Celestica Inc. (CLS) Q3 2023 Earnings Report, Transcript and Summary

Good morning ladies and gentlemen. And welcome to the Celestica Q3 2023 Earnings Conference Call. At this time, all lines are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session. [Operator Instructions] This call is being recorded today, October 26, 2023. I would now like to turn the conference over to Craig Oberg, Vice President of Investor Relations and Corporate Development. Please go ahead.

Good morning. And thank you for joining us on Celestica’s third quarter 2023 earnings conference call. On the call today are Rob Mionis, President and Chief Executive Officer; and Mandeep Chawla, Chief Financial Officer. As a reminder, during this call we will make forward-looking statements within the meanings of the U.S. Private Securities Litigation Reform Act of 1995 and applicable Canadian securities laws. Such forward looking statements are based on management’s current expectations, forecasts and assumptions which are subject to risks, uncertainties and other factors that could cause actual outcomes and results to differ materially from conclusions, forecasts or projections expressed in such statements. For identification and discussion of such factors and assumptions, as well as further information concerning forward-looking statements, please refer to yesterday’s press release, including the cautionary note regarding forward-looking statements therein, our most recent annual report on Form 20-F and our other public filings, which can be accessed at sec.gov and sedar.com. We assume no obligation to update any forward-looking statement, except as required by law. In addition, during this call, we will refer to various non-IFRS financial measures, including ratios based on non-IFRS financial measures consisting of non-IFRS operating margin, adjusted gross margin, adjusted return on invested capital or adjusted ROIC, adjusted free cash flow, gross debt to non-IFRS trailing 12-month adjusted EBITDA leverage ratio, adjusted earnings per share or adjusted EPS, adjusted SG&A expense and adjusted effective tax rate. Listeners should be cautioned that references to any of the foregoing measures during this call denote non-IFRS financial measures whether or not specifically designated as such. These non-IFRS financial measures do not have any standardized meanings prescribed by IFRS and may not be comparable to similar measures presented by other public companies that report under IFRS or who report under U.S. GAAP and use non-GAAP financial measures to describe similar operating metrics. We refer you to yesterday’s press release and our Q3 2023 earnings presentation, which are available at celestica.com under the Investor Relations tab for more information about these and certain other non-IFRS financial measures, including a reconciliation of historical non-IFRS financial measures to the most directly comparable IFRS financial measures from our financial statements and a description of modifications to specified non-IFRS financial measures during 2022 and 2023. Unless otherwise specified, all references to dollars on this call are to U.S. dollars and per share information is based on diluted shares outstanding. Let me now turn the call over to Rob.

Thank you, Craig. Good morning, everyone, and thank you for joining us on today’s call. Celestica’s third quarter revenue of $2.04 billion was towards the high end of our guidance range, while our non-IFRS adjusted EPS came in at $0.65 exceeding the high end of our guidance range. Our non-IFRS operating margin of 5.7% was our 15th consecutive quarter of year-to-year non-IFRS operating margin expansion. Our CCS segment continues to benefit from improved business mix, due to the strength of our hyperscaler portfolio reflected by segment margin of 6.2% for the third quarter, the highest ever. We also saw meaningful sequential revenue growth in our HPS business. Our ATS segment delivered solid double-digit year-to-year revenue growth, as we continue to see tailwinds from new program ramps, as well as demand strength in our aerospace business. Celestica’s strong results in the third quarter are reflective of the bullish secular trend underpinning our portfolio and our team’s solid execution. Before I provide an update on each of our end markets and some color on 2024, I would like to turn the call over to Mandeep who will provide a detailed review of our third quarter financial performance and our guidance for the fourth quarter of 2023. Mandeep, over to you.

Thank you, Rob, and good morning, everyone. Third quarter revenue came in at $2.4 billion towards the high end of our guidance range. Revenue was 6% higher year-over-year, supported by higher revenues in both segments, including double-digit growth in our ATS segment. Our third quarter non-IFRS operating margin of 5.7% was 60 basis points higher year-over-year. This margin expansion was driven primarily by strong profitability in our CCS segment, supported by solid operational execution. Non-IFRS adjusted earnings per share for the third quarter were $0.65, exceeding the high end of our guidance range and were $0.13 higher year-over-year, driven primarily by higher operating profits. Moving on to our segment performance, third quarter ATS revenue was $859 million, up 12% year-over-year and in line with our expectations of a low double-digit percentage increase. The year-over-year increase in ATS segment revenue was driven by the ramping of new programs in our industrial business, improving demand in A&D and solid growth in our HealthTech programs. This growth was partly offset with ongoing market related softness in our capital equipment business. ATS segment revenue accounted for 42% of total revenues in the third quarter, compared to 40% in the same period last year. Our CCS segment revenue of $1.18 billion were up 2% compared to the prior year period and accounted for 58% of total company revenues in the third quarter, compared to 60% in the prior year period. Year-over-year dynamics were largely unchained from last quarter, as very strong growth in our enterprise end market, supported by strong demand for proprietary compute, was largely offset by anticipated demand softness in our communications end market. Enterprise end market revenue in the quarter was up 31% year-over-year, higher than our expectation of a low double-digit percentage increase. Revenue growth was driven by program ramps and continued strength in demand for proprietary compute from our hyperscaler customers in support of artificial intelligence applications. Revenue in our communications end market for the third quarter was lower by 10% year-over-year versus our expectation of a high single-digit percentage decrease. The decline was driven primarily by tough comps from a strong prior year period. HPS revenue was $493 million in the quarter, 5% lower year-over-year, but up 39% sequentially in line with our outlook provided last quarter. HPS revenues were 24% of total company revenues in the third quarter, compared to 27% in the prior year period. We expect HPS revenue to return to year-to-year growth in 2024, as we anticipate networking customers demand to increase. Turning to segment margin, ATS segment margin in the third quarter was 4.9%, 10 basis points lower year-over-year as the benefits of volume leverage and ramping programs in our industrial business were more than offset by softness in the capital equipment business. CCS segment margin during the quarter was 6.2%, up 100 basis points year-over-year, marking the first time one of our segment margins has exceeded 6%. The increase was driven by higher volumes with our hyperscaler customers, as well as production efficiency. Moving on to some additional financial metrics. IFRS net earnings for the third quarter were $80 million or $0.67 per share, compared to net earnings of $46 million or $0.37 per share in the prior year period. Adjusted gross margin for the third quarter was 9.8%, up 90 basis points year-over-year due to higher volumes in both segments and improved mix. Third quarter non-IFRS adjusted effective tax rate was 20%, compared to 21% in the prior year period. Non-IFRS adjusted ROIC for the third quarter was 21.5%, an improvement of 2.3% compared to the prior year quarter. Moving on to working capital. At the end of the third quarter, our inventory balance was $2.26 billion, down $85 billion sequentially and down $65 million year-over-year. Cash deposits were $875 million at the end of the third quarter, up $65 million sequentially and higher by $251 million compared to the prior year period. When accounting for cash deposits, inventory continues to improve meaningfully, lower by $316 million on a year-to-year basis at the end of the third quarter and lower by $150 million sequentially. Inventory days net of cash deposit days were 72 in the third quarter, compared to 85 in the prior year period. We anticipate a further improvement in inventory days over the coming quarters as material lead times continue to normalize. Cash cycle days were 72 during the third quarter, one day lower sequentially and nine days higher than the prior year period. Capital expenditures for the quarter were $27 million or approximately 1.3% of revenue, compared with 2.0% in the third quarter of 2022. Non-IFRS adjusted free cash flow in the third quarter was $34 million, compared to $7 million in the prior year period. This represents our 19th consecutive quarter with positive non-IFRS adjusted free cash flow and brings our year-to-date figure to $110 million, more than double our performance of $51 million from the same period last year. Given our strong year-to-date performance and positive outlook for the fourth quarter, we are raising our non-IFRS adjusted free cash flow expectation from $125 million to $150 million for 2023. Moving on to some additional key metrics. Our cash balance at the end of the third quarter was $353 million, which, in combination with our approximately $600 million of borrowing capacity under our revolver, provides us with liquidity of approximately $1 billion. We believe this is sufficient to meet our anticipated business needs. Our gross debt at the end of the third quarter was $613 million, leaving us with a net debt position of $260 million [ph]. Our third quarter gross debt to non-IFRS trailing 12-month adjusted EBITDA leverage ratio was 1.1 turns, down 0.1 turns sequentially and down 0.4 turns compared to the same quarter of last year. At September 30, 2023, we were compliant with all financial covenants under our credit agreement. We did not purchase any shares for cancellation under our NCIB during the third quarter. We do, however, intend to continue to be opportunistic on share repurchases under our current NCIB for the remainder of the year and intend on renewing our NCIB program in December, subject to necessary approvals. Now turning to our guidance for the fourth quarter of 2023. Fourth quarter revenues are expected to be in the range of $2.0 billion to $2.15 billion, which, if the midpoint of this range is achieved, would be slightly higher compared to the same quarter last year. Fourth quarter non-IFRS adjusted earnings per share are expected to be in the range of $0.65 per share to $0.71 per share, which would represent an improvement of $0.13 per share or approximately 23% compared to the fourth quarter of 2022 if the midpoint of the guidance range is achieved. If the midpoint of our revenue and non-IFRS adjusted EPS guidance ranges are achieved, non-IFRS operating margin would be 5.7%, which would represent an increase of 40 basis points over the prior year period. Non-IFRS adjusted SG&A expense for the fourth quarter is expected to be in the range of $67 million to $69 million. We anticipate our non-IFRS adjusted effective tax rate to be approximately 20% for the fourth quarter, excluding any impact from taxable foreign exchange or unanticipated tax settlement. Now turning to our end market outlook for the fourth quarter of 2023. In our ATS segment, we anticipate revenue to be up in the low single-digit percentage range year-over-year, driven by expected double-digit growth in our industrial and A&D businesses, partly offset by ongoing market softness in capital equipment. We anticipate revenues in our communications end market to be down in the mid-teen percentage range year-over-year, driven by tough comps from the prior year period. Finally, in our enterprise end market, we expect revenues to be up in the high 20% range year-over-year, driven by anticipated continuing demand strength in proprietary compute programs from our hyperscaler customers. I will now turn the call back over to Rob to provide details on the outlook for our end market and business overall.

Thank you, Mandeep. Based on our solid performance this quarter and our strong guidance to close out the year, we are pleased to raise our preliminary 2024 outlook. In the coming fiscal year, we are maintaining our expectation of non-IFRS adjusted EPS growth of 10% or more compared to our 2023 outlook, which has increased from $2.25 to $2.36 based on the midpoint of our fourth quarter guidance. We expect this growth to be driven by a combination of higher revenue across each of our end markets and solid non-IFRS operating margin. I would now like to provide some detail on the outlook for each of our businesses. Beginning with our ATS segment, our industrial business has continued to experience very strong growth in 2023, driven by ramping new programs. We expect this momentum to continue into the next year as these green programs continue to ramp. Our PCI business also achieved solid revenue growth in 2023 and we are pleased that they are on track to achieve the synergy objectives establish at the time of acquisition. We anticipate continuing growth in 2024, supported by our investment to expand capacity in Indonesia, which is expected to be online by year end. The recovery in commercial aerospace demand continues to fuel solid growth in our A&D business, supporting a greater than 30% increase in revenues year-to-date compared to the prior year period. Our defense business is also experiencing solid double-digit growth in 2023, supported by a number of new program ramps and we anticipate this momentum to continue into next year. With commercial air traffic now approaching more normalize levels, we anticipate our overall A&D revenue growth rate moderating in 2024, though remaining relatively strong as we continue to have a healthy backlog. Moving on to capital equipment, demand continues to be soft across the broader wafer fab equipment market, which has been compounded by the recent U.S.-China trade restrictions affecting the semi industry. We continue to be encouraged by our ability to execute in a challenging market and remain profitable despite a material year-over-year reduction in volume. Overall, our capital equipment portfolio is benefiting from a combination of favorable mix and the ramping of new program wins. Looking ahead, we believe that our capital equipment business is operating at trough levels and while we expect the underlying market demand to be relatively flat year-over-year in 2024, we do expect our business to grow based on new program wins. In our HealthTech business, the ramping of new programs in surgical instruments and imaging devices are supporting solid growth during 2023. Overall, the demand outlook for our HealthTech business remains healthy with growth into 2024. Now turning to our CCS segment, the broader environment continues to be positive for our CCS segment as hyperscalers are making significant investments in data center capacity. Market observers have suggested that we may be in the early days of this long-term secular trend accompanied by a major hardware upgrade cycle to support artificial intelligence applications and the resulting increase in data center traffic. We believe that the different stages of this investment cycle will be synergistic and support demand for our entire suite of data center offerings at various times throughout the entire cycle. Demand in our enterprise market is showing significant strength benefiting from the tailwinds of hyperscalers investments in data center compute capacity to support the growth in artificial intelligence applications. Our medium-term outlook for this business also remained very positive, with expectations for continued strong demand and proprietary compute, as well as ramping programs and storage. We anticipate that these factors will support double-digit revenue growth rate in our enterprise business through 2024. The near-term outlook for our communications end market remains soft into the end of the year, primarily due to tough comps. However, we do expect that this business will resume year-to-year revenue growth in 2024 as customer investments in compute begin to pull through demand for networking. We are encouraged by our medium-term outlook for our communications end market, supported by our leading position in 400G and recent wins in 800G. We are also encouraged by the sequential growth in our HPS business in the third quarter and believe that it is poised to return to annual growth in the coming year as customer inventory levels are expected to normalize and new networking and compute programs ramp in 2024. Finally, I am pleased to announce that being a Virtual Investor Briefing on November 29th, we are looking forward to walking the investment community through an overview of our CCS and ATS portfolios, including a more thorough look at the opportunities we see in our hyperscaler business. We also intend to provide further details on our 2024 outlook, as well as our long-term financial targets and capital allocation framework. We will be releasing the details of the event shortly and we hope that all of you can join us on that day. We have much to look forward to as we aim to close with a strong finish to the year. We are on track to achieve the highest ever non-IFRS adjusted operating margin and non-IFRS adjusted earnings per share in the company’s history, eclipsing both of the previous highs set last year. I have the utmost confidence and trust in our team to execute on our long-term strategy, continue to deliver on our targets and set us up for another great year in 2024. With that, I would now like to turn the call over to the Operator for questions.

Thank you, sir. [Operator Instructions] Your first question comes from the line of Robert Young from Canaccord. Please go ahead.

Hi. Good morning. The first place I wanted to ask about is one of the last topics on your prepared remarks around what you have talked about the pause and switch sales to hyperscalers. I think previously you suggested it was buffer inventory that needed to be digested. And I think at the very end of your comments you suggested that it was now tied to the proprietary compute opportunity and so I was wondering -- I was hoping you could get into a little more detail around what’s the driver between the switch sales, how closely tied to the AI opportunity is it and then maybe a little more detail around how that recovers?

Hi, Rob. Sure. First, I will start off with saying that, our hyperscalers will grow close to 30% this year and we have very strong demand with that group of customers into next year. In fact, the demand is so strong, our growth as we exit the year is being paced by material availability, which we think will clear up in the very early parts of next year. In terms of networking demand, we are getting towards the end of some inventory burn down for the top customers that we tracked that had the most buffers, one of them has returned to growth both sequentially and year-to-year, and the other one will do so very early next year. We are expecting the pull-through of networking to happen with the increased demand of proprietary compute. We are also starting to ramp some new 800G programs in the second half of 2024.

Okay. Thank you. And a question on capacity, if the AI optimized server business continues at this pace and the switching business recovers, do you have the capacity to grow both of those businesses?

We do, Rob. We started some expansion earlier in the year in Southeast Asia and that capacity 80,000 square feet will be coming online in the first quarter of 2024. We are also starting to invest side-by-side with our customers to expand capacity in Thailand another 50,000 plus square feet and that’s going to support AI growth well into the future and that capacity will come online in the first part of 2025. Again, we have a very bullish view of AI growth going into the medium- to long-term. We think we are at the very beginning of a long-term upgrade cycle, and as such, we are investing alongside our customers to increase our capacity to support their very robust demand.

Okay. One -- just one clarification there on the side-by-side investment with a customer, does that create any kind of exclusive relationship or does it tie a customer to you a little more closely, maybe a little more clarity around that and then I will pass the line.

Yeah. I will say it’s a very sticky relationship with our customers that we are doing this with and it just shows the commitment that they have with us relative to investing side-by-side with us and expanding the capacity. And also in Thailand, we are building basically a dedicated building just to support AI growth with our customer and that’s a pretty profound statement.

Thanks for all that. I will pass the line.

Your next question comes from the line of Maxim Matushansky from RBC Capital Markets. Please go ahead.

Yeah. Good morning. I just wanted to ask if there’s anything you can share in terms of how the conversations with the hyperscaler customers are going for 2024 visibility or otherwise, I guess, at what point do you expect to have a better idea of that demand for the back half of 2024 across the different programs?

Thanks for the question. Hyperscalers typically lock down their full-year budget towards the end of October, early November. So right now I think we have pretty good visibility into the third quarter of 2024. In the next two weeks, we will probably have full visibility into all of 2024. And in our Investor Update Briefing in November 29th, we will be providing additional color on 2024 and also color for our three-year outlook as well. But right now, demand is very robust across our hyperscalers, especially in the areas of proprietary compute.

Just in terms of your competitiveness with those customers, have you seen any changes in competitive positioning, whether that’s competitors being more aggressive on price or new entrants or maybe supply chain conditions are better for competitors? Like anything that might impact your relationships with the hyperscaler customers in the foreseeable future?

This class of customer right now is very focused in on partners that could reliably and technically scale volume and that plays to our strengths. These compute modules, proprietary compute modules are very complex. They require water cooling, which we are very good at and we are also very good at ramping new programs. So the most important award criteria is suppliers that could reliably scale new production and that’s why we have been winning more than our fair share of work with these guys.

And maybe just one final one. On the Q4 guidance, it implies enterprise segment revenues to reaccelerate quarter-over-quarter, while ATS, I guess, it implies fairly flat quarter-over-quarter. Are these more timing related or is there anything to call out in terms of the changes kind of maybe in the near-term to those end markets?

Hey. Good morning, Maxim. It’s Mandeep here. First off, I would talk about the second half of 2023 in totality, which is we are coming in at $7,900 [ph] for the year. The outlook we had nine or three months ago for the second half is largely intact. We did see some accelerated demand that took place in the third quarter. So a little bit of revenue did shift from Q4 to Q3, but largely otherwise, Q4 is in line with what we were seeing just a few months ago. To your point, in terms of the underlying dynamics, the enterprise area is probably the area of the most growth that we are seeing right now. That’s been happening as we have gone through the year and it’s continuing into Q4, and frankly, it’s going to be continuing into next year and it’s tied in many cases specifically to the proprietary compute demand that we are in the process of fulfilling. ATS too, if you just look at ATS in total, I mean, the growth this year has been terrific, right now it’s on track for about 13% year-over-year growth on a full year basis. And so there’s a little bit of timing delay sometimes between various quarters. But after growing strong double digits last year, it’s going to be low double digits this year and our outlook going into next year for ATS continues to be targeting that 10% number. And if you -- the last thing I would also say is that, if you look at the end markets within ATS, we saw a very robust growth in three of the four markets. So we are going to be growing 13% this year, despite capital equipment being down over 30%.

Great. Thanks for that line.

Thanks, Maxim.

Your next question comes from the line of Daniel Chan from TD Cowen. Please go ahead.

Hi. Thanks. Mandeep, if you are talking about the ATS strength this year, next quarter you are kind of guiding it for, sorry, next quarter you are guiding it down to be up about low single digits. So a decel in that growth. Anything to call out there for that decel? Is it anything the semicap weakness or any delays like that?

No. Relatively flat on a sequential basis, Dan. But I’d point maybe to a couple of things. One is, again, outside of capital equipment, we are seeing good growth across all of our end markets, but we are also facing tough comps. If you just look at the fourth quarter of last year, ATS grew by 29% organically. So it was a very strong fourth quarter of last year. But we are glad to see that this peak revenue that we are seeing currently in ATS, which I believe is at a record level is holding going into the fourth quarter.

Okay. That’s good to hear. And then if we just switch gears to the HPS business, one of the strongest sequential growth we have ever seen out of the business. Are AI programs being migrated to HPS engagements or is there something else driving that strength?

We are seeing some HPS proprietary compute programs being migrated to HPS. That is still in the early stages. The drivers of the HPS growth is really a starting of some increased network demand, as one of the earlier caller mentioned. We are seeing a couple of our hyperscalers starting to buy more and more networking gear, which is HPS gear as well.

Yeah. So going into next year, Dan, we are expecting growth in HPS and there’s two nice drivers that are happening. One is the 800G switches now starting to come online and some of those are HPS products that will be towards back end of the year. And then there is some compute products as well in our HPS portfolio, which are tied both -- you could tie both of those to overall AI.

Great. Thank you.

Thanks Dan.

Your next question comes from the line of Thanos Moschopoulos from BMO. Please go ahead.

Hi. Good morning. Generally speaking, it seems like macro conditions have deteriorated the last couple of months. Are you seeing any signs of that in any of your end markets or no because of the specific ramps and markets you are involved in?

Hi, Thanos. I would say, overall, our markets are holding pretty tight. We are not very exposed to consumer markets or things that are very interest rate sensitive. Just going around the markets within A&D. A&D business continues to be strong. We have a very healthy backlog. It’s tool availability is really pacing our ability to support demand there and going into next year we see some incremental growth coming out of defense programs supporting what’s happening in the world. Within an industrial, I would say, across the Board we are seeing a little bit of a slowdown in the EV charger portion of our portfolio. Again, that’s a very small portion of our portfolio, 2%. But the other portions of our industrial portfolio are growing very nicely. Industrial is having very robust growth this year and very strong double-digit growth going into next year as well. And then we also talked about, more broadly speaking, proprietary compute and all of our products that support AI growth, very strong growth going into 2024 versus 2023, and 2023 is also having some stupendous growth as well.

Great. Cash cycle days were up due to higher receivables. Can you provide some color on the dynamic there?

Yeah. Hey, Thanos. I’d say quarter-to-quarter dynamics, sometimes they are just account specific. Overall though, if we look at free cash flow, we are happy with the conversion that we have been seeing $110 million year-to-date. That’s kind of double what we did at the same time last year and then as you saw in our prepared remarks, we are increasing our free cash flow target for this year to $150 million, at the beginning of the year it was $100 million. So we are starting to see some good working capital movements. We do expect to see a strong conversion going into the fourth quarter and into next year as well. So while the cash cycle days may have a little bit on some of the specific accounts, it will normalize as we go into the next few quarters.

Great. Last one for me. It sounds like you have had a lot of new program ramps across your business this year. Normally my understanding is new program ramps are at a lower margin until they get up running and are optimized. Does that inherently provide a good margin opportunity for next year or is that going to be offset by other new programs that will be ramping next year?

Well, we are always ramping programs, which is a good thing and so we are always going to have a little bit of that mix change, if you will, on our margin profile. I would say that right now the -- some of -- many of the programs that we are ramping are not margin dilutive. In some cases, we have already reached scale. So if you use industrial as an example, we are very pleased with the margin profile that’s happening in industrial despite the fact that we are still ramping so many programs, because we have achieved a certain level of scale. And then on the hyperscaler side, it’s really about a portfolio and suite of portfolio of products, and we are pleased with the margin performance across all of our hyperscaler customers right now. Now as we go into next year, as you would see, we are targeting 10% EPS growth over 2023. 2023 will be at record levels. Last year was at record levels. We are implying 2024 will be at record levels and there’s different ways that we may get there. Some of it will be on topline growth, but there is an opportunity on margin expansion as well.

Great. I will pass the line. Thank you.

Thanks Dan.

Your next question comes from the line of Matt Sheerin from Stifel. Please go ahead.

Yes. Thanks very much. Just another question regarding your cloud business, particularly on revenue recognition, on the enterprise side. Is any of your business on a consignment basis and are you planning to shift any of that and does that have any impact on margins?

There is some consigned materials in revenue that we do recognize, Matt, and so what that means ultimately is that we are not putting it through into our revenue and we are also not marking it up. It makes sense in the EMS world to have consigned inventory, otherwise customers would be paying a margin stack on some very expensive components. That being said, there is not a major shift in the concentration of consignment that we have. Look, if you compare next year to what we are seeing this year, it’s going to be relatively consistent. We are not looking to consign a lot more new material.

Okay. And relative to your CCS business, I know that hyperscale is the fastest growing and is the largest portion of that business, but you do still have a strong OEM business. Could you talk about the dynamic going on there in market demand and as you continue to grow the hyperscale business at a faster rate, do you expect margins in that overall segment to expand?

Yeah. We do have OEM business as well and those OEMs also sell into the hyperscaler business. So we don’t count that in our hyperscaler class but those businesses are growing quite nicely as well. Right now, they are working through some excess inventory challenges, but as we get into next year we do see those guys returning to growth.

There has been some pockets of softness amongst the enterprise customers when it relates to small, medium businesses. But as Rob mentioned, we also have a large set of customers that are selling directly into the hyperscaler. So we have seen in most cases that that’s balancing itself out.

Okay. Thank you. And just lastly on the model, could you give us your estimate for the interest expense and other line? I know that was down and I imagine with working capital coming down, that line will also continue to come down.

Yeah. Right now, for both taxes and for interest, I would suggest on the tax side put there to use 19% to 21% next year. This year we are on track for around 20% and at this point we don’t see a major deviation from that. And then to your point on interest expense, we are starting to see a little bit of a reduction. Despite rates having gone up so much because of the cash conversion that we are having, we are having reduced AR sales and we are not having to hit the revolver as much. I think right now, if you modeled somewhere close to $70 million for next year. It would be representative of what we are expecting and that is a bit of an improvement over 2023.

Okay. Very good. Thank you.

Thanks, Matt.

Your next question comes from the line of Todd Coupland from CIBC. Please go ahead.

Great. Thanks. Good morning, everyone. I wanted to ask about the volatility in the enterprise business, obviously, strong in Q2 and then dipping down this quarter and moving back up next quarter. Can you just talk about why you are seeing that type of volatility and how we should think about the rhythm into 2024?

Yeah. Within enterprise, the volatility is really being driven by storage. We have had a new program ramp that was put on pause by a customer as they qualify another piece of the rack that they are looking to deploy in their data center and as that comes online, that program will continue to ramp. So really within enterprise it’s the demand fluctuations that are happening within the storage area. Again within enterprise, we also have our proprietary compute business and that continues to be very robust both in the third quarter and in the fourth quarter and going into next year.

Okay. And you called out switching growth starting to return. I guess that’s going to show up in the enterprise line as well and I know 800G is second half of the year. So when are you thinking some of that switch demand might show up. Is it just with the initial orders of 800G or will that come with some of the established products? Thanks.

Well, switching would be part of our communications end market and that, well, should come out of the gates in 2024 hot out of the gates, the 800G will start ramping towards the end of 2024, the second half of 2024, I should say.

Yeah. I think we are very pleased about, Todd, is that we have won a number of programs in the 800G market and so it’s really about the ability for our customers to absorb the hardware that they are ordering. As we talked about last quarter, we are seeing proprietary compute really be the leading indicator, obviously, we are fulfilling a lot of that right now. We are pleased that we have already received the wins that we were looking for in the 800G market. And then so it’s really a matter of just the time on when specific customers start shifting towards that spend. But we are already in very active dialogue on the design front with those customers and are preparing for qualification of as we go into 2024.

Just to add on, Todd, as the 400G to 800G transition happens, we have actually won all the follow on competitions from 400G to 800G with our hyperscalers, which just shows you the level of expertise that we are bringing to the party with respect to our design capability and manufacturing capability.

Okay. One last question on this point. So when you say starting 2024 hot or out of the gate, do you -- you mean in Q1 comms business will pick up from 400G. So should the investor expectation be reduced seasonality in Q1 because the comms business is expected to pick up, how should we think about that?

Yeah. Todd, I wouldn’t provide too much detail yet on the quarters themselves. Just as we are focusing really right now on the fourth quarter and then we will look at full year, we will give more color as we go along. But what I would say is that, more of it is going to be towards the back half. Although, we are getting the orders on the 800G side, there aren’t going to be material shipments happening in the first half of next year. It’s really tail end related. But that being said, we are seeing strong hyperscaler demand in each of the quarters next year and so even if we are not shipping the energy product, there still is a large part of our portfolio that’s 400G and some hyperscalers are still buying 400G. Some have not yet shifted to the 800G in a meaningful way, and then, of course, the compute side, we are seeing demand continue throughout all the next year.

Yeah. Yeah. One last question for me. So this is more of a strategic question. Obviously, you have collapsed the multi-node structure and your large shareholder has divested its holdings. You have a strong position in a key trend in the tech market right now. How are you thinking about sort of like strategic positioning of the company from an M&A perspective? Is this something investors should have on their minds? Could there be consolidation in the EMS sector as a result of this strong demand trend. Just give us your thoughts on that? Thanks a lot.

Thanks, Todd. We are very happy with the progress that we have made in executing our strategic plan. And right now, on the M&A side, as Mandeep mentioned in other calls, we continue to have a very tight filter and be very selective on looking for M&A deals. We are keen to look for capability based M&A and we are also very keenly focused on expanding our services business, especially as it relates to servicing our CCS and hyperscaler customers. But we don’t see any big moves on the horizon.

Thank you.

Thanks Todd.

There are no further questions at this time. I’d now like to turn the call back over to Mr. Rob Mionis for any closing remarks.

Thank you. I am pleased that we posted another solid quarter marked by our highest quarterly adjusted EPS ever. We continue to see positive momentum as we enter the final quarter and into 2024. We also look forward to hosting you at our investor update towards the end of November. Thank you again for joining today’s call and we look forward to updating you next month.

Thank you, sir. Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines. Have a lovely day.