Vertiv Holdings Co (VRT) Earnings Call Transcript & Summary

Welcome, everyone. I'm Lance Vitanza, Cowen's Equity -- Senior Equity Research Analyst in TMT, and I'm delighted to have with us at our 49th Annual TMT Conference Vertiv today. It's a very exciting time for the company. I'm thrilled to have with us David Fallon, the Chief Financial Officer; as well as Gary Niederpruem, Chief Strategy and Development Officer. And before we begin, let me just mention quickly that like many of you, I am still working from a remote location. So please bear with me if we have any brief interruptions, dog barking, construction and so forth. But with that, Gary and David, thank you very much for being with us. We've got a lot to get to. So I hope we can just jump right in.

Super.

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So let's cut to the chase and talk about the current environment. In the first quarter, I mean, I apologize if this sounds like a history lesson here, but I think this is important to start here. First quarter sales were up 22%. You talked about strength in all regions and verticals, record backlog. Could we start by talking about where you're seeing the strongest growth in terms of geography, product, channel? Or if it's easier, could you just sort of walk us through what you're seeing in terms of the current outlook by region, by category, however you'd like to do it.

Yes, absolutely, Lance. I can start, and then David can certainly add some additional color as well. And by the way, there's no problem repeating history where you have numbers like 22% order and sales growth. We say that all day long. So it's great to have good numbers that you're proud of. So I think from a demand side, let's break it down by the end markets, which is how we typically talk about, particularly on our quarterly call. So cloud and colocation is really pretty strong still in every region in the world. So there will always be periods of digestion that occur from time to time. But at this point in time, we see supply and demand in that cloud and colocation being pretty well aligned and being pretty well in equilibrium. So we don't think as far out as we can see over the next couple of quarters, that there's going to be any pullback from the cloud and colocation demand. So that is really, really robust. The enterprise and IT channel, talk a little bit about that for a second. We -- it was a pretty big deal when we upgraded that from red to yellow in our last earnings call. And that came about primarily because we did start to see signs of health in the enterprise, and we've continued to see our IT channel business grow and have some momentum over the last 3, 4, 5 quarters now. So that was the reason for the upgrade. And then when you talk about our telecom business, telecom has been pretty strong also, both primarily in China and in the U.S. where there's pretty heavy 5G builds going on. We don't see quite the level of investment in sort of Southeast Asia or India or Europe just yet, but that will come over the course of the next couple of years. So we're not worried about it. That's just a timing sequence. So really, for the most part, Lance, I would say that we see most of our end markets being really pretty robust and pretty robust in each one of the major regions that we operate in. So I'm happy to have you double click, but I'll sort of stop there, so I don't ramble too long.

Yes. No, no, that's great. So I guess one of the big questions that we hear a lot is, to what extent is this sort of a onetime COVID -- either a COVID bounce or a onetime COVID acceleration that will wane now that we've got people returning to the office and so forth. What are your thoughts on that?

Yes. I don't think it is. I mean, we don't see that happen. When we talk to our customers, yes, there are always anecdotes around, hey, Zoom users went up or people did more gaming from home. So those are all anecdotal pieces of it, certainly. But I think what we've experienced in the last 12 to 15 months is just a way of life and how we're going to do things moving forward. So I don't think there's going to be any less data traffic that gets generated 2 years from now than where we sit today. And in fact, there's only going to be more. So I don't think that -- the other question we get asked quite a bit, are people placing orders right now? Is there double counting in there? Are people pulling demand in or anything? And honestly, we don't see that either. We just see a relatively well balanced environment where the supply and demand in this cloud and colocation world are pretty good. We see enterprise continuing to ramp. And with all of the work we've done in the IT channel space, we think we're taking a little bit of share there. And 5G and telecom will always be a little bit more volatile or lumpy than any of the other businesses. But we have great presence, and we have really good runway with the other regions of the world that haven't even started with 5G. So long story short, I don't think this is just a one-time pop. I think we're fundamentally in a pretty good market, and we're in a really good position in that market.

Great. And then I think you kind of answered this, but the long-term guidance that you had given before COVID, and I go back to when we launched on Vertiv over a year ago, the numbers et al reflected an underlying industry growth of 3% to 4%, which is respectable. But clearly, the market over the past 6 months is growing a lot faster than that. And so it sounds like -- it sounds like you're saying, you think that, that is sustainable. I'm not looking for new guidance, but essentially, at the end of the day, we should -- I mean, should we be thinking about something greater than 3% to 4% and therefore, something greater than the -- I think it was the 4% to 6% long-term revenue growth that you've kind of laid out as a guidepost?

Yes. Great question. So I would say, at this point, when we talk about that 3% to 4% growth, that's sort of a through the cycle number. So last year would have been a little depressed. This year is going to be a little bit higher than that, I certainly think. So it's hard to tell. We think the market last year was probably down 3% to 4%. And organically, we were down less than 1%. So we think that probably meant a little bit of goodness from a share standpoint there. This year, we think the market probably is going to be certainly in the upper end of that range, probably actually closer to 5% to 6% from what we can see right now. And I think -- and David, correct me if I'm wrong, I think with our latest guide, organic sales for this year, it's probably going to be 9% to 10%. So squarely, squarely outpacing the market, squarely in that 1.5x to 2x market growth rate, what we want to strive for. When we look out to '22 and '23, could it be a little bit north of 3% to 4%, potentially, it could be, but probably a little early to call the ball. So I think the best way to say it is, there's certainly nothing that we see that suggests that we couldn't be on the high end of that market growth range, and there's nothing that we see that suggests that it's going to be on the low end of that by any means.

And I think that's an important clarification that you mentioned a minute ago that, that 3% to 4% was always meant to be a long -- I mean, through the cycle. So certainly, there will be multiyear periods where that could be above or below that. It sounds like we're just in one of those above multiyear periods now.

Exactly right. Very, very well said.

Okay. So you mentioned the performance relative to peers or relative to the market, however you want to phrase it. And clearly, Vertiv is doing something right. Are your customers telling you anything in particular? I'm trying to get a sense for why you are winning? Is it superior product? Is it a broader portfolio of product? Is it reach and your ability to deliver globally? Is it pricing? Is it sales execution? I know you've been working on all of these areas, but what are you hearing?

Yes. So it's hard to distill it down, so I'm going to do my best and give you probably 2 or 3 bullets. So I think number one is the revamped go-to-market efforts that we have been putting in place now for the better part of 4 or 5 years are clearly, clearly taking hold. And so the way we see that is before they were -- before meaning 4 or 5 years ago, there was opportunities at our customers that we weren't even seeing. We didn't have the visibility to it. Now we see it. And we ask our salespeople who say, I don't care if there's a 1% chance of winning or 100% chance of winning, that needs to go in the pipeline. So our pipeline is much bigger today than would have been years ago. And a lot of that is because of the visibility that we have with the enhanced go-to-market effort. So that's clearly #1. But #2 is once you have that visibility, then it's incumbent on you to do something about it. And so what we've been able to do about it is the product development initiatives. And we've been very public about wanting to take our R&D spend from 3.5% to up to almost 6%. Now I think this year, we're going to be 5.2%, 5.3%, 5.4%, somewhere thereabouts, so not all the way up to 6%. But what's that allowed us to do is now that we have visibility what the customers are doing, we can jointly partner and collaborate with them, particularly in that cloud and colocation space to build a product of what they need and so I think when you have that visibility, then you double down in the R&D dollars that you are able to commit to. That only helps the product development cycle. And when you can collaborate with the customers in that product development cycle, that's a pretty powerful circle of life that we can create there. So I think -- look, there's a lot of different things we can talk about, efficiency and service technology and websites and all that type of stuff, but fundamentally, is you got to -- it's like in baseball, you see the ball, hit the ball. So we see the ball -- we see the customers, and we want to hit them with all that collaboration and innovation that we're developing.

Well, and I think for me, the key takeaway, at least, is that essentially, by going in and doing a better job of understanding what your clients' needs are, [Audio Gap] size of your addressable market, so that you're able to basically tackle an opportunity where it is growing much more quickly than the 3% to 4% underlying growth.

We have added billions of dollars to our served market over the last 3 or 4 years, Lance, just because those -- that's the visibility and the ways that we can see things today. Yes, the market's grown a little bit, but billions of dollars in our certain market just because now we see everything. And now that we see it, we can run after it pretty hard.

Great. So what about margin performance? And you mentioned R&D, and obviously, that's an important part of growing the pie. 1Q saw a very nice increase in margin, not surprising given the sales growth. And in fact, I was going to ask you, to what extent was that margin -- just the benefit of higher revenues, given the operating leverage in the business for, were there cost-outs or operating efficiencies? I know that's obviously been a big part of the game plan here is to sort of bring your margins more in line with peers. I'm just trying to figure out to what extent it was specifically that versus just the growth in the underlying revenues?

Yes. I'll certainly let David chime in. He can answer this beautifully. So...

There you go. So as you know, Lance, a big philosophy that Dave Cote has brought to Vertiv is something that he really mastered and championed at Honeywell. And that's a concept of keeping fixed cost constant, and it's fairly simple philosophy. You keep your fixed cost constant, you grow the top line and you benefit from leverage. The first quarter was a perfect case study of the benefits of that philosophy. So I think the adjusted operating margin increased almost 800 basis points from the first quarter of last year. Contribution margin, which we define as just sales less maybe a bucket of 10 to 15 truly variable costs in direct material, direct labor, freight, commissions. Contribution margin percentage was relatively flat. And fixed costs, dollars were flat. So the entire increase in the adjusted operating margin in the first quarter this year versus last year, was due to that sales leverage. And it's only one quarter and probably a little bit amplified just because the first quarter of last year was a relatively low sales quarter and pretty impressive 22% growth this year. But it's really a case study of the power of fixed costs. Now we're not going to see that every quarter. But when you go from our guidance for adjusted operating margin for full year 2021 of 12% to 16%, which is where we think our competitors are to eventually to 20%, that philosophy of fixed cost constant while growing that top line, consistent 1.5x that industry growth really should drop anywhere from 75 to 100 basis points, if not more, to that adjusted operating profit on an annual basis and even more if we outpace that growth. So first quarter versus last year, certainly driven by that sales leverage. But going forward, we have some pretty significant plans to also improve that contribution margin. And the 2 areas that has been a focus -- that had been a focus over the last 24 months, and certainly will continue going forward is productivity from purchasing. We really started to mature with a global purchasing organization over the last couple of years. And a lot of the productivity we are seeing currently is based on leveraging the $4.9 billion global spend, where historically, we did not. We really purchased this 20 $200 million companies. And then also pricing, which I'm sure you'll have some questions related to the recent inflationary pressures that everybody has been seeing. But we anticipate a continued ramp-up of contribution margin based on purchasing improvements and also pricing.

Okay. And I do want to get more into the details on the cost side in a minute. But before we do, something that comes up a lot, and I think we have some new people on the line. So I'd like to cover hyperscale colo versus enterprise in more detail. And first, I want to kind of continue to debunk this myth that Vertiv is somehow over-indexed to enterprise and under-indexed to hyperscale colo. I think people will often look and they'll see that most of your revenue comes from enterprise or more of your revenue comes from enterprise than it does from hyperscale colo, and they just jump to that erroneous conclusion. Isn't the fact of the matter that your business mix is really your -- mix, rather, is really just reflecting the overall industry composition and that hyperscale colo is becoming a bigger source of revenue for Vertiv every day?

Absolutely. And you're right, Lance. We do get this question quite a bit. So a couple of data points we can point to. So for the most part, over the last 5 years or so, our businesses consisted of about 70% data center, so 70% data center. 5 years ago, of that 70% of the data center, cloud and colocation businesses represented probably 5% to 10% of that. So a relatively small amount. If you fast forward that to today, we're probably almost at 30% of that 70%. So there's been huge, huge strides that we've made to close that gap over the last 4 or 5 years, evidenced by the 3 or 4 years of successful organic growth here. So that's sort of data points 1 and number 2 is, we think right now that the data center industry probably has about 35% of the spend going to cloud and colocation and 65% going to enterprise. So if the market is 35%, 65%, we're probably 30%, 70%. So are we slightly under-indexed the cloud and colocation? Yes, maybe slightly, but we've come from 5% to 30% in the last 5 years. So I have no doubt that we'll continue on that tour pace moving forward. So yes, slightly, likely under indexed, but really made up a huge amount of ground, and there's still plenty of room for runway as we move forward.