Vertiv Holdings Co (NYSE:VRT) Q4 2022 Earnings Call Transcript

Vertiv Holdings Co (NYSE:VRT) Q4 2022 Earnings Call Transcript February 22, 2023

Operator: Good morning. My name is Brica, and I will be your conference operator today. At this time, I would like to welcome everyone to the Vertiv’s Fourth Quarter, Fourth Quarter and Full Year 2022 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. Please note that this call is being recorded. I would now like to turn the program over to your host for today’s conference call, Lynne Maxeiner, Vice President, Investor Relations.

Lynne Maxeiner: Right. Thank you, Brica. Good morning, and welcome to Vertiv’s fourth quarter and full year 2022 earnings conference call. Joining me today are Vertiv’s Executive Chairman, Dave Cote; Chief Executive Officer, Giordano Albertazzi; and Chief Financial Officer, David Fallon. Before we begin, I would like to point out that during the course of this call, we will make forward-looking statements regarding future events, including the future financial and operating performance of Vertiv. These forward-looking statements are subject to material risks and uncertainties that could cause actual results to differ materially from those in the forward-looking statements. We refer you to the cautionary language included in today’s earnings release, and you can learn more about these risks in our annual and quarterly reports and other filings made with the SEC.

Any forward-looking statements that we make today are based on assumptions that we believe to be reasonable as of this date. We undertake no obligation to update these statements as a result of new information or future events. During this call, we will also 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.vertiv.com. With that, I’ll turn the call over to Executive Chairman, Dave Cote.

Dave Cote: Well, 2022 was quite a year of transformation at Vertiv, a year focused on driving price, Americas improvement and progress on a high-performing culture. After a very disappointing 2021, we developed an ambitious plan to turn around the performance of the business over the next four quarters. 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 have consistently said the fourth quarter ’22 performance will position us well for ’23, and we believe that it has. We are increasing our view on 2023 adjusted operating profit guidance primarily due 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 demand environment continues to look good, and we’re entering 2023 with significant backlog. Gio’s focus on improved execution on everything is already apparent, and it certainly demonstrated in the improved performance in the Americas. I’m very excited about where the Company is headed with Gio’s leadership. So with that, I’ll turn the call over to Gio.

Giordano Albertazzi: 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 executional rigor and productivity, combined with the intensity that fosters a high-performance culture. And we are on Slide 3. 2022 was certainly a story of two halves, the first half painful when we did a lot of the hard work needed for acceleration and the second half strong with indeed a very strong fourth quarter, the strongest in our history. Fourth quarter organic sales were up 22% and driven by very robust growth in 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 ended the year again with a record backlog of $4.8 billion, which firmly supports our top line 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, closed by the COVID wave there. E&I 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.

I firmly believe that to deliver on commitments is the best way to respond to skepticism. And this is 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 higher inventory due to some continued supply chain constraints. Because adjusted free cash flow is crucial, we’re instilling more rigor accountability and discipline in the whole process. David Fallon and I are keenly focused on this. Let’s look at 2023 our guidance a significant step forward, a significantly improved performance. Our organic sales are expected to increase 15% year-over-year at the midpoint of guidance, mainly because of foreign exchange, we are raising our AOP guidance from the $730 million to $750 million we announced in October to $750 million to $800 million, now over 75% increase year-over-year.

We’re guiding to $300 million 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 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 4, and let’s 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 and hyperscale providers may swing a bit between building capacity in-house or outsourced to cloud providers.

So after the two categories should be looked at together. Our Asian market views remain consistent with last quarter. We have operated in a quieter market environment in Asia for 2022. I’ve recently visited Asia and I have to say, I’m pretty encouraged by what I saw and heard on the ground. For example, India 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 their height over the last couple of years, they are still growing and investing at a healthy pace and one that supports our trajectory of business. We have discussed periods of digestion before. Certain customers are digesting their capacity. But this is a normal part of the cycle, and they typically digest at different times, which smoothes the overall impact in the market.

Additionally, spending is being directed to higher-density loads, such as artificial intelligence which demands more compute power and the need for additional infrastructure. We also believe that there is a normalization of orders that is happening as supply chains improved and lead times reduce. As this continues, customers are likely going to return to more normal order behavior. That is good for the industry overall but they make order comparatives look more negative than what is really happening in the market. We remain cautious on the enterprise. Now 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 U.S.A. or at least a period of 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 5. Customer demand still feels good. This is also confirmed by conversations with our customers around the world. Levels of investment and demand for our products and services continue to be healthy. We had signals — we have signaled that fourth quarter year-on-year orders growth would be negative given a very strong comparison in the prior year, and that is what happened. As an example, 4Q ’21, we experienced an order growth rate of more than 100% in Americas.

We expect to see the same in 1Q 2023 with a tough comparison with the prior year when orders were up 34% and now an environment where customers return to a more normalized pattern of ordering. So, 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 worded partners 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 a 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 and still dealing with disruptions.

We do think a normalization of the backlog at Vertiv and in the industry in general, is starting. And we expect this to continue as customers are seeing gradual improvement in supply chain and associated reduction in the 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 continue to exercise the pricing muscle I referred to already on the 26th of October to price for the value we provide to our customers. Inflation, we 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 executional rigor we are fostering.

Supply chain continues to incrementally improve, but still not without its challenges, especially in the power electronics area. We are moving from a wack-a-mole environment to one where we are in better control also thanks to the increased supply chain resiliency, our alternative component and supply efforts are enabling. And 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 bit of wind 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 up well for successful 2023 despite navigating what could be a more challenging macro environment.

We are strengthening and I’d like to repeat this, the operating models and executional rigor in general and certainly around everything cash flow. So with that, over to David to walk us through the financials. David?

David Fallon: Perfect. Thanks, Gio. First, turning to Slide 6, this slide summarizes our fourth quarter financial results. Although fourth quarter results were lower than our expectations, looking at this slide holistically, you can appreciate the marked improvement from a year ago. As both Dave and Gio mentioned, there is 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 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. This organic growth included 12% from volume and 10% from pricing while 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 all 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 and weaker-than-expected results from E&I.

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. And 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 was still a $15 million headwind versus prior year. Fourth quarter E&I 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 a lack of visibility on costs, largely focused within a single manufacturing plant and both issues are very much fixable and are being addressed as we continue to integrate E&I in the Vertiv processes and systems. While certainly a challenging quarter and quite frankly, a challenging year for E&I, 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 150% E&I backlog growth during 2022. To support this higher volume, we are actively investing in capacity expansions at existing Vertiv facilities in Mexico and Slovakia as we continue to push E&I products through legacy vert of 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, while 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.

We certainly were 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 Gio both mentioned, optimizing working capital will be a significant focus for 2023 for Gio, for myself and quite frankly, 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 7. 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.

Otherwise, organic sales would have been up about 9%. Americas 40% organic growth, you need to say that again, organic growth was supported by 26% volume growth and 14% pricing. And each of these is an impressive number in and of its own. The volume growth was supported by launching additional thermal capacity in Monterrey, 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 were price/cost positive. Americas improvement was the most pronounced as they were the first region last year to be hit by inflation against an underpriced 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 8. We added this slide to highlight the turnaround specifically in the Americas region in 2022. Under Gio’s 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’s still early innings and still work to do, but we are pleased yet not satisfied with the progress to date.

Gio borrowed 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-20s. 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 9. 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’ll 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 — or was $95 million in the first half, but $345 million in the second half. Adjusted operating margin was 3.7% first half 11% second half. 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 the Vertiv turnaround story which we capture on the next slide, Slide 10. In this slide, nicely captures the 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 $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 2023 sales increasing 15% at the midpoint with 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 that’s up from the $730 million to $750 million range previously. And this change is primarily due to the strengthening of foreign currency from 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 is certainly significant. And we include a bridge on Slide 31 in the appendix that summarizes the drivers of this increase. And Gio 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 tailwinds are offset by an assumed $175 million of inflation.

And this includes labor. About $75 million of labor inflation is included in that $175 million. 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 2x increase from 2022, and that’s mainly driven by the improved adjusted operating profit. Adjusted free cash flow guidance of $300 million to $400 million is primarily driven by higher adjusted operating profit and optimized working capital, which, as we mentioned, will be a significant focus going forward. Gio will provide some of the additional color on working capital initiatives in a couple of slides. And please refer to Slides 31 and 33 in the appendix for additional detail on core assumptions supporting our ’23 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 2022, sequentially improving quarterly financial performance across each of these financial measures in 2023 is the expectation. First quarter net sales are expected to be up 21%, 25% organically given 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. Adjusted EPS improvement is coming primarily from higher adjusted operating profit. Adjusted free cash flow is anticipated to be a use of cash of between $50 million and $100 million. 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 and simply from the timing of payroll. Like many industrials, our 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 Gio.

Giordano Albertazzi: Well, thank you, David. Thank you very much, and we turn to Slide 14. We know that this guidance may look aggressive to some. It may as well conservative to others, but I want you to share some points that support our assumptions, our guidance. I’ll 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 30%. Additionally, there is always a lot more book and ship time and materials, services, spare parts, flow business, parts of the business that transact on a very short cycle and provide additional volume on the year. Our Q4 book-to-bill ratio was 115% and high levels that have characterized the entire 2022. Obviously, some moderation in our book-to-bill ratio is expected going into 2023 as customers return to more normalized, as I said, order pattern.

This 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. We have a pricing plan that is largely 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 cash flow now. You have heard all of us speak directly about adjusted free cash flow. We know we did not execute well in this metric in 2022. Certainly, the improved adjusted operating profit starts of off at a very different point for 2023. We have reasonable assumptions for elements that typically do not vary too much like interest back CapEx 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 price 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 for 2023 are clear, clear reflection of our priorities. We won the entire team pulling in the same direction. We are working on the culture fostering a high-performance culture where we do what we say, where ownership is clear where we hold ourselves accountable for delivering the results and we reward performance. Culture doesn’t change overnight. It is a process. 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, Ireland, the Middle East have met many people at all levels. And I’m very encouraged by what I see. People who love and care for what they do and care for 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 are primary focus areas, and we will continue to build those muscles, 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. It’s 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 by finish to 2022. The year was certainly not profit but are signs of real progress permeating 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 assertive. 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.

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Q&A Session

Operator: The first question we have from the phone line comes from Scott Davis of Melius Research. Your line is open.

Scott Davis: I really just have one main question, and it’s just related to the order cancellation of the hyperscale customer. Could you give us a little bit more color around that? 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 kind of a start of a trend, if you will. I’m not trying to be paranoid here, just. A little bit color there, I think, would be helpful.

Giordano Albertazzi: Scott, we know that paranoia is always very healthy. We try to exercise paranoia everything. And everything we do when it comes to running the business almost religiously. This is Gio. But obviously, we’re not able to share customer-specific information. But I would say, it’s it is not unusual sometimes that there are some reconfigurations in terms of what customers decide to do with their infrastructure. Having said that, of course, being paranoid, we keep an extremely sharp eye on our orders dynamics, and other now what we have signals — we signaled, we 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 nothing extraordinary.

Scott Davis: Okay. And just as a natural follow-up, I mean you’ve had a quarter now of kind of order normalization. Historically, is that typically last two to three quarters? Or is it something that is a little quicker than that?

Giordano Albertazzi: It’s hard to refer to history here because I do not think that I’ve been in the industry, as you know, for quite some time. I have never seen anything like what has happened in the industry in the last 1.5 years, 2 years. The magnitude of the combination of lengthening lead times and demand growth has driven a let’s say, desire to cover longer and longer demand periods of our customers. That is absolutely unprecedented, all in general, not just Vertex customers in the industry in general. So being able to say how that will undo or normalize, it’s very, very hard. But our expectation is that, it will probably take six months. But hey, this is a guess. We’ll keep our eyes open and try to understand how it exactly unfolds. And I’ll probably be able to tell better in

Operator: Thank you. Your next question comes from Nigel Coe of Wolfe Research.

Nigel Coe: Just David, going back to the raise guide for ’23, you mentioned FX which makes total sense, of course, with the dollar movements. But then you mentioned E&I as a timing issue, the large timing issue. Are you assuming that sort of the lost EBIT at E&I comes through into ’23. Any help in terms of the path of recovery there would be helpful.

David Fallon: Yes. I wouldn’t necessarily call the E&I issue from the fourth quarter, a timing issue. We were referring more to the sales timing for China related to COVID. All those sales were based on orders we have in hand and no guarantee we’ll make that up in Q1, but that’s certainly just a timing as it relates to E&I there we certainly expect improvement in 2023 versus what we saw in 2022. I think full year adjusted operating profit for E&I is between $50 million and $55 million. We anticipated 80 at the beginning of this year, and we certainly would anticipate something north of 80 for full year 2023.

Nigel Coe: Okay. That’s great. And then I think if you look at your 1Q sales guide, I think 21%, 22% of your midpoint sales coming through in 1Q as a portion of the full year. That’s actually the highest proportion we’ve seen since averted as a public company going back to 2018. So obviously, we like front-end loaded guidances, but does that indicate sort of inherent in it in the way you built up the plan? Or does it indicate some of the expectation of the slowing in the back half of the year relative to norms?

David Fallon: Yes. That’s a good question. I would say — if you look at the risk from a sales perspective in our plan for 2023 and very consistent with 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 challenges 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 much better at the end of the first half.

Nigel Coe: So just to be clear, you still expect there to be supply constraints in the back half of the year.

David Fallon: Specifically as it relates to electronic components and Gio 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 than 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 that’s AC power or thermal. One, in particular, is 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 a matter of quarters, not a matter of looking out what a year is going to potentially look like?

Giordano Albertazzi: Yes, I can comment further. Thank you, David, Nigel. So we have on the supply side of things to aspects at the same time in parallel. One is us getting, of course, stronger, more robust. As we explained, we have strengthened our SIOP processes. We have made our supply network and supply base more resilient with multi-sourced components and also supplies. But at the same time, the market, albeit improving is certainly not normalizing that is at the same time on the supply side, especially as Dave was saying, everything that has to do with the part semiconductors. But the part semiconductors are present in this lot of things — a lot of the components we use. They’re not just as such, but components in the components we 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 message is not that everything is perfect out there. And it’s still a complicated market, but we’re much better equipped to navigate in that market.

Operator: Thank you. Your next question comes from Steve Tusa of JPMorgan.

Steve Tusa: Can you talk about maybe some of the levers on cash into ’24 and kind of where normalized free cash would land for you guys in the next couple of years? Or not normalized, but where you think you can get to on that number beyond this year?

David Fallon: Yes. This is David. So if you look at our guide, for ’23. And we break down the components, I think, Page 33 in the appendix. So you can see how it kind of built up the most important, certainly, you got to start with adjusted EBITDA. And that certainly there’d be an expectation for that debt to flow through if that’s higher or lower than what we’re targeting. Putting working capital aside, the other three components, as Gio mentioned, there’s some probability of variability there, but I wouldn’t say significant. Certainly, if we’re more profitable, we’ll pay more taxes. That’s just kind of how it works. But fairly certain that we would — our CapEx number will come in within a range of what’s reasonable with what we guided.

And then, interests were definitely subject to movement in interest rates. But if we have significant upside or slight downside, it more than likely isn’t going to be related to those three components. It’s 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 Gio mentioned. Working capital in and of itself will be a headwind due to the 15% organic growth, right? That’s just how it works. But with that said, it’s not hundreds of millions of dollars. It’s not a $300 million or $400 million headwind, and we’re expecting very significant or including 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 that’s based on what we think sales are going to be in the fourth quarter of 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. The supply chain is not 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, an adjusted net income for the full year, it’s probably 75%, 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 100% of free cash flow conversion if the expectation is to grow 10% to 15% a year.

With that said, we believe this is a reasonable guide between the $300 million 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.

Steve Tusa: Right. So, the short answer to that is 90%. You view as being normalized, 90% of that income.

David Fallon: That would be the long-term goal. Yes, 90% of adjusted net income.