Q4 2022 Vertiv Holdings Co Earnings Call
We'll present, both GAAP and non-GAAP financial measures, our GAAP results and GAAP to non-GAAP reconciliations can be found in our earnings press release and in the Investor Slide deck found on our website at investors that bird of Dot com with that I'll turn the call over to executive Chairman Dave Cody.
Yeah.
Yeah.
2022 was quite a year of transformation that burden.
A year focused on driving price.
America is improvement.
And progress on a high performing culture.
After a very disappointing 2021, we developed an ambitious plan to turnaround the performance of the business over the next four quarters plus.
Fourth quarter results demonstrated marked improvement consistent with the profit profile, we shared last February .
Our adjusted free cash flow performance, however was not what it should have been largely because of working capital.
We've consistently said the fourth quarter 'twenty, two performance will position us well for 'twenty, three and we believe that it has.
We are increasing our view on 2023 adjusted operating profit guidance, primarily due to foreign to foreign exchange and that represents an over 75% increase year over year.
And our adjusted free cash flow is anticipated to improve significantly because of higher income and less working capital usage.
The environment continues to look good and we're entering 2023 with significant backlog.
Geos focus on improved execution on everything is already apparent and it certainly demonstrated in the improved performance in the Americas.
I am very excited about where the company is headed with Joe's leadership.
So with that I will turn the call over to Jill.
Thank you Dave Thank you very much.
I can certainly confirm that already in my initial days as CEO . There has been a renewed focus on execution rigor and productivity.
Bind with the intensity that fosters a high performance culture.
We are on slide three.
2022 was certainly a story of two halves. The first half painful when we did a lot of the hard work needed for acceleration in the second half strong with indeed, a very strong fourth quarter the strongest in our history.
Fourth quarter organic sales were up 22% driven by very robust growth in the Americas, and EMEA Asia and China in particular was hindered by the impact of Covid and we expect this impact to be short in nature.
We extend we ended the <unk>.
Again, with a record backlog of $4 $8 billion, which firmly supports our topline growth projections for 2023.
Adjusted operating profit of $211 million was a little short of the guidance range. This is mainly due to the approximately $40 million less volume in China.
Caused by the Covid wave there.
<unk> performance was also weaker than expected due to some project cost overruns.
These headwinds were partially offset by foreign exchange, although still negative more favorable than assumed in our previous guidance provided in October .
We are pleased by our pricing performance, we were on plan as we realized $135 million of price in the fourth quarter, and we delivered $365 million.
For the full year.
We executed on the commitment we made early last year.
There may have been some skeptics, who discounted our ability to get price.
That is understandable.
Normally believes that to deliver on commitments is the best way to respond to skepticism and.
As true in general.
We demonstrated good sequential improvement in cash in the fourth quarter, but adjusted free cash flow was below expectations.
There are reasons for the shortfall such as delayed collections in China again due to Covid.
And hiring the entry due to some continuous supply chain constraints.
Because adjusted free cash flow is crucial.
Sterling more rigor and accountability and discipline in the whole process.
<unk> fallen and I are keenly focused on this.
Let's look at 2023.
Our guidance is signal.
A significant step forward.
Significantly improved performance.
<unk> sales are expected to increase 15% year over year.
At the mid point of guidance, mainly because of foreign exchange we are raising.
Our <unk> guidance from the southern $32 $750 million, we announced in October .
Two 750 $800 million now over 75% increase year over year.
We're guiding to 300 to 400 million in adjusted free cash flow.
Supported by our plan of increased profit and working capital optimization.
We will provide additional details around these plans as we make our way through the slides.
Of course.
We execute the year a quarter at a time it starts with a good execution in the first quarter and we have details on our first quarter guidance later in the slide presentation.
Let's now turn to slide four and lets spend a few minutes on the market.
Only one change from the October view, we moved cloud Hyperscale down from green to yellow in EMEA.
This was driven by seeing some market signals that demand may be stabilizing, albeit at pretty high levels.
Worth noting in general cloud.
Cloud and Hyperscale providers may swing a bit between building capacity in house or outsource to Colo providers. So after the two categories that should be looked at together.
Our Asian market views remain consistent with last quarters, we've operated in a quieter market environment in Asia for 2022.
I have recently visited Asia, and I have to say on printing encouraged by what I saw and heard you on the ground for example.
It is really just at the beginning of what looks to be a meaningful investment cycle.
Americas is also consistent with the last quarter market view, even though cloud hyperscale may be coming off the height of the last couple of years, they are still growing and investing at healthy pace.
And one that supports our trajectory of business.
We have discussed periods of digestion before certain customers are digesting the capacity, but this is a normal part of the cycle and they typically quote unquote digest at different times, which is smooth.
The overall impact in the market.
<unk> spending is being directed to higher density loads, such as artificial intelligence, which demand more compute power and the need for additional infrastructure.
We also believe that there is a normalization of orders that is happening our supply chain improve and lead times reduce as discontinued customers are likely going to return to more normal order behavior that is good for the industry overall, but they make order competitive look more negative.
Then what is really happening in the market.
We remain cautious on the enterprise not that what we're seeing.
A different dynamic unfolding since last quarter, but more so because we are mindful of the macro around us.
We know this segment would typically be the first to reflect a possible recession in the USA or at least appear to economic slowdown. This happened in 2020 with economic slowdowns related to COVID-19, So we are staying vigilant.
All in all we remain cautiously optimistic on the market driven by the continued need for data globally and favorable technology trends like artificial intelligence, requiring a higher density and more compute power.
Now, let's move to slide five.
Customer demand still feels good.
This is also confirmed by conversations with our customers around the world levels.
Levels of investment and demand for our products and services continues to be healthy we had signals we have signaled that fourth quarter year on year. This growth would be negative given a very strong comparison in the prior year and that is what happened as an example in full Q2.
'twenty, one we experienced an order growth rate of more than 100% of Americans.
We expect to see the same in <unk> 2023, with a tough comparison with the prior year.
When orders were up 34% and now an environment, where customers returned to a more normalized pattern of ordering.
We expect Q1 orders to be down double digits. It is hard to provide precision on what double digits could look like as normalization of wood patterns is still unfolding.
We continue to have record high backlog and ended the year at $4 $8 billion, which is a 49% increase from the end of 2021.
This is inclusive of absorbing some order cancellations from our large hyperscale provider.
This backlog represents over 70% coverage of the 2023 sales guidance, which is a much higher coverage ratio than we have seen in the past. This is reflective of an industry characterized by a very tight supply chain is still dealing with the disruptions we do think.
Monetization of the backlog adverse event in the industry in general is starting.
And we expect this to continue as customers seen gradual improvement in supply chain and associated reduction in lead time.
We believe this process of normalization of the backlog will really be quite healthy for the overall market.
We delivered on our pricing expectation as previously mentioned, we continued to exercise the pricing muscle referred to already on the <unk> October two price for the value we provide to our customers inflation.
Inflation was still anticipated to be a headwind in 2023, but we expect to have a net favorable price versus overall inflation impact of approximately $100 million. Thanks to the actions and execution rigor we are fostering.
Supply chain continues to incrementally improve but still not.
Without its challenges, especially in the power electronics area, we're moving from a.
<unk> environment to one where we are in better control also thanks to the increased supply chain resiliency.
Alternative component supplier efforts are enabling.
In summary.
While we see some mixed signals in the macro the long term demand continues to be healthy for our business, we have a beta of.
Wind at our back relative to price cost supply chain is trending a bit better and we started the year in a very strong backlog position.
Visibility is.
Still not great in a dynamic global environment, but we are focused on what we can control.
I like where we are starting the year, our fourth quarter performance sets us up well for successful 2023, despite navigating what could be a more challenging macro environment.
We are strengthening.
Like to repeat this the operating models and execution rigor in general and certainly around everything cash flow.
So with that.
Over to David to walk us through the financials, David perfect. Thanks, Joe first turning to slide six this slide summarizes our fourth quarter financial results.
Although fourth quarter results were lower than our expectations.
<unk>.
Looking at this slide Holistically you can appreciate the marked improvement from a year ago.
Both Dave and Geo mentioned Theres still work to do but fourth quarter adjusted operating profit of $211 million.
Was not only a record high but a record high by about 40%.
Going forward, it's our aim for every quarter to be a record quarter and we are <unk>.
Certainly better positioned today to deliver those types of results in large part due to what we have gone through over the last 18 months or so.
With that said.
Let's look at the fourth quarter detail.
Net sales increased 17% from last year's fourth quarter and were up 22% organically.
Organic growth included 12% from volume and 10% from pricing while.
I'll still comfortably within our guidance range for sales.
Versus expectations sales were negatively impacted by approximately $40 million from the Covid wave in China, which significantly limited our production in the final two months of the year.
Lower sales in China.
Were partially offset by a $30 million foreign exchange tailwind versus beginning of quarter expectations as the euro RMB and British pound are strengthened against the U S dollar.
Adjusted operating profit of $211 million was below our guidance range.
And this was primarily due to lower than anticipated volume in China, which should just be timing.
Weaker than expected results from Eni.
Looking at the macro puts and takes we realized a $135 million pricing benefit in the quarter, which was consistent with our beginning of quarter guidance.
Pricing was partially offset by a $55 million headwind from material and freight inflation. Once again also consistent with our guidance.
As a result, we were $80 million price cost positive in the fourth quarter and $60 million positive for the full year.
$165 million higher sales volume contributed $50 million higher adjusted operating profit and foreign exchange, although favorable versus expectation.
What's still a $15 million headwind versus prior year.
Fourth quarter Eni performance was below our expectations and this was driven by cost overruns on several large projects and unfavorable mix.
The project cost overruns were driven by execution challenges and lack of visibility on cost.
Largely focused within a single manufacturing plant and both issues are very much flexible and are being addressed as we continue.
To integrate eni in diverted processes and systems.
While certainly a challenging quarter and quite frankly, a challenging year for Eni.
We are still extremely excited about this acquisition.
There is likely more tactical work to be done than we originally anticipated.
But as we mentioned previously on the last call the potential for sales synergies is much higher than we originally modeled as evidenced by the near a 150% Eni backlog growth during 2022 to.
To support this higher volume we are actively investing in capacity expansions at existing verdict Virtus facilities in Mexico, and Slovakia, as we continued to push Eni products through legacy Virtu sales channels.
And finally on this slide we generated $143 million of adjusted free cash flow in the fourth quarter and that was $135 million higher than last year's fourth quarter.
Although a strong year over year comparison, adjusted free cash flow was significantly below our guidance range driven by several factors, including delayed collections in China from the impact of Covid higher than expected inventory as we continue to manage supply chain constraints.
Managing a record high volume.
And also delayed receipt of advanced payments for several large orders, which were pushed into and likely spread throughout 2023.
Although fourth quarter adjusted free cash flow was short of expectations, we continue to make progress in stemming the tide.
We burned $380 million of adjusted free cash flow in the first half of the year, while we generated $150 million in the second half.
Certainly we're not alone in managing the challenges of inventory in 2022, but unsurprisingly, we saw a similar pattern with inventory, which grew $180 million in the first half, but just $30 million in the second half.
There is still much work to do.
But as Dave and <unk>, both mentioned optimizing working capital will be a significant focus for 2023 for Geo for myself and quite frankly in the entire company.
We believe we strengthened the P&L in 2022, and now we will work diligently to strengthen the balance sheet.
Next turning to slide seven.
This slide summarizes our fourth quarter segment fourth quarter segment results.
With strong organic sales growth in each of the Americas and EMEA.
APAC organic sales were relatively flat, primarily due to COVID-19 otherwise organic sales would have been up about 9%.
Americas, 40% organic growth.
You need to say that again, 40% organic growth was supported by <unk>.
26% volume growth and 14% pricing in each of these.
Is an impressive number in and of its own <unk>.
Volume growth was supported by launching additional thermal capacity in Monterey, while also proactively addressing several supply chain issues, including the qualification of new suppliers.
From an adjusted operating margin perspective, all regions were up significantly from last year's fourth quarter and for the first time all regions for price cost positive.
America's improvement was the most pronounced as they were the first region last year to be hit by inflation against an enterprise backlog.
They were approximately $60 million price cost positive in the quarter, which demonstrates the significance of the aggressive pricing program put in place at the start of the year, both the Americas and EMEA adjusted operating margin were above 20% for the quarter, but APAC was not that far behind.
Next turning to slide eight.
We added this slide to highlight the turnaround specifically in the Americas region in 2022.
Under <unk> leadership, we saw significant sequential quarterly improvement as that business focused on getting the fundamentals right.
Improving processes, while also holding people accountable by emphasizing a high performance culture.
It is still early innings and still work to do but we are pleased yet not satisfied.
With the progress to date.
Geo borrow best practices from EMEA and institutionalize those in the Americas and as this slide demonstrates we are certainly seeing the results.
Of course, and as a reminder, the Americas region adjusted operating margin just a couple of years ago was in the mid <unk>. So there is still certainly room for significant upside in the Americas and quite frankly in all regions in 2023 and beyond.
Next turning to slide nine.
This slide summarizes our full year results.
We developed an aggressive framework to transform the business at the beginning of the year and we made significant progress.
And we will touch upon that in the next slide but it really was a story of two halves with each financial metric.
Sales were up organically, 4% in the first half, but over 20% in the second half adjusted operating profit was up 95 or was $95 million in the first half.
$345 million in the second half adjusted operating margin was three 7% first half 11% second half adjusted.
Adjusted free cash flow was a burn of $380 million in the first half, but a generation of $120 million in the second half.
So although full year results are critically important the underlying dynamics of the cadence of our improvements through the year.
Are likely more pertinent to understand divert a turnaround story, which we capture on the next slide slide 10.
And this slide nicely captures that turnaround executed in 2022, while there were puts and takes along the way we execute it relatively consistent with the profile we presented in February and delivered sequentially improving performance each quarter, improving adjusted operating profit by almost two.
$200 million from the first quarter to the fourth quarter.
And of course, our fourth quarter performance is not an end in and of itself, but it serves as a strong foundation for continued improving results in 2023 and well beyond.
Which serves as a good segue so moving from the rearview mirror to the road ahead, let's turn to slide 12, which summarizes our full year 2023 guidance.
We anticipate 2020.
<unk> sales, increasing 15% at the midpoint.
Approximately 10% from volume and 5% from pricing of which a significant portion is carryover or based upon enacted price increases.
Markets currently remain healthy and we have a record backlog of $4 $8 billion coming into the year.
Despite the recent strengthening of the Euro RMB and British pound against the U S. Dollar, we do anticipate a full year foreign exchange headwind of approximately $40 million.
And that includes a $70 million headwind in the first half, partially offset by a $30 million tailwind in the back half.
We have raised our 2023 adjusted operating profit guidance range to $750 million to $800 million and thats up from the $730 million to $750 million.
<unk> previously and this change is primarily due to the strengthening of foreign currency.
The end of October when we provided that previous guidance.
The midpoint of our revised guidance range represents an over 75% increase year over year, which.
Which is certainly significant and we include a bridge on slide 31 in the appendix that summarizes the drivers of this increase and gene will touch upon some of the dynamics in a couple of pages, but big picture is driven by higher sales supported by our record backlog and additional pricing much of which is carryover. These.
These tail winds are offset by.
And assumed $175 million of inflation and this includes labor.
$75 million of labor inflation is included in that $1 75 and.
And also a $40 million combined investment in R&D and additional capacity to support higher expected sales in 2023 and beyond.
Adjusted EPS of $1 22 represents a two X increase from.
2022.
And that's mainly driven by the improved adjusted operating profit adjusted.
Adjusted free cash flow guidance of $300 million to $400 million.
Primarily driven by higher adjusted operating profit and optimize working capital, which as we mentioned will be a significant focus going forward.
Joe will provide some of the additional color on working capital initiatives in a couple of slides.
Please refer to slides 31, and 33 in the impact in the appendix for additional detail on core assumptions supporting our 'twenty three guidance.
Next slide 13.
This includes a summary of our first quarter financial guidance.
And our first quarter, certainly showed significant year over year improvement across all financial measures, although we realize it's against a relatively easy comparison to a.
Weak prior year first quarter that said, our first quarter guidance continues the trajectory of improvement building off a strong fourth quarter.
However, as a reminder, seasonality in our business generally results in our first quarter being the lowest quarter and our fourth quarter being the highest so in general like 2020, twos sequentially, improving quarterly financial performance across each of these finance financial.
<unk> financial measures in 2023 is the expectation.
First quarter net sales are expected to be up 21%, 25% organically.
Driven by higher volume and pricing benefits, partially offset by a foreign exchange headwind.
Adjusted operating profit is expected to be $125 million at the midpoint with pricing volume and productivity offset by inflation and growth investments.
<unk> EPS improvement is coming primarily from higher adjusted operating profit.
Adjusted free cash flow as anticipate.
We anticipate it to be a use of cash of between 50 and $100 million.
Approximately.
Approximately $75 million better than last year's first quarter, despite year over year headwinds of $20 million from cash interest due to higher interest rates.
$20 million simply from the timing of payroll.
Like many industrials are first quarter typically drives the use of cash and we anticipate generating adjusted free cash flow for each of the remaining quarters in 2023.
With that said I turn it back over to Jill.
Thank you David Thank you very much and we turn to slide 14.
Okay.
We know that this guidance may look aggressive to film.
It may as well conserved.
Others.
Tier two shave some points that's <unk>.
<unk>.
<unk> guidance.
Let's start with adjusted operating profit and let's look at the volume assumptions.
We are at the highest backlog coverage point in our history over 70%.
Additionally, there is always more book and ship timing them tools services spare parts.
<unk> business.
Parts of the business that transact on a <unk>.
Short cycle and provide additional volume on the <unk>.
Our Q4.
To build ratio was 115%.
High levels that have characterized the entire 2022.
Obviously, some moderation now book to Bill ratio is expected going into 2023 as customers return to a more normalized as we said order pattern.
The supply environment has been improving.
And this should lead to a decrease in our need to do spot buys we believe we have conservative estimates for inflation.
Have a pricing plan that is not already in backlog or based on actions that have already been taken.
And we have demonstrated our ability to get price.
Let's look at the cash flows now.
You have heard all of us speak directly about adjusted free cash flow.
No we did not execute well in this metric in 2022, certainly the improved adjusted operating profit stops us.
At a very different point for 2023, we have reasonable assumptions for elements that typically do not vary too much light interest tax capex and.
And we have strong working capital initiatives. This is a top priority.
For the organization and we are managing this very closely.
I would reference.
How we approach pricing last year. It was all hands on deck rigor around the process accountability and focus on execution and we executed well the same rigor is around executing the working capital initiatives and the adjusted free cash flow generation.
Let's now turn to slide 15.
Our focus areas through 2023 are clear.
Clear reflection of our priorities, we want the entire team pulling in the same direction.
We are working on the culture.
<unk> got a high performance culture, where we do what we say we're ownership is clearly where we hold ourselves accountable for delivering the results and we reward performance.
It doesn't change overnight it is approved.
But as we strengthen.
Our focus.
We have seen signs that the high performance culture, starting to take hold and we see that through improved financial results.
I've been visiting many parts of the organization lately, including China, India, Mexico, Slovakia Island.
The middle East.
Many people at all levels and I am very encouraged.
By what I see people, who love and care for what they do.
Careful the company, we have a lot to do.
But I feel the energy of the organization.
Again.
Pricing supply chain resiliency and trade working capital optimization, our primary focus areas and we will continue to build those mussels continue to institutionalize. This in the organization.
This is what high performing companies do.
We still have great potential to operate in a more efficient and effective way across the company.
There is no magic wand, its constant focus on the things that matter and strong operational execution.
Rigorous relentless pragmatic execution.
At all levels and starting from the top.
I am encouraged the finish to 2022.
Was.
Certainly not profit.
Signs of real progress.
<unk> throughout the organization and most importantly.
Showing up in our financial results.
Dave started off the call today by indicating 2022 was a year of transformation.
I wholeheartedly agree and it is just the beginning.
With that said, we will now turn the call over to the operator, who will open the line for questions. Thank you.
Okay.
Yes.
Thank you.
We will now begin the question and answer session in order to ask a question.
Please press Star then the number one on your telephone keypad.
We'll pause for a moment compiled Q&A.
SaaS question you have from the phone line comes from.
Scott Davis.
Research Your line is open.
Hi, good morning, everybody.
Good morning, Hey, Scott.
I really just have one main question and Thats just related to the order cancellation of the.
The hyperscale customer could you give us a little bit more color around that and and.
And is it your experience that these things tend to be one offs I mean, I would think that if one customer is canceling it could be.
A.
Start of a trend if you will and not trying to be paranoid here just.
A little bit color, there I think would be helpful. Thanks.
Scott We know the paranoia is always very healthy we try to exercise paranoia and everything and everything we do when it comes to running the business.
Almost religiously.
So this is giovanni.
But obviously, we're north Abel.
Customer specific information, but.
I would say it's.
Okay.
It is not unusual sometimes that they're awesome reconfigurations in terms of what the customers decide to do with the with their infrastructure.
Infrastructure.
Having said that of course.
Being paranoid, we keep extremely sharp eye on all of those dynamics.
And although not what we have signals with Sig mood.
Have noticed we have not noticed anything extraordinary let's say in the dynamics.
So we will continue to be to exercise.
Extreme focus there but.
And Ah.
Nothing extraordinary.
Okay, and just as a natural follow up.
<unk> had a quarter now of kind of order normalization historically is that typically last two to three quarters or is it something that.
That is a little quicker than that.
It is.
Yes. It is.
<unk> referred to history here, because I do not think that I've been in the industry. As you know for quite some time have never seen anything like what has happened in the industry in the last year and a half two years.
Magnitude of.
The combination of the lengthening lead times and demand growth.
Driven a.
Let's say desire to cover longer and longer.
Demand periods of our customers that is absolutely unprecedented.
In general not just vertical customers and industry in general.
Being able to say how that will undo or normalize.
It's very very hard, but our expectation is that it will probably take a.
Six six months, but hey, this is this is a guess.
We'll keep our eyes open and try to understand.
How it exactly unfold.
Probably be able to tell better.
In it.
That's very helpful. Best of luck this year as I'll pass it on thanks. Thank you. Thank you Scott.
Thank you.
Your next question comes from.
Nigel Coe of Wolfe research.
Thanks, Good morning, and thanks for the details again.
Just.
David going back to the the.
The <unk> guide for 'twenty, three you mentioned FX, which makes total sense of course with the total movements.
But then you mentioned Eni.
As a timing issue the largely a timing issue or are you assuming that.
The lost EBIT.
Ni come through into 'twenty, three any any help in terms of the path of recovery that would be helpful.
Yes, I wouldn't necessarily call the Eni issue from the fourth quarter of timing issue we were referring.
More to the.
Sales timing for China related to Covid.
Although sales are based on <unk>.
Orders, we have in hand and.
No guarantee we'll make that up in Q1, but that's certainly just the timing as it relates to Eni.
Yes.
We certainly expect improvement in 2023 versus what we saw in 2022 I think full.
Full year, adjusted operating profit pretty nice between $50 and 55% we anticipate at 80.
At the beginning of this year and we certainly would anticipate something north of 80 for full year 2023.
Okay. That's great and then I think if you look at your <unk> sales guidance I think 'twenty, 132% of your mid point sales coming through.
And <unk> portion of the full year, that's actually the highest proportion we've seen.
Since.
<unk> as a public company.
Going back to 2018, so obviously, we'd like front end loaded guidance, but does that indicate sort of inherent conservatism in the way you've built up the plan.
Or does it indicate some expectation of a slowing in the back half of the year relative to our norms.
Yes.
That's a good question.
I would say.
If you look at the risk from a sales perspective in our plan for $2000.
'twenty three and very consistent what we said at the end of the third quarter.
It's not going to necessarily be backlog, but it will be related to the availability of supply and in particular, we have continuing.
<unk> with with power semiconductors and electronic components.
So there may be a bit of a hedge in the back half of the year, because we don't have great visibility in that market similar to.
Everybody, who is trying to get their hands on those power semiconductors. In addition.
There is still a healthy amount of book and ship that is.
Out there for the back half of the year, and we'll have better visibility into that at the end of the first quarter and probably <unk>.
Better at the end of the first half.
So just to be clear are you still expecting that to be supply constraints in the back half of the year.
Specifically as it relates to electronic components, and Geo, Ken can speak to the supply environment, but.
One of our objectives on this call is.
To make it clear that we're not through the supply chain issues right and I would say many components we purchase.
Are much better.
Then they were three months ago six months ago.
But there are.
Certainly still challenges on very critical components that we have to.
Procure across our entire product line, whether thats AC power or thermal.
One.
In particular as the power semiconductors, and there's long lead times there and.
We don't have great visibility, we do anticipate that improving as we go through the year, but our visibility there probably is.
In a matter of quarters not a matter of.
Looking out a year is going to potentially look like.
Yes, I can comment further thank you can I have it in Asia. So we have on the supply side of things too.
The two assets at the same time par level, one is us getting of course stronger more robust as we explained we have strengthened our SIOP processes we have.
We have made our supply.
Network and and.
Supply base more.
Resilient with.
Multi source components and also sources supplies.
But at the same time the market will be improving is certainly not.
Normalizing that uses the same the same time on the on the supply side, and especially US as Dave was saying everything that has to do with the Pos and they come back to us but.
The past semiconductors.
President and lots of things lots of the things a lot of the components, we use the not just as such but components in the in the components.
With purchase so we believe we are stronger.
We believe we have figured a lot of things out during the course of 2022, but by all means the messages.
It's not that everything is perfect out there that's still it's still it's still a complicated market.
Much better equipped to navigate in that two to navigate in that market.
Great great. Thanks very much.
Okay.
Thank you.
Next question comes from Steve Tusa with JP Morgan.
Hi, guys how are you.
Hello, Allison and very well.
Can you talk about maybe some of the levers on cash into 'twenty, four and kind of where normalized normalized free cash would would land for you guys. In the next couple of years or maybe not normalize but.
Where you think you can get to on that number.
Beyond this year.
Yes. This is David so.
If you look at our guide.
For 'twenty, three and we breakdown the components I think page 33 in the appendix you can see how it kind of built up.
The most important certainly you got to start with adjusted EBITDA.
And.
<unk>.
Certainly.
There'd be an expectation for that to flow through if that's higher or lower than what we're targeting.
Putting working capital aside the other three components as Joe mentioned there is.
Some probability a variability there, but I wouldn't say significant.
Certainly if we're more profitable will pay more taxes thats, just kind of how it works.
But.
Fairly.
Certain of that.
Our capex number will come in within a range of what's reasonable with what we guided and then.
Interests are definitely subject to movement in interest rates, but.
If we have significant significant upside or slight downside it more than likely isn't going to be related to those three components is going to be the working capital component.
And if you look at the $75 million use.
For full year 2023.
We certainly assume success in some of the working capital initiatives.
That Joe mentioned.
Yes.
Working capital in and of itself.
It will be a headwind due to the 15% organic growth rate, that's just how it works.
But with that said.
It's not hundreds of millions of dollars its not a three or $400 million headwind and we're expecting very significant or.
Included in our guidance.
Very significant working capital initiative benefits, so that headwind could be $1 million or $200 million you can do the math.
And Thats based on what we think sales are going to be in the fourth quarter 23 versus the fourth quarter of 2022. So we have some provision in these numbers for.
Success with optimizing working capital, but it could end up being.
A conservative assumption.
There's still a lot of complications.
Fly chain is not.
Ill.
Back to stable. So there's a lot of challenges in front of us, but we're confident with this guidance we have provided but if you look at the 350.
Versus.
If you will and adjusted net income for the full year.
It's probably 75% to 80%.
We would target in the long run.
Being in the 90% plus range.
It's always hard for an industrial company to get to a 100% of.
Free cash flow conversion.
The expectation is to grow 10%, 15% a year.
With that said we believe this is.
A reasonable guide between a three and $400 million, but.
Is definitely room for upside if we're able to execute some of our working capital initiatives.
Quicker than what's assumed in the guidance.
Right so.
The short answer to that is 90% as you view as being normalized 90% of that income.
It'd be a long term goal.
90% of adjusted net income.
Can you get there and do you think 24.
I believe we can.
And.
Okay.
If you look at our issues, they're all very flexible right.
Inventory.
An increase this year.
We up $250 million.
It was definitely somewhat of a chaotic environment.
But we have a game plan for this year and.
That also goes for many of the components of working capital. So we have some.
Complex.
Larger orders that.
We had processed in 2022 with multiple deliverables very tactical.
Very tactical issues that we can address so.
I feel fairly confident we can get to that 90%.
Number in 'twenty, four and go forward, but.
Let's get through 2023 first and then we'll provide some insight on what we think the timing would be for that number going forward.
Great. Thanks, a lot.
Thank you.
Your next question comes from Jeff Sprague with vertical research. Please go ahead. Your line is open.
Good day everyone.
Two questions one of them.
We'll just pick up where Steve.
These low score.
Just thinking about the actual process of deleveraging here and if there is any.
Any leakage in the equation I know, there's always noise at year end, but it looks to me like net debt only declined by about a third of what the free cash flow was in the quarter. So there's no like other uses somewhere which I haven't figured out at that time to today to try to sort that out but.
Yeah, if you do $350 million of free cash flow in 2023, and we should expect something in the neighborhood of.
Deleveraging net cash.
The.
Improvement kind of in that range.
Yes.
The significant use outside of free cash flow in the fourth quarter, Jeff was related to the tax receivable agreement there was a $75 million payment in the fourth quarter, which takes that off our books completely.
<unk>.
If you look at the leverage if you look at the math at year end and Youll get a trailing 12 month EBITDA number I think our net debt leverage is about five six which.
Certainly.
Is much higher than we would like but if you look at that.
Same ratio looking at a forward looking EBITDA number.
Meaning the <unk>.
Approximately 865 of EBITDA I anticipate it for 'twenty three.
It's about three five times levered.
And then if you assume the $350 million of <unk>.
Expected free cash flow.
Is used to delever, whether sitting in cash on the balance sheet or to pay down debt.
The net leverage gets down to three times, so if we execute.
Upon our plan in <unk>.
2023.
Relatively quick path to that deleveraging and our long term goal is to keep leverage between two and three times, we're willing to go either below or above that range for specific reasons, but.
In general if we execute what.
What we have on paper here in 'twenty, three we should be closer to three times levered as we exit 'twenty three.
Great. Thanks for that and then just.
Back to just kind of business conditions.
Back on slide five.
Comment that the pricing environment remains favorable and many of our product segments sort of implies that is not favorable.
Others could you just maybe.
Talk about the.
The tenor of price on new incoming orders in and where there might be softness if you're implying there is some softness in that statement.
Okay.
Well there are two.
Two different dynamics at play one what I mentioned as our pricing muscle so a inability to better price for the value that we deliver we deliver to our customers.
So thats something that will always be there and something that we did not have at least in north.
The efficacy that we have.
Now in the past.
So that stays.
I think that Shouldnt read the phrase on the negative side.
<unk> is despite.
In an environment in which we see.
Let's see on the cost side in general.
Moderating inflation, but inflation Nonetheless, we still see we still see that in many parts of our business.
We still can continue to work the price the price lever.
And that's what we're doing when it comes through 2023 in particular.
A big chunk of our prices are already in our backlog.
That price in our backlog of course.
<unk>.
Very important for us.
To deliver on now on our guidance, but also the price of that is not.
And the backlog is a price that we see being realized.
<unk>.
The order that the orders that we are undertaking but.
And I expect over time, a normalization also in tons in terms of price and when that happens.
And it is not necessarily now in the market because again.
The inflationary trends are still there when that happens we are better equipped with the with.
But with an ability to price for value.
Great. Thank you for the color.
Thank you. The next question comes from Lance Vitanza with Cowen. Please go ahead.
Hi, guys, Thanks, and congrats on the quarter I had two questions. If I could the first is actually back on slide four the market environment and I was hoping you could drill down a little bit more on the EMEA, which cloud Hyperscale, EMEA, which moved from green to yellow and GL could you.
Could you talk a little bit more about what's driving that change and is it linked to fears around an economic contraction or has that market just becomes somewhat saturated and then I guess is the next move do we think is it more likely to be a move from yellow to red or do we think it's more likely to move back to green.
Thanks.
Well as I was saying.
It's.
We could have a very sharp eye on although the signals in this moment in which the order the order dynamics.
Very dynamic as we as we explained during the <unk>.
We were going through the <unk>.
<unk>.
We have no signals in this moment that would tell us at this moment that would tell us that there is.
Red looming behind the colors that you see here, but again, well keep our eyes wide wide open.
In case something changes when it comes to the EMEA, we see it more.
Of all the change of mix between cloud Episclera and co location as I mentioned in one of our in my comments earlier and.
And again.
It simply is simply a change of mix between what our Hyperscale and cloud providers build.
For their own direct infrastructure vis vis what they leave.
And any color may may flip.
I would not.
We dramatically into that just to say hey, EMEA is going through the same type of order normalization.
That signal I mentioned already.
We'll.
We'll see how that plays out.
Okay and then just lastly for me you mentioned actually I think it was David you mentioned that with Eni that there might be a need for some more tactical work. There I was wondering if you could flesh that out a bit and then with respect to the backlog I think you said the backlog was up like 100 plus percent.
I'm wondering if you could break that out a bit in terms of U S versus EMEA versus Asia Pacific. Thanks, guys.
We may not have time to go into the details by region here when it comes to the backlog.
But I must say that we are very very happy about the sales leverage that we are obtaining expanding the adding the eni portfolio too.
Broader but if you go to market and indeed, if you will we've been also quite surprised by how strong the market reaction has has been.
So with that and it is.
Dave was mentioning we are expanding capacity, we are expanding capacity quite quite vigorously specifically for eni. The rest is about acceleration to accelerating the integration, making sure that the same rigorous.
Execution.
Approach that we are instigating for full vertical as a whole is applicable is applicable to eni and continue to drive continue to drive trucks.
Thank you. This concludes our question and answer session.
I would like to turn the conference back over to you.
Joe Janet Albert <unk> for any closing remarks.
Well.
Thank you thanks to all of you for joining our call today.
I really appreciate the support.
And very much looking forward to reporting out on our Q1 2023 progress so stay tuned and again big Thank you.
Thank you.
Conference has now concluded thank you for attending this presentation.