Vertiv Holdings Co (VRT) Earnings Call Transcript & Summary

Perfect. Good afternoon, everyone. My name is Amit Daryanani. The IT, hardware and networking analyst here at Evercore. Delighted to have with us Vertiv here for our next fireside chat. And from Vertiv, we have David Fallon, the Chief Financial Officer; and Gary Niederpruem, the Chief Strategy and Development Officer, with us today. We will keep the fireside chat around 30, 35 minutes. I'm going to spend the first 20, 25 minutes, start with going through some of the questions I have prepared for them. I'm happy to open up to the audience from there. [Operator Instructions] So with that, thanks a lot, gentlemen, for being here. I appreciate your time. And I think before we kick off the whole session and I get into all the questions I have, David and Gary maybe we'll talk, spending a few minutes just talking about Vertiv 101 a little bit and talk about what the key financial targets that you tend to focus on.

Sure. Why don't I -- I can start just on the Vertiv 101, and then, David, turn it over to you certainly for the financial information. So Vertiv is a carve-out historically from Emerson. So we operated as Emerson Network Power for a number of years. And then about 5 years ago, we carved out Emerson Network Power from Emerson, rebranded ourselves Vertiv and it's that point in time when Platinum Equity came into the picture and bought us. So we were effectively a self-contained entity of Platinum for the better part of 3 or 3.5 years. And then about 2 years ago, almost to the day, we met Dave Cote in his Goldman Sachs SPAC that we worked with, for probably the better part of 6 months to complete that transaction. And then in January, February of 2020 is when the deal closed and when we started trading on the New York Stock Exchange. So to bring you up to present date, we're just north of a $4.5 billion company, trading under the VRT ticker symbol. And really, I meant what we do is -- what we tell everybody we do is provide critical digital infrastructure or data centers, communication networks and then light commercial and industrial applications. We have -- a lot of things we do in the portfolio, but fundamentally, the biggest pieces of it are, we provide clean power and battery backup for all of the sense of electronics that are in data centers and telecommunications network. So there's power management piece. Once you power all of those electronics, they certainly give off heat, so you need to remove that. So we have a big piece of our business that's in thermal management. We have a large chunk of our business that would be inside what we would call the white space of a data center, so racks and single-phase UPSs and rack PDUs is another part of our business. And then we have a really large service business that's almost $1.5 billion that would monitor, maintenance and install and maintain all of our products. And then we have, from a geographic standpoint -- we'll just wrap that up, and I'll turn it over to David. About 50% of our revenue is in the Americas; about 30% of our revenue is in Asia Pacific; and then about 20% of our revenue is in Europe, Middle East and Africa. So what we tell everybody really is all of the products and services that we offer are relevant to each 1 of the 3 end markets that we participate in. And each 1 of those end markets are pervasive in each 1 of the regions and geographies we play in. So that's sort of the stitching and the glue that holds the portfolio together. So David, with that, I'll turn it over to you to talk about the financials for a little bit.

Yes. And so if you start at the very top, and any time you talk about financial targets, you talk about the targets that are tied to compensation. So from the perspective of the incentive compensation program that we had for executive management and several layers lower, the 2 metrics that drive the annual incentive comp is adjusted EPS and free cash flow. So not too different than many companies, but we are identifying metrics that are aligned with shareholder interests, and we're predominantly all shareholders as well. So performance from a trailing perspective on those metrics are foremost in our planning sessions and what we do for the current year in the long run. Now if you take it 1 level lower than that, from a profitability perspective, we obviously have the goal of growing 1.5x the market. That's the top line goal for us, both short run and long run. And then when you look at the flow-through from those sales, we have a margin expansion initiative. We're currently about 12% adjusted operating margin for 2021. Our goal is to get that to 16%, which is where we think our competitors are, and then in the long run to 20%. And that's probably another question, but there's a lot of different moving pieces to get there. And then part of that is fixed costs, and our goal is to keep fixed costs flat on an ongoing basis.

Perfect. Thanks a lot of for that overview. And David, I think there's more than a few -- or 1 question on the margin expansion targets that I've lined up for you. So we'll go through that in a bit. Maybe I want to go back to -- you talked about 1.5x -- your target to grow top line, 1.5x the underlying industry, which 3% to 5% is kind of what we've talked about historically. Maybe expand on that a little bit for us and help me understand what is enabling that? Are you just going in the right end markets that are growing faster and you over indexed? Or is it more share gains? Maybe touch on kind of what's driving that. And then on the share gain side, where are they coming from? The bigger guys, the regional guys? Just any color there would be helpful.

Yes, absolutely, Amit, I can take that, and, David, please add any color as well. So I think there's a couple of different dimensions to that. You touched on several of them, Amit. So the first is we -- or have put a really big focus in the company for the last couple of years on growing in 2 specific segments. So we want to grow in all the segments, but when you look at where we really have put additional horsepower is one is growing with the cloud and colocation folks in the data center. So we think that the overall -- we think that the market for where Vertiv products and service plays is, to your point, grows probably 3% to 4%. The data center piece of that is probably in the 4% to 5%. But if you disaggregate even that data center piece, the enterprise piece of that, inclusive of some of the IT channel stuff, probably is about flattish. If you look at the cloud and colocation segment of that, though, that's probably growing at 10%, give or take, a couple of percentage points. So we have clearly put a lot of horsepower and effort to grow fast in that cloud and colocation market. And the numbers would demonstrate that we've been really successful in that. So we're going to continue to double down there. So we'll certainly get some updraft because we are pivoting towards that fast-growing part of the market. The other piece of the market that we're focused on is this IT channel piece. And while that business probably grows at 3%, 4%, 5%, we have less than 8% or 10% share in that space. So there's a lot, a lot of runway for us to be able to take market share specifically in that IT channel space. So we think that with those 2 dynamics playing out at the same time, being -- learning how to be ambidextrous and calling on both, the big folks in the market and the littler folks in the market, those 2 dynamics right there will naturally give us some uplift above and beyond just the regular market growth. And then in addition to that, and we've been pretty vocal about our ability to add R&D to the portfolio where we sit today. So if you go back a couple of years, we probably spent 3% of sales on R&D. And we've been inching that up every so much over the last couple of years to the point where I think we're just above 5% or so of engineering spend to sales right now. And that is certainly more than the competitive set. So we feel that with the go-to-market initiatives that we've had for the last several years, pivoting towards the faster-growing segments of the market, and then you overlay that with increased investment in R&D, so we could be closer to our customers and churn out more products that are more customer-focused. The combination of all of those things is what gives us pretty good -- a really pretty good feeling that, that 1.5x of market is certainly attainable, not to mention the fact that we've demonstrated over the last 2 years now that we've been able to grow more than 1.5x the market. And that was before a lot of this R&D investment team into the company. So put all those things together, and we feel really good about that as our top line growth trajectory.

Perfect. Gary, that is really helpful and actually go -- take you to my next point, which is a consistent discussion I end up having or ultimately having with me is how are Vertiv's products different from their peers? I mean I think about this R&D going from 3% to 5% to 6% -- and I'm sure we could spend the next 30 minutes talking about how your products are different from every one else's, but what are the 2, 3 things that enable the differentiation that you call out? Where are these investments going? Maybe just elaborate on that a bit more for us.

Yes. No, you're right. We could definitely set up a whole another fireside chat just on that 1 question, without a doubt. When I think about it, I think there's a couple of big differentiators. One is the breadth of which we offer. So other people will offer power, other people will have bits and pieces of the portfolio, but nobody has a lot of what our customers come to us for besides power is the thermal management piece of it. And so that's a very complex system that you need to make sure is tuned very, very specifically for the applications. So just having the breadth of those products in the thermal world, and now we can do anything from talk to our customers about liquid cooling, which is an emerging but very small technology, but we think is going to grow a little bit, to do you want to cool something at the room level, at the rack level, at the row level or at site level, we are really the only ones that can expand that entire gamut or spectrum of how you pool those data centers, which is super important because a lot of the OpEx in the power consumption comes from the cooling units. So you want to make sure you have an expertise around that. So that clearly is one. Number two is you think about the controls in our units. So both the controls in our thermal unit and the controls that we have in our UPS unit. So where we're advancing to from a UPS standpoint is we want to be able to -- today, utility power comes in, that's what feeds the UPS. Tomorrow, we can definitely believe in a world where whether you have solar and/or wind and/or fuel cells and/or generators and/or batteries and/or energy storage devices, the UPS needs to have smart controls and algorithms to know when am I going to draw from which power source. So we're working on those real time right now. So you think about you have the thermal units, which the breadth in the portfolio that we have is definitely a differentiator. And secondly, you think about the controls and the algorithm that goes into the thermal and the power side. And then the last one would be, think about our service organization, having 3,200 field technicians around the world that not only provides a nice uplift from a financial standpoint, but they're really sticky with our customers. We're in our customers' location every day, learning about our products, how they operate, our customers, what applications are running. And so being that close to the customers, you just can't replace. And that provides for a really good feedback loop for us of what we need to do on the next product development cycle. So I could talk for 30 more minutes on any given 1 of those, but I'll sort of stop there with those 3 big themes, I guess, and turn it back to you.

No, that is extremely helpful for me to actually answer this question when I get it next time. So thank you for saving -- making my life easier with my forward discussion with clients. Maybe I'll go to the growthy part of the house, the cloud, the colo business that we have, right? It's about 30%, I think, of revenues, give or take. And it has really remained very strong, I think, throughout the pandemic for you and for everyone else. Can you just talk -- I mean, I need to understand what drives the strength in public cloud broadly, but can you talk about the durability of the growth you're seeing there? And how much of the growth you're seeing specifically in cloud is end market versus share gain driven?

Yes. So I'd say a couple of things. So we definitely continue to lump cloud and colocation sort of in a grouping together. And the reason we do that is the cloud classic customers can either choose to build their own data center or they can choose to lease that data center out to a colocation partner. So we'll always talk about those things pretty much in tandem. And that segment, you're right, that has grown tremendously in the market. It's grown even faster for us inside of Vertiv over the last couple of years. And throughout the last 3 or 4 quarters and everything we see for the next couple of quarters suggest that there are no signs of slowing down right now. When you take the fact that underlying data traffic is going to grow at 22%, 23%, 24% CAGR every year on a really large number, that data has to go somewhere. And that is the biggest advent of what's driving cloud. Think about all of -- we've said it so many times, but literally, these phone calls, my family is on -- I think we had Netflix a year ago. Now we have Netflix and ESPN+ and HBO+ and all these other things. And I didn't want to look at my credit card bill anymore because there's always these pluses that keep coming out of them. But all of that, every time somebody signs up, that's more demand for a data center and more demand to push power and compute and storage closer to the consumer. So I don't think we're going to see this slow down anytime soon. Now could there be a couple of quarters where digestion occurs? Yes, there could be. But the -- as long as the underlying fundamentals of data traffic's continuing to grow at 20%-plus rates, that will continue to signify that the market is in a really, really healthy position.

Perfect. Maybe if I just stick to the cloud discussion for a bit, a content concern people tend to have is margins -- operating margins broadly, gross or operating, really, lower on the cloud side versus the rest of the industry. And I see a -- I personally have examples of companies that actually make more money in the cloud than anywhere else. But I'd love to know how do you guys -- how do you folks look at it? Is cloud a lower margin proposition, gross and operating for Vertiv?

Yes. I think there's a couple of interesting dynamics as we do get that question quite a bit. So the first thing I would say is when you're dealing with that class of customers, more often than not, we're going to be selling them a solution, which oftentimes also means we're going to have a large part of third-party content that is in that solution. So we'll buy generators and batteries and some other third-party items that you notionally just can't mark up as much as you do your own organic content. So from a solutions mentality, if you were to break down that bill of material, you would see our organic product at margins that are commensurate with sort of fleet average. But then you would see a lot of third-party gear that is only marked up an appropriate amount of 10% or 20% or something like that, so that's going to drive the overall margin of the solution down just because of the third-party content. So that's one thing that it's really -- it's more of a percent gain, but our organic content is, within that solution, pretty healthy margins. So that's sort of number one. Number two is a straight-up UPS or a straight-up thermal unit, yes, there's a little bit more price pressure in that domain. However, it's within a sort of a standard deviation. So if our fleet average is 35%, it's not like the hyperscale and cloud folks' margins are at 15%. I mean it's 500 basis points lower, 700 basis points lower or something like that. So it's sort of within the standard deviation. The offset to that, though, is two things. One is our service business still is relevant to the cloud and colocation folks. So we'll still get service contracts. And they might look a little different than a traditional contract, but the margin rates of that service is still really pretty accretive to the overall company. And then lastly is, from a portfolio standpoint, that's also why we want to sell more into the IT channel, because the IT channel business, for us, operates at least 1,000 basis points higher than the fleet average, which more than offsets any headwinds that we see from some of the hyperscale folks. So I would say, in general, is -- the answer to the question, is it a little bit more price competitive in hyperscale? Sure, it is. We don't have our head in the sand around that topic. But some of it's because of the solution orientation nature of that sell, some of it is offset because of service and some of it -- and the rest of it is going to be more than offset by our growth in the IT channel.

No. It's totally fair, Gary. And I also got to imagine that you're selling to a smaller number of people there, so hopefully, the sales and marketing expenses are somewhat lower than selling to thousands of enterprise SMB customers and so on.

That's exactly right. So while the GP may be a little bit lower, the SG&A to service those customers is low as well. So from an operating profit basis, it's really -- it's still really, really good business for us. And think about a lot of our business over the last 4, 5 quarters with enterprise hasn't been depressed, was to telecom and cloud and colocation and we still exhibited margin expansion over the last couple of quarters, while most of the business was shifting towards cloud and colo at the same time.

Yes. Absolutely. And maybe if I move towards the enterprise and the small medium business kind of part of the house. And it's about -- I think 1/2 of your revenue actually come from this bucket. Just talk about what are you seeing in this marketplace, because -- and really the question is around what do you see in terms of a recovery phase in this marketplace? Enterprise SME was the hardest hit through the pandemic, I think.

Yes. No doubt. So when Dave and I talked, we loosely will sort of put this into 3 buckets. Bucket 1 would be the class of enterprise customers that we're spending even during COVID. So education, big box, retail, government, medical. Those verticals within enterprise sort of spent even during -- amidst COVID. Bucket 2 then are the class of customers that we have seen really now start to come back online after taking a 12-month pause. And so that would be a lot like manufacturing and service-oriented companies. So there's a lot of companies that have said, "Hey, either I'm just about to go back to work, and so I need to upgrade my IT closets for my office facilities," or "I really didn't want to do anything in the manufacturing environment because I wasn't sure what tomorrow is going to bring, but now I know I'm going to institute more robotics. I know I'm going to have more IoT work and so I want to upgrade my manufacturing facility." So that's sort of bucket 2, and we have seen that come back over the course of the last several months. And that was the biggest thing that led us to really upgrade, on our last quarterly call, the enterprise market from red to yellow was this bucket 2. Bucket 3 then are the customers that we've not seen come back just quite yet, but we think we're getting close. So that would be more regional or local retail environments. That would be hospitality, travel and entertainment type of folks. So we haven't seen that come back just yet. But just seeing how the economy is starting to open back up, and you look at occupancy rates in hotels and airplanes, they're really starting to get much healthier than they were. So we would anticipate over the course sometime over the next couple of quarters that, that third bucket of customers would start to come back as well. So that's really real time where we're seeing it and why we chose to upgrade in the last quarterly announcements, and this bucket 3 will probably be that last frontier, which we think we're starting to see a little bit of signs of life, but still just too early to do anything about it.

Got it. Perfect. I have a few questions here from the audience on the call here, so maybe I'll try to weave some of these in. Maybe on the enterprise side, there's a couple of -- I guess, are you seeing enterprises starting to move back from -- away from the cloud back to on-premise? Is that a trend you're seeing at all? And I'll tell you, I mean, those are really big white paper, but I had [ recent to harrow ] that kind of said this maybe a sense for some companies recently. So I'm curious, one, are you seeing that? And then secondly, we've talked on parts of it, but if a customer moves a workload from the enterprise to the public cloud, what does that mean for Vertiv?

Yes. So it is fascinating. The debate between sort of on-prem and off-prem is almost a religious debate to some extent for a lot of people. But there's no doubt that customers, even like Vertiv are moving more and more of our workloads to the cloud. With that said, there are so many customers now that are getting to a size and scale where they start to question, well, maybe I need to bring this back in-house because I don't want to be holding -- people holding to just 1 cloud person or 1 colocation provider. So we really think that the reality of the situation is the hybrid environment is going to be where most of this stuff settles out. So you will always have things on-prem, you will always have things in cloud and you always have things in colo for a company of any general size and scale. So we have seen some companies that have pulled back from cloud deployments and said, I want to do it themselves -- I want to do it myself. We have seen other people accelerate it. So I just think -- you can find an exception to any rule, but in general, this hybrid cloud computing environment is going to be, in my mind, where the answer is because it's going to be -- you're going to have data everywhere for a number of different reasons, whether it's GDPR, whether it is for regulatory purposes, whether it's going to be for latency purposes, you're going to have data in a number of different locations, and that's probably just the facts of it. To your question about if somebody moves an application from on-prem to off-prem, really, all that does is just say, "Hey, look, yes, there's going to be more workload that is in the cloud or colocation environment than somebody is on-prem." But what we see is there's a limit to what people can move on-prem to off-prem for a number of different reasons. And so back to our other point before, the amount -- take a bank in example. Between the regulatory environment and between the vast amount of data that continues to come at them every day, they are outsourcing more and more to cloud and colocation companies, but they are also having to build out data centers themselves. Just because the data is so immense, the amount of data is so much, they have no choice but to use all 3 vehicles to be able to support their data needs. So that's -- the hybrid environment on that to me is really the answer, which is great for us because that plays into edge, enterprise, cloud, colocation and obviously, we service them all.

Perfect. And maybe let's go back to the margin -- operating margin discussions for the company, right? We're at 12%. And I think the aspirations David talked about, going to 16% and longer term to 20%. I guess I'd love to understand how much of that margin expansion, let's just say, 12% to 16% near term, is revenue-driven versus self-help lever? And what are the big self-help levers, the 2 or 3 things you would call out?

Yes. So as we're kind of discussing it at the outset, the 12% to 16% -- the 16% is kind of a weighing station, right? We are looking at that only because that's where we think our competitors are at. And there's no reason we should stop at 16%. And our goal really is to get to 20% plus. But we got to get to 16% before we get to 20%. So internally, if you look at our financial statements, it's different from a GAAP financial statement. So we break down our P&L between sales variable costs, which are probably 10 or 15 different accounts, including direct labor, direct materials, freight, commissions, a handful of others. And the result of that is a contribution margin. And then we include all of our fixed costs in another bucket, and those fixed costs include anything that is truly fixed or maybe a hybrid fixed and cost of sales or SG&A, okay? And we see -- if you look at the fixed cost as a percentage of sales, that's where we will definitely get leverage with the top line growth. And if you do the math, and it's probably a separate call to kind of talk about the culture and how you execute fixed cost constant, but if you do the math there, even if we grew at a conservative 4.5%, 5%, you keep the fixed costs flat, you're going to get 75 to 100 bps of margin expansion each year just from that. And if you grow more aggressive than that, of course, the drop is going to be even better. So unquestionably, a central thesis to the margin growth is going to be correlated to top line growth because of leveraging those fixed costs. And I can get into the whole philosophy of the fix cost constant. But we also see opportunity with the contribution margin. And the 2 levers that we most frequently talk about is continued productivity on the purposing side. It's -- we've only developed internal [ first time ] global organization over the last couple of years. And we're getting tens of millions of productivity each year from purchasing effectively managing that organization and leveraging the $4.5 billion or $5 billion spend as opposed to previously really looking at it as 20 smaller purchasing organizations. And then the other lever, which has been getting a lot of attention more recently is from a pricing perspective. That is something that this company historically kind of convinced itself that if we were flat on a pricing perspective, it was a good year. We've leaned into that and taken a more of a strategic approach to pricing. And as a result, we got about $25 million in pricing in 2019 last year between 15 and 20. And certainly, partly because of -- due to a response with the inflation we're seeing in '21, we should be a lot higher than that this year. And we've talked about the timing of the commodity and freight inflation has actually been somewhat beneficial to us because it forced us to see what is the art of the possible from a pricing perspective. And I think what we've learned over the last 3 or 4 months is that we probably have more pricing power than we had previously thought or wanted to risk for customers. So that's something that certainly is going to benefit us going forward.

Yes. That is extremely helpful, David. And I can see the winning now, winning later booking behind you. So I'm sure there's a lot of insights over there in terms of how to manage the cost structure. I guess you mentioned this towards the end of your discussion, but maybe talk a little bit on the supply chain dynamics, right, what is happening over there? Are you able to hit the revenue that you want? Are you having some issues over there? And then maybe just continue this pricing discussion because to your point, you are raising prices. Do you think this could be a more durable dynamic that perhaps folks don't appreciate about the working narrative is, pricing power could start to come back in the model.

Yes. So first of all, I think every industrial company has been impacted by inflation and probably every company in every industry. But we're certainly not immune from that. And just to kind of quantify what we had implied in our most recent guidance was about a $45 million headwind related to commodity and freight and probably more skewed to the commodity side, but freight in certain regions, notably the Americas, has been a little bit more of a challenge than in others. But what we had included in the guidance we shared after the first quarter was about $25 million of pricing to offset that. So that's about a $20 million hole, if you will, in 2021. But we do believe that, that $25 million is probably a -- more of a floor than it is an expected value. So we believe there's more opportunity for us for pricing. We may not get to complete parity in '21, but we do believe as we exit Q1, Q2, we should be able to offset what we're seeing from a commodity side. And then from your perspective or from the perspective of your question, there is a potential tailwind for us if inflation subside and we're starting to see some of that actually already from a pure commodity perspective. It's not going -- it's not declining or anything, but over the last several weeks, we've seen a little bit of a plateau. But to the extent it does go the other way or it does rebound from a commodity perspective, we actually could see a tailwind from a pricing perspective. Because historically, when we've done this, there is stickiness upwards. And we're certainly not anticipating commodity cost to subside anytime soon, but that could create a tailwind for us going forward. So it's certainly a dynamic situation. We are leaning in a lot more aggressively now than we probably were 6 months ago. But we feel pretty confident with what we've implied with our guidance, but we'll give a little bit more of a robust update with our Q2 earnings.

Perfect. I look forward to that, David. Unfortunately, I think I'm past my time here, and I have a few more questions still to go. But I'll stop here, nonetheless. I want to turn the floor back to you, David and Gary, and see if there's anything I did not touch and I did not cover that you think investors should really be cognizant about the Vertiv story. I'll turn the virtual mic back to you folks to kind of cut some closing comments.

Yes, I'll start and let Gary add. I mean we're obviously very excited about this story. And we probably could write a book, not at par to Dave Cote's book, but just the transformation that we've gone through over the last 3 to 4 years and certainly has been accelerated since we had -- we de-SPAC-ed and a lot of that is due to the guidance from Dave Cote. But we run the business for the long run, and we're in the right industry. If we do what we're supposed to do, the growth is going to be there. And then from a margin perspective, we do believe -- we trade at a discount from a multiple's perspective from a lot of our peers, a lot of the industrial peers. We think that's because of that margin gap. And that's very high on our list to attack and exciting story and appreciate the support we get from you and others to help spread that story.

So for -- yes, I think David summed it up very well. My 2 themes I think, Amit, would be we are in a good position in a great industry and/or a great position in the good industry, either 1 sort of works in our case. So that fundamentally will provide us runway on the top line. And then for as proud as I think David and Lynne and I are for what we've accomplished the last 3 or 4 years, there's that much more to do over the next couple of years. So the runway is -- there's more runway in front of us than there are still is behind us, which is the exciting part of the whole thesis. So couldn't be happier to be here and to see what we deliver on over the next couple of years or so. And thanks for having us today.

No, thanks a lot. And I can't wait to see what you guys accomplish in the next year as well. But thanks a lot, and we'll wrap it up with this.

Thanks, everyone.