Vertiv Holdings Co (NYSE:VRT) Q3 2023 Earnings Call Transcript

Vertiv Holdings Co (NYSE:VRT) Q3 2023 Earnings Call Transcript October 25, 2023

Vertiv Holdings Co beats earnings expectations. Reported EPS is $0.52, expectations were $0.44.

Operator: Good morning. My name is Bruno, and I’ll be your conference operator for today. At this time, I would like to welcome everyone to Vertiv’s Third Quarter 2023 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. Please note that this call is being recorded. I would now like to turn the program over to your host for today’s conference call, Lynne Maxeiner, Vice President of Investor Relations. Please go ahead.

Lynne Maxeiner: Great. Thank you. Good morning, and welcome to Vertiv’s third quarter 2023 Earnings conference call. Joining me today are Vertiv’s Executive Chairman, Dave Cote; Chief Executive Officer, Giordano Albertazzi; and Chief Financial Officer, David Fallon. Before we begin, I’d like to point out that during the course of this call, we will make forward-looking statements regarding future events including the future financial and operating performance of Vertiv. These forward-looking statements are subject to material risks and uncertainties that could cause actual results to differ materially from those in the forward-looking statements. We refer you to the cautionary language included in today’s earnings release, and you can learn more about these risks in our annual and quarterly reports and other filings made with the SEC.

Any forward-looking statements that we make today are based on assumptions that we believe to be reasonable as of this date. We undertake no obligation to update these statements as a result of new information or future events. During this call, we will also present both GAAP and non-GAAP financial measures. Our GAAP results and GAAP to non-GAAP reconciliations can be found in our earnings press release and in the investor slide deck found on our website at investors.vertiv.com. With that, I’ll turn the call over to Executive Chairman, Dave Cote.

Dave Cote: Good morning, everyone. Well, we’ve delivered another strong quarter, built squarely on getting the fundamentals right, good operational execution throughout the organization that translated nicely, outperforming guidance in the third quarter. I believe we’re starting to see a trend and one we plan to continue. Financial and operating performance continues to strengthen significantly across the board. And the most exciting part of that is we’re still early in our path of improvement. Alignment to great end market matters. We have a great position in a good industry, and our technology differentiation continues to strengthen. Data continues to proliferate in good times and bad times. And that portends a very favorable end market environment for the foreseeable future.

We’re intending to finish the year strong. The benefits of our seed planning are taking hold and still to be fully realized. Our end markets remain resilient. Operational execution continues to improve, and there is still a lot of runway ahead. That is a great setup as we think about 2024 and beyond. So with that, I’ll turn the call over to Gio.

Giordano Albertazzi: Well, thank you, Dave. In the last 12 months, we have created intense focus on operational execution, including margin improvement and cash flow generation, combined with a sense of urgency, which underpins a high-performance culture. This quarter shows progress across the board, exceeding our own expectations, demonstrating there is still more value the business can deliver. Here are some highlights. Third quarter sales were up 17% organically. Americas continues to lead the growth, up 40%. We continue to see headwinds in APAC, specifically in China. More on that in a few slides. Very pleased with our orders, up 11%, excluding FX. We were not totally surprised by the strength in orders. We have seen pipelines built, but timing is never certain.

We are encouraged by the order booking acceleration. We believe this is a sign of good things to come. Adjusted operating profit that was $296 million, and adjusted operating margin of 17%. Operational execution is sharpening and certainly translating into margin performance. We had another strong cash flow quarter, an area of intense focus, and we are delivering. Of course, this has a nice effect on our leverage, which was 2.4 at the end of September, and guidance gets us close to 2x by year-end. Given our performance year-to-date, we are raising our full year guidance. Again, we’re now expecting sales for the full year to be up 21% organically, AOP between $1,020 million and $1,030 million and adjusted free cash flow of $625 million at the midpoint.

A very strong year continues to unfold, and we see that momentum enduring. Let’s turn to Slide 4. No changes on the market environment slide. Things are consistent with the picture we gave 90 days ago, healthy markets overall. The data center end market remains strong, with the cloud hyperscale and colocation continued to lead the growth. We see accelerating demand and a strong overall market for the foreseeable future. Different customers are at different points in their demand cycle, but they all recognize that strong future demand is coming. There are encouraging signs from enterprise. We are hearing a more positive outlook, but still balanced against some macro concerns. Telecom is still weak. Some telco carriers have delayed investments, and there is a lull in the market after a few years of a strong 5G investment.

Regionally, APAC remains soft, mainly due to a slow Chinese market, partially offset by encouraging signs in India and rest of Asia. We don’t anticipate a sharp recovery in China and expect that it will stay soft until the back end of 2024. Now the bright spot in APAC, India, is quite convincing. A lot of investment happening, and the trend is likely to continue for quite a while. We are also seeing good activity in Malaysia, the Philippines and Southeast Asia in general. I continue to be quite encouraged by the market signals. We are seeing the demand formation in the pipeline, in the order book, in conversations with customers all over the world. There’s a very good seg to Slide 5. Let’s go to Slide 5, please. Orders in Q3 were up 11% year-on-year and 16% sequentially.

I have said throughout the year that pipeline activity is strong. We are seeing that translate into orders. So not entirely surprising, but encouraging velocity. We anticipate Q4 orders will also be positive year-on-year. I wouldn’t be surprised if Q4 growth was like Q3’s, velocity is increasing. Now we get a lot of questions on the amount of AI activity in our order book. Those questions are often formulated as binary questions. Is it AI? Or is it not AI? But there is no binary answer. If we talk about technologies that univocally are applied to high-density GPU or compute, as for example, liquid cooling, CDUs or some rack-level power distribution solutions. I will still say our order book is in the tens of millions of dollars. But many elements of our portfolio, chillers, direct expansion cooling, heat rejection systems, switchgear, busbars, UPS, you name them are used – regardless if GPU or CPU compute, high density or normal density.

So, the volume supporting AI or future AI-proof data centers is way larger than that tens of millions. Also, many data centers have been designed to be multipurpose. So, the majority of our products will support many types of compute, including AI. That is the beauty of having a comprehensive portfolio of all critical infrastructure technologies, across the entire span of the powertrain, the thermal chain and IT-wide space infrastructure, something that very few companies truly have. Different players, hyperscale, colocation, but also enterprise and edge will have different approaches to AI. And now that suits us well. Complexity, customization at scale, all things we’re good at. So overall, AI is coming, and we anticipate it will show up. We’re in a more pronounced manner in 2024.

Now on to supply chain. We are in a much different place than we were historically, much different. I’m not just talking about incrementally better than 90 days ago. If you look at the progress over the last year, you tangibly see this in our reduced lead times. Suppliers of key components have been making substantial capacity investments, and we are seeing the benefit. We have qualified many additional suppliers, with a sharp eye on geopolitical diversification and overall supply chain resilience. We are doing capacity locks in key areas to make sure the supply base is strong for today and for the future under various growth scenarios. We will be ready. Let’s move to Slide 6. Here, we want to provide some additional color around capacity, an important topic given the different growth scenarios that are indeed possible.

We start in a strong place, with 22 manufacturing plants around the world. It’s much more believable to say you can scale with this strong starting point. The existing footprint was built with the idea that future growth would need to be accommodated. So you’ve seen us scale, expand existing facilities, ramp-up the two facilities – the two new facilities to support growth. And we have buffer capacity in our plants today, roughly around additional 25% to support more intense growth periods and can flex across facilities, to optimize our production. And of course, we continue to invest. Productivity is another capacity lever. The utilization and productivity opportunities are plentiful. And candidly, just starting. Vertiv’s operating system is being deployed vigorously across the organization, unlocking further capacity.

I enjoyed tremendously running a plant during my early years with the company. So, there is a manufacturing in general is near and dear to my heart. It has my and there’s a full attention. We’ll continue to make capital investments to support growth. We will be ready for what is ahead, but this can be done in a measured way that does not significantly change the cash flow profile of this business. We can invest for growth, prudently and deliver strong free cash flow. And with that, over to you, David.

David Fallon: Great. Thanks, Gio. Turning in the presentation to Page 7. This slide summarizes our third quarter financial results. As you can see, strong financial performance continues across the board. Organic net sales up 17%, with 9% from volume and 8% from pricing. As Gio mentioned, we continue to see the Americas, which was up 40% organically, drive the growth engine, particularly in this past third quarter. Adjusted operating profit was $162 million higher than last year’s third quarter, mainly driven by $100 million price cost benefit and $45 million of volume. Adjusted operating profit was $40-plus million higher than our prior guidance, driven by $15 million higher-than-anticipated pricing and $30 million lower inflation, as we have seen some core metals, notably steel, trending lower in the past quarter.

We did have a onetime $7 million benefit from a commercial concession, as we note on this slide that also contributed to the favorability versus prior guidance. This commercial concession also favorably influenced adjusted operating margin by 40 to 50 basis points as adjusted operating margin reached 17% in the quarter. And that’s 790 basis point higher than last year, a great indicator of the significant progress we have made in a relatively short period in driving operational execution. Certainly more work to do, but third quarter results should provide some confidence in our ability to achieve our longer-term margin targets. Moving to the right on this slide. We had another strong quarter of adjusted free cash flow, generating $221 million in the quarter, a year-over-year improvement of $241 million.

We continue to see the benefit of higher profitability and improved working capital management really across the organization. Cash taxes were higher, the inevitable result of driving higher profitability. But in general, we are driving much more consistency and predictability with our cash flow, controlling the things that matter, notably trade working capital, as we fully appreciate that sales and profitability mean little if they do not translate into cash flow, which is absolutely essential to drive long-term shareholder value. Last on this slide, if you look at the bottom right-hand corner, net leverage declined to 2.4 times at the end of the quarter and is expected to be approximately 2.1 times by year-end. Of course, this net leverage improvement certainly correlates with improved cash generation.

Clearly, our balance sheet continues to strengthen, which provides flexibility as we think about capital deployment. And more to come on capital deployment in our November 29 Investor Conference. Next, turning to Page 8. This slide summarizes our third quarter segment results. The Americas region continues its strong growth trajectory with organic net sales up 40%, including 28% from volume and 12% from pricing. We continue to see substantial year-over-year improvement in adjusted operating margin in the Americas, up 910 basis points, which is largely driven by favorable price cost and fixed cost leverage. APAC top line, moving to the center section of the graph, continues to be negatively impacted by China, with organic net sales in that region declining 7% from last year.

From a sub-region perspective, the rest of Asia, so everything outside of China continues to grow nicely year-over-year, up low double-digits in the third quarter. Adjusted operating margin for APAC remained flat year-over-year despite the lower sales at 19.1%, really a strong testament to their focus on cost control while continuing to drive margin enhancements. Now we do anticipate that APAC will return to mid- to low single-digit year-over-year growth in the fourth quarter, in part due to typical fourth quarter seasonality in China, but this region will likely be down for full year 2023 versus 2022. And we are not planning for a sharp recovery in China at the beginning of ’24. Rather, we are expecting sales activity to be relatively muted, at least until the back half of next year.

The EMEA region was relatively flat organically in the third quarter, which was slightly better than we anticipated in guidance. Flat year-over-year sales in the quarter was mostly due to timing, as we expect a significant sequential increase in the fourth quarter, with full year organic sales growth in that region in the upper single to low double-digits. EMEA continues to deliver strong adjusted operating margin, almost 28% this quarter, an increase of 1,030 basis points compared with last year’s third quarter, with the improvement driven by favorable price/cost and good fixed cost control. And finally, on this page, corporate costs in the third quarter were approximately $7 million higher than last year, driven by both R&D investment and an incremental $3 million foreign exchange loss.

Our current guidance assumes second half corporate costs in the aggregate to be consistent with the first half. Next, turning to Page 9. This slide summarizes our fourth quarter guidance. We expect a strong finish to the year with adjusted operating profit in the range of $295 million to $305 million and adjusted operating margin at 16.3% at the midpoint, 360 basis points higher than last year’s fourth quarter. Adjusted operating margin is expected to be down sequentially from the 17% in the third quarter as regional mix plays a role with higher APAC volume. And recall that the third quarter was favorably impacted by the commercial concession that we talked about a couple of slides ago. Adjusted free cash flow is also projected to be lower sequentially as we expect CapEx to ramp up about $35 million, a lot of that driven by timing.

And working capital use should be approximately $35 million higher in the fourth quarter versus the third quarter as sales are expected to increase about $100 million sequentially. China cash collections are a watch item for the fourth quarter, with larger customers paying a bit slower given the macro environment there and the impact on cash availability. Next, moving to Slide 10, our full year guidance. We are increasing projected full year sales by approximately $30 million and adjusted operating profit to $1.20 billion to $1.30 billion, an increase of over $580 million from 2022. This revised guidance is approximately $75 million higher than previous guidance, with $40 million from the third quarter beat and $35 million from the raise in the fourth quarter.

Full year adjusted operating margin is expected to be 15%, 730 basis points higher than last year, with approximately 500 basis points from higher variable contribution margin and over 200 basis points from fixed cost leverage. And finally, on this page, we are increasing adjusted free cash flow guidance by $75 million to $625 million at the midpoint, $885 million higher than last year. This improvement demonstrates our focus on cash and the operational process improvements that, have taken a hold across the organization. And our commitment to delivering strong and consistent free cash flow is a crucial part of our high-performance culture, and I believe this could be a harbinger of continued good things to come. And with that said, I turn it back over to Gio.

Giordano Albertazzi: Well, thank you, David. Thanks a lot. And let’s go to Slide 11. So some initial thoughts on 2024. I’m going to say we see more tailwinds than headwinds. Our starting point, is a strong. The data center market continues to accelerate. And AI is forming a tailwind that will likely be more evident in 2024. Our supply chain – resilience is at a much greater level of maturity. This is important as we think about the demand profiles that may emerge for next year and beyond. Balanced investments in the business will continue. R&D capacity, things that will support the growth of the business for the years to come. We will continue our relentless focus on operational execution and implement the Vertiv operating system increasingly deeply.

This will support continuous improvement consistently. We have started making progress, but much more to come. There are headwinds too. Certainly, China is slow, and recovery doesn’t appear near term. Worth noting, we anticipate more normal seasonality returning in 2024. And for Vertiv, that typically means our financial measures in absolute dollars get stronger sequentially as the year progresses. Let’s go to Slide 12. Once more, remind everyone that we have our first Investor Conference on the 29th of November. So here are the topics we plan to cover that day. And we’ll be sharing a lot of exciting information. I look forward to spending the day with you, talking about our strategy, technology, use on the market, operations and financial framework.

We hope you will be able to join us, preferably in person, or remote. Let’s go to Slide 13. I’d say we have meaningfully evolved from where we were a year ago. You can see that across all the key takeaways on this slide. A lot of improvement. It has been quite intense and fun, and we are still quite far from our full potential. I want to thank our team around the world for the passion and the hard work, tackling challenges every day, making sure we exceed our customer expectations, helping the entire industry scale and holding ourselves accountable for delivering strong results every quarter. I am sure you can see the early signs of a high-performing culture. With that, over to the operator. Over to you, Bruno.

Operator: Thank you. [Operator Instructions] Our first question comes from Scott Davis from Melius Research. Scott, your line is now open. Please proceed.

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Q&A Session

Scott Davis: Hi. Good morning, everybody including Dave Cote, good morning.

Dave Cote: Good morning, Scott.

Scott Davis: Where – I’m looking – I am good Dave I am not as good as you are for the last couple quarters net worth gone up is a little bit. But I am assuring [ph] honor. So I appreciate it. I am looking at Slide 11, where does telecom fit in this tailwind, headwind? Or is it the lack of kind of telecom being on here, I mean it’s more of a neutral? Or just – I don’t know, I’ll just stop there?

Giordano Albertazzi: Yes. No, Scott. I would say, Telecom is neutral right now in this whole picture. Honestly speaking, the fact that telecom is soft is no new news this quarter. That’s something that we already signaled for at least in the last two calls. So, we see that continuing in 2024. So if anything, we can be surprised by the opposite. Yes. In the industry, there is some expectations that sooner or later, the extreme edge will happen in the, let’s say, telecom perimeter operations. But again, not counting on that, but having the right technology available and the customer reach, if that happens.

Scott Davis: Okay. That’s helpful. And just as a quick follow-up, price. This has been an industry historically where price wasn’t really a big deal, until you had the – not meaningful contributor one way or another until you had the supply chain debacle and needed to get after some. But do you have to start giving back some of that when you get into 2024? Is there a new paradigm just, because your — perhaps your kind of value-based selling and kind of figure out how to hold that – how to hold the line on price a little bit more effectively than maybe in the past?

Giordano Albertazzi: Yes, Scott. Certainly, value is a big element. The industry and the line technology is becoming more complex. We will talk certainly about high density. We’ll talk about the overall net increment on installed power, and the need for total cost of ownership, efficiency, et cetera. So the world is becoming more complex. Value in terms of the technology that you deliver matters. And we talked about Vertiv’s ability to exercise the pricing muscle, both in terms of process and in terms of translating value in the initial price, both in terms of project price process and in general, pricing new technology. But it’s also true that the industry – in the industry in general, there is more demand than capacity. So that is certainly a favorable environment in many respects.

I’m going to say that we see in the future, diminishing price gains. We have certainly enjoyed a lot of the kind of catching up after the inflation. But again, we continue to be positive about the future investor respect.

Scott Davis: Sounds encouraging. We’ll see you all at the Analyst Day. Thank you.

Giordano Albertazzi: Looking forward.

Operator: Our next question comes from Nicole DeBlase from Deutsche Bank. Nicole, your line is now open. Please go ahead.

Nicole DeBlase: Thanks. Good morning, guys.

Dave Cote: Good morning, Nicole.

Nicole DeBlase: Maybe we could just start with the comments that you guys made about 2024. I think it’s an important distinction with one half versus two halves since the comps are really difficult in the first half. And I guess the follow-up to that comment is, do you still expect to be able to grow organically in the first half of the year? Or is that going to be totally back half weighted just because of the comp dynamic? Thanks.

Giordano Albertazzi: Nicole, as we – as I mentioned, let me elaborate on it. As I mentioned, we are going more towards a normal is what is, historically normal first half/second half. 2023 may expect a little bit abnormal in the sense that we had a pent-up backlog, let me say, almost a 2022 backlog residue that we moved because of the shortage of components, et cetera, moved to the first half of the year. So that makes certainly a more flat H1, H2 year. In this moment, we are thinking something that probably will be around 45%, 55% top line, first half, second half. Give and take something, it’s too early to say, but that’s probably the thought – that thought process. I would be surprised, and it’s again, early, but I would be surprised if H1 ’24 were below 2023. So we – I don’t think it was going to be positive all the way through. But again, we’d like to be clear about the seasonality. That’s all.

Nicole DeBlase: Thanks. Yes, that’s really helpful. And then the comments that you guys made about capacity and investing in the business. I guess, if we kind of look at the multiyear CapEx picture, are you trying to send the message that CapEx does need to grow from current levels? Or do you think that you can kind of expand capacity gradually at the current levels of spend? Thanks.

Giordano Albertazzi: There will be some CapEx growth, as a matter of fact, just as our top line grows. I mean, there will be an element of a proportionality, but probably a little bit more than that. Again, I think this is a unique trend in the industry, the main industry that we serve. And as we said, we have many ways to make sure that we make the capacity available. Productivity being one, we’re making sure that we use everything that we have created in terms of capacity over the last couple of years. But yes, we – if the conditions, as we believe, will favor that, we think we can be a little bit more aggressive. But I want to once more highlight the fact that we do not believe that this will materially, meaningfully change the cash flow profile of the business overall.

Nicole DeBlase: Thank you.

Operator: Our next question comes from Amit Daryanani from Evercore. Amit, your line is now open. Please go ahead.

Amit Daryanani: Thanks for opting my question. And congrats on a really good set of numbers here. I guess the first one I had was, your orders accelerated really nicely, I think it was up 11% year-over-year, you sound more positive going forward on this as well. How much of this uplift do you think in orders is driven by volume versus pricing? And any sense if the duration of – orders that customers are putting in is starting to stretch out as well? And maybe that’s helping also. Maybe you can talk about pricing versus volume versus duration on orders would be really helpful?

Giordano Albertazzi: Okay. So I would say that there is a lot of volume in the orders that we’ve taken. As I’m saying, we are – as we are saying, we are – we’re printing nice price numbers this year in our sales. We expect that to trim a little bit. And the growth – the future growth will have a very good volume component. When it comes to the duration, I think you’re asking duration in terms of how far out the orders that, we are receiving and covering. And I would say it’s a little bit of a mixed bag. On the one hand, there are shortened lead times, that I mentioned in a few occasions and also earlier today, are favorable in terms of accelerating what is the so-called run rate more territory business, which is always good, great also in terms of installed base creation for future service revenue.

But we see also increasingly the big part of the – big players, be them hyperscalers or be them the large colocation players increasingly look out in terms of coverage. So it’s really a good combination of the two.