Celestica Inc

TSX:CLS

Earnings Call Transcript 2021-Q2

[Operator]

Good day, and thank you for standing by. Welcome to the Celestica Q2 2021 Earnings Call. [Operator Instructions] Please be advised that today's conference is being recorded. [Operator Instructions] I would now like to hand the conference over to your speaker today, Craig Oberg. Please go ahead.

[Craig Oberg]

Good morning, and thank you for joining us on Celestica's Second Quarter 2021 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 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 operating earnings, operating margin, adjusted gross margin, adjusted return on invested capital or adjusted ROIC, free cash flow, gross debt to non-IFRS trailing 12-month adjusted EBITDA leverage ratio, adjusted net earnings, adjusted EPS, adjusted SG&A 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 use 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 Q2 2021 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.

[Robert Andrew Mionis, President, CEO & Director]

Thank you, Craig. Good morning, everyone, and thank you for joining us on today's conference call. Our strong performance in the second quarter is attributable to the execution of a multiyear transformation. It also reflects the stability and resilience of our global operations and our ability to operate under challenging conditions. Our second quarter revenue of $1.42 billion was at the high end of our guidance range, driven by another quarter of year-over-year double-digit growth in our Hardware Platform Solutions, our HPS business and double-digit growth in our ATS segment. A non-IFRS adjusted EPS of $0.30 and non-IFRS operating margin of 3.9%, both meaningfully exceeded the high end of our guidance range. Our second quarter operating margin performance represented our sixth straight quarter of year-to-year operating margin improvement and was within our target range of 3.75% to 4.5%. Our strong Q2 performance and multiyear margin expansion efforts are a result of the execution of our strategy, including portfolio reshaping and driving operational excellence across the enterprise. Our non-IFRS adjusted free cash flow came in at $31 million for the quarter or $52 million year-to-date, and we continue to target $100 million of free cash flow in 2021. Throughout the quarter, we continue to face operational challenges in the form of supply chain constraints and workforce curtailments in locations such as Malaysia due to the resurgence of COVID-19. But our team's operational agility and advanced planning tools are enabling us to effectively navigate this dynamic environment. We believe that our portfolio is stronger than ever with an improved margin profile and the fundamentals to drive long-term organic growth. We expect our operating margin to continue to expand in the coming quarters, driven by our anticipation for higher HPS concentration in our CCS segment as well as volume leverage fueled by steady growth in our ATS segment. Despite being tempered by continued softness in our commercial aerospace business, ATS segment revenue grew by 12% year-to-year in Q2, driven by another exceptionally strong quarter in our Capital Equipment business, as well as return to growth in our Industrial business. Our ATS segment reported its fifth consecutive quarter of sequential segment margin expansion and remains on track to achieving segment margin within our 5% to 6% target range by the end of the year. Within CCS, our non-Cisco portfolio experienced another quarter of year-to-year growth as both Enterprise and Communications end market revenues exceeded our expectations. The CCS segment continues to perform well, with segment margin of 3.7% in the second quarter. With double-digit year-to-year growth, our HPS business recorded sales of more than $300 million in the second quarter. HPS grew 13% on a year-to-year basis, and year-to-date HPS revenues of $501 million are up 24% compared to 2020. Demand for our Hardware Platform Solutions continues to be robust. And our current expectations are that revenue for HPS will exceed $1 billion for 2021. In recent quarters, we have begun to highlight the financial performance of our life cycle solutions business which combines the revenues of our HPS business and ATS segment. As we noted during our previous quarterly conference calls, our Lifecycle Solutions portfolio generates higher margins, presents greater barriers to entry for competitors and offers a more robust growth profile compared to our traditional EMS portfolio. We are encouraged by the performance of our Lifecycle Solutions portfolio which has exhibited double-digit revenue growth on a year-over-year and sequential basis. Looking ahead, we are pleased to provide third quarter revenue guidance in the $1.4 billion to $1.55 billion range. and non-IFRS operating margin guidance of 4%, representing the midpoint of our revenue and adjusted EPS guidance ranges. Achievement of 4% operating margin would represent the highest quarterly operating margin at Celestica in the last 20 years. Additionally, we currently expect our performance in the fourth quarter to be at third quarter levels or better. I am pleased with the progress we have made in executing our strategy and transforming our business. Year-over-year operating margin has been expanding for the last 6 quarters. Revenue from our Lifecycle Solutions business continues to grow as a percentage of overall revenue, and Celestica is currently on track to post year-over-year revenue growth on an absolute basis in the fourth quarter. Additionally, our bookings performance has been strong, driven by our engineering-led approach, and our efforts have resulted in a diversified portfolio with strong secular tailwinds. Before I offer some additional detail on the outlook for each of our end markets and the overall business, I would like to turn the call over to Mandeep who will provide you with more color on our financial performance in the second quarter as well as more detail on our third quarter guidance.

[Mandeep Chawla, Chief Financial Officer]

Thank you, Rob, and good morning, everyone. Second quarter 2021 revenue came in at $1.42 billion at the high end of our guidance range. Revenue decreased 5% year-over-year and increased 15% sequentially. Our non-Cisco revenues grew 6% year-over-year and grew 15% sequentially. We delivered non-IFRS operating margin of 3.9%, 40 basis points ahead of the midpoint of our guidance range, driven by stronger-than-expected performance in both segments. Non-IFRS operating margin was up 50 basis points year-over-year and up 40 basis points sequentially. The year-over-year improvement was driven by improved operating leverage in ATS, resulting from double-digit revenue growth and improved CCS performance, including higher HPS revenue concentration. The sequential improvement was due to higher volumes and favorable mix across several businesses as well as strong performance in our CCS business. Non-IFRS adjusted earnings per share were $0.30, above the high end of our guidance of $0.27 and up $0.05 year-over-year; and up $0.08 sequentially. The IFRS earnings per share were $0.21, up $0.11 year-over-year and up $0.13 sequentially. ATS revenue was up 12% compared to a year ago, slightly below our expectations of a mid-teens percentage year-over-year increase. Sequentially, ATS revenue was up 6%. The year-over-year revenue growth in ATS was driven by a recovery in demand and a return to growth in our Industrial business and new program wins and market share gains in our Capital Equipment business. This was partly offset by continued softness in commercial aerospace. Sequential growth was driven by continuing strength in Capital Equipment, partly offset by HealthTech. CCS segment revenue was down 14% year-over-year, largely driven by the Cisco disengagement partly offset by strong demand from service provider customers, including in our HPS business. Sequentially, CCS revenue was up 22%, led by strong demand from service provider customers, strong demand in our HPS business as well as normal seasonality in our Enterprise business. Revenue in our CCS portfolio from businesses other than Cisco increased by 2% year-over-year. Communications revenue was down 7% year-over-year, less than our expectation of a low double-digit percentage decrease. The decline was largely due to the Cisco disengagement, partly offset by strong demand from service provider customers. Sequentially, Communications revenue was up 20%, reflecting strength with service providers. Enterprise revenue in the quarter was down 25% year-over-year, less than our expectation of a low 30s percentage decrease. Lower revenues were the result of program-specific demand dynamics with several of our server customers. Sequentially, Enterprise revenue was up 26%, driven by normal seasonality and program-specific strength with certain storage customers. Our HPS business delivered its highest revenue quarter ever, with sales of $302 million, up 13% year-over-year, led by consistent demand strength and new program ramps with service providers due to continued data center growth. As Rob mentioned, our Lifecycle Solutions business, a combination of the revenue from our ATS and HPS businesses continued its robust growth trajectory. Lifecycle Solutions accounted for 60% of sales on a year-to-date basis, compared to 51% in the first half of 2020. We continue to believe that Lifecycle Solutions is the best representation of our diversified portfolio. Our top 10 customers represented 67% of revenue during the second quarter, down 1% year-over-year and up 2% sequentially. For the second quarter, one customer represented 10% or more of our total revenue versus one in the same quarter last year and none in the prior period. Turning to segment margins. ATS delivered a segment margin of 4.1% in the second quarter, up 100 basis points year-over-year and 10 basis points sequentially. This marks the fifth consecutive quarter of sequential ATS segment margin expansion. The year-over-year margin improvement was driven by double-digit percentage revenue growth in Capital Equipment and growth in HealthTech, which more than offset a soft commercial aerospace demand environment. The sequential improvement was due primarily to strong growth in Capital Equipment, driving better operating leverage. CCS segment margin of 3.7% came in above our target range of 2% to 3%, and was up 10 basis points year-over-year, and up 60 basis points sequentially. This represents the sixth consecutive quarter of year-to-year margin improvement in our CCS segment. The year-over-year margin improvement was primarily driven by favorable mix due to our portfolio reshaping activities and an increasing concentration of revenue from our HPS business and strong commercial recoveries. The sequential margin improvement was due to demand strength in HPS. Moving on to some additional financial metrics. IFRS net earnings for the quarter were $26.3 million or $0.21 per share, compared to net earnings of $13.3 million or $0.10 per share in Q2 2020, and net earnings of $10.5 million or $0.08 per share in the previous quarter. Adjusted gross margin of 8.4% was up 90 basis points compared to the same period last year and down 20 basis points sequentially. The year-over-year improvement was driven by strength in HPS and Capital Equipment, partly offset by headwinds in A&D, while the sequential decline was largely due to higher variable compensation. Second quarter adjusted SG&A of $54.7 million was up $1.4 million year-over-year, primarily due to investments in the business. Adjusted SG&A was up $1.1 million sequentially. Non-IFRS operating earnings were $55.0 million, up $4.2 million from the prior year period and up $11.7 million sequentially. Our non-IFRS adjusted effective tax rate for the second quarter was 20%, compared to 24% for the prior year period, and 21%, last quarter. For the second quarter, non-IFRS adjusted net earnings were $37.9 million, compared to $31.7 million for the prior year period, and $27.8 million in the first quarter. Non-IFRS adjusted earnings per share of $0.30 was up $0.05 year-over-year due to higher non-IFRS operating earnings and lower interest expense. Sequentially, non-IFRS adjusted earnings per share were up $0.08 driven by higher non-IFRS operating earnings. Second quarter non-IFRS adjusted ROIC of 13.7% was up 0.8% compared to the same quarter of last year and up 2.9% sequentially. Moving on to working capital. Our inventory at the end of the quarter was $1.22 billion, up $71 million sequentially and up $19 million compared to the same period last year as we continue to support growth in our HPS business. Inventory turns were 4.4 turns in the second quarter, up from 4.0 turns last quarter, but down from 4.9 turns in the prior year period. Capital expenditures for the second quarter were $10 million or just less than 1% of revenue. Non-IFRS free cash flow was $31.2 million in the second quarter, compared to $37.9 million for the same period last year and up from $20.9 million in the prior quarter. This is now our tenth consecutive quarter of delivering positive non-IFRS free cash flow. Cash cycle days in the second quarter were 71 days, up 11 days year-over-year and down 11 days sequentially. The sequential improvement of our cash cycle days reflects normal seasonality and our continuing efforts to improve working capital performance despite the well-known challenges in the supply chain environment. In the second quarter, we incurred $3 million of restructuring charges or $0.02 per share to further adjust our cost base to better align with changing demand levels in several of our businesses and geographies. Moving on to some additional key metrics. Our cash balance at the end of the second quarter was $467 million, up $31 million year-over-year and up $18 million sequentially. Combined with our $450 million revolver, which remains undrawn, we continue to have a very strong liquidity position of approximately $900 million in available funds. We continue to believe that our liquidity is sufficient to meet our current business needs. We ended the quarter with gross debt of $440 million, unchanged from the previous quarter, leaving us with a net cash position of $27 million. Our second quarter gross debt to non-IFRS trailing 12-month adjusted EBITDA leverage ratio was 1.4 turns, flat sequentially, and an improvement of 0.3 turns from the same quarter last year. At the end of June 2021, we were compliant with all financial covenants under our credit agreement. During the quarter, we repurchased approximately 1.6 million shares at a cost of $13.4 million. Since commencing our NCIB program last November, we have repurchased a total of 2.2 million shares at a cost of $18.7 million, and we intend to deploy capital towards share repurchases in the third quarter of 2021. We ended the quarter with 126.8 million shares outstanding, a reduction of approximately 2% from the prior year period. We remain committed to our previously stated capital allocation priorities. We are focused on generating positive free cash flow and balancing the paying down of our debt with maintaining optimal financial flexibility and dry powder to enable the acceleration of our strategy through disciplined M&A. We continue to target returning 50% of non-IFRS free cash flow to shareholders with the other 50% to be reinvested in our business over the long term. Given our strong balance sheet and levels of our share price relative to our view of our fundamentals, we will continue to opportunistically purchase shares for cancellation under our NCIB program. Our current NCIB plan expires in November of 2021 and has up to approximately 6.8 million shares remaining that are eligible for repurchase. Now turning to our guidance for the third quarter of 2021. We are projecting third quarter revenue to be in the range of $1.4 billion to $1.55 billion. We note that we have widened our typical guidance range for revenue this quarter from $100 million to $150 million to account for the potential impacts from a dynamic supply chain environment. At the midpoint of this range, revenue would be up 4% sequentially and down 5% year-over-year. For our non-Cisco portfolio, achievement of the midpoint of our guidance range would represent revenue growth of 6% year-over-year. Third quarter non-IFRS adjusted earnings per share are expected to range from $0.30 to $0.36. At the midpoint of our revenue and adjusted EPS guidance ranges, non-IFRS operating margin would be approximately 4.0%, an increase of 10 basis points over the same period last year and up 10 basis points sequentially. Non-IFRS adjusted SG&A expense for the third quarter is expected to be in the range of $56 million to $58 million. We anticipate our non-IFRS adjusted effective tax rate to be approximately 20%, excluding any impacts from taxable foreign exchange or unanticipated tax settlements. Turning to our end market outlook for the third quarter of 2021. In our ATS end market, we anticipate revenue to be up in the low double-digit percentage range year-over-year, driven by continued demand strength in our Capital Equipment and HealthTech businesses and a continued recovery in Industrial, partially offset by continuing demand softness in commercial aerospace as a result of COVID-19. In CCS, we anticipate our Communications end market revenue to be down in the high single-digit percentage range year-over-year driven by our disengagement from Cisco. The remainder of our communications portfolio is growing, driven by strength in demand from our service provider customers as well as our HPS business. In our Enterprise end market, we anticipate revenue to decrease in the low 20s percentage range year-over-year due to market demand softness, particularly from server customers and a relatively strong comparative quarter last year. Our outlook sees Lifecycle Solutions continuing to account for a growing portion of our consolidated revenue as we continue to diversify our portfolio. It will serve as our long-term driver of operating margin improvement. We maintain our expectation for Lifecycle Solutions revenue to grow in the low double-digit percentage range in 2021. I'll now turn the call back over to Rob for additional color on our end markets and overall business outlook.

[Robert Andrew Mionis, President, CEO & Director]

Thank you, Mandeep. Our financial metrics are beginning to reflect the benefits of the critical decisions we made to improve the business over the last 24 months. We believe we have strong momentum and are opportunistic regarding our ability to capitalize on the opportunities that lie ahead. However, the road ahead does not come without its challenges. Material constraints are becoming more severe in the second half of 2021. And in certain geographies, concerns are rising regarding the resurgence of COVID-19. To the best of our ability, we have factored these dynamics into our outlook and feel confident that our talented team can effectively address any challenges ahead. Now turning to the outlook for our segments. In ATS, we remain on track to achieve our targeted 10% revenue growth in 2021. With continued strength in Capital Equipment, growing momentum in Industrial and an expectation of a modest recovery in commercial aerospace, as we ramp new wins in the second half of the year, we are on our way towards reaching our target segment margin range of 5% to 6% by the end of the year. Our Capital Equipment business continues to experience very strong growth, supported by demand tailwinds and market share gains. The demand environment in the semiconductor Capital Equipment market remains robust. As we have noted before, we believe that the factors driving this growth have an extended runway and are not short term in nature. We expect these conditions to persist for the remainder of the current year and into 2022. In the display market, we believe that spending is shifting to subsequent periods as component shortages are delaying new program ramps and capacity expansion plans. We continue to anticipate CapEx spending growth to resume in future periods, supported by new OLED technology shifts and demand tailwinds in key end markets, including mobile, TV and IT applications. We reiterate our expectation for our Capital Equipment business to exceed $700 million in revenue in 2021, which would represent 30% plus growth compared to 2020. In Industrial, we are seeing the beginning of a demand recovery with double-digit growth during Q2 2021 compared to the prior year period driven by new wins, largely in energy storage and EV charger markets. As an example, we are excited by our recently announced win with Luminar, where we will partner to produce its Iris LiDAR system with engineering-led wins like this and continuing demand strength across our Industrial business. We expect year-over-year growth in Industrial to continue into the second half of 2021. In A&D, while demand appears to have stabilized on a sequential basis, headwinds in the commercial aerospace market persist, and the market remains meaningfully softer than a year ago. While we expect demand in commercial aerospace market to remain depressed compared to pre-COVID levels into 2022, we do expect a modest recovery to materialize in the latter half of this year and should begin to see sequential improvement as new programs begin to ramp. In our HealthTech business, demand remains robust, supported by new program ramps and COVID-19-related projects. Our outlook calls for continued year-to-year growth for the duration of 2021. In the second half, while we do anticipate a moderation in demand for some COVID-19 products, we expect growth in other programs such as surgical instruments. Now turning to CCS. Our CCS segment continues to perform well. The strong performance is driven by our portfolio reshaping initiatives and the continued growth of our HPS business, both in absolute terms and as a portion of our CCS segment revenues. We expect both of these factors to continue to support strong margins in our CCS segment into 2022. Although CCS revenues remain lower on a year-to-year basis, our non-Cisco CCS business is up nearly 8% year-to-date, compared to the first half of 2020. Our Hardware Platform Solutions business continues to deliver strong results with year-to-year growth of 24%, primarily driven by robust demand from service providers in our Communications end market. Our order book and general market outlook continue to be very positive, and we reiterate our expectations for HPS to achieve double-digit percentage revenue growth for 2021. In the Communications end market, we expect market demand to remain strong in 2021, largely comprised by service provider customers. Both of these customers have backfilled our capacity from their Cisco disengagement. As noted, although we expect Communications year-to-year revenues to be lower compared to 2020 as a result of the Cisco disengagement, we expect Communications revenue growth to resume on an unadjusted basis in the fourth quarter compared to the prior year period. In our Enterprise end market, the demand environment continues to be relatively soft, notably from server customers. We expect that these market conditions will persist for at least the duration of the year. As we enter the second half of 2021, we are pleased that our transformational efforts are yielding results. Our momentum continues to build, and we believe we are positioned where we need to be in order to achieve our strategic goals and financial targets. Our areas of focus for the balance of the year remain unchanged, a return to absolute growth, margin expansion, including ATS returning to its target margin range and executing a disciplined capital allocation strategy. As we look to 2022, we expect the market to remain dynamic. However, we believe that robust secular tailwinds, strong operational performance and the ramping of new programs bode well for Celestica. As a result, assuming that the severity of supply chain constraints expected for the remainder of 2021 do not worsen, we anticipate revenue to grow in 2022 compared to 2021, and are targeting to generate $6 billion or more of revenue for 2022, with operating margin within our target range of 3.75% to 4.5%. We are also anticipating that adjusted EPS will expand by approximately 10% or more in 2022, compared to 2021. Our entire team remains focused on executing our game plan and driving the evolution of our business while effectively navigating any challenges. Their commitment, talent and resiliency of our entire global team remains the driving force behind our success. Their ability to consistently meet the challenges faced by our business and deliver on expectations instills me with the utmost confidence and optimism for the immediate and long-term future of our company. We look forward to updating you on our progress over the coming quarters. And with that, I would now like to turn the call over to the operator for Q&A.

[Operator]

[Operator Instructions] Your first question comes from the line of Thanos Moschopoulos from BMO Capital Markets.

[Thanos Moschopoulos, VP & Analyst]

Congrats on the very strong quarter. Rob, historically, you haven't been as specific in terms of providing color on the subsequent year. And so just curious as what more that you did this time. Do you have a higher level of visibility perhaps given the supply constraints, or are customers giving you maybe longer lead times as a result of that? Or does that also speak maybe to your confidence on the sustainability of some of the macro trends like in Capital Equipment?

[Robert Andrew Mionis, President, CEO & Director]

Yes. A little bit of both, Thanos, and thanks for the recognition on a strong quarter. In much of our business because the supply chain constraints are so prevalent and the lead times have extended, we have several customers that are saying -- they're extending their order horizon and basically saying listen, if you could build it, we will take it. So that's giving us some increased confidence. And then just looking more broadly at our wins over the last 18 to 24 months in terms of what we've been able to book gives us this confidence. And then lastly, I would say, just the broad secular tailwinds that we're seeing in the majority of our markets. And I would even say, even in A and B, we're starting to see recovery starting to happen, gives us the confidence to kind of do some foreshadowing of what we think of 2022 coming on.

[Thanos Moschopoulos, VP & Analyst]

Great. And in terms of the supply constraints, it was $30 million impact on revenue this quarter. What are you assuming it's going to be in the upcoming quarter. I think you commented that it seems to be getting worse rather than better.

[Robert Andrew Mionis, President, CEO & Director]

Yes, it is certainly getting more severe. Just stepping back for a minute, I think we got a jump on it. We saw this happening in the second half of last year. So we extended our lead times with our suppliers. We asked -- worked closely with our customers to make sure they open up their order books. So for the first half of this year, I think we were only modestly impacted. Going into the back half of the year, I think everyone else has caught up, frankly. So it's going to get a little bit more severe. That being said, the demand that we're seeing is largely not perishable. In fact, the demand is coming in stronger than our guidance range. So if we're able to push through and solve some of these shortages, there's a possibility for upside as well. And lastly, I would say that within HPS, we've got a lot of supply chain resiliency into our design process, which has proven to be a benefit and being a design authority within HPS has given us some incremental leverage versus some of the other EMS players. So at this stage of the game, I would say it would be, we're starting off the quarter with a higher amount of revenue that's gated by material, hence, our larger revenue guidance range. But at the same time, we got to beat on it in terms of working it down.

[Operator]

Your next question comes from the line of Ruplu Bhattacharya from Bank of America.

[Ruplu Bhattacharya, Vice President]

The CCS segment saw a pretty strong sequential margin improvement. I think in the prepared remarks, you also talked about some onetime disengagement gain. Can you just help us bridge the sequential improvement from 3.1% to 3.7%.

[Mandeep Chawla, Chief Financial Officer]

Ruplu, Mandeep here. Yes. So I would say that overall, the strong performance in CCS was in line with our expectations, high concentration of HPS, and HPS performed very well in the quarter. And then, of course, revenues were up sequentially. In terms of the recoveries, we're actually quite pleased by it. As you know, we went through a long disengagement. And along the way, there's a number of various items that need to be negotiated with our end customers. We were able to operationally execute very well and had a number of signed releases in the quarter where we were able to essentially get those recoveries that we would have been working towards for quite some time. But even as we go forward, we continue to expect the CCS business is going to perform very well as the HPS concentration continues to grow.

[Ruplu Bhattacharya, Vice President]

Got it, Mandeep. I wanted to ask on the guidance for fiscal '22. I think the margin guidance was that -- it would be within the 3.75% to 4.5% range. I just wanted to clarify that because even this quarter, you were in that range. Are you saying that for the full year fiscal '22, you're going to be in that range? Or do you think that every quarter of the year you're going to be in the range?

[Mandeep Chawla, Chief Financial Officer]

It's probably a little bit early for us to give the specifics on the quarters because, of course, we're not giving guidance for the full year. But what I would say is this, the performance that we had in the third quarter, we're clearly seeing carryforward right now into the back half of the year. And the strength that we are seeing in the second half is continuing into 2022. As you know, we do have a little bit of seasonality in our business, in a sense, Q1 is lower than when you look at the trailing quarters. But overall, the fundamentals are continuing to strengthen. We do feel comfortable to be in the target margin range for the entire year and how each of the quarters play out, we'll get more color as we get closer to it.

[Ruplu Bhattacharya, Vice President]

Okay. And just for my last question. I think you talked about the display market pushing out a bit. Do you expect that to come back in the first half of next year? Or is there any color on when that market can come back?

[Robert Andrew Mionis, President, CEO & Director]

Ruplu, it's -- right now, I think we're seeing the majority of the ramping happening in '23, relative to '22, reason being some of the chip shortages that are slowing down the introduction of new technologies. So the OEMs, the people buying the CapEx equipment are actually flowing new product launches. And as a result of that, it's slowing down some of our capacity expansion plans. So we're expecting the majority of the ramps actually have been pushing away, and we expect it to happen until the end of '22 or into '23 at this stage of -- again.

[Ruplu Bhattacharya, Vice President]

Got it. Congrats on the quarter.

[Operator]

Your next question comes from Todd Coupland of CIBC.

[Todd Adair Coupland]

Yes. I also wanted to ask about 2022, 6% above FactSet in terms of, $6 billion, versus consensus expectations, between this quarter and last quarter, what's sort of the biggest changes that you've seen in the market? And if you could sort of rank order those as we think about 2022?

[Robert Andrew Mionis, President, CEO & Director]

Todd, thinking about -- I think the biggest change is our conviction in what we're seeing in Capital Equipment. The severity of the chip shortages, the spending strength that we see out of the end OEMs on adding capacity. The investments that people are making, and we'll be making in the adoption of 3-nanometer nodes is all expected to accelerate and keep semiconductor Capital Equipment spending very robust. So that's giving us a lot of confidence moving forward. On top of that, we've been -- actually within Capital Equipment, we've been growing much faster than the market, certainly, this year and looking at the wins that we've been able to clock up over the last 18 months, we're also anticipating to go faster than the market in next year. We've been gaining share in high-level assembly and machining and also new investments in robotics. We've picked up some new customers in display. We've been making some investments in new verticals, and frankly, being the largest and the most capable player out there relative to our peers. Our customers are turning to us, especially in these times because we've been able to meet their capacity -- basically deliver on time and be able to ramp efficiently. So that's giving us a lot of confidence. On top of that, the strength that we're seeing in our HPS business in terms of pure data center growth is giving us a lot of confidence as well. And lastly, just in some of the other segments, we're seeing increased outsourcing in HealthTech. We're seeing a recovery in our industrial markets. And our defense markets are starting to pick up based on new program wins, and we're seeing some good growth. coming out of commercial aerospace, again, moving into the back half of the year and into next year. [indiscernible] has been picking up a little bit. The MRO markets have started to turn. So it's a combination of a lot of different things, Todd.

[Todd Adair Coupland]

And just on Aerospace and Defense. It sounds like you're being cautiously optimistic. Is that potentially a material swing factor as we go through 2022, could you just share what some of the upside items could be in that area, what should we watch for in terms of that actually coming through?

[Robert Andrew Mionis, President, CEO & Director]

Yes. In terms of 2022 in A&D, I wouldn't call it a material swing factor. We are counting on a gradual recovery of the A&D market. What we're seeing into the back half of the year, we're seeing a little bit of a pickup in defense, I'll say about -- that's about 25% of the growth. The balance of the growth is coming out of commercial aerospace. It's being led by new programs wins and market recovery in single aisle, and also in business aviation. Some of the dual aisle is starting to pick up a little bit as well. So what the analysts are saying, the industry analysts regarding commercial aerospace is they're not expecting full recovery before 2024, but it's more of a modest recovery. And I think we're in line with that modest recovery in terms of how we see our business -- A&D business tracking?

[Todd Adair Coupland]

Right. Just one last question on commercial aerospace. You had been on the 737 MAX program. Is -- does that need to have a significant turnaround for you to achieve these goals? Or is it the single aisle and the defense that can still get you there regardless of what happens there?

[Robert Andrew Mionis, President, CEO & Director]

Yes, it's the latter. Our exposure to 737 at this stage of the game from a percent of revenue is very low single digits. So it's just a broad market.

[Operator]

Your next question comes from Rob Young of Canaccord Genuity.

[Robert Young, Director]

You reiterated the expectations for the Capital Equipment business at, I think, $700 million but the display is pushed out. So the -- I guess, the semi capital business is materially better than where you thought it was, even a couple of months ago. And so I was wondering if you could confirm that, if there's any color around the magnitude of the improvement? And then if the display business comes back, in the second half of 2022, what does that imply on the margin structure of the Capital Equipment business for those 2 businesses going strong?

[Robert Andrew Mionis, President, CEO & Director]

Rob, I'll start off, and I'll let Mandeep finish up on that one. So yes, I think our views on the strength of the semiconductor Capital Equipment business have gotten more bullish as the year has gotten longer. And that's been bolstered by an uptick in our customers' forecast in the mid to -- short to midterm, I would say, and also been bolstered by some new wins that we have. So again, we're growing much faster than the market, this year. We anticipate to grow much faster than the market next year. So that's giving us a lot more confidence. In terms of the display market, it is pushing -- continues to push to the right. The end fundamentals, and I'll let Mandeep talk about the margin profile, but the end fundamentals of that market are still intact, in that, when the spending does resume based on the availability of chip to support the new product launches, it's going to come in the form of increased IT spend. There's broad OLED adoption for PCs and monitors, automotive spending in terms of OLED displays in cars for high contrast and robustness is picking up, obviously, mobile phones in terms of [ foldables ] and new advanced smartphones and large-sized TVs, mini or micro LEDs, advanced technology OLEDs, all on the horizon. It's just a question of when these product launches will occur and back to that a little bit of time, and that's when spending will happen. And I'll turn it over to Mandeep to talk about the margin profile.

[Mandeep Chawla, Chief Financial Officer]

Yes. So as Rob has mentioned, we are growing faster than the overall market right now. We grew over 30% last year. We're attracted towards growing 30% or more this year as well. And a lot of it is because of market share gains overall. So semi is performing very, very well. From a margin perspective, we're operating at the high end of the target margin range. And that's with display being at slightly depressed levels. Eventually, we do expect semi to go moderate, but if display and semi are both coming in very strong, we do have an opportunity to perform above the target margin range. I think you're hitting on it, though, which is as we look forward, eventually, the semi demand will normalize, but we have 2 areas of strength that will, we believe, keep the ATS overall segment in a strong margin profile. One of course, is display, which still needs to come online. And then Aerospace and Defense, which we expect will be a multiyear recovery, and should also help over the coming years.

[Robert Young, Director]

Okay. That's great. And then the HPS revenue expectation, you said over $1 billion in 2021. That is -- do you need to be below the pace for this current quarter and the first half. So are you expecting maybe a moderation there? And then I was just trying to reconcile that with the comments around the demand from hyperscale and comms, since it is a big driver behind HPS now. How durable is that demand? And how strong is that pipeline?

[Mandeep Chawla, Chief Financial Officer]

Yes. So it's a great question, Rob, because HPS is just performing very, very well. We mentioned that the year-to-date revenue was around $500 million. And the reason that we shared that we expect it to be $1 billion or more is to basically confirm that our second half expectations are in line with the first half, if not more. And so we continue to see very strong growth coming into the back half of the year. It also goes to one of their earlier questions in terms of why are we seeing strength for the $6 billion going into next year as we've been dealing with the mature constrained environment. We have been working with our customers to get longer order lead times, and in some cases, far more POs. And as Rob also mentioned, from a macro perspective, data center growth rates are very, very high. And we believe that that's continuing into next year. And all of that bodes very well for HPS. So basically to say the second half is going to be as strong as the first half or stronger and that momentum should be carrying into next year.

[Robert Young, Director]

Okay. So you're a bit -- you're just a bit afraid that material constraints are going to have a bigger impact on these high-growth programs. Is that the key factor?

[Mandeep Chawla, Chief Financial Officer]

Yes. I mean, we've taken that into account, in our guidance. And so you're hitting on it, which is we believe that we have been able to account for what the challenges of material constraints would be, but we are -- we have an order book that is higher than the guidance that we're providing. And Rob touched on this briefly, but so far, the impact from a material constraint environment has been basically our inability to deal with the drop in orders and upside. It actually hasn't had a material impact on the revenue that we had in the quarter. So on the HPS side, if we're able to secure all of the materials that we want, we could be growing faster than what we're outlining.

[Operator]

Your next question comes from Paul Steep of Scotia Capital.

[Paul Steep, Analyst]

Could you talk just a little bit -- maybe a different way to think about the visibility into the $6 billion. What -- how much of that would actually be sort of booked and secured today, or maybe stated another way, what else needs to occur to sort of exceed the $6 billion range based on what you already have in hand.

[Mandeep Chawla, Chief Financial Officer]

I want to make [indiscernible], and I think it's Jim Suva actually, on the phone. So is that right, Jim? We're talking to you?

[Paul Steep, Analyst]

No, it's Paul.

[Mandeep Chawla, Chief Financial Officer]

Sorry, Paul. Okay it is you. Paul, what I would say is that overall, the growth rate that we're expecting on Lifecycle Solutions is 10% or more. And so we talked already about the growth rates that we're seeing on the HPS side and then the ATS fundamentals, we're targeting 10% or more next year as well. So if we can achieve 10% growth rate in Lifecycle Solutions or more, we feel that we have a very good line of sight to the $6 billion. On the remaining parts of the CCS portfolio, we are targeting growth in key areas that are strategic for us, and that could possibly present some upside opportunity as well.

[Paul Steep, Analyst]

Great. And then maybe just the other question related to that would be, how far through the sort of, let's call it, portfolio rationalization are we? Like I know you've discontinued a lot and there's always moving parts quarter-to-quarter. But how sort of happy are you with the overall state of the business, things seem to be definitely heading in the right direction, but I'm just wondering how much more is sort of left to be done and which areas do you think broadly.

[Mandeep Chawla, Chief Financial Officer]

I'll start and I'll let Rob finish off maybe. But from a revenue perspective, look, the only tailwind right now in our numbers is from Cisco. That's continuing to impact us on a year-to-year growth basis. But when you look at the portfolio, excluding Cisco, we're growing, and our guidance in the third quarter indicated the same thing. When we look towards the fourth quarter, Cisco is essentially going to lapse by then. And so we are targeting to show revenue growth on an absolute basis, starting in the fourth quarter. And I'll let Rob talk about the rest of the portfolio.

[Robert Andrew Mionis, President, CEO & Director]

Paul, so with respect to the portfolio actions, as I mentioned before, portfolio management is an active part of our strategy. That being said, we're ranking #1 and #2 on close to 95% of our customer scorecard. I think we've proven that we're pretty disciplined. So we're not pursuing revenue for revenue's sake. We make sure that the revenue aligns with our capabilities and our strategy. So at times, we might feel that it's better to step away, but that would be through a strategic lens. But right now, I think we're happy with our portfolio. And I think we're growing in all the areas that we want to grow in. And just to pick up a little bit on your first question with respect to next year's $6 billion or anticipation. We just finished our strategic planning process that we do. We do it formally once a year and we refresh it quarterly. So we went market by market, account by account. We went through the bookings, we went through our technology roadmap. And taking all that into account in the micro and macro environment, we feel pretty good about our ability to flash to everyone here on the call that we plan on doing $6 billion or more next year. We plan on expanding our EPS, and we expect to stay within our target margin range for the full year.

[Paul Steep, Analyst]

Great. That's helpful. Last one for me. Just maybe a broader market question, Rob. What are you seeing in terms of maybe contracting dynamics within A&D, if we think about more specifically the Capital Equipment business, any changes out there in terms of how your competitors are going to market? Or do we think we've sort of sustained a nice, healthy environment with strong demand?

[Robert Andrew Mionis, President, CEO & Director]

Well, within Capital Equipment, the supply chain, the order visibility is certainly longer given the ordering lead time. So we have a much more robust slot plans with our customers. So that's certainly helpful. And within A&D, a lot of our growth right now is on the heels of new program wins. And it's also on the heels of just, broad market recovery. If you want to look at some leading indicators, if you look at air traffic and the amount of the fleet that's actually parked as soon as traffic picks up and some of these parked aircraft start getting back in service. And the OEM build rates pick up, we're expecting our order book to book up. But the contracting process, it's pretty disciplined. And we haven't seen a lot of dysfunctional behavior I would add.

[Operator]

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

[Paul Michael Treiber, Director of Canadian Technology & Analyst]

Just wanted to ask a couple of questions on the production side of the equation. Can you speak at a high level what was the strategy you took to mitigate some of the challenges in Malaysia this past quarter? And then also, to what degree can you move production between various facilities that you may have?

[Robert Andrew Mionis, President, CEO & Director]

Yes. So in Malaysia, the team has been very adept at making sure that we understand the government restrictions with respect to material control orders in terms of where people could go, how many people work at different times. So we've been pretty innovative with shift patterns, and other things along the lines to minimize the impact to our customers and also impact the -- impact to our financial performance. We also have a pretty broad network. So if we're not able to fulfill work out of Malaysia, then we're able to potentially fill it out of other regions. And that's been helpful as we move forward as well, to answer your second question.

[Mandeep Chawla, Chief Financial Officer]

Paul, I'll just add to that. To date, when we've seen challenges in various countries because, as you know, we're in 14 countries around the world. And we do get impacted by short-term closures. We very quickly are deemed to this point to be an essential service. And so while we need to work with the local authorities to get the proper documentation in place, we normally, and as we saw in the case of Malaysia, are able to keep the factors running very soon after.

[Paul Michael Treiber, Director of Canadian Technology & Analyst]

And a bigger picture question in terms of production, just in regards to 2022, to what extent is your outlook constrained by production capacity? Or maybe another way to ask it is, at what point in revenue, annual revenue, do you need to expand capacity, either bring more facilities on or add existing lines to those facilities? How do we think about CapEx going into 2022 and beyond?

[Robert Andrew Mionis, President, CEO & Director]

Yes. For the most part, we have ample capacity. There are -- I wouldn't say any of the investments that we need to make are going to support 2022. But looking at a long-range plan, we probably need to make some investments on building out some additional North American capacity, and those are some of the things that we're looking into right now. Some of it might be in Mexico, some of it might be in other areas as we enter into new lines of business.

[Mandeep Chawla, Chief Financial Officer]

Yes. And just to build on Rob's answer. As he mentioned, we've just gone through a very detailed strategic planning process, which includes understanding the investments that we need to make to support the order book that we have. And we feel that for the large part, we have sufficient utilization across the factories to support a pretty robust revenue level of growth. On the investments that we're making in the U.S., these are really on the back of customer orders and customer requests. When we're investing green dollars in the U.S. for facility expansion as an example, we have an order book that follows behind it. And then in terms of just overall CapEx as we look forward, we continue to think that the 1.5% to 2% of revenue range will be sufficient. We don't really need to build out a lot more capacity in order to support the revenue.

[Robert Andrew Mionis, President, CEO & Director]

One of the things -- just one other thing to add, and later on this week, we're having a grand opening in our New Hope facility in Minnesota. That's our ITAR facility to support increased defense work. So I'm looking forward to seeing our brand-new facility and meeting some of our customers there. And not only is the defense side, but it's also supporting some of our HealthTech business as well. And we expanded that facility, Paul, from 50,000 feet to 100,000 feet, from where we were to where we are now.

[Operator]

Your next question comes from Jim Suva of Citigroup.

[James Dickey Suva, MD & Research Analyst]

It's very encouraging to hear a company like Celestica talk about 2022. Behind that, can you let us know, is it -- you have like contracts that are giving you more confidence? Or that the Lifecycle business is just much stronger? Or was it -- you just want to send a message to people out there? It's just kind of interesting to see that you have so much conviction which is quite positive to talk about 2022, when we saw 6 months left in this year.

[Robert Andrew Mionis, President, CEO & Director]

Jim, we do have a lot of conviction as we move into 2022. As I mentioned, when we stepped back, we've really been working very hard on transforming our business, and we think we're to the knothole, if you will, we're really pleased with the growth of our HPS portfolio. We're really pleased with the investments that we've made in our engineering capability to drive improved margin in across the -- our ATS segment. And going through our strategic planning process, going market by market, account by account, we thought it was the right time in our transformation as we went from transformation to optimization, and now we're going from optimization to growth to kind of let our investors know that we feel really good as we move into 2022 and to kind of set some guardrails of where we are targeting our business to be in terms of revenue and margin and earnings expansion. We've been getting, I guess, a little bit of top headline news headwinds from the Cisco disengagement. And frankly, when you step back from it all, we have emerged a much stronger company and we just want to let our investors know that we feel really good about where we have been and where we're going.

[James Dickey Suva, MD & Research Analyst]

Congratulations.

[Operator]

Your next question comes from Daniel Chan of TD Securities.

[Daniel Chan, Research Analyst]

There are some comments in the industry of the chip shortage lasting even longer than expected. Do you think that potentially extends the semi cap strength you're seeing?

[Robert Andrew Mionis, President, CEO & Director]

Repeat the second part of that. I missed -- I got the first part in terms of extending, but what was the second part of the sentence, Dan?

[Daniel Chan, Research Analyst]

Yes. Do you think that potentially extends the semi cap strength you're seeing?

[Robert Andrew Mionis, President, CEO & Director]

Yes, there's different views on how long the chip shortage lasts. I mean we heard it from the Intel CEO, not so long ago, about it will end in well into -- through the end of '23, I think he mentioned. My crystal ball is a little murky right now. I do think the chip shortage probably lasts certainly through the end of this year into mid-next year. But as it gets into CapEx spending, I think the peak of CapEx spending as we see it right now, might be in '22. But then frankly, as you look into '23, '24, '25, some of the adoption of the advanced nodes, 3-nanometer at sellers, should stabilize it. So I don't think it's going to be -- again, my word, I don't think it's going to be a sharp decline. I do think we have very strong secular tailwinds for years to come in this space. And again, we have been and yes, we are anticipating it to still grow faster than the market.

[Mandeep Chawla, Chief Financial Officer]

Yes. Dan, just to build on it, which is while the very strong growth that we're seeing in semiconductor has maybe accelerated a little bit because of the material constraint environment, the industry itself has been growing now since 2019. And so even without a constrained environment, we continue to see various good long-term trends happening in the Capital Equipment space for the things that Rob is talking about, the applications that semiconductor is supporting or increasing and becoming more diverse than cycles before.

[Operator]

Your next question comes from Kurt Swartz of Stifel.

[Kurt Van Orden Swartz, Associate]

On the supply side, hoping you can just maybe discuss in a bit more detail, which component areas you're seeing as most constrained right now and whether there have been any particular areas that have significantly sort of pushed out from a lead time perspective over the past 3 months. And then can you also detail any pricing pressure you may be seeing and the extent to which you're able to pass on those elevated costs to customers?

[Robert Andrew Mionis, President, CEO & Director]

Sure. So I think the most constrained would be semi cap -- semiconductors, I should say, excuse me, semiconductor lead times are about 31 weeks right now, which, frankly, is about 100% higher than normal levels. Several semi suppliers are asking for order coverage through the end of 2022. We're seeing wafer fabs above max capacity at 95%. Right behind it, we're actually seeing capacitors becoming more constrained, capacitors commodities have seen about a 30% increase in lead times over the last 6 months, whether it's MLCCs or resistors or capacitors. We expect the lead times to further increase as in the back half of this year. We might even get back into allocation, [ Kurt ], time will tell. And lastly, to your point, Kurt, Material pricing has been on the rise. But I would say, for the most part, the majority of that has been being passed on through the entire value chain.

[Kurt Van Orden Swartz, Associate]

Understood. And then -- Maybe just on the working capital and cash flow side, how should we be thinking about cadence through the balance of the year and into fiscal '22, given some of the dynamics you've discussed?

[Robert Andrew Mionis, President, CEO & Director]

Yes. So Kurt, we're pleased with the cash generation that we've already been able to have about $52 million in the first half of the year. we'll continue to target $100 million for the full year of 2021. And as we look into 2022, we're targeting $100 million or more of free cash flow. We're pleased with the performance that we've had on the working capital side despite the very challenging materials environment. We've generated positive free cash flow for the last 10 quarters. And so we're expecting that to continue as well. And then just in terms of the balance sheet that goes with that, with our leverage at 1.4x, the balance sheet is very healthy right now. And it gives us an opportunity to really continue to invest in the business by getting money back to the shareholders as well. And so we've been buying so far on our share buyback program. We're buying so far this quarter, and we will continue to be opportunistic on deploying that cash.

[Operator]

There are no further questions at this time. I would now like to hand the conference back to Rob for any closing remarks. Thank you.

[Robert Andrew Mionis, President, CEO & Director]

Thank you. Overall, I'm pleased with our performance for the first half of 2021. Our efforts to diversify our portfolio are yielding results with Lifecycle Solutions, representing 60% of the company's revenue, up 9% from a year ago. And in Q2, the revenue of the company's non-Cisco business grew 6% year-over-year. And in the fourth quarter, we are currently on track to post year-over-year revenue growth on an absolute basis. Additionally, our operating margins continue to expand in Q2, and we posted our sixth sequential quarter of year-over-year non-IFRS margin expansion. As we move into 2022, we are targeting to generate $6 billion or more of revenue with operating margin within our target margin range of 3.75% to 4.5%. We are also currently anticipating that adjusted EPS will expand by approximately 10% or more in '22 compared to '21. We are excited that our efforts to transform our business are yielding results. I'd like to thank our global team for remaining vigilant and keeping themselves and each other safe. And thank you for joining today's call. I look forward to updating you as we progress throughout the year.

[Operator]

This concludes today's conference call. Thank you for participating. You may now disconnect.