Vertiv Holdings Co (VRT) Earnings Call Transcript & Summary

Yes. I've been very clear about two things. One is the acceleration that we have seen, both in the last quarter of 2023 from an order standpoint and this first quarter of 2024 is predominantly coming from hyperscaler and colocation. That's where the -- this accelerated way of getting ready for AI is really coming. The non-colo cloud, so everything let's call it, enterprise, that will be predominantly a more an on-prem solution. There are many other types of models. But that is pretty much reflecting the direction that we shared with the investors at Investor Day in November. So mid-single digit, more or less. When we think about what's going on in the market, is there a possibility that the enterprise part of the business will accelerate, just a simple effect of AI being adopted more globally and more across the board in the market? Well, I think that possibility is there. I think the possibility is there. It is still at early stage. But I think it's a very legitimate way of looking at the market dynamics.

So I want to put a little spending framework around your capacity management to your growth. You guided CapEx to $200 million in 2024, $130 million last year. You're ramping liquid cooling capacity, I believe it was 40 to 45x by the end of '24. You're doubling switch gear, busway capacity by 2025. So first of all, talk about how those expansions are tracking, if you can. And then can you talk about how much of this investment is based off of just purely the current orders and backlog versus where you see the industry moving over time?

The examples of capacity expansion that you gave certainly have been accompanied by a more general expansion of capacity across all lines of business. But definitely, the expansion of capacity is following the plans that we have internally and that we have that -- even those that we have shared with the investor community. So we are happy about the progress. Yes, we are pretty satisfied about the way we are implementing those plans, definitely. When it comes to what do we base that upon, we base it on demand expectations or backlog. Well, it's hard to separate the two in a sense because we have demand expectations. Then we have mentioned we are pretty maniacally looking at our pipeline -- opportunity pipeline that gives us quite a good visibility out in the market. So there is a demand, where the demand should go modeling, what's happening out there, what people experts in the industry say, and we are among those industry experts. Then we corroborate that vision with what we see happening in our pipelines, speed of the pipeline, the size of the pipeline, how many opportunities we generate in any given period, and we track that speed as well. And then we see how that translates into orders and backlog. So it's hard for me to separate the three. It's almost a flow. So we look at all three together. Clearly, they need to be consistent. In the moment, they are inconsistent somewhere along this, let's say, demand -- high-level demand expectations, pipeline indications and order booking, that means that's something wrong somewhere in the process, in the expectations or in the execution. But in this moment, the three are pretty much at in the same direction. And so we like what we see in terms of the direction.

Very interesting perspective. So I wanted to talk about a portion of the business that doesn't always get a lot of airtime, and that services. We're wondering, what is all this orders growth implied for service? First, can you help us size the service opportunity that's really embedded in the backlog and the implied growth of the company?

Okay. So I'd like to say service is one of the most important superpowers of Vertiv. It's really something that separates us from competition. It's something that is enormously important and, if you will, a testament to the fact that we've been in the industry for years and decades, so that we have built something that indeed that takes decades to build. So I think we also -- everyone can think and talk more in terms of service and service opportunity, and we do that a lot internal. How much service is embedded in our backlog? Two aspects to that. First, important to separate the two souls or the two parts of services for us. One is project services, everything that goes and is sold with the product, with the system, with the solution. And that typically includes a project manager -- project management, commissioning, all the things that allow for a complex system and product, typically part of a very complex infrastructure to start work, I mean, to be available to the customer. So that's an important part of the business. That is squarely into -- in actuality, let's say, part of the backlog when we say orders for AI, colo and hyperscale has increased. That's part of those orders. But then there is in that backlog clearly, and very importantly, let's say, the opportunity -- the potential opportunity. Everything we do, everything we deliver is very critical back to our conversation, very critical. And if you think about the very critical nature of liquid cooling, can you be more critical than that? You actually touch the actual server, the actual GPU. So you are in the -- it's almost the blood and the brain. You use the brain and the liquid circuit is the blood. So criticality is of the essence. So the installed base that the backlog creates is that something that we typically capture quite well.

Well, it's funny because I think,, historically, your service contracts were more associated with power rather than thermal. And by the way, I'm always going to be attentive to the service opportunity because I think, if you know, I worked in my family service business in the HVAC space. So I'm somewhat biased. But basically, as liquid cooling deployments grow, it seems like the number of companies that can actually service these systems is more limited, perhaps, than the broader thermal offering. So can you maybe talk about the incremental service revenue opportunity associated with the liquid cooling build-out?

So you were saying UPS probably historically more central. Is that correct to the equation? Correct. That also has to do with some of the models -- service models that may have characterized our activity in North America for the non-power side of the portfolio. But more generally speaking, again, I see -- I always look at the service opportunity being proportional to the critical nature of the kit. So clearly, power is very critical and complex. Hence, a direct and a very crisp opportunity. But when you see and when you look at the thermal part of the business, you take large chillers, large -- direct expansion units, you think in terms of, again, liquid cooling for the reasons that I was explaining, then the very same critical nature that is characteristic of a UPS, say, definitely applies to that part of the infrastructure. So we see comparable to UPS and to the power attach rates for the -- for that part of the thermal portfolio. And again, I go back to my -- the specific case of liquid cooling, my analogy of the brain and the blood veins, et cetera, and the CDU becomes the heart, and it's a heart where you want to have a service presence very close by, if not embedded, in the larger sites to make sure that not only you can intervene if something goes wrong, but you can have the right telemetry, you can have the right digital services, the condition-based maintenance that -- equipment of that critical nature may have. So one point you were mentioning is not many companies have that service presence. Well, I agree with that. Not many companies have that service presence. And again, if your data center is in Spain or if it is in -- on one side of the U.S., you cannot wait just to fly someone in or in Singapore or in Malaysia. You cannot wait to fly someone in if the problem occurs. You have to have people that are local, that are trained. Training is an important factor. We've been training service engineers, again, for decades. We have a very well-oiled machine. And the expansion and this acceleration requires a lot of training prowess. So it's something that we make available to the industry.

I think around the margin trajectory in services, we can clearly see the improvement on the product side in gross margins as a combination of the pricing, the efficiency, the Vertiv operating system, services margins more gradual improvement. How do we think about the margin trajectory for services relative to all of the growth that you're seeing on the product side?

I'll start talking about -- again, going back to two aspects of services, the project services and the life cycle services, if you will. They also have somewhat different margin profiles with the latter, of course, being more stronger as it is for every industry. So every time we look at service margin, let's remember there is a mix element to that equation, and a mix element that makes us more towards the project side of things when there is, again, acute acceleration on product demand, let's say. Having said that, the trajectory for service is pretty much aligned with the trajectory that we see for the rest of the industry, the same logic, the same pricing muscle that we are using, the efficiency, the productivity that we're using for the rest of the business that we are implementing, for the rest of the business applies to an [indiscernible].

Yes. And so on margins, in general, you're guiding to 40% incrementals this year. You've targeted 20-plus margins in the '26 to 2028 time frame. We've been asked this by many investors. Is there any way to frame a plus comment in terms of what you could achieve with sustained incrementals above 30%? And how do we think about your biggest controllable levers to drive margin expansion in this time frame besides the targeted 35% leverage on sales volume you typically have?

Well, in general, what we say, and David always says, that in a 20% is a number, and it's a number that we have had out there for quite some time. It's a number of that for us makes sense. It doesn't represent necessarily a silly, hence the plus. What that plus will exactly look like, I think it would be a little bit premature to say. So it's not that when we are at 20% or will be and try to pull the handbrake and stay there forever. So let's see as we get closer to that level what the opportunities are and let's also see how the dynamics of the industry -- or the industries that we serve will play. When it comes to the what are the levels, certainly, there is the constant operational leverage that comes from fixed cost constant. So fixed cost constant is an important and continues to be a very important philosophy mantra for us. You know that. Of course, we increase our spend in engineering and R&D, in general, or in -- to make capacity available. But the underlying philosophy of fixed cost constant stays. So anything else that doesn't have to scale up is sustained flat, and that is yielding and has proven to yield quite good operational leverage. And then an important element of what we do, an important change in acceleration in the last 1.5 years has been around vertical operating system. So driving productivity and driving efficiency across everything we do. Of course, I have talked about fixed cost constant and productivity and leveraging our processes delivers a lot of that. But there is a variable thought to VOS, to all the lean efforts that we are implementing that is starting to show in our numbers. A lot more to do. So no one thinks that we've done, we are done, and the efficiency and the productivity that we could have extracted from the company, from our system, from manufacturing are already being extracted. Now that's a forever journey, and we're very, very focused on continuous improvement and lead as part of Vertiv's operating system. And then there is the price cost level that we have already discussed quite extensively.

I want to end with a capital allocation question. Obviously, we saw very strong deployment out of the gate, 1Q with buybacks, $600 million spend on -- out of the $3 billion authorization. Can you talk to us a little bit about what the path is from here around buybacks? Is it going to be opportunistic? Are you looking to offset dilution? Talk to us a little bit about that philosophy and also where debt reduction sits in your priority list right now?

I think we can and should go back to the philosophy that we shared with the investor community on the 29th of November at our Investor Day. Things have not changed, actually. Our philosophy has not changed. We said that we -- as you mentioned, authorization for buyback, we saw an opportunity, so we acted opportunistically. Going forward, we will continue with the same philosophy and with the same strategy. When it comes to debt leverage, we were talking about staying between 1 and 2. Now we temper a little bit higher than that. And we also said that if for opportunistic reasons, we have to be a little bit higher than that, no drama. But again, going back to that 1 to 2 range leverage is an important part of our strategy going forward. So it is the strategy as we shared with the community in November and that we have reiterated a few times on the system.

Well, we're at time. There are a lot of people listening, a lot of people want to meet with you today. We appreciate the time. Looking forward to more of the discussions today. I'm sure we're going to get into some of the additional questions we received. And those -- anyone can follow up with us as they need. Again, you can e-mail at noah.kaye.co.com. Again, thank you very much to the Vertiv management team. And I hope everyone has a great conference.

Thanks a lot. Thanks, everyone.