Vertiv Holdings Co (VRT) Earnings Call Transcript & Summary

Welcome, everybody. I'm delighted to have Vertiv participating at our conference this afternoon, and I'm delighted to introduce both David Fallon, the CFO, and Gary Niederpruem, Chief Strategy and Development Officer. Unfortunately, neither gentlemen could be here with us live in person in the room, but we are thrilled to have you on the screen. I wish you could be here because if nothing else, you get to see yourselves on a giant 25-foot screen, you're larger than life. So it's good to see you.

I think it's about 1 inch screen in front of me is [indiscernible]

That's right. This view is scary not for me. So that's probably too much what you're looking at. Our apologies.

Not at all. Not at all. Okay. So -- in terms of the agenda for today, we have about 30 minutes. I'm going to try to potentially include a little Q&A, but we've got a lot to get through, so I don't know that we will get to that. But here's kind of what I was thinking and recognizing that these are all sort of interrelated and overlapping. But I want to talk about demand and order flow. I want to talk about the recent E+I acquisition and potentially other M&A opportunities that might be out there. I want to talk about, obviously, the supply chain and the critical part shortages, balance sheet and liquidity. And then as I mentioned, if there's time and interest, we'll do some Q&A from the room. So at the outset though, perhaps just for those who may not be familiar with the story would either be gentlemen, would you be interested in maybe setting the stage, just talking a little bit for a couple of minutes about Vertiv at a high level, what the company does, who -- what your market share is, rough size competitive positioning? Sort of a Vertiv 101, if you will.

Yes, happy to Lance. I'll start, and then David can chime in, and I'll try not to take the full 30 minutes with the intro. But effectively, Vertiv is a critical digital infrastructure provider. And what we do philosophically is we provide power cooling solutions and services for the data center communications networks in commercial and industrial applications. We participate in about a third now with the E&I acquisition about a $35 billion to $38 billion market. Our revenues sit at somewhere $5.5 billion or so, give or take a little bit. So if you average sort of everything out, we have about a 15% share across the board. Some product lines are a little bit higher than others. But fundamentally, when you think about critical applications and vital applications, those need to be -- all of that data that goes into there needs to be processed, stored in network. And while we don't process store or network, any of that data. We provide all of the infrastructure around that to make sure that, that is possible. So once you power all of the ad equipment, we provide the clean power to do that. Once you power that equipment, all of those electronics generate heat. So you have to get rid of that heat. So that's where our thermal management piece comes in then. So very synergistic with the power management piece. We will provide all of the infrastructure that the servers, storage devices and networking gear will sit in. So the rack power distribution units, all of the stuff that we would say is in the white space or a clean part of the data center we provide. We provide solutions that are as small as 1 rack all the way up to things that would be football fields large for modular data centers. And then we also wrapped out with a full [ turn key ] service organization. About 65% of our business is in the data centers, about 25%, 30% of our business is in telecom. About 10% of our business is in commercial industrial. And then the last, I'll give you and then I'll be quiet is roughly about half of our revenue is in the Americas. About 30% is in Asia, which for us is India, China, Southeast Asia. And then the balance is in Europe, Middle East and Africa. So those are rough percentages, David, you can probably correct me and fine tune if you want lines but that out sort of the portfolio at a glance with 3 minutes [ so liquid ].

That's great. Okay. And so let's start with the good news, right, which is the demand environment seems to be white hot. And I'm wondering if you could maybe. And I know this is somewhat of an open-ended question, but would you talk about perhaps -- and I don't -- whether you do it on a region-by-region basis or you mentioned the different industries, if you want to do it or if you want to talk about it in terms of the different verticals that you're selling into, whether it's the colo hyperscale, whether it's the enterprise, whether it's the channel part, how would you sort of call out where demand is perhaps better or worse? And what the general trends are that you're seeing?

Yes, absolutely. So I think what I'll do, I'll probably talk about it by vertical and a little bit of the regional flare because that's what most people all typically get questions on the vertical piece of it. So let's start with the smallest one, and then we'll work small to large, which is in the commercial and industrial space, that business typically follows sort of the GDP type flow. And what we will do there is we'll sell to hospitals, to subway stations, a little bit to complex office buildings, things like that. That's the market. That market, I would say, is doing just fine, probably on a red, yellow, green type of basis, it's in the yellow to green type of area. So tracking GDP doing relatively well. The telecom business then is a little bit different that primarily is going to track telecom CapEx. So whatever telecom CapEx is doing. We don't follow that a 100% quarter-to-quarter, but over sort of a through-the-cycle type of period. That's what we will track. And right now, the telecom business is relatively robust. 5G deployments are going really, really, really well in the U.S. They're just now starting to come up the curve in Europe. And then there's Southeast Asia, is now in the 5G space. India hasn't even really started yet. China is getting relatively mature. So if you parse all that out, again, on the red, yellow, green, I think it's -- there's probably yellow from an order standpoint and demand standpoint. In Asia, it's probably again a yellowish green when you talk about telecom in Europe and in the Americas. And then when you get to data centers, which is the most complex, but oftentimes the most inquired about is -- let's just break it down into really 2 segments: cloud, colo all lump together and then enterprise. So let's start with the enterprise. In Asia, we see the enterprise business being yellow, which is probably flat to up a little bit. We see enterprise in Europe starting to be relatively decent, and we see enterprise in the Americas being relatively decent. So that's probably -- those are sort of green check marks, I would say, which means orders are going to be certainly north of mid- to upper single digits. And then the biggest piece in the fastest-growing piece is that cloud and colocation segment. And with the exception of China, every other region is really growing very, very robustly. So when we talk about most of the white hot demand. It's not that any other sector is obviously moving backwards. It's the fact that they are all at parity, if not north of parity, but then you have as cloud and colocation demand, which is absolutely phenomenal and something that I've never seen in my 25 years in terms of how widespread it is, how deep it is, how across every product line, every geography it is. Again, the one exception is China, which is probably more just flattish. But for the most part, cloud and colo in every region is growing at an exponential rate. And that's what's led to -- we've had probably 5 or 6 quarters roughly now of order growth, that's 20%, 30%, 40% type of things, which I never thought I'd see in my career. And a large part of that is driven by the cloud and colocation demand.

So you mentioned the order growth, I think in the first quarter of 2022, it was actually plus 34% year-on-year. But could you break that down in terms of volume versus price? I mean how much of that is sort of just a function of the price increases that you've been putting in place versus real underlying demand growth?

Yes, I'll start, and I'll have David just [indiscernible] check me here, but I think at that time period, Lance, we probably had mid-single-digit type pricing. So you would certainly say the majority of it was volume based. And I think pricing in Q1 was probably 4%-5%, somewhere right around 4%, I think. But David, I'll let make sure you comment and I'm accurate here.

Yes. It's a good mix of both volume and pricing. I actually think the pricing was probably closer to 10%. And to support the pricing objectives we have in the second half of the year. But with a probably 70%, 30%, 70% volume, 30% pricing. And it's a question we get quite often because there is the potential perception that a lot of that order growth is driven by price and volume actually has been sacrificed. That is not the case. So the order growth from the first quarter of last year is a good combination of growth and the actual volume of orders. The core volume continues to be strong.

So one way to think about it is despite having hiked prices on the rough neighborhood of 10% a year. You're seeing 20% volume growth, which is -- that's a pretty good environment, and that's overall. Now just -- not to be a negative nilly, but you mentioned that the one sort of weak spot, I guess, was China. And I'm just curious, is that because of COVID lockdowns? Is that because is there something else structural going on there? And can we expect that China -- or is it just sort of the tequila effect, they've been growing so long for -- so quickly for so long, and now they're just going to be in -- is this going to be a multiyear period of sort of subpar growth in that region? Or how would you expect that to play out?

Yes. I think from a China standpoint, probably 2 phenomenons. One is China typically is a little bit more cyclical in their telecom business. So they'll build out and then look like to build on and digest. It's relatively episodic from that standpoint. So I think from a telecom standpoint, there still is a lot of growth in that market. It's just that they're digesting all of the 5G equipment that they bought from us and probably other vendors over the last couple of quarters. From a data center standpoint, what we have talked about is the China government came out sometime mid- to late Q4 of last year. And they really are focused on energy efficiency. And so they're encouraging existing data center providers to fill up their existing data centers before they go and build new ones. And so that's purely because just the government is trying to get a handle on and drive energy efficiency and utilization up. So how long that takes is a little bit TBD, but it's probably measured more in quarter certainly than years. So I think anything that we're seeing in China, which, by the way, is still growing for us. But what we're seeing in China on this peak what we would call power efficiency curve, it's probably more short to midterm, certainly than long term because the demand in China is still very robust even in this current state, what we are seeing is a lot of demand for infill for retrofit for service work where they can upgrade their existing data centers to get that power efficiency back up versus sometimes building new data centers. So there still is a lot of activity, a lot of pipeline, a lot of demand in China. But typically, that's -- those are the two big things that are going on in China right now. Both of them are sort of normal from a telecom standpoint. And then from a data center standpoint, it's probably measured in quarters before that to start rebuilding a lot of their data centers. Again, it's not years by any means.

Okay. Great. So you recently completed a fairly major acquisition of E+I. Could we -- I want to focus here next. Could you talk a little bit about -- just remind us the strategic rationale. And now you've had a little bit of time since the deal closed, if you could talk about the extent to which that strategic rationale is being proved out. I'd also like to just discuss the management of E+I how you go to market, if that's any different than the rest of the organization at this point and how that might be evolving? And then that sort of just ties into the integration update and where we stand from that perspective.

Yes, certainly, okay, a whole lot to unpack there. Let's -- I'll try to remember in order to the best I can. So from a strategic rationale standpoint, what E&I brings into the Vertiv portfolio is really 3 big pieces. One is switch gear, two is plus way and three is probably a little bit more mature modular and power skin architecture than what core Vertiv have. So any time you're going to build a data center, there's UPSs, there's power distribution. Sitting right next to that UPS, 100% of the time is going to be switched gear. E&I manufacturer switch gear. And so it's a very, very complementary offering to what we had in the Vertiv portfolio because we didn't have any of that in the Vertiv portfolio. So it really rounds out that power chain on the front end of a data center. Once you get that power up and running, so it comes in through the switch gear goes from the utility into the switch gear, into the UPS, then you have to distribute that power throughout the rest of the data center. And you can distribute power a couple of different ways. One of those ways is to distribute power using a product called busway which is typically overhead in the aisles and the racks and that will literally be the connection injunction point for all the copper and aluminum that's going to transmit that power. We did not have a busway in our portfolio either. E&I had that. So it's a super complementary fit. Lastly, from a product standpoint, the modular power skids, we did have modular capabilities in our portfolio, but specifically when it comes to power skids and having a location to do that, not only in Europe, but also in the Americas, was a huge benefit for us. So it was -- it's really a combination of 100% complementary. There's almost no overlap in the portfolio, so we didn't need to spend time killing product lines or rationalizing this that really was 100% complementary fit from a product standpoint. From a geographic standpoint, E&I was strongest in Europe, they were probably mid strength in Americas, and they were unbelievably nascent when it came to Asia. And so what we are able to do right now as we go into the go-to-market piece, you asked just a little bit is we were able to put the switch gear busway module units into the Vertiv sales channels and have that be pushed out relatively easily because a lot of our salespeople already have some knowledge of those products. They're fluent with the customers when they talk to them about it, and we know our customers are buying those types of products. Now we just need them to switch and buy those products from us. So we're doing that in a very thoughtful manner. We don't want all of a sudden 3000 salespeople all around the world just to open up and be able to start selling everything because we play overrun the factory. So we're being very thoughtful about how we open those gates up, but we're working on all sorts of on joint go-to-market efforts, all sorts of configurators, marketing collateral, targeting certain customers. The Tier 2 colocation customers are a huge focus of ours, and I didn't really focus on that. So there's just a tremendous amount of go-to-market synergies, and that was the biggest reason why we did do the deal because of the complementary product nature. We know along the way, there would be some cost reductions, and we baked that into our 3-year plan. But for the most part, this opportunity really is about the complementary nature, the bespoke environment that they build the switch for units being able to offer a broader portfolio to our customers. And from all of that standpoint, it's -- the receptivity of the sales channels, the sales teams and our customers has been overwhelmingly positive from that standpoint. It's really worked out great. I think that was point one and three I address. Point two was the management that you asked about. So all of the key managers from E&I are still there. They're running the data for today business. Phil O'Doherty is the Managing Director. He works for Rob, fully participatory in everything that we do. We have multiple reviews with them on a weekly basis, on a monthly basis, on a quarterly basis. We have that cycle set up. And so from that standpoint, the management team is fully intact. And what Vertiv has been able to bring in some additional horsepower resources when it comes to the integration side. So the integration team is working really pretty well. There's a lot of elements in finance and operations and supply chain and standing up an SIOP process and all those things that you do when you want to take the company from $300 million or $400 million to $600 million, $800 million over the course of x amount of years. So that's the type of foundational work that the integration team is doing. The only downside or hiccup right now is, which we've talked about before, which we've been very open about, is as much as Vertiv was probably late to the game, getting incremental price increases at the mid- to the end of last year. I was even a little bit later. So it wasn't until the very end of last year when we actually closed the deal earlier this year, when series price increases started to be the norm in that business. So we've clearly gotten a handle on that, just going to take a little bit of time for that price to show up in the P&L. And then just much like the core Vertiv piece where there's been some supply chain disruption, the breakers, the electromechanical parts of the breakers that E&I buys are probably their biggest bottleneck. So there's some fits and starts with that. But again, we're fighting through that. But -- so outside of sort of pricing, which we now have a handle on in getting supply of breakers, which is ebbing and flowing at this point outside of that. The team's doing great. The opportunities in the marketplace have been great, just battling those first two issues better than that. I think we're really, really pretty happy with it.

And maybe that's the good segue into the supply chain piece. And I think it's important to set the stage here by saying prior to the supply chain really breaking down, I guess, it was last fall when it started, Vertiv had actually been on a very successful role. I recall that when the company came public, you had a roughly 500 basis point gap between your margins and the margins of your closest competitors. And I want to say that over the coming 12 to 18 months, if I remember correctly, you had closed that gap to 300, 350 basis points or in that range. So you were basically delivering on the promise and then the supply chain hits in all, hell breaks loose. So could you -- again, for people who weren't necessarily following at real time, what happened exactly? And why if Vertiv was caught a little bit flat-footed, what exactly was the cause? And how have you responded since then? And what might we expect over the balance of the year.

Yes. That's a great question. I hope we have another half hour, so if you're not familiar with the story, looking back at the end of last year to what happened during 2021. If I were to summarize that, we consistently underestimated the impact of inflation. So as you mentioned, we started out the year very strong in '21, actually had a pretty strong beat in Q1 and took guidance up, I think, $20 million, $25 million. So unfortunately, inflation started to hit us. We saw signs of it in Q2, and it really accelerated Q3, Q4. Every step of the way, we underestimated, number one, the impact of the dollars of inflation but probably as notable for us with the supply. So we started to see significant headwinds as it relates to the availability of parts, which contributed to inflation. So we had to go to market for spot buys and to get parts in timely and a ship product timely, we utilize premium freight, and we include both of those items in our definition of inflation. As I mentioned, we underestimated what inflation would do each step of the way. And as a result, and this is the most important takeaway, we reacted too late and too lightly as it related to our pricing, right? So we were always a step behind. And as we exited the year, we were significantly behind on -- from a price/cost perspective, right? And that turned the business upside down. It was a challenging fourth quarter, and it was an even more challenging first quarter. Now we reacted pretty quickly in the first quarter of this year with very aggressive pricing numbers. So we mentioned the 10% in pricing in the orders that we saw in the first quarter. That was across virtually all product lines, all regions, we probably have the ability to be more aggressive in some. But as a result, of the pricing actions that we really took in the first quarter. Some of that was late 4Q. The turnaround, if you will, from very negative price cost to what we expect to be very positive price cost in the second half of the year is really driven by the benefits of that pricing. So in the first quarter, I think our adjusted operating profit was $10 million to $15 million. Our guidance for 4Q, just to understand the magnitude and the speed of this turnaround, the adjusted operating profit in our guidance for 4Q is $240 million. So you take a step back in $13 million which is probably our worst quarter ever, to $240 million in the fourth quarter, which is probably 70% better than our previous high quarter. That speed of that turnaround is very substantial and very quick and absolutely driven by the impact of the pricing, which leads to a very strong, we believe, entry into 2023. And when we look at the business and look at the health of the business, you can't erase what happened in Q1 and Q4 and even Q2 is going to be a little bit light of a quarter. But if you look at what we are doing in Q4 and look at the run rate impact, it should serve for a very, very strong 2023.

So that's what's most compelling, right? Because I would -- I think it's pretty clear that the stock is currently not reflecting this big back half recovery. So if you're able to hit that, I think you're going to be -- I think a lot of people will be very pleased and there'll be a revaluation in the shares. With that said, what kind of visibility do you really have on this back half? And to what extent are you -- does it reflect some -- perhaps just some optimism that the supply chain can't remain this difficult for this long?

Yes. Those are two good questions. And if we were to kind of handicap the risks and opportunities within our guidance, and we have a guidance range out there. And in the meeting we had earlier this afternoon, we're asked to look kind of enumerate what we see as what needs to happen to get to the top end, what happened to need to happen to get to the bottom end. The 3 primary variables are volume, which is pretty obvious. But for us, volumes specifically as it relates to the availability of parts, right? And if you drive into that a little bit, at electronic parts and fans. So we certainly have provisioned in our guidance, and the guidance is based on our visibility into allocation of parts. There's potential upside there. We're doing some very proactive things to qualify new suppliers, redesign parts. So there's some upside. But in this environment, we're day to day. It's kind of hand-to-hand combat, day-to-day. It's a different supply issue on a Monday and a different one you're dealing with on a Friday. And then it's pricing and inflation. We feel good about pricing. We're only 1/4 of the way through the year. We have about $150 million of backlog pricing in backlog for the remainder of the year, but we still have about $165 million that is still go get in book and ship, good visibility, good results in orders, but we still need to do it. And then inflation, we've included $100 million provision for additional inflation in 2022 versus what we saw exiting 2021. We're hopeful we don't need that full provision, but there's scenarios out there where inflation could continue to accelerate learning from what happened in 2021. So we believe our current guidance is balanced, and we'll give a more robust update at the end of Q2. But I think you're absolutely right. As it relates to valuation, we had a rough fourth quarter. We've been very transparent. We believe our credibility took a hit in Q4 based on the miss and don't blame the market for not believing numbers in projections until we actually do it. And -- but we feel really good about the second half.

So we're down to about our last minute. I unfortunately have like 20 more questions that we're not going to get to. But before I do, I just quickly, anything from the room? No. Okay. And let me just close with this. So when I watched on Vertiv, I was particularly excited because this was a pure play. Well, not a pure play quite on data centers, but it was the most exposure to the data center sector that I could find. And now given -- and by the way, it was working, right? So Vertiv had been growing much more quickly than the Schneiders and the Eatons of the world because it was focused to such a great extent on the data center channel. Is that -- has that come to be sort of an arbitrage from the standpoint of, do you need to be a larger more diversified company, not obviously to get into different verticals, but to have the scale to be able to purchase and to in-source the supply chain the way that some of your competitors have been able to do?

Yes. I think in a word, let and the answer would be no. I think that we still believe that we have at $5.5 billion, give or take. We have plenty of health and weight to throw around with the supply community. We're also still able to be independent maker on capital allocations and we can be nimble because we want to do something, we just do it. So I think all of that main thesis is still 100% attack we had a question earlier, and David answered it very well. What we are doing is we continue to reevaluate on a product line by product line, region-by-region basis in terms of hey, what's the best supply chain for this. That might be different than that same product in a different region or this customer might need that. So we're taking this time to make sure we reevaluate and learn from this time. But in terms of -- are we not big enough to be able to compete, I actually don't think that that's an issue at all. I don't worry about that one so ever.

Thank you, gentlemen. We're out of time. I appreciate it. Thanks again for being here with us, and have a great rest of the day.

Thanks, Lance, to you guys.