, we have less exposure to memory and memory is going to under pressure right now from a growth perspective; and lastly, a good portion of our growth is coming from our vertical integration capabilities supporting the aftermarket and using our mechanical capabilities.

And the second reason, we feel confident that will perform better than the market is really new program growth. A lot of those programs have started to ramp this year and will extend into next year. So, net-net, we feel pretty confident that will perform than the market, and we should be up to – flat to up as we go into 2023..

Okay. Thanks for all that color. And the margin guidance is very impressive. If I think back to past comments, I think you said that in order to get above 5%, it would require recovered in commercial aerospace. I was just wondering does the guidance for 2023 anticipate if that business becoming a contributor to operating margins.

Or maybe you just give us an update on, where the margin contribution from A&D is and where it’s likely to go over the next year?.

Yeah. Good morning, Rob. So we’re pleased with the trajectory that the company is seeing right now from a margin perspective, and some of the things that we highlighted 5.1% this quarter, and that’s our guide for Q4 highest margin in the company’s history.

If you take the midpoint of the Q4 guidance, it implies 4.9% for this year that’s the highest in the company’s history. And then what we’re doing now is we’re raising the range for next year by 50 basis points between 4.5% and 5.5%. Really, there’s 2 main things that are driving that. Number one is continuing benefits from mix.

So as Lifecycle Solutions revenue, which is two-thirds of the company’s revenue continues to grow. And the margin profile for Lifecycle Solutions combined is accretive to the company. You will see benefits from a mix perspective. The second is we are starting to see the benefits of volume leverage.

While we were going through the transformation over a number of years ago, we made the strategic decision to maintain our investments functionally and in the factories, we didn’t take cuts everywhere that maybe we could have been asked to do so. And because we knew that – we could maintain that structure when we were growing.

And so our SG&A right now is not growing nearly as fast as the top-line. So we’re seeing volume benefits there as well. To your point specifically on A&D. So there’s some puts and takes within the markets themselves. CCS as you can see is performing incredibly well.

There are some mix benefits happening right now, which will probably moderate, but we expect that CCS margins will still be strong going into next year, and then ATS coming back at 5%. So we’re pleased with the margin profile in a couple of the businesses, Capital Equipment is performing very well, HealthTech is performing very well.

But A&Ds demand is still not where it was pre-COVID. And we are seeing improving profitability sequentially. But it’s still more opportunities to be had in A&D and some volume bounce back. We’re seeing the same thing in Industrial, a significant part of our top-line growth is coming from Industrial. But those programs aren’t yet at full profitability.

And then lastly, as you know from last quarter, the PCI business, which is an excellent business for us, and is a profitable business still, despite the fire that they had, is not operating at their peak levels either. So there’s still some tailwind if you will within ATS to help improve margins as we go into next year..

Right. And that’s beyond the 4.5% to 5.5% operating margin….

No. We’ve taken all that into account. So, well, CCS may moderate a little bit going into next year. ATS has an opportunity to probably pickup any moderation. And then, again, as we grow over a Lifecycle Solutions that will help us hopefully get to the higher end of that range as we go through next year..

Just to last little one, the midpoint of EPS guidance is below that double-digit long-term guidance, you gave us, right? No, I wasn’t able to find that reiterated anywhere. Is that still the expectation? And I’ll pass the line..

Yeah, I mean, so what we’re very pleased with this, as you know, the EPS growth that we’re showing this year. The midpoint of the Q4 guidance calls for $1.86. The highest EPS that we had as a company, I believe, is $1.44 back in 2000, so significant increase in overall EPS.

Now that’s up 43%, I think on year-over-year basis, when you look at the $1.95 to $2.05 next year. The $1.95 implies 5% and the $2.05 implies 10%. And so, we are, of course, working towards the higher end of the range. We do believe that 10% EPS growth is still the right number over the medium- to long-term.

There will be some years obviously that are going to be a bit higher, and then some years that will be a bit lower. But we are targeting 5% to 10% right now, given the visibility we have today..

Okay. Thanks. Congrats on the quarter..

You’re welcome..

Your next question comes from Ruplu Bhattacharya of Bank of America. Please go ahead..

Thank you for taking my questions and congrats on the strong results in the quarter. My first question is on margins. You’re guiding 2023 operating margin to 4.5% to 5.5%.

What needs to happen for you to get to the top end of the range versus the midpoint versus the low end? And specifically, you said that the CCS segment, obviously, it’s been performing much above the long-term range.

So how should we think about margins in that segment in fiscal 2023?.

Yeah, so the margins of 4.5% to 5%, I would say, is also tied to how the revenue is probably going to turn out. We said, again, at least $7.5 billion. If we come in just at $7.5 billion, we won’t be at the higher end of that range, we would be somewhere between probably around 5%.

But as we continue to grow revenue, because of the strong backlog that we already have, we do expect to see some additional volume leverage, which will help us get to the higher end of that range.

When you look at the segments specifically, so again, since we started posting segment margins back from the beginning of 2018, what we just posted for CCS is the highest they’ve ever posted. We don’t expect that CCS will necessarily be above 5% next year.

But at the same time, we don’t expect them to go back to historical rates, because of just a very different mix now with HPS. And on the ATS side, we do continue to have opportunities to grow that margin is at 5.0% this past quarter, but there are opportunities.

We talked a little bit about A&D, already there continues to be a recovery, which gives us cost leverage because that’s a heavy fixed cost business. PCI is not where it was expected to be this quarter based on both revenue and margin.

But as that production comes back on to full equipment is on being utilized by the end of the year, we do expect benefits in PCI as well. And then just overall, it’s the maturity of the ramping programs that we have. So we are ramping a significant amount of business specifically in our Industrial business.

And as those programs continue to mature, there is improved profitability that we would expect..

Okay. Thanks for all the details there. My next question is on revenue growth.

What was the expected contribution from PCI to fiscal 2022 revenue growth? And you said HPS in the first 9-month is contributing, or it was up 67% year-on-year? How should we think about the contribution from HPS in fiscal 2023? I think you’re guiding 5% year-on-year growth at the midpoint of the fiscal 2023 revenue guidance.

So how much of that would be from the HPS revenue growth?.

Yeah. So, Ruplu, we don’t break out PCI specifically, but I go back to some previous public remarks when we bought the business was around $300 million business that business has been growing. We’ve been seeing good commercial synergies as well.

There could be up to $100 million of additional revenue contribution next year from the PCI business relative to 2022. On HPS, specifically, I mean, this is just outsized growth 72% year-over-year in the third quarter, 67% on a year-to-date basis, obviously, that is not sustainable.

Based on the trajectory of where the business is going right now, that business maybe up anywhere from $700 million to $800 million year-over-year for fiscal year 2022. As we go into next year, we’re expecting that growth rates are now going to probably normalize, maybe back down to market rates.

So there will be a moderation in overall growth within HPS. But we do expect that the margin profile will continue to be very strong, and continue to be accretive to the company..

Got it.

And maybe for my last question, if I can ask you on the capital allocation priorities for fiscal 2023, specifically, as you look at uses of cash for M&A versus returning cash to shareholders, how do you prioritize that versus reducing debt?.

Yeah, so our number one priority right now is strong cash generation. I mean, we were very happy with the strength of the balance sheet. As you know, $1 billion in overall liquidity only 1.5 times gross leverage overall. So there is, we do have a healthy balance sheet.

We’re going to continue to invest in the business in areas like CapEx, you saw strong CapEx this quarter, because we are directly investing in new program wins that we have. So we’re pleased with that as well.

But when you go beyond that strong free cash flow generation and continue to invest in the business, I would see in the immediate short-term is to continue to reduce our net debt likely by building up a little bit more of a cash balance that allows us to tap our credit lines a little bit less inter quarter reduces their interest expense.

We’re going to have the NCIB program open until December 5, and then our intention, as we mentioned, just to open up a new one, so we can always have one open. We will opportunistically buy shares when there is severe depression on the share price. As an example, we’ve already said, we bought back $5 million of shares last quarter.

I can tell you that we actually bought back $5 million of shares in October already, because of the severely depressed share price. And with a price at around where it is right now, they’re actually probably isn’t a better use of cash. It’s a good way to return value to shareholders.

That being said, we continue to have a long-term view on growing the business strategically. And M&A, when it’s the right M&A either adding capabilities that we need to accelerate our strategic roadmaps or to give us added capacity, which we can find synergies with our existing customer base, where we won’t hesitate to invest.

We have a robust M&A funnel. We’re very disciplined. As you know, when we look at a lot of targets, and we don’t pull the trigger on the vast majority of them.

But we do believe that with the balance sheet that we have, the cash outlook that we have going into next year, the healthy balance sheet that we can pivot, whether it’s in the share buyback front or in the M&A front..

Got it. Thanks for all the details, and congrats again on the quarter..

Thank you..

Thank you, Ruplu..

Your next question comes from Jim Suva of Citigroup. Please go ahead..

Thank you. And your outlook in your current growth trajectory is very impressive in margins. Just curious about the impact and how we should be thinking about CapEx and maybe working capital like inventory, you mentioned, supply chain is getting better as far as component availability.

But, I think, your inventory went up, but I’m sure it has to do with growing the business.

But can you help us know about kind of CapEx and inventory you kind of your expectations going forward a little bit?.

Yeah, absolutely. Good morning, Jim. So, on the CapEx side, we have traditionally said that our target range is between 1.5% and 2% of revenue. In the first half of the year, we were quite light, frankly around 1%.

But now that we’re seeing the world come back to normal, restrictions being lifted in various countries, and on the back of a number of new wins, we are seeing a higher level of CapEx investment. In the third quarter, we did 2% of revenue. In the fourth quarter, we’ll probably be again at around 2% or even slightly higher than that.

But as you look into 2023, I think the 1.5% to 2% range continues to be the right range, we may operate at the higher end of that range. But we have a good track record of being very disciplined on the CapEx investments we make.

Overall, I would say that the working capital opportunity is there for us in 2023, as we had talked about, when clear-to-build is starting to improve meaning we’re getting more materials and then maybe we would have in the past.

It gives us an opportunity to build less inventory as you talked about, probably, the primary reason that inventory has been building is because we’re growing revenue close to 30% year-over-year.

But with the revenue guidance that we’re providing next year, getting back into the single digits, the level of inventory is just not required as much as before. And as material constraints continue to improve, it gives us an opportunity to start reducing inventory as well.

And so we do expect some working capital unwind in 2023, which should provide us with a good opportunity on free cash flow..

Thank you. And congratulations to you and your teams..

Thank you..

Thanks, Jim..

Your next question comes from Paul Treiber of RBC Capital Markets. Please go ahead..

Hello, thanks very much and good morning. I just had a couple of questions on your outlook for 2023, which is obviously quite a bit stronger than the Street was expecting.

In terms of the macroeconomic environment, to what degree are you factoring in a slowdown in the environment? Or maybe – in other words, you know, what do you see is driving upside to your guidance, if that would occur? And then conversely, what would lead to downside to your outlook?.

Hey, Paul. Yeah, we have a pretty in-depth planning process when we do our strategic plan, but more importantly, our annual operating plan. We do bottoms up interlock with all our sites and all our key customers. So, the guidance that in the outlook, we provided we feel pretty good about it to answer your questions directly.

What would provide upside to the outlook, it would be continued strength in our HPS business or data center expansion growth a little higher than we anticipated. Perhaps not as much as a down cycle in wafer fab equipment spending as we’re currently anticipated, faster recovery in our aerospace markets would also help give us boost.

And our Industrial business is going through a number of ramps. And, should those be able to ramp a little bit more quickly and market adoption for those products that we’re ramping improve that would also give us some more upside.

On the downside pressure, I would say, everything that I just mentioned, but obviously, the inverse of it would put downward pressure. But that being said, again, we have a pretty balanced view of 2023.

And we’ve taken the pluses and the minuses, and we hope to be able to improve upon the numbers that we provided, as the year gets along, just like we have done in 2022..

That’s helpful. A couple of follow-on questions. Just you didn’t mention supply chain as a variable for 2023. It looks like things are improving here.

Is your outlook for 2023, does it in terms of supply chain? Does it potential slowdown on the consumer side? Does that become a net positive or strong net positive for you in 2023 in regards to supply chain?.

Yeah, it’s a good point, Paul, I probably shouldn’t mention that. It isn’t that positive, we’re assuming a gradual recovery, nothing instant, but a gradual recovery. Right now, our clear-to-build have gotten better, the de-commits from our suppliers are less frequent.

That being said, lead times for semiconductors in specific are still long, we need them to get shorter that would certainly improve things.

And there are still certain technologies and certain suppliers that are – will remain constrained, I think all through 2023, because on the older node technologies were a lot of the suppliers and that building capacity out there. So, we’re assuming all, gradual improvement in our outlook as we get into 2023.

But nothing the monstrous in terms of major improvements..

Thank you. I’ll pass it on. Congrats on the quarter and the outlook..

Thank you..

[Operator Instructions] Your next question comes from Daniel Chan of TD Securities. Please go ahead..

Hi, good morning, guys.

So you mentioned that the component supplies are helping with performance? Does improving component suppliers have an impact on your margins? Or is it neutral given your ability to pass those costs due to your customers?.

To some extent, improve components supply improve the efficiency of our factories. So it does help our margins in terms of pricing through the cycle of price increases. For the overwhelming majority, we’ve been passing on those price increases in terms of forward pricing to our customer. So, we’ll rise and contract with the tight on that..

Okay. Thanks for that.

And to what extent is there a risk that your customers ordered more than they needed during supply issues, much like we saw in the retail sector? And what components supply is normalizing and you working through the backlog that there’ll be excess inventory in the channel in the near future?.

Yeah. Good morning, Dan. It’s always a risk. Anytime you have a constrained environment, where customers are going to start wanting to hoard product. I would say that that is always something that’s out there. But it is something that we believe is been manageable.

Overall, one of the things that as you know is we’ve been building a lot of deposits from our customers in order to build inventory, we have almost $600 million on the balance sheet.

And so, when we are being asked by customers to build inventory relative to a forecast that’s there – often they’re putting their money down to confirm that the demand is real.

The other thing, and I know, you know this about our business, the vast majority of the working capital that we have, our inventory specifically is the liability of the customer. And so, we are doing orders relative to a forecast.

But customers also know that if they over order, or provide a forecast that doesn’t really materialize that inventory is going to get pushed back to them, and it’s going to become their liability. So, I’d say that there’s a rationality right now in the overall marketplace.

We are mindful of pockets of maybe buffering that’s been happening, but we don’t expect right now that it’s going to be over the material..

And I would also add, Dan, today, we’ve either seen demand tempering or growth – demand decreasing or growth tempering. But we haven’t seen customers cancel up, push things out customers have been asking us to fulfill the backlog and it may be reducing the outlook a little bit whether it’s lower growth or a lower demand.

But we’ve been converting our backlog so it hasn’t been a material issue to date..

Great. Thank you..

Thanks, Dan..

There are no further questions on the phone lines. I would now like to turn the conference back to Rob Mionis for closing remarks..

Thank you. We continue to our strong start to the year by posting another solid quarter results. And we continue to execute well through a difficult supply chain and macro environment.

I’m pleased that we’re able to raise our financial outlook for the full year and feel confident in our customers demand and profile in order to do so, and given the current macroeconomic backdrop. I’m also pleased we’re able to provide our initial outlook for 2023.

And we will continue to work to diligently raise our projections as we progress throughout the year. Lastly, we are well skilled at managing our business to economic cycles and feel confident in our ability to continue to navigate through any potential choppy waters that [my lay] [ph] ahead.

Thank you all for joining today’s call and I look forward to updating you as we progress throughout the year..

Ladies and gentlemen, this concludes your conference call for this morning. We would like to thank you all for participating. You may now disconnect your lines..