Celestica Inc. (CLS) Earnings Call Transcript & Summary

Good morning, ladies and gentlemen, and welcome to the Celestica Q2 2023 Earnings Conference Call. [Operator Instructions] This call is being recorded on Thursday, July 27, 2023. I will now like to turn the conference over to Craig Oberg. Please go ahead.

Good morning and thank you for joining us on Celestica Second 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 meaning 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 12month 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 meaning 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 Q2 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 conference call. We are very pleased to have delivered solid financial results in the second quarter. Our revenue of $1.94 billion and our non-IFRS adjusted EPS of $0.55 each exceeded the high end of our guidance range. Our non-IFRS operating margin of 5.5% was the highest in the company's history, with non-IF operating margin firmly above 5% for the past 4 consecutive quarters, reflecting the new Celestica. Finally, our non-IFRS adjusted free cash flow of $67 million marked our highest quarterly result in over 3 years. The strength of our results reflect the benefits of our portfolio's strategic diversification and our exposure to a number of very attractive markets. In our CCS segment, we continue to see solid growth in our hyperscaler business as we believe their investments in artificial intelligence and machine learning will provide long-term secular tailwinds in a number of our served markets. In our ATS segment, ramping of new green energy programs, coupled with returning commercial aerospace demand, have continued to support double-digit year-over-year growth. We continue to execute well for our customers and our focus on operational excellence has enabled our growth and margin performance. Additionally, the material supply environment continues to gradually normalize, allowing us to further improve operational efficiencies. Before I provide an update on the outlook for each of our end markets, I would like to turn the call over to Mandeep, who will discuss our financial performance in the second quarter and our guidance for the third quarter of 2023. Mandeep, over to you.

Thank you, Rob, and good morning, everyone. Second quarter revenue came in at $1.94 billion, exceeding the high end of our guidance range. Revenue was 13% higher year-over-year, supported by over 20% growth in our ATS segment and higher revenues in our CCS segment. Our second quarter non-IFRS operating margin of 5.5% was 70 basis points higher year-over-year and driven primarily by improved volume leverage in both segments, including strong profitability in our CCS segment. Non-IFRS adjusted earnings per share were $0.55 for the second quarter, exceeding the high end of our guidance range and were $0.11 higher year-over-year, driven by higher operating profit and lower shares outstanding. In the second quarter ATS segment, revenue was $865 million, up 24% year over year and higher than our expectations of a mid-teens percentage increase. The year-over-year increase in ATS segment revenue was driven by continuing strength in our industrial business, supported by returning commercial aerospace demand and A&D, which more than offset demand softness in our capital equipment business. ATS segment revenue accounted for 45% of total revenues in the second quarter. Our CCS segment revenue of $1.07 billion were up 5% compared to the prior year period. The increase was driven by very strong revenue growth in our enterprise end market, supported by strong demand for proprietary compute driven by AI and machine learning applications, and was partially offset by anticipated softness in communications demand. Our HPS business generated revenue of $354 million in the quarter lower by 23% year-over-year. HPS revenues have moderated compared to the prior year period, driven by tough comps and anticipated shifts in hyperscaler CapEx spend from networking products towards compute capacity in support of AI applications. HPS revenues were 18% of total company revenues in the second quarter, compared to 27% in the prior year period. We do expect HPS revenues to grow sequentially in the coming quarters. Communications and market revenue for the second quarter was lower by 15% year-over-year in line with our expectation of a mid-teens percentage decrease. The decline was driven by tough comps and reduced HPS networking purchases from hyperscaler customers, although we support these customers with other Celestica solutions. Enterprise end market revenue in the quarter was up 42% year over year, well above our expectations of a high 20% increase, driven by the strong demand for proprietary compute. Turning to segment margins. ATS segment margin was 4.8% in the second quarter. 30 [Technical Difficulty] was driven by greater volume leverage as our industrial green energy programs continue to ramp and commercial aerospace recovery as well as strong productivity. CCS segment margin of 6.0% was up 100 basis points year-over-year and was the highest on record. The increase was driven by higher volume leverage, particularly in our enterprise end market as well as strong productivity and favorable mix. Moving on to some additional financial metrics. IFRS net earnings for the quarter were $56 million or $0.46 per share compared to net earnings of $36 million or $0.29 per share in the prior year period. Adjusted gross margin for the second quarter was 9.7%, up 70 basis points year-over-year, primarily due to volume leverage and cost productivity improvements. Our second quarter non-IFRS adjusted effective tax rate was 21% compared to 22% in the prior year period. Non-IFRS adjusted ROIC for the second quarter was 20.0%, an improvement of 3.8% compared to the prior-year quarter. Moving on to working capital. Our inventory at the end of the second quarter was $2.3 billion, down $58 million sequentially and up $238 million year-over-year. Cash deposits were $810 million at the end of the second quarter, which was nearly flat sequentially and higher by $284 million compared to the prior year period. Cash cycle days were 73 during the second quarter, 2 days lower sequentially and 4 days higher than the prior year period. Capital expenditures for the second quarter were $32 million, or approximately 1.7% of revenue, compared with 1.3% in the second quarter of 2022. The increase in our capital expenditures aligns with our previously communicated expectations for increased investments in support of new program win. Non-IFRS adjusted free cash flow in the second quarter was $67 million compared to $43 million in the prior year period. Given our solid year-to-date performance, we are now expecting $125 million in non-IFRS adjusted free cash flow for 2023. Moving on to some additional key metrics. Our cash balance at the end of the second quarter was $361 million, down $5 million year-over-year and up $42 million sequentially. Our cash balance in combination with the approximately $600 million of borrowing capacity under our revolver, provide us with liquidity of approximately $1 billion, which we believe is sufficient to meet our anticipated business needs. At the end of the second quarter, our gross debt was $618 million, down $5 million from the previous quarter, leaving us with a net debt position of $257 million. Our second quarter gross debt to non-IFRS trailing 12-month adjusted EBITDA leverage ratio was 1.2 turns down 0.1 turns sequentially and down 0.5 turns compared to the same quarter of last year. At June 30, 2023, we were compliant with all financial covenants under our credit agreement. During the second quarter, we purchased approximately 1.4 million shares for cancellation at a cost of $15 million. We intend to continue to be opportunistic on share repurchases under our NCIB for the remainder of the year. Now turning to our guidance for the third quarter of 2023. Third quarter revenues are expected to be in the range of $1.90 billion to $2.05 billion, which would represent an increase of 3% year-over-year if the midpoint of this range is achieved. Third quarter non-IFRS adjusted earnings per share are expected to be in the range of $0.56 to $0.62 per share. If the midpoint of our revenue and non-IFRS adjusted EPS guidance ranges are achieved, non-IFRS operating margin would be 5.6%. This would represent an increase of 50 basis points over the prior year period and a 10 basis point increase sequentially. Non-IFRS adjusted SG&A expense for the third quarter is expected to be in the range of $66 to $68 million. We anticipate our non-IFRS adjusted effective tax rate to be approximately 19% for the third quarter, excluding any impact from taxable foreign exchange. Now turning to our end market outlook for the third quarter of 2023. And our ATS end market, we anticipate revenue to be up in the low double-digit percentage range year-over-year, driven by continued growth in our Industrial, HealthTech and R&D businesses, partially offset by continued market headwinds in capital equipment. In our CCS segment, we are expecting revenues to be approximately flat year-over-year in the third quarter as lower communications revenues are anticipated to be mostly offset by higher enterprise revenues. We anticipate revenues in our communications end market to be down in the high single-digit percentage range year-over-year, driven by tough comps and lower anticipated demand from certain programs in networking, including in our HPS business. We anticipate a meaningful improvement on a sequential basis when compared to the second quarter. Finally, in our enterprise end market, we anticipate revenue to be up in the low double-digit percentage range year-over-year, driven by anticipated continuing demand strength in proprietary compute from our hyperscaler customers. I'll now turn the call back over to Rob to discuss the outlook for our end markets and business overall.

Thank you, Mandeep. Following a strong financial performance in the second quarter, we are pleased to raise our annual outlook for 2023. Our revenue outlook for the year is now at least $7.85 billion, which if achieved, would represent growth of at least 8% and our highest revenue level since 2007. Our outlook for 2023 non-IFRS adjusted EPS is now raised to $2.25. If achieved, this would represent 18% growth compared to the prior year. We anticipate non-IFRS operating margin of 5.5% for 2023, which would represent an increase of 60 basis points from 2022. As we look forward to 2024, we expect revenue growth across each of our businesses supported by anticipated strong secular tailwinds and new program wins. We believe that this growth with continuing margin strength will lead to non-IFRS adjusted EPS growth of 10% or more in 2024 relative to our 2023 outlook. Now I would like to provide some detail on the outlook for each of our businesses. We continue to expect our ATS segment revenue to grow in the mid-teens percentage range in 2023 compared to 2022. Our industrial business has been the most significant growth driver in our ATS segment so far in 2023, with revenues up more than 40% year-to-date compared to the prior year period. We anticipate that the year-to-year growth experienced by our industrial business in the first half of the year will continue in the second half of the year. Our long-term outlook is also very positive, as we believe that a number of structural tailwinds support demand, particularly for green energy, EV charging and on-vehicle projects. We also believe that our business is well-positioned to continue to capitalize on this demand as we ramp a number of new program wins in the space. Our outlook for capital equipment remains muted as the wafer fab equipment market continues to work through a reduction in demand. We are encouraged that due to the scale and structural adjustments made to our capital equipment business in recent years, we expect it to remain profitable during this downturn and outperform the broader wafer fab equipment market due to the benefits of our mix, market share gains and new program wins. We anticipate our capital equipment business to return to growth in 2024, in line with the most current outlook for the wafer fab equipment market. We are also pleased to be ramping a number of new programs, including a new lithography customer. We are seeing a strong recovery in demand within commercial aerospace and the normalization of commercial air traffic is expected to continue. We are seeing benefits from this trend across all submarkets of our commercial aerospace business, including single and dual-aisle aircraft and business aviation. Additionally, we are benefiting from a number of new defense program ramps in 2023. The outlook for our overall R&D business remains positive. Our HealthTech business is experiencing solid double-digit year-to-year growth, driven by new program ramps in the areas of surgical instruments and imaging devices. Our outlook for our HealthTech business remains positive and stable, with less anticipated volatility in demand relative to other markets. Now let's turn to our CCS segment. For 2023, CCS revenues are expected to be up in the mid-single digits compared to 2022, with anticipated growth in enterprise expected to more than offset softness in communications. We anticipate the recent strength in segment margin to continue and remain accretive to our overall business throughout 2023. Our enterprise market is experiencing very strong growth being the beneficiary of our hyperscalers customers demand for advanced computing capacity to support artificial intelligence and machine learning applications. We anticipate the demand for proprietary compute will continue to support double-digit revenue growth rates in enterprise throughout 2023. As mentioned, the 2023 outlook for our communications end market remains muted when compared to 2022 as a result of a moderation in customer demand and difficult comps. Our HPS business continues to experience demand moderation compared to 2022. We anticipate stronger and sequential revenues in the second half of the year, and our current outlook calls for our HPS business to resume year-to-year growth in 2024 as new programs ramp. Our total portfolio of businesses within hyperscaler customers remains very healthy as they are continuing to make significant investments in their AI and machine learning capacity and capabilities. We have been a key partner for our hyperscaler customers as they have worked to build out their data center infrastructure. hyperscalers now represent approximately $2.5 billion of revenue over the past 12 months for Celestica, having grown at approximately a 50% CAGR since 2018. Recent hyperscaler demand has skewed towards proprietary compute products. Moving forward, we anticipate hyperscalers ongoing deployment of AI and machine learning infrastructure will accelerate their networking refresh cycle. As they are expected to need more advanced networking infrastructure to support their investments in computing capacity. As a result, we anticipate demand for our HPS products and services to increase in future periods. We are market leaders in the 400G switches and are pleased that we are continuing to win engagements in 800G switches based on our continued investment in next-gen applications. Our strategic offerings and unique capabilities and networking are expected to support revenue growth with our hyperscale customers over the long term. I am pleased with our strong performance during the first half of 2023. As the latter half of the year takes shape, we look forward to continuing to execute on our long-term strategic vision, delivering on our targets and driving value for our shareholders. We remain encouraged by the prospects for our business in the months ahead and into 2024. With that, I would now like to turn the call over to the operator for questions. Thank you.

[Operator Instructions] Your first question comes from Rob Young from Canaccord.

Maybe just a little bit of information on the proprietary compute elements of the business. I think you had [ 110% ] customer in CCS. I assume that's in proprietary compute and maybe if you could give a little more color around how many customers are in this space, if it's one driving all of this or if it's multiple, if you're an enterprise and hyperscaler or if it's just driven by the hyperscaler? Maybe just a little more color to broaden that out.

Sure, Rob. Yes. In the areas of proprietary compute, we're supporting multiple hyperscaler customers and ramping these types of products. And across those customers, it's not just proprietary compute, we're actually doing a number of different engagements. That means high -- hardware platform solutions, services, proprietary compute and other high-value EMS engagements. It's also to point out, I'll add that, you know, our top-10 concentration right now is 61% down 7% year-over-year.

Okay. And then in your deck that accompany the earnings, you know, it suggests that there's an AI deployment which would accelerate the network refresh cycle for you. I assume that's a reference to the 400 gig switch in HPS. And so if you could give maybe a little more color around what exactly that means, why would there be a network refresh cycle driven by that? And how do you participate there?

Yes, there's a couple of interesting mega trends associated with the proliferation of AI and ML products. On the networking AI is driving the requirement for more networking power. So these accelerators such as GPUs and TPUs significantly increase the need for bandwidth and thus power usage by more than 20x. So this is actually creating pull through demand for our core networking products where we have a commanding share. The other important networking -- mega trend I should say, is 400G to 800G migration. So this migration is going to enable higher speed networking equipment, you know, over the next couple of years. And we anticipate broader adoption of 400G and also building of 800G volumes. Again, we're a market leader in 400G, and we also have several new engagements on 800G based on our strong heritage and the 400G. So we expect those volumes to continue as AI and ML proliferate and create this pull through demand.

And Rob, just to add that, that 400G to 800G migration, that's primarily HPS product. So when we talk about HPS resuming growth in forward periods, that is part of the driver.

Great. And then that's my last question is related to the HPS outlook. I think you said last quarter that it was some of your large customers working down buffer inventory and then now I understand maybe it's more driven by a spend shift towards this proprietary compute. You know, if you're looking forward into 2024, do you have the capacity to manage both of those businesses at the current level of demand when HPS, you know, demand returns? If I can make that assumption.

Yes, we're actually expanding capacity in our Thailand facility to enable this growth. That capacity, we're already started the expansion. That capacity will come online in the second half of the year. But we do have capacity to do HPS products and also the proprietary compute products. These are, you know, highly automated lines and our Thailand facility is our flagship facility and has continued to operate fantastically through the pandemic and now coming out of it, it's at peak efficiency.

And if that buffer inventory that some of your customers are working through, if demand, you know, drives them to choose to just -- you know, to build up inventory again or if their inventory if they eat into inventory fast, could that come back faster than 2024? And then I'll pass the line.

Yes. On the AI/ML products, if we're able to get some of the silicon a little faster, it's certainly the demand -- the backlog is certainly there. We should be able to actually fulfill that demand. But right now AI and ML products are being paced by material, broadly speaking. Aside from that, and also aside from aerospace and defense, the material environment is largely back to pre-COVID levels. That being said, lead times are still extended on several commodities.

Congrats on the quarter.

Thanks, Rob.

Your next question comes from Thanos Moschopoulos from BMO.

Just given the acceleration in free cash flow, what are your current thoughts on capital deployment as you think about buybacks versus deleveraging versus M&A?

Yes. Dennis, we're really pleased with the cash flow generation. As you know, we've generated now positive free cash flow for over 4 years. So 18 quarters I think in a row now. We're pleased that we're able to raise our overall outlook. Our balance sheet is very healthy, 1.2x leverage. To specifically answer your question, we've been active on the buyback front, but we have been opportunistic, as you know, the share price, of course, has materially accelerated through the quarter, but we did some buybacks early in the quarter and we were able to buy back about $15 million worth of shares at just over $11 a share, which is very good value. We'll continue to be opportunistic if we believe that our results are not being properly reflected in our share price. But other than that, I would say we would continue to build dry powder. We continue to have a very robust M&A funnel. We don't have a large ticket item that I would say is right in front of us, but we are focused on tuck in acquisitions which will help continue to expand our capabilities. And so we want to continue to maintain that optionality, but we're able to pivot pretty quickly based on what's happening in the market.

Great. And then Rob on A&D, just doing that business. I know for a while it was operating at depressed margins. So our margins kind of now at, you know, ATS group average levels. Is there more room for operating leverage as volumes continue to ramp? And then just any color you can provide in terms of just the rough size of that business would be helpful.

Thanos, I'll start off and let Mandy finish. So the A&D business is certainly growing and getting back to pre-pandemic levels, we believe in 2024. In terms of margin performance, material availability, as I mentioned earlier, is still a gating item. So that has been impacting margins and we still have a strong backlog and a lot of past dues, and that is also impacting our efficiency. So it's not yet, you know, operating at pre-pandemic margins at this stage of the game.

Yes. What I would say overall, if I take a step back and talk about ATS margins, we're very pleased right now with the performance that we're seeing in industrial. As many of those new programs in green energy have been ramping. We're pleased with the performance that we're seeing in HealthTech. We continue to believe that there's a margin opportunity in A&D, probably at -- maybe not immediately in front of us, but as we go into 2024, as materials availability become better, we can drive more efficiency. We continue to evaluate pricing opportunities with on our longer term contracts. So we think there's still some opportunity in A&D. And then of course, we believe there's opportunity in capital equipment. You know, this is a very different capital equipment business than what we had in the last downturn. We're profitable right now. We've taken cost actions without getting rid of capabilities. And so we continue to see an opportunity, even though we see is already a profitable business, that as that demand comes back, we'd be able to continue to grow. In terms of the size of A&D, so I've mentioned this a few times, which is our industrial portfolio is our biggest business and our A&D business and our capital equipment business often are considered roughly the same. It's about an $800 million business. But we do believe that there's still an opportunity to grow it as we go into 2024.

Your next question comes from Todd Coupland from CIBC.

I was hoping to get some context on how the AI deployment has worked out over the last couple of years. My understanding is the initial capacity and modeling was put in place by the hyperscalers back in 2020. So can you just take us through how Celestica -- if you did indeed benefit from that, how you did? And then I have a follow-up question.

Yes, we've been -- thanks, Todd. We've been growing with the hyperscalers now for, you know, quite some time, as you saw in our presentation. hyperscaler growth this year is over 30% and it's a 51% CAGR. I believe we mentioned during the call. With the hyperscalers, one of the products that we provide them, our compute products as AI and ML have proliferated and proliferated. The use of custom silicon has also proliferated and because of the cooling requirements and the complexity that's required to actually build these products, it really plays to our strengths -- our heritage and our strengths in terms of providing advanced manufacturing solutions. So when this trend kicked off, so did our growth with them and being able to provide these products not just, you know, at scale, I would say, Todd, because, you know, our heritage and our strength and our ability to actually scale these things and provide them reliably and considerably has really led to some of our growth in these products. Furthermore, I would say in terms of the refresh cycle, what we see now is that the x86 compute modules are being replaced by these proprietary compute modules and over time we see this refresh cycle lasting for, you know, quite some time. So it bodes to further growth. Hopefully that answers your question.

That's helpful. Then if we think about visibility and how lumpy the business might be, could you just provide some context on that and perhaps include whether or not, you know, outside indicators like GPU growth at chip suppliers like NVIDIA for AI demand are good indicators for the strength of your business as well?

Yes, those are good indicators. We have good visibility on especially this line of business. Our customers are asking us to go out there and place orders for, you know, long periods of time and the lead times for their custom silicon or a little shy of a year. So we've placed our orders for multiple years, if you will, and our customers. CapEx forecasts are also robust in investing in these types of products. So we feel, you know, very confident that this growth will continue. So GPUs and TPUs are actually good leading indicators in terms of what we're doing to support our customers in this area.

Yes. Maybe I'll just add to it, which is, as you saw in the presentation, our hyperscaler business now is close to $2.5 billion. It's well over 50% of the overall CCS business that's reflective of what's been happening in the broader market over the last 5 to 7 years, which is a significant amount of shifting from OEMs to the hyperscalers. And as it relates to AI and generative AI, you know, a lot of those applications need to be run through a datacenter or a cloud provider just given the very heavy compute requirements. And so it is a concentrated industry. That being said, we're pleased that we're able to do business with most of the top hyperscalers in the world. And then within our engagement models, we've focused very much on servicing them through multiple programs. And so with some of our largest ones, we're doing both HPS and non-HPS products, we're doing networking as well as compute products and so that's the area of focus for us, which is real diversification within the customer.

Mandy, if I could have one last follow-up here. The business seems to be focused around hyperscaler. Are you seeing any specific large businesses, large financial institutions or governments come in and lead the demand in terms of their own interest in AI apps? Or is it all happening as the hyperscalers are conduits for those end customers?

I'll start off and Rob can add on as needed. But what I would say is that we're seeing the primary demand drivers coming right now from the hyperscalers. That being said, the products that they are adopting, which are the most leading edge technologies, do eventually find their way into other applications as time goes on. And so as an example, even though the hyperscalers are moving from 400G to 800G switches, those 400G switches continue to have robust demand outside of the hyperscalers. And so we envision that would be similar on the compute side as well.

The only thing I would add tangentially is that we also expect our enterprise communication customers to benefit from data center interconnects growth due to the proliferation of AI and the increased growth of data center traffic. So this AI proliferation is really impacting a number of our end markets and a number of our served products, if you will.

Your next question comes from Maxim Matushansky from RBC Capital Markets.

Yes. I just wanted to circle back on the strong proprietary computer results. Have those trends stayed mostly the same over the past 90 days in terms of the hyperscaler demand, or has been any changes in terms of how fast you expect the hyperscaler business to grow this year?

Maxim, I would say over the last 90 days, the demand has increased and our ability to serve that demand also has risen. It's one of the reasons for the beat in Q2 and increased outlook for the year. You know, we continue to run very efficiently in our Thailand facility and we continue to be able to clear materials shorts with help from our supplier partners. So demand in that area is -- has been increasing and our ability to serve that demand has also risen to the occasion.

So just in terms of framing that with the kind of mid-single digit increase that you expect for CCS in 2023, just given that stronger demand, is that a reflection of perhaps the weaker communications segment or is that more of a timing thing? Or I guess, how should we think about that mid-single digit revenue for CCS?

So what I would say -- Maximus, Mandeep here is we're really are dealing with incredibly tough comps in the CCS business. You know, the CCS business in Q3 and Q4 last year grew between 30% and 40% year-over-year. And so we're in that period of dealing with tough comps. There has been a demand shift from networking, which is one of the reasons you've seen HPS be down into the proprietary compute. But as we go into 2024, the demand signals that we're getting right now from our customers is that we will be able to grow across multiple served areas. So it's really about tough comps in the second half of this year.

Okay. Got it. And just final question for me. Just in terms of the AI driven data center build out, are you seeing any changes in either the competitive advantage or the market positioning as it relates to the types of switches and equipment that the hyperscalers are looking for, just as compared to kind of a more traditional data center build out? You know, is there any different players or competitors that perhaps are stronger in that technology that's needed for AI driven data centers as opposed to the traditional?

Yes, the need for AI is really going towards this custom silicon which has higher power usage and has higher cooling requirements. So the folks that are able to actually produce these products at scale are the ones that are winning in that space, and that frankly describes us very well. We have a very strong heritage in engineering, a very strong heritage with all the HPS products that we've been producing that support our ability to actually produce these types of very complex products at scale.

[Operator Instructions] Your next question comes from Daniel Chan from TD Cowen.

Just wanted to drill into the Enterprise guide for next quarter. You're going for low double digits next quarter. I'm guessing that implies about $400-ish million, which is down from our estimated $500 million. So just any color around that volatility they are expecting for the next quarter would be helpful.

Yes, it is going to be down a little bit. Some of that is there's some seasonality in there. Again, we're coming off of some very tough comps, but on a year-over-year basis, still strong double digit growth. What I would again say is, is that the growth is going to be continuing beyond Q3 and some of it's gated on when the demand is coming in, some of it's, you know, gated by material availability. And then as Robert also mentioned, we have been investing as well in capacity. And so we do continue to see that business growing even as we come out of Q3.

Okay. That's helpful. And then, Rob, you talked about some pull through demand from networking as customers accelerate their AI investments. Are they engaging on programs outside of traditional data center hardware? So for example, you brought up cooling a number of times. Are they looking into different cooling solutions with you or anything outside of your typical networking compute and storage solutions?

Most of the solutions we provide them are completed products. So we're deploying our cooling solutions in our HPS designs. We're also deploying them in proprietary computers. So we tend not to do engineering as a service. We tend to provide complete solutions, but we're also growing our aftermarket services business with these providers, especially in the areas of iPad and things along those lines, which is going to be a huge growing business for us moving forward.

Thank you. There are no further questions at this time. I'll be turning the call over to Rob Mionis for closing remarks.

Thank you. I'm pleased with our continued strong performance in the second quarter and encouraged by our continued momentum as we enter the back half of the year. As a majority of our end markets are poised for growth in 2023. I'm also pleased we continue to be able to raise our 2023 Financial outlook and also pleased that this momentum is continuing into 2024. Thank you for joining us on today's call and we look forward to updating you as we progress throughout the year.

Ladies and gentlemen, that concludes your conference.