Earnings Call Transcript - JBL Q1 2023

Operator, Operator

Greetings, and welcome to the Jabil First Quarter of Fiscal Year 2023 Earnings Call. As a reminder, this conference is being recorded. I would now like to turn the call over to Adam Berry, Vice President of Investor Relations. Thank you. You may begin.

Adam Berry, Vice President of Investor Relations

Good morning, and welcome to Jabil's first quarter of fiscal 2023 earnings call. Joining me on today's call is Chairman and Chief Executive Officer, Mark Mondello; and Chief Financial Officer, Mike Dastoor. Please note that today's call is being webcast live, and during our prepared remarks, we will be referencing slides. To follow along with the slides, please visit jabil.com within our Investor Relations section. At the conclusion of today's call, the entirety will be posted for audio playback on our website. I'd now like to ask that you follow our earnings presentation with slides on the website, beginning with the forward-looking statement. During this conference call, we will be making forward-looking statements, including, among other things, those regarding the anticipated outlook for our business, such as our currently expected second quarter and fiscal year net revenue and earnings. These statements are based on current expectations, forecasts and assumptions involving risks and uncertainties that could cause actual outcomes and results to differ materially. An extensive list of these risks and uncertainties are identified on our annual report on Form 10-K for the fiscal year ended August 31, 2022, and other filings. Jabil disclaims any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. With that, I'd now like to shift our focus to our solid quarter. To kick off the fiscal year, the team delivered approximately $9.6 billion in revenue, well ahead of our forecast and at the top end of our guidance range, driven by even better-than-expected revenue in automotive, healthcare and industrial. All other end markets largely performed consistent to our expectations from 90 days ago. When you put all of this together, at the enterprise level, revenue grew by 12% year-over-year and 7% sequentially. Core operating income during the quarter was $461 million, an increase of 15% year-over-year, representing a core operating margin of 4.8%. This is up 10 basis points over the prior year and in line with expectations. From a GAAP perspective, operating income was $362 million, and our GAAP diluted earnings per share was $1.61. Net interest expense in the quarter came in higher than expectations at $66 million as the combination of higher interest rates and better-than-expected demand drove our working capital needs higher during the quarter. During the quarter, we also repurchased 2.6 million shares for $161 million. Core diluted earnings per share was $2.31, a 20% improvement over the prior year quarter and at the higher end of our range as core operating income grew much faster than net interest expense. Now turning to the segments. Revenue for the DMS segment was $5.1 billion, an increase of 8% on a year-over-year basis and ahead of our plan from September, while core operating margin for the segment came in at 5.2%, slightly below expectations as upside strength in automotive and healthcare was offset by operational inefficiencies associated with mobility in China. Revenue for our EMS segment came in at $4.5 billion, an increase of 18% on a year-over-year basis, while core margins for the segment was 4.3%, up 50 basis points year-over-year, reflecting solid operational execution on strong revenue growth. So in summary, another strong quarter is in the books for Jabil. And I know the team here is extremely proud of the strides we've made to not only improve our business over the last 10 years but also make it stronger and more resilient. In a moment, I'll turn the call over to Mark and Mike to provide some additional thoughts on our performance in the quarter and update our outlook for fiscal '23. And I think you'll see there's still so much opportunity as we move into fiscal '23 and beyond. Thanks for your time today. It's now my pleasure to turn the call over to Mike.

Mike Dastoor, CFO

Thanks, Adam. As Adam just detailed, our performance in Q1 was quite strong. I continue to be extremely pleased with the strength of our business, which delivered double-digit growth in revenue, core operating income and core diluted earnings per share in the quarter. Our diversified portfolio and continued participation in end markets with long-term secular trends was once again reflected in our Q1 performance. I'd now like to walk you through our balance sheet and cash flow performance in the quarter. In Q1, cash flow from operations was $166 million and net capital expenditures totaled $164 million. As a reminder, our customers routinely co-invest in plant, property and equipment with us as part of our ongoing business model. We often pay for these co-investments upfront, which are then later reimbursed to us by customers. Due to the high dollar value of these co-investments from our customers and how they are reflected on our cash flow statement, it is important to net the two line items shown on the slide to reflect the true CapEx number and what we refer to as net capital expenditures. For the quarter, inventory days came in at 78, down 1 day sequentially on improved working capital management by the team. As a reminder, we offset a portion of our inventory levels with inventory deposits from our customers. Net of these deposits, inventory days were 61 in Q1, also down 1 day from Q4. We continue to be fully focused on bringing this metric down further in FY '23 as some of the supply chain constraints continue to improve. We exited the quarter with total debt to core EBITDA levels of approximately 1.2x on cash balances of $1.2 billion. Turning now to our second quarter guidance on the next slide. We expect total company revenue in the second quarter of fiscal '23 to be in the range of $7.8 billion to $8.4 billion. At the midpoint, this anticipates DMS and EMS revenue to be $4.1 billion and $4 billion, respectively. Core operating income is estimated to be in the range of $347 million to $407 million. GAAP operating income is expected to be in the range of $319 million to $379 million. Core diluted earnings per share is estimated to be in the range of $1.64 to $2.04. GAAP diluted earnings per share is expected to be in the range of $1.44 to $1.84. Interest expense in the second quarter is estimated to be approximately $67 million and for the year to be in the range of $265 million to $270 million, which is higher than we forecasted in September due to more conservative interest rate and working capital assumptions. The tax rate on core earnings in the second quarter is estimated to be approximately 19%. Moving to the next slide, where I'll offer an update on the end market demand assumptions that we noted in September. As a reminder, our FY '23 guidance assumed a moderate economic slowdown and some moderation in growth in the second half of our fiscal year. Based on what we know today, our assumptions from a demand perspective remain largely consistent. Across many of our end markets, demand has been extremely resilient, particularly in areas that continue to benefit from strong secular tailwinds like electric vehicles, healthcare, renewable energy infrastructure, 5G and cloud. We continue to expect these secular markets to expand in the pace of an economic slowdown. At the same time, we also continue to expect some consumer-centric end markets to underperform year-on-year consistent with our thoughts in September. All together, we still expect good growth in FY '23, as you'll see detailed on the next slide. Starting with our automotive business, which continues to outperform despite global supply chain issues as the transition to EV accelerates. We've seen this rapid acceleration manifest in FY '23 automotive revenue growth expected to be in excess of 40% year-on-year. We're also expecting double-digit year-over-year growth in our healthcare business, which continues to benefit from an outsourcing of manufacturing trend and has historically been recession resistant with long product life cycles, accretive margins and stable cash flows. Further, our industrial business is also expected to expand by double digits this year, fueled by growth in clean and smart energy infrastructure as government legislation, such as the Inflation Reduction Act in the U.S. accelerates investment in the space. And in 5G wireless, we continue to expect solid year-on-year growth. Infrastructure rollouts are accelerating, and our localized manufacturing capabilities are leading to growth in other geographies such as India. We expect these rollouts to play out over the next several years regardless of near-term economic conditions. Within our cloud business in September, we detailed our plan to shift certain components we procure and integrate from a purchase and resale model to a customer control consignment service model. This transition, in fact, began in November, which is earlier than our expectations 90 days ago. As a result, revenue would be lower than previously expected as an incremental $300 million of components was shipped to the new model. This is in addition to the $500 million of consignment impact we announced in September. Adjusting for this shift, we expect continued robust unit growth in the cloud space in FY '23 and beyond. In summary, we feel the outlook for our business is solid and expect demand across many of our end markets to remain strong with year-over-year revenue growth at an enterprise level to be approximately 3% for FY '23 despite an assumed economic slowdown in the second half of the fiscal year. Now turning to the next slide. We have intentionally structured our business with the aim of delivering core operating margin expansion, sustainable earnings growth, strong predictable cash flows and shareholder returns. With that in mind, while we continue to expect growth in our business despite recessionary headwinds, we have identified certain cost savings mainly in our SG&A and support organization for the second half of our fiscal year as we continue to look at doing more with less. And non-core expenses associated with our optimization activities will be approximately $45 million, with the benefits expected in the back half of the fiscal year. We anticipate these costs will result in a net benefit to core earnings per share of approximately $0.10 in FY '23 and $0.20 in FY '24. This benefit has been considered in our updated core EPS outlook for FY '23 of $8.40. We expect the cash outlay associated with our optimization efforts to be incurred over the next two quarters, and we continue to expect free cash flow of more than $900 million in the fiscal year. We expect the momentum underway across our business to continue even in a subdued economic environment and feel the steps we've taken to optimize our business are appropriate and make us stronger. I would like to wish everyone a safe and happy holiday. Thank you for your time today, and thank you for your interest in Jabil. I'll now turn the call over to Mark.

Mark Mondello, CEO

Thanks, Mike. Good morning. I appreciate everyone taking time to join our call today. I'll begin by saying thanks to our team here at Jabil. Thank you for your attention to detail, and thank you for the way you care for and accept one another. Your attitude is amazing, and your dedication is incredible. With that, let's move to our next slide. It's staggering when I think about what our team has built and tailored over the past five to six years. A large-scale portfolio of business sectors, eight discrete yet interwoven sectors, which offer Jabil a high degree of resiliency during times of macro and geopolitical disruption as well as gearing times when we simply welcome the ongoing demands placed on us by our customers. IN looking at this slide, I think about a world where countless products and a massive number of supply chains need to be created, redesigned or modified, therefore placing Jabil deep in the heart of essential end markets. Before moving to our next slide, it's worth revisiting the topic that we addressed during our Investor Day event back in September, the topic being the intentional output of the portfolio you see in front of you with the intention being that no single product contributes more than 5% to Jabil's overall earnings. This result is a good thing. It's a really good thing, especially when we think about dependability and sustainability. It also shines a bright light on the strategic importance of diversification and scale and the clear impact it has when operating our business. In recognizing our Q1 results, along with our 2Q guide as detailed by Adam and Mike, combined with a watchful eye on the back half of the year, we find ourselves with an updated financial plan for FY '23, an outlook which has us increasing core earnings per share to $8.40, an increase of $0.25 from our forecast roughly 90 days ago. In addition, we believe that core operating margin will hold at 4.8% for the year on revenue of roughly $34.5 billion, while free cash flow remains north of $900 million. Integral to this outlook is the fact that our team is doing an exceptional job of proactively managing costs and controlling what they can control in today's environment. Moving to our next slide. I'll share thoughts on our path forward. Shown here are fundamental catalysts, which are key to favorable results and future outcomes for Jabil: The unique combination of our approach, structure and experience, our ability to execute, combined with our engineering expertise, financial plans that are grounded in rational assumptions and our commitment to returning capital to shareholders. And rounding on our path forward, maybe it makes sense to step back a bit and think about the past few years. The data suggests that what we're doing is working, a testament of just how well our team is managing the business. I'd now like to transition from our path to our purpose. Here at Jabil, we're never confused about our obligation to deliver a fair return to shareholders. With this obligation well understood, and considering the upcoming holiday season, we're taking a little extra time to heighten our focus on ensuring a meaningful purpose in all we do. We're encouraging our employees to take a deep breath and a short pause, creating a little time for reflection, reflect on our team, reflect on their personal lives and reflect on giving back to those in need. And speaking of reflection, when it comes to helping those in need, I'm proud to report that our employees around the world just surpassed 1 million hours of personal volunteer time for calendar 2022. What a positive difference created for so many around the world, so many who need it most. Our team's effort was extraordinary. And in multiple ways, their effort was life-changing. Here at Jabil, we fully embrace the meaning and importance of carrying a purpose, both at home and in the workplace. And we do so with exceptional conduct and care. I'm just so honored to serve such a strong and steady team. Their approach is responsible and reliable. They value the relationships we have with all of those that we serve. Each day, we welcome the challenges put forth by our customers. And in doing so, Jabil is making the world just a little bit better. In closing, to all of you here at Jabil, please know that you can be your true self without anxiety or fear of recourse each day when you come to work. And to everyone on the call today, I wish you a safe and peaceful holiday season. With that, I'll now turn the call back over to Adam.

Adam Berry, Vice President of Investor Relations

Thanks, Mark. Operator, we're now ready for Q&A.

Operator, Operator

Our first question is coming from the line of Steven Fox with Fox Advisors.

Steven Fox, Analyst

Two questions, if I could, please. First, on inventories, Mike. A little bit of improvement there quarter-over-quarter and it looks like you were able to get more components on the auto side. I wonder how close we are to just sort of calling spring in terms of normalizing inventories during the course of the next 12 months. And then I had a follow-up.

Mike Dastoor, CFO

Hey, Steve. Yes, so the inventory days that we just printed 61 days, down 1 day from Q4. A normalized run rate, Steve, would be around that 55, 57. That's what I expect. Not anytime soon, but that is the ultimate sort of aim. I do expect that 61 days to continue to go down to that 58, 59 level. There will be quarterly nuances, timing nuances, et cetera. But overall, the trend would be in the downward direction, particularly with the supply chain constraints easing, as you mentioned.

Steven Fox, Analyst

That's helpful. And then as a follow-up, I was wondering if you could talk a little bit more of some of the stuff you're doing on the energy infrastructure side. It seems to be supporting some good growth in industrial from the standpoint of how the new program backlog looks, what your right to play in those markets, whether it's increasing and where you're seeing production interest.

Mark Mondello, CEO

Steve, that's a significant aspect of our business. As you know, it's integrated with our industrial operations. We typically don't detail all the individual products. However, when looking at overall energy management and clean energy, I would say that the growth rate of this segment of our industrial business surpasses that of many other areas within the industrial sector. Whether it involves solar energy, off-grid battery storage, or the efficiency of off-grid and mobile power generation, this is a strategically important area for the next three to four years in our overall industrial business. While I might not predict growth in this area to be as pronounced as with electric vehicles, it can be compared to our earlier decisions to heavily invest in the EV market around five to six years ago. That segment of our industrial business is receiving significant focus.

Steven Fox, Analyst

Any skill set you would point out as to why you guys are winning in that segment in particular?

Mark Mondello, CEO

Yes. You're welcome. I guess I'd make a general statement and a specific statement. I think one of the interesting characteristics of Jabil is to be really effective in this business over the long term, I think scale matters. And then in one of the slides that we just indexed through, if you look at the overall portfolio today that make up the $34 billion, $35 billion of revenue, the balance of the portfolio is substantial. And so again, coming back to your specific question, when I think about the markets that you're referring to, A, we've got a whole set of engineering staff that are, let's just say, expert in that area. But much like all of our businesses, they also have a vast pool of engineering resources in other sectors that they also get to confer with and talk to and think about being creative in terms of overall solutions in the industrial space. And I think that makes a big difference.

Operator, Operator

Our next question is coming from the line of Jim Suva with Citi.

Jim Suva, Analyst

You mentioned a little bit of manufacturing challenges with the DMS segment. I assume that has to do with the COVID closures and things. Can you just update us as we sit here now around December 15? Have those kind of been back to normalized? Are there still inefficiencies going on? Or any changes in how we should think about those efficiencies and inefficiencies?

Mark Mondello, CEO

Hey, Jim. I think for the quarter, so if we backward look to September, October, November with the kind of zero COVID policy, everything that was in the media around China and then kind of our exposure to that and our experience with that, in very round numbers, I would say that the kind of overall China COVID activities probably impacted Q1 by about $10 million, give or take. As you've seen recently, and maybe you're referring to this with some recent changes around the zero COVID policy, we'll continue to manage that in much the same way, being very careful, practical, thoughtful in terms of managing China coming out of a zero COVID policy. We've been doing that around the world since January of 2020. I think our protocols around the world and in China are kind of best-in-class. And I think protocols and processes aside, Jim, I give a huge amount of credit to our leadership team and our supervisors on the ground in China. We have a fabulous relationship with our people and our employees, and that in and of itself makes a huge difference. So anyway, that's our intent.

Jim Suva, Analyst

And then as a follow-up on a different topic, you mentioned some more consigning. That was kind of the same customer? Or is it expanding more or the relationship getting deeper? Or is it kind of getting broader for the consignment? I'm just kind of curious, it seems like to me, I should think about the consignment as a good thing for like more sticky business and sticky relationships.

Mark Mondello, CEO

Yes. I'm not going to get into customer-specific. I think when it comes to parts of our cloud business, Jim, we've been very, very consistent. And I don't know the first time we came out on a call and started talking about our entry into the cloud business based on our right to play and the solutions that our team wanted to bring forward. But what we talked about maybe back in 2018 and through 2019 and even through 2020 and COVID and on and on and on, we've been extremely consistent with the fact that our value proposition in that area of our business is very geo-centric and very asset-light. And said differently, we do a very good job of aligning variable costs with the puts and takes of the revenue. This is nothing more than that continuing. And the team has done an absolutely fantastic job of growing that business. I think on one of the slides again that we showed, you can see our cloud business or let's just say, cloud and 5G is now $6 billion, give or take. So I think that's a proxy for how successful they've been. And again, we'll continue, and our intent is to continue to run that an asset-light way.

Mike Dastoor, CFO

And Jim, I just want to add that when we provided guidance in September, we assumed the consignment would begin in March. However, we were able to complete it much earlier in November. As a result, you’re noticing an earlier impact from this consignment, slightly in Q1 but primarily in Q2.

Operator, Operator

Our next question is coming from the line of Shannon Cross with Credit Suisse.

Shannon Cross, Analyst

I wanted to understand a little bit more about the decision to reduce costs. I understand there's continued productivity improvements that you can do. But I'm wondering sort of what you saw out there that led you to do this? And how much of it is proactive versus changes you've already seen in customer behavior? And then I have a follow-up.

Mark Mondello, CEO

I believe it's a reasonable decision. The world is a bit choppy right now, and whether it's regarding how we run our business in different sectors based on customer needs, our execution, or overall cost management, we felt that it was necessary to be more cautious for the latter half of the year. Mike and I met with our leadership team, and I am pleased with the results. This was a difficult decision for the overall team, but we are being proactive about overhead costs and other expenses associated with our factories. I want to emphasize that our proactive approach to cost management is different from writing off or writing down assets. It's about analyzing the business, being aggressive and proactive, and ensuring shareholders receive a fair return promptly. Mike mentioned that with our cost management efforts and the charge taken this quarter, investors could expect around a dime back in the second half of this year. More importantly, the payback for 2024 and beyond is projected to be between $0.20 and $0.25. I believe this is a good use of our efforts and will provide nice returns for shareholders.

Mike Dastoor, CFO

And Shannon, our business assumptions continue to be extremely robust. I think I highlighted some of the secular trends that we're actually participating in. All of those continue to show very decent growth.

Shannon Cross, Analyst

How are your customers considering the geographic distribution of manufacturing these days? With the challenges in China, which is starting to open up again but has fluctuations, I'm curious about how much customers are discussing options like Eastern Europe and India. You're well positioned to assist them as they shift production. Thank you and happy holidays to everyone.

Mark Mondello, CEO

Thank you. Happy holidays to you too. I don't think there's a general trend. We have over 400 customers, and their views vary widely as they strive to optimize their businesses based on their products. This highlights the complexity of the situation and is a key reason our structure is efficient and effective in delivering customer solutions. At Jabil, our operations are tailored to each customer, addressing them individually. For instance, if a product has a certain unit cost but is expensive to distribute, we may choose to manufacture it regionally. Conversely, if moving a product is relatively inexpensive compared to its cost, we might centralize production. Additionally, geopolitical factors, including the ongoing situation in Ukraine, complicate these decisions. It’s difficult to pinpoint a collective mindset among our customers since the business environment doesn't function that way. Not to mention, our portfolio spans eight sectors and numerous subsectors, showcasing our strength in diversification, which leads to a multitude of solutions. We engage with each customer uniquely to meet their specific requirements. As for geographic expansion, we anticipate growth in Eastern Europe, continued expansion in Mexico, and we are confident in our presence in China. Over the coming years, we also expect to see more growth in India.

Operator, Operator

Our next question is coming from the line of Matt Sheerin with Stifel.

Matt Sheerin, Analyst

I have a question, Mark, about your updated revenue guidance for FY '23. You're increasing the outlook for auto and healthcare. Is that due to improved supply conditions or is it demand-driven? Why are you raising those numbers?

Mark Mondello, CEO

We're increasing our forecasts because we believe we can. At this moment, someone might wonder why we're adjusting our numbers if we're somewhat cautious about the second half of the year due to uncertainties around what the U.S. Federal Reserve is doing in the markets. However, we exercise sound judgment. One of the strengths of Jabil is that we segment our business into very small parts, which allows us to closely monitor all aspects of our operations. Generally speaking, we anticipate double-digit growth in the automotive and transportation sectors, primarily driven by electric vehicles. Healthcare is expected to exceed 10%, and our industrial semiconductor business is experiencing similar growth, particularly on the industrial front. The growth in those areas is partly due to improvements in the supply chain. While legacy semiconductors in the EV sector remain limited, the overall supply chain is significantly improving. Our capacity to procure parts compared to others is quite strong, and in several areas, demand remains stable.

Matt Sheerin, Analyst

And then a question, Mike, regarding the incremental consignment revenue that you talked about. So total $800 million in revenue going to consignment for your cloud customer. Does that move the needle on gross margin at all? Is there any change in terms of the operating margin or operating income on that business?

Mike Dastoor, CFO

Yes, it does have a slight effect on margin, but there are some offsets. Adam pointed out some inefficiencies we experienced on the mobility side in China, especially in the first quarter. We also made some assumptions regarding further COVID impacts in various regions, which does influence margin slightly. However, you're correct that the consigned side has a minor positive impact on margin, and that's a key reason we are pursuing this with the customer.

Mark Mondello, CEO

If I could add to that, here's a simple way to think about it in very round numbers. Two years ago, the overall operating margin for the company was 4.2%. Last year, it was 4.6%. At the beginning of this year, we projected that the operating margin would be 4.8%, and we're maintaining that figure, which we're proud of. This represents a 20 basis points increase from 2022 to 2023. About half of that improvement comes from our cost management in the second half of the year, along with the continued growth of our asset-light cloud business, while the other half relates to what we might refer to as the core business. However, I prefer not to separate them because all of these efforts are integral to operating a successful business. So, in terms of your modeling and how to understand it, I believe that's a reasonable perspective to take.

Operator, Operator

Our next question is coming from the line of Ruplu Bhattacharya with Bank of America.

Ruplu Bhattacharya, Analyst

My first question is about the DMS segment. Mark, you've experienced significant growth in automotive and healthcare, increasing those two segments by $600 million for the full year. However, as you mentioned, the consumer-facing markets within that segment are weaker, and you're adjusting that down by 200 basis points. When I examine the operating margin, it has decreased by 10 basis points. Can you share your thoughts on margin risk in DMS if the consumer-facing markets continue to weaken? Do you believe margins could decrease in that segment? What offsets do you have in place? Typically, one might expect automotive and healthcare to yield higher margins, so if there's a shift in that direction, what's causing the 10 basis point decline? How do you perceive the risk if the consumer-facing markets diminish further?

Mark Mondello, CEO

That's a broad question, and I'm not entirely sure how you meant it, but I'll respond based on my interpretation. If there's a significant decline in all consumer-facing products, it's possible that overall DMS margins could decrease further. Currently, I believe we've managed to prepare reasonably well for the latter part of the year. Your assertion is primarily accurate; we have adjusted our expectations for consumer-facing products. Conversely, we feel optimistic about our performance in industrial, automotive, and healthcare sectors. As you compile your projections for the year, keep in mind that we just released our first-quarter results and provided guidance for the second quarter. Looking ahead to Q3 and Q4, I believe that you will find that our DMS margins are likely to end up around 5% or 5.1%. Q4 is poised to be a robust quarter, which aligns with your observation regarding higher margins in the automotive and healthcare sectors. Additionally, I want to highlight the significant efforts and complementary work that our EMS team is doing concerning their business and margins this year. When we entered the first quarter, we anticipated EMS margins to be in the range of 4% to 4.1%, but they came in at 4.3%. If you review our guidance and perform your calculations, you will notice a solid return in margins for the second quarter. Last year, EMS margins were approximately 4.2% to 4.3%. At the start of the year, we projected EMS would be around 4.4% to 4.5%, but it appears we may achieve closer to 4.6% to 4.7%. So, let's take a moment to appreciate that the entire business functions as a comprehensive portfolio. I understand your question focused on DMS, and I hope this provides some clarity.

Ruplu Bhattacharya, Analyst

For my second question, Mike, can you help us understand the impact of inflation on the company's operating margin of 4.8%? I assume, like other EMS companies, you are passing on increased component costs. If that's the case, your margins might be affected negatively. What would that 4.8% look like without the inflation pass-through? Additionally, looking at the margins over the past five years, particularly shown on Slide 13, can you provide insight into what factors could influence margins moving forward? While a decrease in inflation should benefit margins, what other factors might drive them? Also, could you share your thoughts on what target margins might be in the long term?

Mark Mondello, CEO

Ruplu, let me address that for a moment. That was quite a bit of information. To focus on the first part of your question, you're right that in the first quarter, margins were at 4.8%. You mentioned that in the first quarter of last year, margins were 4.7%. We had anticipated that margins for Q1 would be 4.8%, and they indeed came in at that level. DMS margins experienced a decrease of about 20 basis points, while EMS margins increased by 20 basis points, which reflects the size and scale of our operations as well as our strong diversification. Without effective agreements with our customers regarding the equitable sharing of variable costs, we wouldn't have achieved that 4.8%. I want to emphasize that this isn't a cause for concern; rather, it highlights the strength of our business structure and customer relationships, which our leadership team finds very satisfactory. As for other factors that could affect overall margins this year, it’s difficult to predict. On the downside, a worsening macro environment could be a concern. Yes, there is the possibility of macroeconomic challenges, but we remain confident in our team's execution and capabilities. I believe in the strength of our portfolio, the size of the market, and our ability to continue gaining market share. Overall, I think our teams, both at the factory and above, are doing an excellent job managing what is within our control.

Ruplu Bhattacharya, Analyst

Got it. I mean I really appreciate all those details. And wondering, maybe now if I can sneak one more quick one in. I know you've announced Kenny Wilson to be the new CEO effective May 1, and you're going to take on more of a strategy, corporate development role. So can you just talk about from now until then, what are some of the handover activities you're going to do? And should we think of any change in direction to the company? Or how should we think about this transition? Congrats again on the quarter.

Mark Mondello, CEO

Well, that's an interesting question. I've been at this a long time, and I'd make this comment not directly around my relationship with Kenny. Whether my relationships with Kenny or Borges or Dastoor or McCoy or JJ or all the folks that you've met, we have a significantly tight-knit group. We've all been at this a long time. Sometimes that becomes problematic because it feels sometimes like we've complete each other's sentences. So we've got to continue to challenge ourselves so we don't have a group think. But Kenny has been with us a long time, so has the balance of the team. I don't envision any of this being revolutionary. I think it will be evolutionary. We also added some other new leadership to the team recently with LaShawne and Kristine in legal. So I think we'll carry on. With that being said, as I continue to move more and more throughout the year into an active Chairman role, and you're right, I'll have my hands firmly involved with investors and our foundation and strategy and other stuff, I hope the team takes my 10 or 11 years and is disruptive in a positive sense. I think one of the things that this team has done over and over and over and over, and time and time again over 30 years is I think we're proactive. I think we change when we need to change. We don't change for the sake of changing. And I'd say, Kenny and some of the expanded leadership team is probably, in some sense, a little bit more edgy than I can be. And I think that's a good thing. So I think there'll be I think there'll be some good changes. You can think of them as evolutionary, not revolutionary changes because the foundation we've built for this business has never been stronger. And I'm really, really, really looking forward to the next two, three, four years to see how things shake out.

Operator, Operator

Our next question is coming from the line of Paul Chung with JPMorgan.

Paul Chung, Analyst

So just on cash flow, you've typically seen more cash investments in 1Q, but you actually squeezed out some free cash flow this quarter. So is this more about timing or maybe less need for working capital investments kind of given elevated build last year? And any comments there in the kind of the shape of free cash flow for the year? And then also on guidance, it remains unchanged. So how are you kind of offsetting the increase in interest expense and kind of cash outlays on optimization? Or was that kind of included in your projections last quarter?

Mike Dastoor, CFO

Yes. The current free cash flow assumptions account for all relevant charges and associated cash outlays, as well as the savings on the other side. Everything that influences the free cash flow is taken into consideration. For the first quarter, it's primarily a matter of timing. Our Capital Expenditures remain in the 2.5% range, and there are no significant changes from the guidance we provided in September. There will always be timing differences and nuances. Looking at the overall shape of the year, I would refer to patterns from previous years, which should be quite similar. While timing may cause some shifts, we still remain confident in our $900 million free cash flow target for the year.

Paul Chung, Analyst

Got you. And then just a follow-up on op margins, seem very kind of good progression here over the last two years, some nice benefits from cloud consignment. But can you expand on the drivers to get to that 5% mark and kind of the pace beyond fiscal year '23? You're doing some cost optimization here, but will it be more a function of mix kind of efficiencies or even scale as you guys are approaching $10 billion in quarterly revenue run rate now.

Mike Dastoor, CFO

I would suggest all of you about, Paul, I think it's definitely a mix, operational efficiency, something we always execute on. We've always invested in the past around automation, robotics, et cetera. So we feel good about that as well. And overall, the margin, does it go beyond 5%, 5.5% as well. We're not stopping at 4.8%, and we're definitely not stopping it at 5% either. So it's something we're actively engaged in and feel very strongly about.

Operator, Operator

Our next question is coming from the line of David Vogt with UBS.

David Vogt, Analyst

I have a big picture macro question on sort of demand. And you talked about your demand characteristics being relatively consistent with 90 days ago. But I'm trying to square it with your commentary being a little bit more cautious as we move through the back half of this year. I guess my question is when you think about what's happening in the marketplace, we're seeing some intensity drop from a capital spend in telcos and cloud. How much of your demand visibility or your revenue visibility has to do with elevated backlogs because supply chain has been sort of elevated for quite some time versus the in-period demand that you're seeing today from your customers? And then I have another question.

Mark Mondello, CEO

David, welcome to the group. We're excited to have you on board and look forward to helping you understand our business better. Regarding your questions, there is pent-up demand, but I want to be cautious in my response. For example, our networking or legacy telco segment is about $3 billion out of a $35 billion total. So while we do have backlog from these segments, I'm unsure how significant that is for our overall corporate results. We have certainly seen pent-up demand and backlog in nearly every area of our business affected by supply chain constraints. Generally speaking, if I were to make a broad estimate, I believe most of the pent-up demand and backlog will likely be resolved by late Q1 2023 or into the second quarter of 2023, thus easing out in the first half of that year. I think most of the backlog will clear and normalize as we reach the second half of calendar 2023. I hope that gives you some insight, but it's a general observation as we look across the business.

David Vogt, Analyst

No, that's helpful. What we're trying to kind of understand is sort of the normal cadence of sort of order trajectory of the business, stripping aside what we've kind of lived through the last couple of years. So that's helpful. We appreciate it. And then maybe just a final question on cash flow and capital priorities. You've done a great job in terms of returning shareholder capital and managing cash flow over the last couple of years. Does your commentary about the second half or maybe some of the cash used for the restructuring change any of your priorities in the balance of this year. I wouldn't think so, but just wanted to just confirm with you.

Mike Dastoor, CFO

No, there's no change to our capital allocation. As we mentioned in September, we still have approximately $1.1 billion remaining from our authorization, which we are actively utilizing. We used a substantial amount of that in Q1, and we plan to continue with buybacks in the range of 150 to over 200 each quarter. Therefore, nothing in the second half is expected to impact this, and it may even create an opportunity for additional buybacks if conditions begin to decline.

Mark Mondello, CEO

We have reached the end of our question-and-answer session. With that, this does conclude today's teleconference. We appreciate your participation. You may disconnect your lines at this time. Enjoy the rest of your day, and happy holidays.