Vertiv Holdings Co (VRT) Earnings Call Transcript & Summary

Thank you, everybody, for joining us. My name is Mark Delaney, and I cover Vertiv for Goldman Sachs. I'm very pleased to be hosting Rob Johnson, the CEO; and David Fallon, the CFO of Vertiv. Thank you both for joining us.

Good to be here. Thank you for having us.

For those of you who don't know, the company is a leading supplier of power, cooling and IT infrastructure management solutions geared toward the data center, commercial, telecom and edge markets. Vertiv generates about $5 billion of revenue annually.

I thought to get started, we could begin by discussing some of the demand trends in the market environment that Vertiv's seen. Vertiv has spoken historically to industry growth being in the 4% to 4.5% range longer term. Is that still the right range for investors to be thinking about? And do you think the pandemic led to some pull in demand? And is there going to perhaps be some digestion as a result of that at some point in the future?

Sure. So what we see, and I'll kind of take it by the industries that we kind of work in, and I'll start with really the telecom space. And what I'd say is we continue to see robust build-out of 5G here in the U.S. We see a little slowdown in China. China did a lot of build-out during the COVID with a lot of government funding driving stimulus money, driving those build-outs. And we began to see Europe really kind of pick up and begin to catch up on the 5G. So we look at telecom, it's always pretty steady and around the 3% growth rate and continue to see that really unchanged. As we jump into the enterprise business, that's an area that we see coming back for us, and that's more closets and smaller-sized UPSs and thermal units and racks and rack PDUs. And we're seeing a lot of growth in the area of the big box stores, putting in infrastructure to compete on the web side of things. And then a lot of chain stores, so things like Starbucks and others upgrading their infrastructure. And as people go back to the office, what we're seeing, Mark, is actual replenishment of their closet's infrastructure that hasn't been needed because nobody was in the office now needing that new thermal unit or that new power unit. The real growth area, the growth -- the driver that's driven kind of our backlog and some of our order rates at the levels that they have is really the colo and hyperscale space. And we continue to see a robust need and demand for that on a global basis. I would tell you, in the past years, you'd see Americas growing and Europe digesting and Asia may be digesting. Right now, what we're seeing globally, and we'll talk about China in a minute. But globally, we're seeing just a robust market as far as we can see ahead, primarily driven by the hyperscalers that are driving colocation to build out that capacity part of them. Just when you thought Americas was full on capacity or didn't need any more capacity, you see them moving to Tier 2, Tier 3 cities in order to put latency-proof capacity in. Europe continues to be robust. We've seen at times where Amsterdam or Ireland would take a break, and those are 2 primary hubs, but we see them full speed ahead now. Germany, France, more and more countries bringing that in. Some of the new growth that we're seeing is India. India was really late to the game in putting in infrastructure, and we continue to see that. And we'll be double-digit growth over there as we see things go forward. And then even smaller countries down in South America or in Africa, we're seeing builds happen, partly driven by latency, partly driven by data sovereignty. Data sovereignty is a big issue these days. People want their core data in country for country. So we continue to see that happen. China, we talked about, was taking a little bit of a pause on the hyperscale, the Alibaba, Tencent, Baidu, by government kind of mandate to use up the capacity that they have and then drive more efficient data centers. So there has been what I would call a little bit of pause there that I think will resume in the second half of this year just to get aligned with the new standards that they're doing for data centers, data centers efficiency. So overall, we say 4.5% in the longer term. But near term, just look at and evidenced by our order rates and some of it's market share, I think we're able to get after with some of our newly innovative solutions, certainly on the thermal side, where we're seeing great uptick with that. And part of it's just the dynamic that people got behind on capacity builds. And because of the supply chain constraints, I really think this happens to go for a while, not just this year because we're not able to and the industry is not able to fulfill the capacity lead times for various components, various finished goods, not just our business but across the landscape. And we're getting 60-week, 70-week, 80-week lead times. You're not able to fulfill. So we see this spilling over into not just '23 but into '24. And we're also seeing, Mark, a lot more of longer-term order, maybe 12 months instead of people ordering 3 months or 6 months ahead to be able to make sure they get that supply.

That's very helpful and a lot there for us to dig more into. You talked about market share, so maybe I can follow up on that next. Maybe you can talk a little bit more on what's unique about the products that Vertiv has and why do you think you're taking market share?

Sure. One of the things I'd like to say first, Mark, around that is a lot of people compare us to just a couple of the big companies that you know appear in the U.S. But we actually compete more like, for instance, in our telecom business, which is a business that those companies present here don't have. We compete with names that you probably -- you certainly have heard of Huawei but maybe -- and Delta. But there's other smaller regional players that we compete on the telecom side. And we'll continue to be that loyal brand, that quality brand. And in the telecom space, certainly, we're blessed here in the U.S. that we work with the major carriers here, and we're a preferred vendor there. So we feel good about that progress. We do compete in China for the telecom business, and we do very well there, too. We've been in China for China for about 25 years. Engineer there. We develop and manufacture and service the equipment there. So that's the telecom business. If you take a look at our traditional enterprise business, it's probably more of the companies that you know, a couple of them public, but then some private companies, size of $100 million to $500 million that we compete against. That's probably more of the single phase, the racks, rack PDUs, the channel-type products that go through CDWs, the Insights, the World Wide Technologies. And we've been innovating in that space, whether it's lithium ion solutions, whether it's the Geist acquisition we made that does custom PDUs for that space, we continue to see our gain against that. So it wouldn't be again just the competitors that you know, there's several private companies in that space as well. And then on the colo and hyperscale, an area that we do a really good job in on the thermal management side. And that's an area -- just in evidence, we don't necessarily break down our backlog, but our innovative thermal solutions that we brought to market, our DSE product line, which is kind of an exclusive to us, the patented technology has taken off really well in the world that we don't want a -- we want environmental-friendly, high -- low PUEs in the data center, and we're seeing that really take hold. And then we continue to innovate with like our E&I acquisition, continue to do more modular, more integrated systems with switchgear and PDUs and our busway system. One of the nice things out of the E&I acquisition was they are a leading provider, a global provider of bus duct systems, which is now becoming very popular and almost standard item in the data center. So we feel good about our position. It's unfortunate the supply is the way it is, so there's orders that we're not taking. But in general, our innovation machine is providing new products and did through COVID and continues to do that, and we see those being well received in the market. And that helps us when we go to try to drive price, which we've been doing.

I definitely have some supply chain and pricing questions for you coming up as I'm sure you're expecting.

Those are good for David though.

Yes, got it. But one more on the market share, specifically in hyperscale. I mean if you go back in time when Vertiv was a part of Emerson, I think hyperscale was a small piece of the business. And you've been working to improve that. And I think it's shown some very good growth for you. Maybe you can level set us on your market share there. Is that now similar to the market share you have in other markets? Or is there still some work to be done on the hyperscale market?

We feel good about our position where we want to play, right? I mean I think with Emerson, it was hyperscalers had leverage on you. And unless you are innovating with them and collaborating with them, it maybe wasn't a good space. So we kind of pick our battles of what we want to do there. So I feel comfortable with how we're positioned there and the innovation. When a hyperscaler wants to collaborate with us, it's a lot better chance for us to be able to get a fair margin. When you're not collaborating and you're just doing kind of that bid type of thing, it's going to come down to things like services, which I failed to mention on the competitive side, our services really drives our overall competitiveness from that perspective. But the colocation side is where I feel like we've been really doing well. And most of the hyperscalers are supplementing or using a lot more colo today for their build-outs because they're in parts of the world that they are not comfortable building with or they just can't build out enough capacity themselves. So I think we're seeing more than our fair share on the colo side. So I'm really happy when posting up what our actual market share is, but our growth engine right now is coming from those spaces.

That's really helpful. Maybe we could dig into the supply chain a bit more. The companies dealt with difficult supply chain like so many companies have been for some time now. I think some of the constraints have been things like electronic parts, fans, breakers. Maybe you can talk about what the key constraints are for Vertiv at this point in time and when do you think it may improve.

So same thing exists today. Breakers or something new that came into the scene probably in December, supply constraints there. And I don't know if those manufacturers, there's only a few manufacturers of breakers globally if they're talking about that, but it's a real problem and it hasn't gotten any better. And I don't believe it gets better this year, I think going into next year. What we've done about that is we were kind of concentrated on a certain manufacturer. We're bringing in #2 and #3 manufacturers as well to work with there. And we have to change some things on our designs, and that takes a little bit of time. Fans, which is something that, again, most of the competitors you know that we go up against, aren't necessarily in that thermal business. But the fan area is an area of constraint. The 2 key suppliers in that area are having difficulty with supply and then capacity expansion. So we're moving -- working with them, but also moving to a third and fourth supplier as well in that space. That could get better in that second half for us as we qualify and bring these suppliers on and ramp up. None of that's baked into kind of our plan. Our guidance was based on what we knew we could get at the beginning of the year. And then chips, I'm sure all of you heard the story. It doesn't feel like because analog chips and TI provides about 70% of those to the market, they're a great supplier. But nobody wants to make analog wafers, right? They all want to make the digital wafers. So TI is coming up on plane and I think sometime mid to the end of next year, begin to see additional supply in the market for those analog chips that most of us industrials use.

I want to make sure I understood. So fans, you expect one, maybe 2 new suppliers, hopefully later this year, which could help your -- the number of options you have on fans. For breakers, it was a little unclear. Do you think you'll have any supplier ready to go this year or not?

Yes, absolutely. We brought on a second supplier. We're beginning to ship now with that. We just had qualify each custom design with that as we go forward. And we're looking at a third and fourth supplier as well because we don't see that the access to breakers are going to get any better with one of the primary suppliers out there.

Okay. That's helpful. When you think about some of the supply constraints Vertiv has dealt with, do you think it has resulted in any market share loss?

I wouldn't say -- order loss, but I wouldn't say necessarily market share loss. I think what had happened maybe early on is people decided who they wanted to do business with. And if somebody wanted to post up a better lead time, it's more about availability right now. And I think the industry has kind of leveled out now where everybody has the same capacity constraints related to supply. Therefore, while I was seeing some movement, we've taken some business. Others have taken some business, but I don't take any great deal of market share shift because of that. And right now, I'd say the whole industry is at kind of full capacity, and it's going to constrain the number of data centers that are going to be built because there's just not going to be that supply.

That's helpful. Maybe we could talk about the Americas region. There are some operational challenges that the company had dealt with around an ERP transition and some of the organizational structure and how different parts of the business were communicating with each other. Where do you stand on getting that fixed?

I'll let David talk just a little bit about the ERP and some of the process stuff and then I can talk about the organization.

Yes, sure. So I think the world knows we launched a new ERP in the Americas at the end of September, so at the end of our third quarter. And the one thing I think everybody agree upon is that there's never a great time to launch an ERP. But in hindsight, for us, it was the absolute worst time. So it was heading into a quarter where there were ample amount of uncertainty as it relates to not only procuring parts but also with rising inflation. And we lost visibility after we launched on a day-to-day basis through the month of October. We regained that daily visibility probably at some point mid-November. But probably more impactful, we lost some longer-term visibility as it relates to what was coming for the entire rest of the quarter. And that's behind us now. So it probably takes a good year for you to get to a place of comfort with an ERP system. But what I would say is that the system is very functional. We are reviewing PPV and freight information on a daily basis. And the information we're getting out of that system right now is more than sufficient for us to not only understand what's going on today, but also to understand what is the impact of inflation and cost going to be for us over the next 3 to 6 months. So I would say that ERP, specifically talking about the ERP implementation, that is behind us. And in the long run, the value -- we had to do it. I mean we were running off a very old ERP system. In different parts of the business, we're on probably 4 or 5 different systems. We consolidated. To get to where we need to be, we had to do that and it was just unfortunate with the timing.

And a little bit about the organizational changes that we've made. Americas, traditionally, when we carved the business out of Emerson, was a bunch of business units. So it was several presidents running various business units. And as we put that together, I felt like we put it together right, but it wasn't until the system was stressed that we really began to understand that we didn't have the robust process that we needed. It didn't have all the players working. It was kind of more of a sales operations, more siloed than it should have been. So bringing in Giordano from EMEA, Giordano has done just an incredible job of getting EMEA's growth and getting its processes in place. Very process-focused, started out in operations, services. So really understands the business, been around for 21 years. So bringing him in and then making a few other changes on his staff in the operations area and in the finance area, I think we feel really good about the team that's there. They understand the problems, and they've been around this business for a while.

So that's helpful and good to hear the progress that you're making in the Americas. One more regional question, if I could, is on China, that there's been a lot of issues the global industry has been dealing with around COVID zero and impacts to supply chain. I don't know if you can share more on what Vertiv has seen in the China region.

Sure. Yes. So China, first of all, within China, we've seen Shanghai shutdown and various regions shut down. So while the business won't go away, some of it is a later push from a local perspective. But if we look at coming out of there, big ports in Shanghai to get product out. Really, components and a lot of those components aren't what we're buying. They're what our sub-suppliers are buying. And I got to say that does affect the supply chain, whether it's chips or PCBs or whatever that subcomponent might be. No one knows when China is going to open back up. Our hopes are sometime next week. But I think that there's a lot more behind the scenes there that's keeping -- and it will continue to keep things closed if they have cases. So while not a disaster, I would say locally, there is some pushing, and then it's affecting supply chain outside of China sub-suppliers that we have, and we'll continue to do that until they open back up.

Okay. That's helpful. Maybe we can talk on pricing. It's been an initiative Vertiv has had for a while now. I think the guidance for this year now assumes $360 million of pricing benefit year-on-year. Maybe you can talk about how much of that you've already either shipped or is in firm backlog here.

Sure. David?

Yes. So at the beginning of the year, we guided to $360 million. We reaffirmed that guidance at the end of the first quarter. Heading into the year, we had about $125 million in backlog and $235 million was subject to book and ship. And after the end of the first quarter, we recognized about $40 million of pricing. And of course, some of that book and ship has shifted into backlog. I think that was about $70 million. So we now have 3 buckets, so $40 million actual Q1, I think $155 million is included in backlog and $165 million is book and ship.

Okay. That's helpful. So it's good to see you making that progress. And you've raised prices and I think it leads to the question, well, how are your prices now compared to some of your competitors? And are there any product areas where you think there's material differences either where you're perhaps too high or have you gone too far? Or are there other areas where you're maybe still too low and you need to go further?

Yes. So what we've done, and again, we weren't good at this prior to. I mean if you would have heard us talk in the previous years, maybe we get $25 million a year in price. What this lesson has taught us is to understand where our vectors of differentiation or innovation are and see that we can get more price in those areas, understanding the other architectures out there. So we've been really smart about it. It's a weekly cadence that David and I have with the teams on a regional basis. We look at each product line, look at the growth area and understand, okay, maybe we've hit price with -- we can't do any more here. This solution continues to go up, hit more price. So pricing is not something that's a once and done for us. It's a constant monitoring of growth rates and what we think we're doing on the share side of things and really looking at that. And I absolutely believe there's still more price to be had and we continue to, like I said, look at it weekly and then exercise on a monthly basis, price increases where they need to be, where we can deliver value. And I think a lot of people ask, Mark, what's going to happen when all this inflation goes away and everything gets back to normal, you're going to lose all that price? And the answer is maybe on commodity, more commoditized-type products. But where we differentiate, we're finding is really studying and making sure that it's the best architecture, the best value for that architecture versus, hey, how does this price up against these other products. So better understanding where that differentiation matters for our customers.

And how are customers responding to the price increases? And are you seeing any change in your orders as a result of the higher prices?

I would say, responding well. Most customers are today, I would say, in the fall time frame, it was a little more, no, we can't do this. We can't do that. We have a supply agreement or we have a supply agreement in place. People need product today, right? So they're willing to pay for that. We haven't necessarily gone to the model of, okay, if you pay a higher price, we'll knock your order down. That's not our methodology. But what we're finding is people want to get ahead in line of orders in advance, and they're willing to pay a price to do that. Not to push other out, but to say, I want supply for another year of this level. So it's not easy. Getting price isn't easy. It takes a great relationship and a great partnership. And salespeople typically don't want to go get price. They want to get the order. So culturally, we've gotten through that. And I feel like we really have good mechanics behind this, working with our Chairman on this. This has been the key focus that we came out with and said we have to execute on this. Feel like we are. You're never done, but it's feeling much better where we're at today.

That's helpful. One of the reasons you're raising prices is because costs have gone up and the company guided for $270 million of cost inflation this year. Maybe talk a little bit more about how you're coming up with that $270 million. And I think some of the exposure Vertiv has is through purchased components rather than just raw material buys whereas some of your suppliers have the responsibility of buying some of these raw materials. So maybe talk a little bit more on what some of the key drivers are that are going into that $270 million and how you come up with it?

David?

Yes. We could break it down in any number of ways. I think if you look at the $270 million, about $160 million of that is just carryover from what we saw in 2021. So the pure wraparound impact. And on top of that, at the beginning of the year, we overlaid an additional $100 million. And we got a lot of questions when we provided that guidance in February. How did we calculate that? How do we determine it? And there literally was no specific science, right, on how we came up with the $100 million. It was a nice round number. But based on what we saw in 2021, what we realized is that we were consistently behind the curve as it relates to predicted inflation. And literally, every quarter, we thought we had hit the point where things have stabilized. So learning from that at the beginning of the year, we included a $100 million provision, and we selected that word very purposefully. It's not a cushion. It's not a hedge. We believe we needed that additional $100 million both to understand our cost structure but also to allow us to price for that. And we are doing that internally. We are assuming that $100 million and now $110 million is real. And when we're going to customers and we're pricing, as Rob mentioned, we are including that provision within the price. So one change that we've made with that additional overlay from the beginning of the year is the timing. So just to avoid any perception of false precision, the way we overlaid that $100 million in the guidance was just $25 million each quarter. And inflation doesn't work that way. Inflation accelerates. After seeing what happened in the first quarter and a portion of the way through April, we've retimed that $100 million, now $110 million. So we saw $10 million of that in the first quarter. And what we're projecting is $25 million in Q2, $35 million in Q3, $40 million in Q4. So we assume that acceleration. And once again, we refer to it as a provision and not a cushion that we would love to get at the end of the year and have that only be $70 million or less. But at this point, we are assuming it's going to hit us. And if you look at maybe some of the other ways to categorize that inflation, probably 70% of that is material, 30% is freight. We do not include labor inflation in what we're calling out specifically as inflation. And from a regional perspective, probably half of that is in the Americas, 35% in EMEA and APAC. And in particular, China has not -- they're not completely immune to inflation, but certainly, what they're seeing is less impactful. That's about 15% of that $270 million.

That's very helpful. And I understand there's a lot of estimation that you have to do to come up with these numbers. I imagine and it sounds like when you first gave the guidance, the $100 million provision, there wasn't a lot of mathematical input you could rely on, right? You had to use more judgment and now you've updated that $100 million to $110 million as a provision. At this point, is it more -- do you have more visibility into that number and you have a better sense of what pricing is because you're further along in the year? Or is there still a fair amount of -- this is just our best view and it's...

It's probably a combination of both those, yes. We definitely have -- every month, we'll have another month of visibility going forward, another month of purchase orders and understanding what the actual costs are. We've seen freight being a little volatile and it will recover for a couple of weeks and then start impacting us negatively the next few weeks after that. So there's definitely a lot of volatility in our ability to kind of predict what's going to happen through the end of the year. But the one thing that became very clear is the retiming. And we do see an acceleration in what we're seeing in Q2 and we see a further acceleration in Q3 as well. So that was probably the most impactful change. We did change it by $10 million, but that's probably within a margin of error. I think the more significant thing we did is just retime it during the 4 quarters.

When we think about some of these different factors, you've raised price, you're dealing with higher cost. What does that mean for your longer-term margin targets? I think the intermediate EBIT margin target was 16%. You've had a long-term margin target of 20%. What needs to happen for the company to get to those?

Yes. I'll start, and I'll let Rob comment. And I would say the ironic thing as it relates to all the bad stuff that has happened over the last 12 months is that we are actually better positioned today than we were a year ago as it relates to having fortitude and getting to that 16%. We had a plan, but the one thing that we would always explain as a potential lever and we would generally mention it at the end of our conversation would be pricing because we never were super aggressive with pricing as we were trying to grow this business. I think when this business was carved out of Emerson, the compounded growth was probably 1% or 2% over the last 5 to 10 years. So we really had to motivate the growth, and we weren't super aggressive for pricing. And I think we underestimated the uniqueness of our product and the value it added to our customers. And we were never aggressive with pricing. We would high five over $25 million of price in a particular year and think we did a good job. I think we will have over $400 million of pricing over a 2-year period as we exit 2022. So going forward and even looking into 2023 and 2024, we actually believe we have a strategic lever to pull with pricing, not only to offset inflation but to use that as one of the top 2 or 3 tools to get to that 16%. So I believe we're going to get there a lot quicker now based on what's happened over the last 12 months versus what we would have anticipated a year ago.

And the other thing, Mark, we've talked about, and it's out of Dave Cote's book, the fixed cost constant and that really works. And we've gotten really good and focused on our fixed cost as a company. So as we grow next year at whatever rate, you get an effect from that. And the final thing that we continue to do, and we said this takes longer, is throughout COVID and whatever continue to work in the factories with our VOS, the Vertiv Operating System. And while we say that could yield 100 to 500 basis points, we're really seeing that begin to take traction in some of our key facilities, and we'll continue to drive that over the long term. So between pricing, fixed cost constant, I mentioned supply chain because that used to be one of the levers we talked about. But right now, that's probably not one to talk about, but that will come back into play because I think we still have some consolidation in global buying that we need to be doing. So yes, as David said, we feel much better positioned today probably than what was a year ago.

Maybe talk about how mix might impact your margins over time. I think traditionally, at least hyperscale and colocation margins were a little bit below the corporate average, and it's a fast-growing segment. Are there other areas that are above average margin that maybe offset that? And maybe just talk a little bit more on how mix might impact the margin targets?

Yes. So if you dissect the hyperscale and colo, there's certainly products in that category that are below the fleet average. Our services, we've always talked about, and it's one of our key differentiators for us as a company is our domain knowledge and our service organizations. We continue to see similar margins, there's the enterprise, maybe just less preventive maintenance calls and that type of thing. So we don't see that margin being eroded there. But if you go within categories where we're leading in thermal management designs, we find that we can get above fleet average. So even within a category, we've got to kind of break that down from that perspective. We've got to continue to grow in the channel. Our philosophy when we first carved this out was we've got to grow in hyperscale and colo, as you mentioned, but we've got to also grow in the IT channel. Those margins are typically above fleet average. We feel really good about our position, but a lot of room to grow there for us, Mark. A lot more work to do, been done very well in the U.S. or Americas specifically, but a lot of work to be done still in Europe and Southeast Asia and other parts of the world. So I feel like that we've got plenty of balancing factors of where we want to target innovation to be able to help drive that margin. We'll continue to do that. We've ramped our R&D. We'll continue to do that, although we don't have a lot more to do from a -- get to 6%. We feel like our Vertiv, our VPD, Vertiv Product Development process has been yielding some really good innovations that we're getting paid for. So we'll continue to do that as well even in those subcategories that may not be as high as the fleet average.

That's helpful. The company did the E&I acquisition recently. It was a relatively large transaction, and there's still some tuck-in but on the larger side. Maybe talk about how that acquisition is going through the integration? And what does it mean for Vertiv going forward?

Yes. So we today probably look back and say this was even a better deal than what we thought it was at the time. E&I has really allowed us to get in some areas and do some things that we haven't as a company. It's given us capacity for modular builds in Americas, certainly in Europe and Middle East. What we're finding is that our customers are moving. They'll move off of competitive solutions that they would normally be buying to pick up E&I because of our service organization. We're finding that certainly in Americas right now, where they didn't have as big a presence, they really covered Europe quite well. But that kind of -- we didn't pencil in any synergy, sales synergy growth as part of doing the deal. But I'll tell you that our pipelines have built quite nicely and some early wins that show that this thing really works together. And as we take it more to India and to South Asia, I think that growth opportunity for us is really there. So it's embraced by our customers, our salespeople. We are having this as a center of excellence for us for busway systems and for specialized switch gear. And we're just finding that the 2 companies really -- sometimes, you don't know culturally what's going to happen. And we feel like the innovation culture, the take care of the customer culture, the do whatever you can, it's a really -- the glove fits the hand perfectly there.

That's great to hear. Unfortunately, we are coming up right on the end of the time here. So let me thank you both. Rob, David, thank you for joining us.

Well, thank you for having us. Appreciate it.

Thanks.

All right.