Vertiv Holdings Co (VRT) Earnings Call Transcript & Summary

Okay. So for those of you that don't know me, I'm Nicole DeBlase. I cover the multi-industry and electrical equipment and machinery groups at DB. Next up on today's presentation schedule is Vertiv. Very pleased to introduce Gio Albertazzi, CEO and President of Americas as well as David Fallon, CFO. So Gio took over as CEO in January of 2023, prior to which, he served as President of the EMEA region and then President of the Americas region. And he actually joined the company in its prior phase as Emerson Network Power in 1998. David has served as CFO since 2017, prior to which, he was CFO of CLARCOR.

So I think we're going to dive right into the fireside chat. Have your questions ready. I'm going to open it up to questions from the audience, maybe when we have about 10 minutes left or so. So don't be shy. All right. So maybe first question, Gio. What has changed or is changing at Vertiv under your leadership?

Absolutely. Well, good day, everyone. First of all, as I have been with the company for quite some time, I know the company very well. So one would expect an evolution with maybe not a revolution, but certainly an evolution that is focused a lot on execution in this phase of our history. History is a bit kind of bumpy in the last 24 months. But I think we've started to demonstrate back end of 2022 and certainly, at the beginning of this year, that we are in execution mode. But execution mode is not just 1 quarter. Execution mode is a mindset that we are injecting in the entire organization, the organization responding very well. We were talking about Vertiv operating system. But the execution for us is really broad, reaching every aspect of conducting the business. Execution for us also means that making sure that we deliver. And as we have started to do on our price/cost equation and certainly deliver on our customer expectations and our investors' expectations. So, so far, so good. Execution is natural to me. I'm originally not a presenter or an operator by education and by experience. But again, I've been in leadership role for quite some time and understand that, while execution is 80% of the success of company. That 20%, that is a strategy can be absolutely and crucially important for the long-term success of the company. That's why a lot of my time now, especially in this moment, the inflection of the industry is on innovation and long-term strategy, something that we are all focused on. And it's also an opportunity to remind everyone that we have an Investor Day coming up at the end of November, where we will be able to know extensively answer your question and what has changed, what is changing as we really crystallize our next -- the view -- our view of the future.

Excellent. Okay. So we're going to get into this topic of AI right away. Just let's get it out of the way. It's what everyone wants to hear about, I'm sure. So post NVIDIA's big earnings beat, what was that, 1.5 weeks ago now, there's been a lot more interest in this AI-driven transition to high-density data centers. So maybe just starting with the liquid-cooling aspect. It seems to me like this is the clearest way Vertiv could benefit. So is it possible for you to size for us like the liquid-cooling business or market today? And just give us a sense of your view of the strength of Vertiv's position.

Yes, I would talk in general about the increased density of power and compute power and the transition, CPU to GPU, transition that the industry will undergo. Clearly, something that will be gradual, probably rapid but gradual, nonetheless, the speed of which is yet to be defined. Prior to that, we've been thinking, I've been talking about an industry that is growing, secular trend, of 6% or 7% going forward. We believe that the transition to GPU and high density will happen in stages. And there will be an initial stage in which air cooling will continue. But also in the -- in its most extreme and future configurations in which you have about 300, 400 watts per chip type of solutions. You will have liquid cooling to the chip, but there is a lot of other heat-creating type of equipment inside rack. So I always think about the mix environment, air and liquid. But liquids will gradually start. This is now kind of a small percent, low single -- low to mid-single digit, and that will gradually transition to mid-teens, let's say, in a few years. But the fact that we have liquid-cooling technology, the fact that liquid cooling never should be looked at in isolation, but also -- and always as part of the system, not only because the 2 coexist, as I briefly explained, but because you have to extract that heat from the primary or secondary, in this case, liquid-cooling circuit, and get it out, either in the environment or sometimes even use the heat for other purposes. So it's always thinking a complex system that goes from a chiller most likely, all the way to inside the rack in multiple means and this complexity and this multi-technology is exactly our sweet spot. We know the space like [indiscernible] been here for decades. And we have the breadth of portfolio, the scale, the global footprint to really accompany the industry in this transition. That is, again, not a binary transition, but it's a transition to a higher level of complexity. We love what we see, and we know it will be -- the speed at which will happen, yet to be defined.

Okay. Understood. And some of the pushback that I've had from investors about the liquid-cooling story for you guys is just when you Google liquid cooling, there seems to be a lot of smaller players in that industry. Do you think that your leading position in thermal today could also echo through to liquid cooling as the market develops?

The answer is yes. But let me elaborate a little bit more. Liquid cooling is at very early stage in the technology life-cycle curve, as it's normal in these cases, you have a lot of new entrants, which is actually fabulous. Because these new entrants serve the purpose that it's multiply the ability to experiment new technologies over and beyond what the incumbents, like ourselves, of course, work and develop organically liquid cooling as well can do. And it's very normal in this kind of industries that the solution that is on a combination of organic and inorganic type of portfolio expansion. But in the end, you need guys like us to guarantee the scale, the service, reliability and presence to really deliver for an industry that will be growing fast. You can't be too small for it. It doesn't happen.

Right. And I'm sure, the service organization has to be a huge part of it as well.

It is fundamental. It's always been fundamental in our industry. In more complex thermal world and power, of course, let's not forget, there is a power story to that equation. Having a strong incredible service global presence is absolutely paramount.

I'm going to get to the power aspect in a second, but just one more on liquid cooling. The other concern I've had is, are we sure that liquid cooling, as an industry or as a product line for Vertiv, will be margin-accretive? And it's more complete industry state? Or is it post-growth industry state?

New technology -- new complex technology with a lot at stake, we talk about, let's say, business-critical. There's nothing more business-critical than singularly -- cooling a server singularly. So if anything, there is more criticality there than anywhere else. We like that. And again, it's about the orchestration. So we believe that the system, and not only, but also the individual point liquid-cooling solution will be a good margin story for us.

Right. I mean I'm sure you wouldn't be trying to participate in this market if that wasn't the case.

Rightly.

Okay. Have you...

Sorry.

That's okay. Go ahead.

We do not see it as a market. It's one of the technology in the bigger market. So I want to be very clear. It's like is there a direct expansion data center, thermal management market? No. There is direct expansion technology. There will be a liquid-cooling technology within the market.

Right. Okay. Important point...

Sorry for the...

Have you started to actually see orders come in? Or is this still to come? I know it's early days, right? We've just learned about this in the past few weeks.

I'll go back to our earnings call, where we were adamant about the fact that quite a few conversations with many customers, and the fact that we do have some high-density orders in our backlog. So it is happening, definitely. And what is happening also is that a lot of our customers, the large customers are sitting with us to say, okay, I know the high density will come. I know that it will be a mix of technologies, and we'll have a higher mix of direct-to-chip liquid cooling going forward. But I can't design our infrastructure around that yet. I need to work with you to design a liquid-cooling transition-ready infrastructure so that my investment today will have a 12, 15 years life-cycle accommodating this transition. And that's a very important role we play with our customers.

Absolutely. Okay. So outside of liquid cooling, couldn't the rest of the business benefit? I feel like everyone is so focused on liquid cooling. But if you're increasing the power consumption of your data center by transitioning to high density, wouldn't that also spur higher demand in the rest of your business as well?

Again, that's a very logical inference in money. That's what we believe. Again, the speed and the intensity at which this will happen is yet to be defined but it's very logical. And again, there will be an efficiency play on the compute side. And we believe that's not only normal, but also welcome, considering how much more compute power that will be needed in the future. But what the exactly -- how the 2 will offset is yet to be defined. We believe it will be kind of a favorable scenario for Vertiv and for the industry as a whole.

Okay. And there's been so much fuzz about this whole retrofit trend. But with the implementation and deployment of AI, don't you also think that this just creates the need for more data center build-out over the next decade?

It would be indeed a combination of the 2. It really depends on how fast the industry will want to transition to GPU-based high-density based. So there will be an element of retrofit if you really want to accelerate or the players will want to accelerate over and above what the speed at which new sites will be built will allow. So it's natural that there will be a retrofit component. Mind you, probably some of the retrofit or some of the initial retrofit at server level, not infrastructure level, may happen still within the envelope of the existing technologies. And that's the good news. And so it doesn't mean that the industry stalls necessarily until everything is retrofit, but it will be a gradual transition.

Okay. And last question on this, and then I'll check with the audience to see if there's more on AI. Do you think this is going to be focused more in the Americas region? Or is this a truly global phenomenon?

I think it -- oh, I'm sorry. I think it will be truly global, but as everything in this industry. North America has, what we call, a 6 to 12 months head-start. It will not be different this time.

Okay. Makes sense. Any questions from the audience on the topic of AI before I move on? Okay. So maybe just shifting away from that into the underlying business. The comps are really tough. Clearly, that's why orders are down, and that's why you're expecting them to be down again, although less so in the second quarter. But how do you expect backlog to kind of trend through the rest of the year? Do you expect material backlog burn? And can book-to-bill remain 1x or better for the rest of the year?

So clearly, we've been, I think, explicit and clear about orders as we summarized in our earnings call. But also, we were signaling, both in February and in April, that the -- well, in February, that the 70% almost backlog coverage that we had in 1st of January, say, was an anomaly for us and for the industry in general. So we expect that the backlog coverage will normalize in not exact sense, but we would think in terms of something sub-50% in a normal business cycle. So we believe we will go down that path going forward, which will be very normal and good for the industry. We like a lot book-to-bill, one or above. But let's see how it goes. But again, for us is -- the reference point is -- in this normalization of order intake that we explained, it's really about having the right amount of coverage -- of backlog coverage that is certainly lower than the 1 week's experience so far.

Sure. Makes sense. When you say you expect moderate CapEx -- or sorry, data center CapEx growth over the next several years medium term, is that kind of like in the mid-single digits? Is that what you would view as a sustainable medium-term growth rate? Or is there a scope for that to be a bit higher with things like AI?

We've been talking about 6%, 7%, 8% growth. That's something that we believe will be true going forward as a really translation of the secular trend. It is very sensible to believe that AI transition in this -- kind of an accelerated transition, I mean not that AI is new, but this accelerated what seems to be an accelerated transition will accelerate growth rates further. But again, that's just a sensible way of looking at things. It's early for us to forecast anything different than we have done so far.

Sure. Okay. So maybe on the near term, what are you hearing from the 3 major types of customers, so hyperscale, colo, enterprise about spending plans?

Pretty much consistent with what we have seen. We have not encountered or experienced parts of the industry that say, hey, we have to stop. We have to digest what we have done in the past. That's specifically, of course, different players that have different cycles -- built cycles. But in general, we see kind of a positive environment across the board. We've been very transparent with what happened with our backlog and with our orders. And we feel pretty positive across the board, and we do not have a piece of the data center business that is [indiscernible].

Okay. And so not that I know you had changed enterprise to yellow on your industry chart a couple of quarters ago, but still no evidence of slowdown in enterprise spend. It's more about concern about macro?

Yes. And again, let's see what this AI acceleration will do. And the AI acceleration will play across the board, not just for the hyperscalers or the cloud providers will be a general impact.

Okay. Got it. China. So China is an area where we have seen a bit of a digestion phase, if you want to call it that, over the past few years. Have you seen any evidence of recovery in demand or customer interest in that region yet?

Back to April conversations or call. China, clearly, that's true across every industry, not just our industry, but certainly true for our industry. And we're not immune. It's been slower than we originally expected, back at the back end of 2022. As we said in April, we have seen an acceleration in pipeline, and that's encouraging.

Okay. Great. So supply chain, what are you seeing? Does component availability continue to steadily improve? And there's been a few companies on the stage this morning that have claimed that supply chain is very close to returning back to normal. So I would love to hear here what you think about.

There are 2 elements to the supply chain story, one exogenous and one endogenous for us. The endogenous is everything we have done over the course of last 12 months or -- not exactly 12 months or a little bit more, in terms of making sure that our supply chain is way more resilient than it was before in terms of making sure that every critical component is more test-sourced. But also, we're moving to the next phase of resilience in terms of what is the long-term example, geographic footprint of our supply base. So that future shocks will find us way more prepared than we were back then. But definitely, there is a normalization of the environment when it comes to the general exogenous part of supply chain. We still have some challenges on -- there are still some challenges on the power electronics, but improving.

Got it. And when you talked about the changes that you're making to your own supply chain, post all of the supply chain constraint that we've seen over the past several years, what exactly are you talking about more dual sourcing? Like what is the plan?

Well, there is certainly a dual or multiple sourcing on existing products. There is certainly an element of near-shoring in some cases. We are much more aware as everyone of the trade-off lead time, freight costs or freight cost risk. Freight costs, of course, are now a favorable side of the equation. But the resilience is also in the complicated geopolitical environment, making sure that, that aspect is also taken into consideration. So a lot of work. So I don't think -- I invite everyone not to think about Vertiv as someone fixing the program and then business as usual. We have learned a lot. And our quest for resilience will not start. Of course, we have hit everything that was short term and risky and problem. And now we are really scanning everything we do to create that resilience that I was talking about.

Okay. Very clear.

Thank you.

Let's move on to price cost. So as we move through 2023, can you talk a little bit about how pricing phases? And how the pricing effort is going versus your plan?

We are satisfied in 2023 with our price/cost equation and especially, as we said, during our earnings call relative to our plan and our guide. But more generally speaking, we're very satisfied about the $365 million price that we delivered last year. And the -- over time, as we move into 2024, 2025, of course, in a moderating inflation or a less inflationary environment in a moderating inflation type of business, everybody's ability to price for inflation or to set inflation will diminish. So marginal price gains will be diminishing, but we have learned a lot. We have built a muscle that is way stronger than it was before. In terms of how we price, how we approve a project in specific price in terms of delegation of authority and in terms of intelligence, but also in terms of incentive to everyone in the organization. So I feel very good and will continue to be strong in pricing, even though, of course, price margins will -- price and margins will diminish. But in the end, price is a translation of the value you provide to your customer. So hence, back to innovation, back to an ability to really enable our customers' business and optimize their total cost of ownership.

Okay. And when we return to this more normal price environment, what is the new normal? Like is this a 1%, 2%, 3% pricing business annually, just thinking about the way you approach list price with customers?

Well, that's very specific to product lines, type of business and think about our business, less about the least price set of business and the project based. So again, it -- clearly, there -- I'll go back to what I would say, we'll continue to see price, favorable price. The intensity of price will depend on really the overall market conditions.

Okay. Fair enough. Just going to check with the audience to see any questions. Okay. I'll keep going. So let's go ahead and shift to margins. So if we will run the clock back before COVID, when Vertiv first IPO-ed, I think that closing the margin gap versus peers was probably one of the more interesting aspects of the story that investors were really focused on. And I think the major driver of that was holding fixed cost constant while driving topline growth. So now that we're kind of moving past this price/cost period, let's hope, do we return to that hold fixed cost constant, grow the topline as a source of margin? Is that the plan?

That's a mantra, not only a plan for us, and it's something that we religiously observe. You'll see, for example, this year, we give ourselves a little bit of a real room to the rule $40 million for innovation and for capacity expansion. And the little wiggle room, which is small relative to the cost base, is something that we will afford ourselves most likely going forward. But other than that, we are absolutely religious about that. The operational leverage that, that drives is fundamental to our value equation. But there is a lot to the value equation that has to do with the overall productivity, also on the variable cost side of the equation. But the answer is yes, absolutely central. And it drives the right mindset as well.

Right, absolutely. And on R&D, I think that was an aspect of -- I mean, it's not a fixed cost, but it's an aspect of your cost that did kind of need to increase. It's been a story for a while. Where do you stand with increasing R&D today? And how do you think about how that needs to trend over the next several years?

When I say that we increased R&D costs, make no mistake, some of the R&D investment is also fueled by being more efficient on the rest of the fixed cost base, so to say, it's not just the extra. But we want to have a little bit more wiggle room again in periods like this one in which there is a clear inflection point from a technology standpoint. We want to have the right fuel to drive innovation. But yes, again, it's not hugely material in terms of our operational leverage story, and even more importantly than that, the long-term benefit in terms of pricing and margin accretiveness of the new technology if really as it does. So is the customer program is something that it is overall good for the bottom line and certainly for the long-term success of the company.

Definitely. Okay. And I think you guys used to talk about like a 45%, I think you call it a variable margin or a drop-through on revenue growth as you hold fixed cost constant. Is that still the right number?

It is not. So when you look at the dynamic over the last couple of years with price/cost, even if you recover every dollar of inflation with price, you're still going to dilute your margin. So you can do the math. We're probably in the mid-30s right now as it relates to contribution. I think that 45% was more forward-looking.

Right. Is that still appropriate, though, for the forward view post price/cost headwind?

Yes, we wouldn't even limit ourselves at 45%. But if you look at the margin enhancement story, certainly fixed costs as a percentage of sales, as we talked about, but even more focused with Gio entering the role is the execution on the contribution margin side. So definitely not satisfied and pleased with the 35%, and that will be a huge lever to first get to the 16% and then in the long term, to 20% and more.

Okay. And it's hard to see where peers are from a margin perspective because data centers is embedded. It's a smaller part of what they do. When you get to 20%, do you think at that point, you're kind of structurally in line with peers? Or is there still more work to do beyond that?

Yes, you're absolutely right. It's not -- our competitors aren't pure-play data center. So there's some guesstimates and some logical inferences on what their margins are, but that's how we drive the 16%. Maybe it's a little bit higher, maybe it's a little bit lower. That's how we first established that as a goal. The 20% is just a nice round number. We believe there's certainly opportunity in the long run and most of the levers that we need to pour in our control from an execution perspective. There isn't really any fundamental differences between our business and these other businesses that would create an environment, where we shouldn't anticipate getting to where they are currently and then based on our execution that we would move beyond that. And hopefully, we're talking about a 20%, 25% margin here and at some point in time.

I hope so too.

Yes.

Okay. Anything from the audience before I move on to M&A, capital deployment? Okay. So maybe just asking about E&I. So can you talk about the performance of E&I? I think that there were some hiccups in the earlier part -- actually, it was the later part of 2022, I believe. So just an update on the integration process.

Yes, absolutely. First of all, I want to reiterate the fundamental strategic importance of the acquisition. We're discussing with some of the colleagues and really details earlier how complete is our portfolio right now. And there's complete grid to sign the server to the chip type of a power portfolio serves us splendidly, especially thinking about a complicating power distribution environment as density increases. So very happy strategically. We are accelerating the integration. Of course, in a very orderly manner. But we are making sure that E&I is really part of the Vertiv fabric, and it's ready to further scale. We're very happy, as we explained in April, about the synergies that we see over and above our expectations. So very good there. We have accelerated the regional integration of the Americas part of E&I into our Vertiv Americas, so that we can leverage strong operational capability that we have built there to address some of the issues that we were transparent about in February. And in general, another thing we've done, we have reorganized everything in busbars and switch gears, going a little bit in detail in these technologies on a line of business basis. That is exactly the same structure that we have across all our technologies so that we are ready to leverage the global footprint. And we are expanding capacity in Mexico, Slovakia, United Emirates right now. So good story. More work to do, of course, but we are moving forward at a good pace, and I'm happy about what I see.

Excellent. And then once we kind of get back to your leverage target, do you see significant M&A in the future? Or is it more about bolt-ons?

Yes, I would say we look in the long run at M&A as a strategic growth driver. I think it's more from the perspective of complementing our current portfolio. As Gio mentioned, the E&I acquisition filled a more significant gap we may have had in that power chain. But we will not be looking at a balance sheet as effectively a hammer looking for a nail. Meaning we won't do a deal just for the sole reason to say we need to do a deal. So we'd be perfectly comfortable with leverage dipping below 2x, but just like we did with the E&I acquisition. Opportunities generally choose their own timing. We'd be perfectly comfortable getting above the 2.5 or 3x to do the right strategic deal. With that said, in the near term, it may be more bolt-on and portfolio complementary type of acquisitions.

Okay. Sure. Well, I think unless the audience has any final questions? Okay. Well, I think we're out of time, so we'll go ahead and wrap it there. Thanks, Gio. Thanks, David.

Nicole, thanks a lot. Thanks, everyone.