Vertiv Holdings Co (VRT) Earnings Call Transcript & Summary

Good morning. Thanks for joining us at the Wolfe Transports and Industrials Conference. We're going to continue with Vertiv. And representing Vertiv this morning, we've got Gary Niederpruem. Gary is Head of Strategy and Planning; David Fallon, CFO; and Lynne Maxeiner, Investor Relations. So thank you for being here. Thanks for being with us again this time. Lots to discuss as always. So maybe just kick into Q&A, unless you've got some opening comments, Gary, David?

I think we're good.

Yes.

Straight to the one.

Straight into Q&A.

So what do you say right now is top of your mind in terms of priorities and kind of like over the next 3, 6 months?

Yes. I can start, and Gary can add on. I think it's hard to start any conversation without the price/cost environment. And for us, very critical in that is the dynamics that we're seeing with parts availability. And I think as most people know, we had some challenges last year. Number one, predicting inflation. It always seemed like we were a step behind as we progressed through 2021. And as a result, we were always 2 steps behind from a pricing perspective. And the end result was a very disappointing fourth quarter. We've made a very strong deliberate pivot as it relates to forward expectations for inflation at the beginning of the year, which is critical not only to understand our cost, but that also drove some very aggressive pricing actions at the beginning of the year. And as a result, I think from a timing perspective, we had a very strong backlog coming into 2022. So there's a little bit of a delay for the benefit of the pricing versus the higher inflationary costs hitting our P&L. We had a decent first quarter. We did what we said we were going to do. But really, the true show-me dynamic will be in the second half of the year, where from a significant perspective, the pricing actions will start hitting our P&L, and the year-over-year gap between pricing and inflation should be fairly significant. Now also wrapped up into that is the dynamic of procuring parts, and no industrial is immune to parts availability. But for us, it's particularly acute because we are very much exposed to electronic parts, whether it's semiconductor breakers, IGBTs. And we've also talked about fans, which go into -- we have a very significant thermal business. And there's a misperception out there that fans are pure mechanical device. But for us, they're due to the precision cooling. There's a lot of internal electronics and supply of the fans. We need to ship our value-added products are subject to the same electronic constraints that we have on the power side. So we're managing through that. It definitely is a day-to-day dynamic. We can't get the pricing unless we ship parts. But we're also managing the supply chain a lot better this year. We have a lot better visibility, plus we're not relying on the market correcting itself. So we've done some very proactive things as it relates to finding alternative fan suppliers and also doing some redesigns to a lesser extent to still be able to meet the pretty significant demand we're seeing in the market.

That's great. That's a great foundation for the conversation. Obviously, second half is important. It's really important, but 2Q is an important bridge to that. We do have in the planned pricing accelerator, I think, pricing doubling from 1Q and achieving price/cost neutrality, which would be the first time in 5, 6 quarters. Is that still on track?

Yes. I probably can't give a specific update, but yes, that definitely was what was implied in our guidance for Q2 was price and cost to be neutral. And then beginning in the Q3, price should exceed inflation. So the -- there are any number of assumptions in our guidance that we've been talking to investors over the last week, and everyone tries in their creative way to kind of get an update on where we are. Probably one of the most popular topics is our exposure to China, and that's particularly interesting at this point because of the COVID lockdowns. So we are certainly exposed to China. We have over $1 billion business there. We also supply out of China, and our suppliers get supply out of China as well. So we're definitely impacted by any type of lockdown. And depending on the geography, it could be more significant or less significant impact to us. But I think the way we have summarized it is, number one, our guidance didn't assume that things were going to clear up on April 1, nor did we assume that it would last until June 30. So I know that's a pretty broad range of things. But definitely, the longer the lockdowns there last, the more impact it's going to have on our business. But maybe just circling back to your question about price and inflation for Q2, we were very comfortable with that assumption at the beginning of the quarter. And the big left really is Q3 and Q4, and a lot of the pricing that we are expecting in Q2 was already in backlog. So I would say probably a little bit lower risk than maybe the book and shift pricing that we're assuming in Q3, Q4.

So it wasn't 1 April, it wasn't through June. So we'll take some in the middle. It seems that mid-May was where most of your peers were assuming some lift in China. Maybe just give us a feel for what you're seeing right now on the ground in China in terms of your facilities, i.e., suppliers, logistics, maybe the customers as well.

Yes. I'll start. And Gary is very much attached to the dynamic there. What I would say, that mid-May assumption is not significantly different than what we would have assumed. And we get different reports on a daily basis as far as the timing of the easing. I think one thing I can definitively say, it's not open up right now. And they're doing some things on the periphery to open things up to allow shipments in and out, but it certainly is not fully opened up yet. I don't know, Gary, if anything you want to add there.

Yes. Yes, sure, David. Nigel, I would say a couple of things. One is so we have a fair amount of employees that are in China. If they're clearly in the Beijing or Shanghai area and they're working from home, most of our -- we have a big, big chunk of folks in Shenzhen, and that's where our 2 manufactured facilities are, both of them roughly within an hour or so of Shenzhen. And so that office is open. Those 2 manufacturing facilities are open. They have not been shut down. But what is impacting, to David's point, is sort of the supply chain. So any suppliers that we have in that Beijing or in that Shanghai who are either feeding our Shenzhen plants is definitely providing a draw in a little bit of pain to our manufacturing facilities. So somebody asked the direct question, are your manufacturing facilities open? The answer is yes, unequivocally. Are they running at full speed? The answer is no because of the inbound supply chain, that's been distorted a little bit. Now with that said, we are working with the government in China to try to get some of our suppliers designated as essential. And so in some cases, we're successful. In some cases we're not. So I would say, in general, we're operating, but it's had a little bit of a disadvantage just because it's really hard to get parts in there. So that's all sort of the supply side. The customer side, customers actually are being relatively resilient. There's a couple of projects that have slipped out a quarter or so. But for the most part, pipelines and funnels and opportunities, all of that, that we track pretty frequently are still relatively healthy for the overall dynamics in China. We had told everybody that there's a little bit of a dynamic going on even outside of COVID in China right now around, the China government is really incenting data center providers to utilize existing buildings that they have before they build new data centers. So that's going to take a couple of quarters to play through. So that dynamic is still out there. But if you take that dynamic, coupled with the COVID, all in all, China business is still doing generally okay.

I'm glad you touched on that, Gary, because that was my next question, was about this air pocket on China data center capacity. How do you track that? I mean if you think about, I don't know, capacity utilization, not sure if that's even the metric that you would track. But if you think about your customer base, colo versus hyperscalers versus enterprise, more so on the -- I guess, the hyperscaled data center side, how do you judge utilization of the capacity right now?

Yes. Yes. Great question. So I'd say there's 2 ways we do it. One is very qualitative. One is very quantitative. So on the quantitative part, -- there are a couple of public colocation providers in China. So Chindata, GDS, there's 1 or 2 others. And occasionally, they will publish their utilization rates and their absorptions effectively of the data centers in China. So we will monitor that. And then -- so that's just 1 data point, but very quantitatively driven. The other one is much more qualitative, which is just good old-fashioned voice of the customers talking to all of the other nonpublic colocation companies as well as the hyperscaler companies. And in general -- yes, if you look at sort of the U.S. and Europe colocation providers, they're going to operate somewhere in the mid-80s in terms of utilization on average in sort of through the cycle. In China, it's much lower than that. And so what the China government is doing is effectively saying, "Look, I don't need you to go from 40% to 85%. But I do sort of want you to go from 40% to 60%, using round numbers. And then once we hit sort of that tipping point again, we'll open up the spickets and allow new greenfield builds to go on." And it's all the way of driving power utilization is really what they want. They want more energy efficiency, so they want people to use new things or existing things before they build new things. In all of that, though, what we are able to do for those existing facilities is there's a lot of retrofit business that we're garnering right now. There's a lot of upgrades. They have older-style UPSs with lower efficiency. Now they're re-retrofiting it with higher efficiency. It's a big play for our service organization. So there's lots of other pockets of potential for us within that. But to answer your question directly, there is some public information around utilization of those -- handful of public colocation companies. Other than that, it's just little old-fashioned VOC.

Okay. well, that sounds good to me. Just maybe a couple of more questions for me, and then I'll throw it up into the audience here. And if there's anyone on the webcast who wants to ask a question, feel free to e-mail us at [email protected], one word, [email protected]. Why would China data center supplies run at much lower utilization than, say, the 85% benchmark we see elsewhere? Is it because growth is faster? Or is there some other reason?

Yes. I think it's a couple of things. One is growth had been a little bit faster in that area. So they just -- there's just a little bit built-in contact mentality to some extent. The other dynamic that you have in China, which is very unique to China, is a lot of the China telecom providers also act as colocation companies. And so in that thing, they don't necessarily disclose those public metrics around utilization when you're a telecom company. So I think the government just sat back and said, "Hey, look, we know that power is more expensive in some of these major cities. So we want to curtail that to some extent. We want to incent people to use existing sites, and then we want to incent people to go into some of the more rural areas if you're going to build." And so I think it's all of those dynamics that just led the government to say, look, let's sort of pump the brakes for a couple of quarters. It is. It's not going to be any more than that. It's going to be a couple of quarters, and that's going to be back on track. But I think those are the slightly different dynamics that you have in China than you do in the rest of the parts of the world.

And that come to the breaks, does that come through on orders? Or has it come through more on shipments, i.e., deferred shipments and then we resume shipments back, I don't know, 1Q '23?

Yes. I would say it's probably more -- what we've seen is on the order side because projects would get delayed a couple of quarters. So it's not like we have orders in hand and they're coming to us and saying, "Hey, don't ship that in May of this year, ship it in May of next year." That's not the case. It's just more the orders on the front end that are being slowed. But with that, when you look at that funnel on the pipeline in China, there's still an awful lot of conversations going around, hey, look, I need to build out 50 meg. I need to build out 75 meg. I need to build out 25 meg. So all of that is still machinating underneath the waterline that wouldn't be visible to people that aren't in the space at this point in time, but all of those conversations are still occurring. They're a really, really healthy clip.

That's great. And then I'll take one more question before I throw it open. So China is high teens percentage of your sales. Help remind us, what is it in terms of sourcing, in terms of components, electronics, et cetera? What percentage of your sourcing is from China?

Yes, I can start, and then David can chime in as well. I don't know if I know exact percentage. But what I would do is break down a couple of things. So if you look at some of the raw printed circuit boards and some of the raw semiconductors, those are either coming typically from either Taiwan or from China. And so we have some subcomponents that we manufacture in our China facilities that are then exported into our own other locations around the world for final assembly and test. But it's much less today than it was a year ago. And a year ago, it was less than it was a couple of years ago. So we're really moving much more rapidly to -- we've always been in the region for region, and that was more from a manufacturing standpoint though. Now we are in region for region from a supply standpoint. So there's definitely still some tentacles on that supply side. But for the most part, it's sort of limited to power electronics, printed circuit boards, sort of minor subassemblies that will export. The majority of everything else is already in the other regions.

I see. Any questions from the audience? Yes, one here, please.

Do you think there's much double ordering in your backlog? And how easy is it? Or are there any sort of financial penalties or any sort of penalties for a customer to cancel orders?

Yes. Super good question. So we'll break -- take those in 2 parts. So in terms of the double ordering, we don't see that phenomenon at all. And we get that question quite a bit. The only chance that there would be in some double ordering is some of the distribution stuff, but we have not seen that at all. And we have a pretty large backlog in our distribution business, and none of that is getting canceled. So I don't see it there at all. And when it comes to the larger orders, when we get those orders, our customer knows where those products are going. So they know it's going to go to Washington, D.C., Site 1, 2, 3. They know it's going to go to Buenos Aires Site A,B,C. So they know the location in the site specifically where the big power, the big thermal is going to be shipped into. And so they don't have the luxury of just double ordering than canceling at the last minute. So we don't see really any double ordering going on. And the biggest reason we feel comfortable that is, again, all of these large orders, they have specific cities. They have specific addresses. They have specific sites where they're going to. And we know that, that's for the data center is actually being constructed. So very, very -- Nigel asked at sort of the beginning, hey, sort of what keeps you up? What's top of mind? The double-order phenomenon is way down the list for us because we just don't see that phenomenon happening at all. On the cancellation piece, that is definitely a contract by contract sort of order by order, customer by customer. Some customers have that in their contracts, some customers don't. But for the most part, what we have with everybody is when -- particularly when it's a customized product and you get within a certain lead time of when you're going to ship that product, then there are cancellation policies that kick in based on a number of different parameters. So I would say at this point, we feel pretty comfortable about the fact that if there is going to be any cancellation, most of what the customers already have some degree of customization, so we'll be remunerated for that. But again, in the grand scheme of things, not worried about double ordering and not worried about any cancellations than a magnitude whatsoever. That is, again, really, really pretty far down on the list of things to worry about for us right now.

That's great. Any anyone else? Okay. Great. I'll carry on. So I mean, David, you mentioned pricing in the second half of the year really sort of flow through. To some degree, that's contingent on the backlog conversion. But maybe just talk about the degree of confidence in achieving that price. I mean how much of that is in backlog? How much of that needs to be actioned from here? And what is the customer reaction right now to these price increases? Are you starting to see some sensitivity? Was there a little bit of unusual behavior in terms of trying to get ahead of some of these price increases? Maybe just give us some context there.

Yes. So the full year goal for pricing in '22 versus '21 is about 360 million. We got 40 million of that in the first quarter. And then if you look at the breakdown between what's in backlog at end of Q1 and what still needs to be executed, I think it was almost 50-50. I think 155 million was in backlog and 165 million was in the book-and-ship amount. So pretty good visibility to about $200 million, both actual and what's in backlog, but still some execution as it relates to getting pricing on some of the shorter-cycle products. What I'd say is we track pricing in orders. So I think last year, we were very much focused on pricing as it hit the P&L, and we realize that isn't necessarily a leading metric. So what we have done since the beginning of the year is track pricing in every order, and we reviewed that across all 3 regions on a weekly basis. And we're very encouraged and very optimistic about what we're seeing as it relates to the pricing orders. Some products, some GBUs in some regions are well over our targets, some are a little bit lower. But in general, we're very much on track to hit the pricing for 2022. Now as it relates to the dynamic of how customers are reacting, it depends on the product. It depends on the region. For the products where we absolutely have a very clear technological advantage it's actually been quite easy. And what has also helped significantly is the demand backdrop. So customers are willing to pay a significant premium if they can get certainty of supply. And that's the linkage between pricing and the parts availability. But in general, we have not seen significant pushback from customers. There's always a ceiling there. And once again, that depends on the product. And we think we've probably hit the ceiling in some of our lines of businesses in certain regions. But to a certain extent, based on the order strength, and I think it was up over 30% in Q1, and even if you adjust it for 2 significant orders, it's still up 10% to 15%. Based on the continued strong order flow, there's probably some availability. So I wouldn't say we're strongly optimistic, we're strongly pessimistic, but I think what we have implied in the forecast is probably properly balanced one way or the other.

Okay. And just to be clear, there's been no change in the incentive structure for sales or management around prices? This is the policy. Discounting is going to be very rigidly kind of controlled, and that's it. There's no change in incentive structure.

Well, I think there was a favorable change to the incentive structure and no change versus what we talked about previously. But we've included in all regions, an element of pricing and product profitability in the formula for commissions, whereas historically, the more orders, the higher your commission. The change we've made is now there is a component for pricing, and that's across all regions. The other change that has been made is more from a controls perspective. So the number of reviews and number of approvals that are required to price a product lower than a target price increase, and we generally do that by looking at margins, that has increased significantly. So Rob, Gary and myself, we probably see 10x the number of approval requests at this point this year versus what we're seeing even in the third and fourth quarter. And so our visibility and our ability to actually reject orders that are going out there at lower price has significantly increased. So we think we have both the carrot and stick. So the carrot with the incentive structure for the sales folks, and then also, we're watching it a lot more closely, both at the regional level. And then Rob, Gary and I are reviewing certainly all the larger orders that are going out.

Very clear. We've got about a few minutes left. Is there any questions from the audience? No. Okay. Maybe E&I and just maybe talk about the progress you've made in terms of integrating E&I into the go-to-market strategy? And then secondarily, E&I does rely on third-party suppliers for a lot of the components. I'm just wondering how that's tracking through given the supply chain tightness.

Yes. I can start with that one. So on the go-to-market piece, Nigel, I'd like to extend this call by about 15 to 20 minutes, aside all the good stuff that's going on, on that front because it really is -- it's pretty impressive. Any time we have customers and salespeople down into their facilities, they come back and they just will gravitate towards sort of selling and selling more of that. So there's a tremendous amount of cross-selling opportunities that are not only in the funnel, but that we've already closed just in the first couple of months of the year already. And that's true for both busway and for switchgear. So if you think about it, one of the things we said early on was the E&I team did not have visibility into the enterprise market, specifically in the U.S. and Europe. And that is where we've seen tremendous lift off with additional busway orders already in the United from the enterprise sales teams in those 2 regions. Then what we also said was that we would be able to sell more switchgear in modular solutions to a lot of the Tier 2 type of colocation companies, and that's where we've seen tremendous amount of opportunities there as well. So I'm really happy with the amount of engagement in terms of we track quotes, we track pipelines, we track order rates, both for E&I as well as synergy type of orders that would be coming through. And that engagement is really, really probably taking off even more than I originally thought it would. So super bullish on that, which bodes well for the long term. The second part of your question is a little bit more of the painful part, which is a little bit more in the present day. There's no doubt that some electromechanical parts, namely breakers, is causing some fits and starts, not only in core Vertiv, but also within E&I. So we're battling through that right now on how to handle that. So we're actively -- there's some -- some of those breakers are more easily obtainable. So we're switching customers actively over to those vendors that we can get product from easier. So that's causing some short-term pain but we're managing through that right now. Midterm to long term, there's more opportunity in this acquisition than even -- than I thought when we made the deal 7, 8 months ago. So a little bit of tale of 2 cities, some short-term pain on the supply chain piece, we'll manage through that, but mid- to long term, the thesis is more intact than ever.

Got it. Okay. Well, I'd love to extend this by 10, 15 minutes, but we can't, unfortunately. But I feel guilty of the fact that we haven't talked about the outlook for data center capacity. We haven't talked about new product vitality, spent a lot of time talking about supply chain in China. But hopefully, next year, we can talk about some of the sexier things in the end markets. But Gary, thanks for your perspective. David, thank you very much for your time. And Lynne, thank you too.

Always happy. Thanks, Nigel.

Thanks, Nigel.

Bye.

Bye-bye.