Q3 2022 Celestica Inc Earnings Call
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.
If at any time during this call you require immediate assistance. Please press star zero for the operator.
This call is being recorded today Tuesday October 22022.
I would now like to turn the conference over to Craig Oberg. Please go ahead.
Good morning, and thank you for joining us on <unk> third quarter 2022 earnings conference call on the call today are Rob My honest, President and Chief Executive Officer, and Andy Chawla, Chief Financial Officer.
As a reminder, during this call we will make forward looking statements within the meetings 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. There in our most recent annual report on form 20-F, and our other public filings, which can be accessed at SEC Gov and seed.
Dot 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 <unk> financial measures, including ratios based on non <unk> financial measures consisting of non <unk> operating earnings non <unk> operating margin adjusted gross margin adjusted return on invested capital or adjusted ROIC.
Adjusted free cash flow gross debt to non <unk> 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 <unk> financial measures, whether or not specifically designated as such.
These non <unk> financial measures do not have any standardized meaning prescribed by EIOPA or us and may not be comparable to similar measures presented by other public companies that report under <unk> or who report under U S. GAAP and use non-GAAP financial measures to describe similar operating metrics.
We refer you to yesterday's press release, and our Q3 2022 earnings presentation, which are available at Celestica Dot com under the Investor Relations tab for more information about these and certain other non <unk> financial measures, including a reconciliation of historical non <unk> financial measures to the most directly comparable <unk>.
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 <unk> operating margin of five 1%.
And our quarterly non <unk> adjusted EPS of <unk> 52.
It was our highest result in more than 20 years.
Our strong third quarter results reflect celestica continued execution of our 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 <unk> adjusted EPS guidance ranges.
At the midpoint, our revenue guidance of $7, one 6 billion, which represents an increase of 27% year over year if achieved.
Also our non <unk> 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 our full year 2023 outlook for.
For the coming fiscal year, we expect to achieve revenues of at least seven $5 billion and our outlook for non <unk> adjusted EPS is $1 95 to $2 five which.
Which if achieved would mark another record high for our company. Additionally.
Additionally, we are pleased to increase our company's target non <unk> operating margin range by 50 basis points to four and a half to five 5%.
Before I provide further color on the outlook for each of our businesses I would like to turn the call over to Mandy who will provide a detailed overview of our financial performance in the third quarter as.
As well as our guidance for the fourth quarter.
You, Rob and good morning, everyone.
Third quarter 2022 revenue came in at 192 billion <unk>.
Exceeding the high end of our guidance range.
<unk> 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 <unk> operating margin of five 1% 30 basis points higher than the midpoint of our guidance ranges driven by strong profitability in both our Ats and Tcs segments.
Non <unk> operating margin was up 90 basis points year over year, and up 30 basis points sequentially.
It represents the first time Celestica has achieved non <unk> operating margin above 5%.
Non <unk> adjusted earnings per share were <unk>, 52 said well above the high end of our guidance range and up 17% year over year and up eight sequentially.
<unk> segment revenue was up 30% year over year in the third quarter meaningfully higher than our expectations of a high teens 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.
<unk> Ats segment revenue was up 10%.
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 strength in our communications end market, primarily due to the strong performance in our <unk> business.
Ccs segment revenue was 13% higher sequentially.
Our <unk> business continued to exhibit very strong growth delivering revenue of $517 million in the third quarter up 72% year over year.
The growth in <unk> was driven by strong demand from service providers as they continue to invest in data center expansion.
We are pleased that our HTS business continues to gain market share, helping us outpace anticipated underlying market growth rate.
<unk> revenue were 27% of total company revenues in the third quarter.
<unk> 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 HTS business and improved material availability.
Enterprise revenue in the quarter was up 13% year over year close to a mid teens percentage expectation driven by increased customer demand and new program ramps sequentially enterprise revenue was 3% lower.
Turning to segment margins.
Segment margin was five zero percent in the third quarter up 70 basis points year over year, and up 50 basis points sequentially.
Year over year margin increase was driven by improved profitability across the segment as a result of stronger demand and maturing program brands.
Ccs segment margin of five 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 <unk> business.
Moving on to some additional financial metrics.
<unk> net earnings for the quarter were $46 million or <unk> 37 per share compared to net earnings of $35 million or 28 per share in the same quarter last year and net earnings of $36 million or <unk> 29 per share last quarter.
Adjusted gross margin was eight 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 <unk> operating earnings were $98 million up $37 million year over year and up $15 5 million sequentially.
Our non <unk> adjusted effective tax rate for the third quarter was 21%, 2% higher year over year and 1% lower sequentially.
For the third quarter non <unk> adjusted net earnings were $64 million up $20 million year over year and up $9 million sequentially.
Third quarter non <unk> adjusted ROIC of 19, 2% the highest in over five 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 two customers that individually accounted for 10% or more of total revenues compared with one 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 had been a focus within our industry in recent quarters driven by the persistent challenges in the supply chain environment, So, let's because higher inventory levels as a result of longer lead times and strong demand, which are partially mitigated by customer cash advances have enabled us to grow at exceptional rates.
Generating strong non <unk> adjusted ROIC.
As a material environment improves we expect inventory balances to reduce overtime.
Cash cycle days were 63 during the third quarter 90 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.
The increased capital investment is primarily to support program growth and our lifecycle solutions business, including expansion in our southeast Asia, and Mexico footprint to support a number of new program wins.
Non <unk> adjusted free cash flow was $7 million in the third quarter compared to $27 million in the prior year period.
$43 million last quarter.
As of September 30th non <unk> 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 our 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 <unk> trailing 12 month adjusted EBITDA leverage ratio was one five times down <unk>, two turns sequentially and up <unk> <unk> compared to the same quarter last year.
At September 32022, we were compliant with all financial covenants under our credit agreement.
During the third quarter, we repurchased approximately 500000 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 and CIB program subject to necessary approvals. After our current program is set to expire in early December .
Return of capital to shareholders remains a priority within our capital allocation strategy. We continue to aim to return 50% of our non <unk> adjusted free cash flow to shareholders and reinvest 50% into the business over the long term.
As noted in previous earnings calls our short term priority is to focus on reducing our net debt while remaining.
Stick with our share repurchases under our and CIB. 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 $8 75 billion to $2.0 billion to $5 billion.
If the midpoint of this range is achieved revenue would be up 29% year over year and up 1% sequentially.
Fourth quarter non <unk> adjusted earnings per share are expected to be in the range of 49 to 55 per share.
If the midpoint of this range of achieved non <unk> adjusted earnings per share would be up 18% year over year.
It's the midpoint of our revenue and non <unk> adjusted EPS guidance ranges are achieved non <unk> operating margin would be approximately five 1%, which would represent an increase of 20 basis points over the prior year period and flat sequentially.
Non <unk> 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 <unk> 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 percentage range year over year, driven by double digit growth in all of our Ats businesses.
In our Ccs segment, we anticipate revenue in our communications end market to be up in the low 30 percentage range year over year, driven by new ramps and continued strong demand for our service provider customers supported by our <unk> offering.
In our enterprise end market, we anticipate revenue growth in the mid 20 percentage range year over year supported by new program ramps and storage and strong demand in compute.
I'll now turn the call back over to Rob to provide additional color on our end markets and overall business outlook.
Thank you mandate 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.
Non <unk> 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 <unk> operating margin improvement.
We are also poised to achieve a new record high and non <unk> adjusted EPS in 2022.
And if the outlook, we provided is achieve surpassed that mark in 2023.
Well, our philosophy 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 our 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 our 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 this strength will continue through the fourth quarter as a 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 three years and market estimates are calling for a moderation in 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 onshoring and our focus on leading edge technologies of less than seven 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 a 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 <unk>.
<unk> for the next several years.
Our industrial business has grown 18% organically in the first nine 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 suggest 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 <unk>.
Solid growth track as governments continue to strengthen their militaries, particularly in the EU.
And our health Tech business, New project ramps and 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 an anticipated softening in COVID-19 related demand for diagnostic equipment.
Now turning to our Ccs segment.
<unk> business remains a primary driver of the strong results in our Ccs segment recording $1 $34 billion in revenue for the first nine months of the year.
67% growth rate compared to that of the prior year period. The remarkable growth. We are seeing in our <unk> 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 Oems.
As we have noted in prior calls it is our view that this trend is likely to continue for at least the near term, 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 customers for our <unk> offering.
We anticipate demand to remain healthy into 2023, as we ramp new wins.
And finally in our.
Enterprise end market continued growth in starch demand 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 to year growth during 2022.
We remain cautious in our outlook as potential signs of slowing demand in the broader economy has typically had a more pronounced impact.
On demand from our enterprise customers.
I'm incredibly pleased with what Celestica has accomplished thus far in 2022.
Quite 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.
If you would like to ask a question. Please press star followed by the number one on your telephone keypad.
If you would like to withdraw your question. Please press star followed by the number too.
One moment. Please for your first question.
Your first question comes from Dennis must Kaplowitz of BMO capital markets. Please go ahead.
Hi, good morning.
Rob if you look at the upside in 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 two factors was it more weighted towards demand up cycle.
Supply chain doing better than you thought.
Okay fair enough I would say.
It's more along the lines of supply chain constraints, improving are clear to build.
<unk> was better than original expectations. So it was enabling us to convert our backlog and fulfill our strong.
Strong demand if you will.
<unk> really not moderate in the quarter, but our fill rates are.
Ability to convert it was actually better than anticipated.
Okay.
As far as 2023, Youre introducing fiscal 'twenty three guidance for 2002 is even over.
Presumably does that speak to the strong level of visibility in the backlog that you currently have.
Correct.
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 in our enterprise business, but net net we feel confident that we're able to provide.
Good I think given the macroeconomic.
Good growth going into 2023.
Great and finally for Mantech.
How should we think about cash flow and capex over the next year, we did see a bit of a reduction in inventory. It sounds like you think that might continue.
Simply I should try some cash generation in <unk>.
Yes, good morning, Dennis 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.
Look 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.
To say, Florida for next year.
Okay, great. Thanks, guys, congrats on the quarter and I'll pass the line.
Thanks Dennis.
Your next question comes from Robert Young of Canaccord Genuity. Please go ahead.
Hi, Good morning, you already talked a little bit about visibility on the semi cap space, where I wanted to dig in a little deeper there.
You highlighted your exposure to leading process node 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 is locked in there maybe just give us a sense of.
The level of visibility there.
Sure Rob So just take a step back in 'twenty two 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 in Malaysia, and Korea, and we also have some fantastic vertical integration capabilities. That's a large reason for our growth.
As we look into 'twenty 'twenty three 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 all that all being said, we should fare fairly well relative to the market for a couple of reasons. The first reason is mix.
From a.
From a mix perspective, we are focused in on the high end node, so that less than seven 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 kind of 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 we'll perform better than the market is really new program growth a lot of those programs started to ramp this year and will extend into next year. So net net.
We feel pretty confident that we will.
<unk> performed better than the market and we should be out up to flat to up as we go into 'twenty 2023.
Okay. Thanks for all that color and the margin guidance.
Impressive if I think back to past comments.
I think that you've said that in order to get above 5% it would require recut.
A recovery in commercial aerospace.
Wondering does the guidance for 2023 anticipate.
That business is becoming a contributor to operating margins or maybe you can just give us an update on where the margin contribution from Andy 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 five 1% this quarter and that our guide for Q4 highest margin in the company's history.
If you take the midpoint of the Q4 guidance. It implies four 9% for this year, that's the highest in our company's history.
And then what we're doing now is we're raising the range for next year by 50 basis points of between four five and five 5%.
Really there's two 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 strategic decision to maintain our investment.
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.
Could maintain that structure when we're growing it so our SG&A right now is not growing nearly as fast as the top lines we're seeing.
Benefits there as well to your point specifically on A&D. So there's some puts and takes within the markets themselves.
So as you can see is performing incredibly well there are some mix benefits happening right now, which would probably moderate but we expect that Ccs margins will still be strong going into next year, and then Ats 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 <unk> is performing.
Very well, but A&D as demand is still not where it was pre COVID-19 and we are seeing improving profitability sequentially, but it is still more opportunity to be had in A&D as volume comes back we're seeing the same thing in industrial.
<unk> part of our topline growth is coming from industrial.
Those programs arent yet at full.
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.
Operating at their peak levels, either so theres still some tail.
Tailwind if you will within Ats to help improve margins as we go into next year.
Great and Thats beyond the four to have four five to five 5% operating margin.
We've taken all that into account so while Ccs may moderate a little bit going into next year Ats has an opportunity to probably pick up any moderation.
And then again as we grow over our lifecycle solutions that will help us hopefully get to the higher end of that range as we go through next year.
Okay, and just a last little one.
The midpoint of EPS guidance below that double digit long term guidance gave US right noted I wasn't able to find that reiterated anywhere is that still the expectation and then I'll pass the line.
Yeah, I mean, so what we're very pleased with is the as you know the EPS growth that we're showing this year the midpoint of the Q4 guidance calls for $1 86 at 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 a year over year basis. When you look at the dollars 95 to 205 next year, the $1 95 implies 5% and the 205 implied 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 than that 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.
Youre welcome.
Your next question comes from Roku, better Sharia 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 your.
Youre guiding 23 operating margin to $40 five to five 5%.
What needs to happen for you get 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 'twenty three.
Yes so.
The margins of four 5% to 5%.
Say it is also tied to how the revenue profile is going to turn out we said again at least $7 5 billion.
If we come in just that $7 5 billion and we.
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, we just posted for Ccs are the highest they've ever posted.
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 down 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.
Talked a little bit about A&D already there continues to be a recovery.
And 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.
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.
The next question is on revenue growth.
What is the what is the.
<unk> contribution from PCI to fiscal 'twenty, two revenue growth and and you said hps in the first nine months is contributing or it was up 67% year on year, how should we think about the contribution from <unk> in fiscal 'twenty. Three I think you are guiding 5% year on year growth at the midpoint of the.
Fiscal 'twenty three revenue guidance, so how much of that would be from this from the HPE fs revenue growth.
Yes so.
Well, we don't breakout PCI, specifically, but I will go back to some previous public remarks, when we bought the business. It 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 'twenty two.
Two.
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.
Just on the trajectory of where the business is going right now and that business may be up anywhere from $7 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.
So there will be a moderation in overall growth within hbf, 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 'twenty three specifically as you look at uses of cash for M&A versus returning cash to shareholders.
Do you prioritize that versus reducing debt.
Yes, so our number one priority right now is a strong cash generation, we're very happy with the strength of the balance sheet as you know a $1 billion and overall liquidity only at one five 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 about that as well.
But when you go beyond that strong free cash flow generation and continuing to invest in the business I would say 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.
Tap our credit lines, a little bit less inter quarter reduces our interest expense, we're going to have the NCI program open until December 5th and then our intention as we mentioned is 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.
And tell you that we actually bought back 5 million shares in October already because of the severely depressed share price and with a price at around where it is right now they are 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 the 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 really when we look at it.
Targets, if 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 on the share buyback front or on the M&A front.
Got it thanks for all the details and congrats again on the quarter.
Thank you.
Your next question comes from Jim Suva of Citigroup. Please go ahead.
Thank you and your outlook and your current growth trajectory is very impressive and margins just curious about the impact on 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 youre 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 one and a half and 2% of revenue in the first half of the year we were quite.
Quite frankly at 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 will probably be again at around two or even slightly higher than that but as you look into 2023, I think the one 5% to 2% range continues to be the right range. We may operate at the higher end of that range, but.
But we have a good track record of being very disciplined on the Capex investments we make.
Overall, I would say that the the <unk>.
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 been in the past.
Got it.
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 are 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 inventories just not required as much as before and as material constraints continue to improve it gives us an opportunity to start reducing them.
<unk> 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 your teams.
Thanks, Jim.
Your next question comes from Paul Treiber, RBC capital markets. Please go ahead.
Okay, Thanks, very much and good morning.
A couple of questions on your outlook for 'twenty three.
Which is obviously quite a bit stronger than the street was expecting.
In terms of the macroeconomic environment and or to what degree are you factoring in a slowdown in the environment or maybe in other words, what do you think is driving the upside to your guidance that would occur and then Conversely, what would lead to downside to your outlook.
Hi, Paul.
We have a pretty in depth.
Planning process, when we do our strategic plan, but more importantly, our annual operating plan.
We do a bottoms up and a lock with.
All of our sites and all our key customers so the guidance.
And the outlook, we provided we feel pretty good about it to answer your questions directly what we provide.
Upside to the outlook would be continued strength in our <unk> business, our datacenter expansion growth.
Little higher than we anticipated.
Perhaps not as much as a down cycle and wafer fab equipment spending as were currently anticipated faster.
<unk> faster recovery in our aerospace markets would also help give us a boost and our industrial business is going through a number of ramps.
And.
Should those be able to ramp a little bit more quickly than end market adoption for those products that we're ramping.
Proof 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 us.
That would pressure, but that being said again, we have a pretty balanced view of of 2023, and we've taken the pluses and minuses and we hope to be able to improve upon the numbers.
We provided as the year gets along just like what we have done in 2022.
That's helpful. A couple of follow on questions. Just you Didnt mentioned supply chain.
Ample for 'twenty three it looks like things are improving here.
Is your outlook for 'twenty three does it and in.
In terms of supply chain does the potential slowdown in the consumer side does that become a net positive or a strong net positive for you in 'twenty three in regards to supply chain.
It's a good point, Paul I, probably should've mentioned that it's it.
It isn't that positive we're assuming a gradual recovery nothing instant but a gradual recovery right now are clear to bill.
I've gotten better the decommit from our suppliers are less frequent.
That being said lead times for semiconductor and specific are still long we need them.
To get shorter that would certainly.
<unk> things and there are still certain technologies and certain suppliers that are.
Well remain constrained I think all through 'twenty three because on the older node technologies, where a lot of the suppliers are not building capacity out there. So we're assuming all gradual improvement in our outlook as we get into 'twenty to 'twenty, three but nothing demand stress in terms of major improvements.
Okay. Thank you I'll pipeline, congrats on the quarter and the outlook.
Thank you.
Ladies and gentlemen, as a reminder, if you would like to ask a question. Please press star one now.
Okay.
Your next question comes from Daniel Chan of TD Securities. Please go ahead.
Hi, good morning, guys.
And that the component supplies are helping was the performance does improve improving component suppliers have an impact on your margins or is it neutral given your ability to pass those costs through to your customers.
Hi.
Some extent.
Improved component supply improves the efficiency of our factories.
So it does help our margins in terms of pricing.
Through the.
Through this cycle of price.
Price increases.
For the overwhelming majority we've been passing on those.
Those price increases in terms of forward pricing to our customers so well.
Ryzen and contract with the tight on that.
Okay, Thanks for that and.
And to what extent is there a risk that your customers ordered more than they needed direct supply issue. So much like we saw in the retail sector and.
And whats components supply is normalizing and you're working through the backlog that there'll be excess inventory in the channel in the near future.
Yes, 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 has been manageable overall one of the things that as you know as 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 our 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 our forecast, but customers also know that if they over order or provided 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 is irrationality right now in the overall marketplace. We are mindful of pockets of maybe buffering thats been happening, but we don't expect right.
Now that is going to be overly material.
And I would also add Dan today, we've either seeing demand tempering, our growth demand decreasing our growth tempering, but we haven't seen customers cancel a push things out customers have been asking us to fulfill the backlog and maybe reducing the outlook, a little bit, whether it's lower growth or or or.
Lower demand.
But we've been converting our backlog so it hasn't been a material issue to date.
Alright, thank you.
Thanks, Dan.
There are no further questions on the phone lines I would now like to turn the conference back to Rob me illness for closing remarks.
Thank you we continued our strong start to the year by posting another solid quarter of results and we continue to execute well through a difficult supply chain and macro environment. I am pleased that we're able to raise our financial outlook for the full year and feel confident in our customers' demand 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 diligently raise our projections as we progress throughout the year. Lastly, we are well scaled that managing our business through economic cycles and feel confident in our ability to continue to navigate through any potential choppy waters my life.
I had thank.
Thank you all for joining today's call and I look forward to updating you as we progress throughout the year.
Yes.
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.
[music].
Okay.
Okay.