Morning. My name is Nick, and I will be your conference operator today. At this time, I'd like to welcome everyone to VirTrax Fourth Quarter 2020 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. Please note that this event is being recorded.
Now I'd like to turn the program over to your host for today's conference call, Lynn Maxeyner, Vice President of Investor Relations.
Great. Thank you, Nick. Good morning and welcome to Virtu's Q4 2020 earnings conference call. Joining me today are Virtive's Executive Chairman, David Cote Chief Executive Officer, Rob Johnson Chief Financial Sir David Fallon and Chief Strategy and Development Officer, Gary Niederkrum. Before we begin, I'd point out that during the course of this Paul, we will make forward looking statements regarding future events, including the future financial and operating performance of Virgil.
These forward looking statements are subject to material risks and Certainties 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 registration statement, our proxy statement and other filings 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 Investors slide deck found on our website at investors. Virdivdot With that, I'll turn the call over to Executive Chairman, David Cotin.
Thanks, Lynn. As I reflect on the past year with Vertiv, I'm even More encouraged that everything we discussed in the roadshow has been proved to be even more true today. Vertiv has a great position in a good industry and we can differentiate with technology. Sales growth and margin rate Expansion opportunity abounds and we have a team that's making it happen. That opportunity is shown brightly in 20 We were able to hold sales flat and significantly increase orders in a terribly difficult year.
We were able to increase our margin rate on flat sales, which is always difficult. And at Same time, we ramped up investment in R and D, other growth drivers and process initiatives like the Vertiv operating system, Vertiv product development, Functional transformation and customer view, the Vertiv user experience. The same is true for 2021 As Vertiv guides to sales growth, margin rate expansion and the reinvestment that drives both In 2022 and beyond. Cash and overall liquidity improved markedly and net leverage is down a lot more than anticipated, especially in a COVID year. My confidence has increased, not decreased, over the past year.
No matter where I look, inverter, we're making great progress. As Tim Buck 3 said in their 1986 song, The future is so bright, we got to wear shades. I felt that way a year ago and I feel that way even more so today. With that, I'll turn the call over to Rob.
Thank you, Dave, and I truly appreciate your partnership and the good advice you continue to provide to me and my executive leadership team. I also want to thank the Vertiv employees for their efforts in Q4 and throughout last year. They pulled together and demonstrated how our collective efforts can accomplish amazing feats during a very challenging time. They've adopted to a can do attitude, Use creativity, ingenuity and outside the box thinking in order to serve our customers during this pandemic. I commend my team, my Board and our many partners for delivering the results I will share with you today.
Moving to Slide 3. Overall, the demand side of our business was very promising as Q4 sales were up over 11% compared to Q4 2019, driven largely by significant growth in the European and Asia Pacific regions. Orders for the quarter were up 9% when compared to the Q4 of last year. And I'm pleased to remind you The orders for Q3 were already up 15% as compared to Q3 of the previous year. Our backlog remains at an all time high and is up $450,000,000 from the end of 2019.
We will talk more specifically about the demand side of the business over the next few slides. From a profitability standpoint, our adjusted EBITDA was $187,000,000 which was up over 25% from last year's Q4. This resulted in adjusted EBITDA margin expansion of 160 basis points, driven higher by sales, Higher contribution margin and lower fixed costs on a percentage basis. Additionally, our free cash flow at the end of Q4 improved over the same time period last year by $86,000,000 to $175,000,000 because of higher earnings and lower transformation spending. Turning to the full year results of 2020.
We delivered $39,000,000 more in adjusted EBITDA as compared 2019 with sales down approximately 1%. This equates to 110 basis point improvement in adjusted EBITDA margin versus the prior year. Our free cash flow improved $171,000,000 over last year to $163,000,000 driven primarily by higher adjusted EBITDA and lower cash interest. Looking at 2021, we anticipate above market top line growth, Increase in profitability and even stronger balance sheet, all while continuing to invest significantly in strategic areas like research and development and sales and marketing. Finally, I wanted to let you know that we have transitioned the measure of profitability from adjusted EBITDA to adjusted operating profit.
While there are a few moving parts associated with this transition, this is nothing more than continuing on our committed path to keeping our financials and communications as simple as possible. In order to aid analysts with this Transition, we've included Exhibit 99.2 in our 8 ks that reconciles all the pertinent information.
David will speak
to this further during his section as well. Turning to Slide 4. We've used this slide over the past Few quarters to illustrate what we are seeing in our market environment regarding demand. It's been updated here to reflect how things look today. In the cloud and colocation market, we continue to see strong levels of activity in every region as indicated by the 6 green buttons in the top two rows.
Emerging digital applications such as online education, telemedicine, video and gaming are benefiting our cloud and colocation customers and that demand benefits us as well. In contrast, we see the enterprise and Small to medium business continuing to be challenged by COVID as indicated by the red and yellow buttons in low 3. Its spending continues to be mixed. We commented last quarter that this segment was slightly more positive in October than it was in July, and it's slightly better today than it was in October. The change is subtle, but it is trending in the right direction.
Switching to the telecom side of things, we see little change from last quarter. However, We are seeing an uptick of 5 gs deployments in U. S. And parts of Asia. Several of our larger U.
S. Carriers are continuing to roll out 5 gs We expect the rollout to continue for several more quarters. Finally, our commercial and industrial business often tracks GDP, But sometimes the quarterly timing can be different. There was a positive movement in a few light commercial and industrial applications over the past few months. The most notable changes we are seeing are taking place in Europe.
So certainly some puts and takes, but overall a strong market picture given our mix of the data center business. The digital applications people use every day continue to become more and more important to daily living as a result of demand increasing for those digital So they can be processed, stored and transmitted. This is creating moving to Slide 5. To reiterate, the overall demand is strong as evidenced by our order rates and backlog. Each of our world region We saw orders growth between 2019 2020, which was led by strength of the cloud and colocation markets.
As I mentioned in the prior chart, The enterprise and IT channel markets are still not back to pre COVID levels, but they are moving in the right direction. The IT channel momentum is evidenced by our integrated Rack Solutions revenue having increased every quarter during 2020 and we are confident about our position in the market for 2021 beyond. Switching to the supply side. Now I'm pleased to report that most of our Our next question comes from the line of John. Please go ahead.
Thank you, John. Thank you, John. Thank you, John. Thank you, John. Thank you, John.
Thank you, John. Although we've seen a strong appetite in the broader market for some of the components we use to manufacture our products, I'm proud of how we have diversified our logistics and supply chain globally to mitigate any serious consequences. With that, I'll turn it over to David Fallon to walk us through the financials. David? Thanks, Rob.
Starting with Slide 6, This page summarizes our 4th quarter financial results versus last year. Net sales We're up $134,000,000 or 11.4%, 9.5% when adjusted for a $22,000,000 foreign exchange Translation head tail end. We continued our strong momentum with orders, which were up 9% in the Quarter after increasing 15% in the 3rd quarter, adjusted EBITDA increased $38,000,000 or 26%, primarily driven Our sales and profitability performance converted into strong free cash flow of $175,000,000 $86,000,000 higher than last year's Q4. We will review some of the drivers of this improved free cash flow in a couple of slides. Turning to Slide 7.
This slide summarizes our 4th quarter segment results. Net sales in the Americas were up $3,000,000 or 0.6% as growth in telecom was offset by lower services sales, Which continue to be negatively impacted by COVID site access issues. Net sales in APAC increased $70,000,000 or 19%, primarily due to continued strong growth in China across most end markets, including data centers, telecommunications and industrials. Geographic locations outside China in APAC were up slightly as we continue to deal with site access challenges in some of those jurisdictions. Net sales in EMEA were up $60,000,000 or 25%, almost entirely in the Critical Infrastructure and Solutions product segment, driven by several larger co location projects.
From a profitability perspective, adjusted EBITDA margin improved in both the Americas and EMEA, but Notably in EMEA, where margin increased over 600 basis points from last year's 4th quarter. This improvement was driven by both higher contribution margin and sales leverage on relatively flat year over year fixed costs. Higher contribution margin was primarily due to continued operational and procurement improvement despite a slight negative mix impact from larger projects. EMEA adjusted EBITDA margin has improved sequentially each quarter in 2020, reflecting the benefits of past transformational spending, The launch of the Vertiv operating system and of course the leverage benefits of growing the top line while holding fixed cost constant. Next, turning to Slide 8.
This chart bridges 4th quarter free cash flow from last year. The $86,000,000 increase is primarily a result of higher adjusted EBITDA, Lower cash interest payments and lower transformational spending. The $175,000,000 of free cash flow in the quarter was higher than our internal expectations primarily driven by the timing of cash collections at the end of December versus early January. After beginning 2020 with the use of cash in the Q1 of approximately $200,000,000 we generated 3 And $66,000,000 of free cash flow over the last three quarters, indicative of the strong cash generation potential of this business. This free cash flow has allowed us to pay down our ABL completely.
And in conjunction with the $157,000,000 Cash we received pursuant to the redemption of the public warrants prior to year end, we increased our liquidity to $964,000,000 at Liquidity currently stands close to $1,100,000,000 up from $446,000,000 at the end of the Q1. Next, turning to Page 9. This slide summarizes our full year financial results. Net sales were down $60,000,000 or 1.4 percent from 20 the year over year comparison. Sales were down 13% in the first half of twenty twenty, but up 10% in the second half, in part driven by more challenging comps in the first half of twenty nineteen, but also demonstrating the rebound from COVID challenges and the continued Resilient growth in our industry.
Despite lower full year sales, adjusted EBITDA increased 39,000,000 Pricing initiatives drove contribution margin improvement and fixed costs were down $40,000,000 aided in part by COVID cost saving actions launched in the second quarter. Finally, on this page, and this is the money chart, Free cash flow improved $171,000,000 from 2019 as we benefited from lower cash interest payments, Higher adjusted EBITDA and lower transformation spending. Beginning on Page 10, we pivot to looking forward, including with this slide, which discusses our transition to adjusted operating profit as our primary financial metric rather than adjusted EBITDA. For avoidance of doubt, we will not be reporting adjusted EBITDA going forward. We defined adjusted operating profit as Operating profit excluding the impact of intangible amortization expense.
Operating profit is a GAAP financial measure that will be included on the face of our income statement and we show an example on the next slide with the only adjustments to operating profit both prospectively and for historical periods, being intangible amortization, which we will also include on the face of our income statement. We believe using adjusted operating profit will greatly simplify our communication and analysis of financial results with analysts And investors and by eliminating all adjustments other than intangible amortization, we address all Components of GAAP financial results enhance the quality of earnings and we also And of course, eliminate the previously disclosed historical adjustments. At the bottom of Slide 10, we provide a reconciliation of adjusted EBITDA to operating profit and then to adjusted operating profit. As you can see, net net, the differences between adjusted EBITDA and adjusted operating profit are the historical FX and also other one time adjustments and depreciation expense. And adjusted operating profit It's simply operating profit less the impact of intangible amortization.
Last item of note On this slide, we will also be restating our historically reported adjusted earnings per share to remove historical adjustments except intangible amortization and we include those reconciliations on Pages 2627 in the appendix. Next, moving to Slide 11. This slide illustrates changes Once again, we will specifically include operating profit, a GAAP measure on the face of the income statement And we will also include components of the previously used other deductions net, including amortization of intangibles. A reader will easily be able to calculate adjusted operating profit for any future or historical period with items included on the face of the income statement. And as Rob mentioned, to aid analysts And investors with this transition, which we hope is a once every 10 or 15 year transition, we have included Exhibit 99.2 to our earnings release 8 ks, which includes restatements for historical periods, including quarters consistent with this presentation.
It also includes revised regional segment information, including reconciliations from historical Adjusted EBITDA to adjusted operating profit and quarterly and full year reconciliations from historically reported adjusted earnings per share to Effective calculation removing historical adjustments. And as always, Lynn Maxiner, our VP of Investor Relations and I We'll both be available for any assistance in understanding and facilitating this transition. Next, turning to Slide 12. This page summarizes Our current financial guidance for 2021. We expect the momentum from the second half of twenty twenty to continue into 2021 With organic net sales up 7% at the midpoint, we project adjusted operating profit of $575,000,000 at the midpoint, up 68% from prior year and up 26% when pro form a For 2020 discrete items as we illustrate on Slide 13, adjusted operating margin is expected to be approximately 12% at the midpoint, up 4.20 basis points from 2020 and up 160 basis points on a pro form a basis.
Of course, analysts, investors and we internally will have to recalibrate margin improvement goals on a relative basis using operating profit as opposed to adjusted EBITDA, with adjusted operating margin for 2021 about 180 basis points lower and the comparable adjusted EBITDA margin, but of course, the magnitude and substance of our long term margin improvement goals are unchanged. We expect 2021 adjusted earnings per share of $1.04 at the midpoint with disclosure of assumptions included on Slide 28 in the appendix. Finally, on this slide, We currently expect strong 2020 free cash flow of $285,000,000 at the midpoint, up approximately $120,000,000 from 2020 and we will provide additional detail on this improvement on Slide 14 coming up. Next, Slide 13, this slide illustrates our bridge from 2020 adjusted operating profit of $342,000,000 To project at midpoint 2021 adjusted operating profit guidance of $575,000,000 Growth of approximately 68%. To the far left in the bridge, we pro form a 2020 adjusted operating profit for 2 discrete items, $92,000,000 for the 2020 transaction costs in the Q1 of 2020.
Compared to the resulting $456,000,000 2020 pro form a figure, We project the operating improvement in 2020 in 2021 of about 26%. Components of this operational increase are illustrated in the bridge and include the following anticipated favorable drivers: higher sales From restructuring of approximately $20,000,000 including $40,000,000 lower costs from The 2020 restructuring program offset by $20,000,000 of additional restructuring and related project expense in 2021. These tailwinds are offset by higher anticipated fixed costs as we discussed in our Q3 earnings conference call, Including additional investment of $65,000,000 for R and D and growth initiatives and an anticipated $40,000,000 impact explaining an other bar, but in this case, there are quite a few variances going each way included in the other bar on this bridge. Tailwinds include $26,000,000 of the FX transaction loss from 2020 and $40,000,000 of cost savings that we expect in 2021 not related specifically to the 2020 restructuring program. Headwinds offsetting headwinds include a $30,000,000 negative foreign Exchange impact on fixed costs, dollars 25,000,000 for global merit increases and $11,000,000 of additional depreciation expense.
Of particular note, the $51,000,000 of historical add backs from 2020, which included $13,000,000 stock compensation expense and $38,000,000 for transformation related adjustments as detailed on Slide 19 in the appendix is almost entirely offset by a combined $50,000,000 of anticipated expense in 2021 Transitioning to Slide 14. We include a bridge for the $122,000,000 operating profit and lower cash interest payments. These positive drivers will be partially offset by certain Headwinds including 2021 restructuring payments pursuant to the 2020 program, higher CapEx due to delayed 2020 projects and anticipated investment in operational restructuring. In addition, cash Taxes are projected to increase due to expected higher profitability in several foreign jurisdictions. Overall, our expected 2021 free Cash flow will be somewhat normalized except for the higher cash requirements for restructuring And CapEx is likely slightly elevated due to the push from 2020 projects and incremental spend from the operational restructuring.
And finally for me, Slide 15. This slide summarizes our financial Guidance for the Q1, traditionally our lowest sales and profitability quarter and typically a quarter where we use cash. Before diving into numbers, as a reminder, relative to other quarters, last year's 1st Quarter sales and adjusted operating profit were most significantly negatively impacted by COVID, notably in APAC. Even though it is challenging to specifically quantify the exact year over year COVID impact since COVID still presents headwinds in parts of our business today. Clearly, last year's Q1 is the easiest Comp of the 4 quarters.
With that in mind, we expect 13% organic growth from the Q1 of last year. Our adjusted operating profit is projected to increase $55,000,000 at the midpoint and adjusted operating margin is expected to increase Approximately 500 basis points. Adjusted earnings per share is expected to be approximately $0.11 at the midpoint, up $0.76 from last year's Q1. This year over year quarterly earnings The share increase includes a $0.54 benefit from 2 discrete items in the Q1, including the 100 and $74,000,000 loss on extinguishment of debt and $21,000,000 of stock transaction costs. In addition, interest expense in last year's I'm sorry, interest expense in this year's Q1 is expected to be $45,000,000 lower in the Q1 of 2019, driving an additional $0.13 per share adjusted EPS benefit, A year over year benefit that does not repeat as significantly over the remaining three quarters due to the timing of the SPAC transaction and debt refinancing last year.
With that said, I turn it back over to Rob. Thanks, David. Turning to Slide 16, I wanted to provide some color on the key themes and initiatives we shared with you on our earnings calls over the past year. First, our focus is on the top line. We continue to strengthen All of our customer relationships, but especially with providers in the cloud and colocation space.
Doing so has led To order increases in 2020. While large projects with cloud and colocation customers will always ebb and flow, we are Gaining greater visibility into the future needs of our customers, which will translate into our ability to meet future demand and win projects down the road. Furthermore, we continue to hone on our go to market efforts in the IT channel area. We saw the greatest traction occur in the United States And the impact got stronger as the year went on. Secondly, we are piloting the VirTrax operating system known as VOS in 2 of our manufacturing facilities.
Already, we are experiencing improved performance and favorable results as we formalize and standardize the way we work. The rollout globally, as we've said, will take time, but I'm pleased with the early results that we're seeing. David talked about margin expansion in his comments and I'm very pleased with our performance in this area. Our sourcing capabilities have continued to improve. Our pricing initiatives have continued to yield favorable results and our restructuring actions announced last quarter We are now in full flight.
The foundation we have established and the trajectory that we are on gives me confidence in our ability to achieve the expansion plans we laid out a year ago. Finally, and maybe my personal favorite, VPD, our Virtu Product Development progress. We continue to focus and fund our research and development programs. Even though we couldn't or had limited travel In 2020, imposed because of COVID, we still conducted the Verdict user experience view sessions to bring us closer to our customers and help us become more stronger strategic partners for the long term. We have seen the pace of new products and service introductions increase year over year and in 2021 There will be no difference.
In addition to these real time results, we have also started to do some seed planning in a few future targeted areas to ensure we continue to be on the cutting edge in our industry. Now turning to Slide 17. I'm very Proud of the Vertiv team and what we've accomplished over the last 12 months. We delivered on our commitment. We demonstrated we are a great company and a growing industry.
We have executed on many key activities, which have implemented many strategic initiatives, which will serve us both well in the short term and in the long term. To all of our employees on the call today, thank you for the dedication and tireless effort to To all of our investors, thank you for your support over the past year and being with us on today's call. I'll now turn the call over to the operator who will open up the line for questions. Thank you.
We'll now begin the question and answer session. We'll pause for just a moment to compile the Q and A. First question comes from Jeff Sprague of Vertical Research.
Thank you. Good morning, everyone. Hey, yes, I think The change in the reporting actually will be positive over time and simplify things. There's a fair amount of confusion here this morning, but from what I can tell, We've bridged to something pretty close to where consensus was. So thanks for all the restates.
I want to talk about the normalization of cash Well, a little bit, if we could. And I understand there's some pressure here in 2021 as you lay out in the bridge. We end up with free cash flow in 2021 that's on the low side relative to adjusted EPS So EBITDA or revenues. I just wonder your view if you could give any context on once we work our way through 20 '21 here, some of these items normalize, how you would kind of frame up the kind of the ongoing free cash flow picture?
Yes. Thanks, Jeff. This is David, and thanks for the feedback. So I would point out 2 things In 2020, cash flow that are somewhat anomalistic. So the first and most significant is the cash Required for restructuring.
So we had anticipated to have approximately a $60,000,000 Cash outlay in 2021 for restructuring programs, our current estimate is closer $70,000,000 $50,000,000 of that is embedded in the restructuring cash payments bridge item on Slide 14. And then we have another $10,000,000 to $20,000,000 included in adjusted operating profit for 20 21 projects. So that's about $20,000,000 or about a $70,000,000 cash outflow. We'll always have some out low for restructuring from a cash basis, but that's probably high by a good $50,000,000 The other item I'd point out is CapEx. I think historically we've kind of provided Go forward direction of CapEx in the $75,000,000 range, we're guiding to $95,000,000 next year.
And a lot of good projects are included in that 95, but it also includes some projects that were pushed from 2020. So if I were doing a model, I probably would include 95,000,000 going forward, but I would include more than 75,000,000. My guess is that we will settle in right around $85,000,000 All the other items, including cash interest, If anything, that should decline going forward. Cash taxes probably will increase. Working capital is one item that we still have a lot of work to do and we see some opportunity going forward.
But Other than restructuring and CapEx, I would say 2021 is somewhat normalized.
Great. Thanks for that. And just one other one for me and On the enterprise related activity and I guess the small signs of some additional life that you commented on. Can you provide any additional color on your visibility there? Can you see a pipeline developing and kind of bid and proposal activity?
Just wondering if you could put a little bit of kind of firmer Yes. How do you expect the
year to play out? Sure. Hi, this is Rob. Yes, what I'd say is We always talk to the fact that we take a look at our pipeline growth, that's always the leading indicator. And even That is pre activity on quoting, as you mentioned, which is exactly that.
We've seen pipeline expand, out of 2020, so that gives us comfort that the enterprise will begin to recover. Activity is intense in the Design area with both electrical and mechanical contractors. So again, that gives me reason to believe that we will see that recovery. It's just a matter of if and when, not if, but when people kind of get out of this COVID thought and But the activity looks good and gives me confidence. And that's globally.
It's not and we've seen probably A quicker recovery on the enterprise in, let's say, Asia and Europe is spotty And then Americas has probably been the slowest, but overall the pipeline looks good and the activity is we're very active there. Great. Thank you.
Your next question comes from Nicole DeBlase of Deutsche Bank.
Yes, thanks. Good morning, guys.
Good morning, Nicole.
Maybe we can start with the outlook Thinking about normalizing towards contribution margins beyond 2022, there's obviously still quite a bit of noise here in 21. So when you think about sustainable levels of restructuring in this business, are you guys going to be factoring in like $20,000,000 or so a year on an ongoing basis. And I guess similarly, is R and D kind of getting to the point where You're reaching your medium term run rate or do you think that there still needs to be a step up in R and D beyond 2021?
Yes. Thanks, Nicole. This is David. I'll certainly address the restructuring question and I'll ask Rob to address R and D. Our plan at this point, especially as it relates to the Vertiv operating system is related to continuous improvement.
Whether you can equate that to continuous restructuring, I think that's probably semantical, but we will continue to invest dollars going forward To take dollars out of the business. So I wouldn't want to specifically commit to a dollar amount per year. I think we mentioned for 2021, we're investing an additional $20,000,000 on Top of the 2020 restructuring program, that's probably a good starting point. But If there are projects out there with returns, we potentially could invest more than that. If there's There aren't projects in any particular year.
It could be a little bit lower, but I think that $20,000,000 probably is a good starting point. And As it relates to R and D, I'll pass it off to Ron. Yes. Nicole, as part of our stated strategy and we talked about it on the roadshow, We plan to take R and D up to 6%. Innovation is our vector of differentiation and will allow us to get that margin expansion and there's a lot of Call adjacencies and other areas that we can participate in.
So what we expect, while you've seen a fairly large ramp We expect that that will produce long term results over time. R and D does take a little while. Some of our products in the channel We'll see benefits within the year. Some of the larger projects we see within 12 to 18 months. But we're very excited about the opportunities.
We have more R and D projects, I would say, than we have funding. Our collaboration efforts have proven To be successful with the Colo and hyperscale allowing us to design in and drive a better margin profile.
Got it. Nicole? Nicole, this is Dave. Just kind of maybe putting the two points together. At the end of the day, we're sticking with our strategy to grow sales and hold fixed costs constant.
And that Creates a lot of room for both margin expansion and reinvestment. So we still plan on doing both, not just in 'twenty one, but long
for the future. Got it. Thanks, Dave. And then just for the follow-up, what have you guys embedded Pricing for 2021. And I guess, further to that, is the expectation that you can offset raw material inflation with pricing or is there any sort of price cost headwind embedded in the guidance?
Yes. Hey, Nicole, good morning. It's Gary Needham from. So I would say if you reflect back on pricing for 2019, we had a pretty good year. I think we've told everybody we were about $20,000,000 to the positive.
In 2020, we were somewhere in that $15,000,000 to $20,000,000 range and our expectation is that for 'twenty one, we will have positive price as well. Certainly, some headwinds coming from commodity and inflationary aspects all around the globe. But we feel pretty good about where we sit right now to continue passing price along, whether it's going to be in the same range of what we're able to do in 2019 or 2020, not quite sure just yet, but we'll Certainly be on the plus side of that equation from where we sit today.
Got it. Thank you. I'll pass it on.
Your next question comes from Scott Davis, Melius Research.
I didn't hear anything and didn't expect
to hear anything on M and A in your prepared remarks, but it's worth asking the question. You're delivering pretty quickly. Is there an opportunity to start to play offense perhaps on bolt ons and perhaps even stuff that's a little bit larger than what you've historically looked at?
Scott, thanks for the question. Our stated strategy and what we Talked about when we were out raising the pipe was we do have a robust list of potential targets that It could be nice bolt ons for adjacencies or completing a global product line. We'll continue to look at those and if it makes sense, It hasn't been our first priority. Our first priority was to pay down debt and look at Acquisitions is something that's opportunistic as they come and like Dave Cody has always said, they Don't always present themselves when we want them to, but we continue to look and follow and track those companies that we might be interested in. But again, it isn't Our first priority is to go out and buy something.
We do like the optimism strengthening of our liquidity to be able to look at various things, but we just Have to take those as they come.
Okay, fair enough. And then just to be clear on the capital spending side, is it when you think about your spending and I imagine there's a mix of things you're spending on, but is it more weighted towards new capacity or kind of tuning up, Upgrading IT spend, etcetera, on existing capacity.
Yes, this is David. So I would say it's Probably split in 3 different buckets and certainly not equally split, but we are continuing investment in IT And that's something that we'll be launching an ERP system in the Americas In 2021 and that takes continued capital. Operational, It's probably a little bit over a third of the overall spending. Some of that is continues maintenance spending, but also related to some of the restructuring that we announced last year and that CapEx We'll be more skewed towards the back half of twenty twenty one and we'll see benefits from that in 2022. And the last bucket is related to the VirTrax product development or R and D initiatives.
And that's something could be in a range of $20,000,000 $25,000,000 that we would anticipate They continue going forward. So overall, as I mentioned to Jeff, the 95 for this year probably is a little bit elevated. But this spending, most of it is investment related, being there is a return as opposed to just The continuing maintenance CapEx.
Your next question comes from Nigel Coe of Wolfe Research.
Thanks. Good morning, everyone. So just curious on the switch from EBITDA to EBITDA effectively, does that match to a way that you're Changing internally in the way that you're measuring and completing execs internally, also just like a change in presentation for us folks. And I do think that some investors are struggling to compare like for like. So just In that regard, it looks like there's about $70,000,000 of expenses that would have been added back in FY 2020.
Stock based comp, Transmission costs and restructuring, those are the 3 buckets I can see. If you can just confirm that in the right ballpark, that would be helpful. Thanks.
Yes, this is David. So Nigel, what I can say is that The way we report to The Street is going to be exactly the way we scorecard ourselves internally. So we had used adjusted EBITDA for internal basis for measuring and compensating. And we are definitely transitioning that to adjusted operating profit as well. On a go forward basis, if you were to look at 2021, adjusted operating profit versus what we had included for adjusted EBITDA for 'twenty one.
So the $660,000,000 versus the $575,000,000 that difference is simply So on a go forward basis, effectively what we're doing is holding ourselves accountable for Capital spending and the resulting depreciation going forward. So of course, I think a lot of the confusion comes looking at the historical and Yes, some of the historical adjustments, but going forward, the only difference between adjusted EBITDA and adjusted operating profit is going to be that Appreciation and of course very critical is not having any adjustments going forward. So we're holding ourselves Fully accountable for any expense that hits the P and L. And the only adjustment from GAAP It's going to be that intangible amortization.
Right. But what I'm saying, look, the specific part of that question was, If we were in FY 2020, just so that investors can compare like for like and get an underlying incremental margin, It looks like $70,000,000 of costs have been fully absorbed in your FY 21 plan that would have been at the back ordinary. Is that the right
I think that is directionally fair. Certainly, if you look And a couple of the items that I mentioned related to Slide 13, we will have $25,000,000 of stock cost in 2021. That is a cost that in 2020 was treated as a historical add back. In addition, we have about $25,000,000 of IT related expense that historically we and these are implementation Costs related to new projects, that $25,000,000 would have been included as an add back for 2020. So that's $50,000,000 right off the bat, the $20,000,000 additional that you expense And that is something if you compare it to the $70,000,000 historical add back from the Q3 last year, So would have been treated as or be subject to be treated as an add back.
So if that's how you're Developing the $70,000,000 I would agree with that math.
That's exactly right. Thanks, David. That's helpful. And then a quick one on the $55,000,000 in investment spending. Where does that take R and D?
I know R and D target is 50% of sales, but what is that mark to market R and D As important sales in 2021.
Yes. So and we'll be filing our 10 ks on Monday. Our R and D expense for and we'll disclose R and D expense, but our R and D expense for 2020 was $230,000,000 which was about 5.2 percent of sales.
That $65,000,000
figure on Slide 13, about half of that is R and D and the other half of it is based on growth initiatives. So assuming an additional $30,000,000 spend in the $4,775,000,000 guidance for next year, takes R and D as a percentage Sales up to close to 5.5%.
Okay. Thanks, David.
Yep.
Your next question comes from Amit Daryanani of Evercore.
Thanks for taking my question. I have 2 as well. First off, when I think about the $65,000,000 of incremental expenses in calendar 'twenty one that have been made, can you just talk about how you think about Payback on these investments, do I think about VoIP's inherent growth being better in the calendar 'twenty two and high tier? Or do I think about a step up in conversion margins? How are we able to pay back on these investments over the next few years?
Sure, Amit. Hi, it's Rob here. What we've said on these investments is that As I mentioned earlier, some of the projects take a little bit longer than others, but the reason for investing is that we so we can outpace the actual market growth. So by investing in these new product Growth. So by investing in these new product categories or new product areas, it will accelerate our growth at 1.5 times the market growth rate.
And those things happen over a period of time. Channel type products, more IT based products, 6 to 12 months, we began to see a payback on those. And then the larger projects, products, typically 12 to 18 months And begin to see the sales on those. And they could be things like larger UPS, UPS is larger megawatt UPS is our Larger cooling or thermal management units, those things take typically a little bit longer to get out globally, but it will It yield over the next several years our ability to outpace the market growth rate.
Got it. And then just as a follow-up, when I think about your webscale, your hyperscale colo customer base, Can you just touch on, do you think you are at this point over or under indexed on a market share basis in that bucket? And what are the steps you can take to drive up your share gains in this market over the next few
years. Sure. So we always great question. We always kind of combine colo and hyperscale because
as we've talked about in
the past, Outside the U. S, the hyperscalers typically work with colocation companies for their For their data center builds and inside the U. S, they typically build themselves. And then there's a mixture of that. I would say there's room for growth in both.
If you just look at our overall market share, we have the ability to grow and we think our collaboration method and model Working closely with our customers to design those products will give us the ability to take additional share. We had some very nice wins in conversion in 2020 of maybe some colocation companies we haven't worked with in the past. So We think there's plenty of room for growth and as the expansion happens on a global basis, you'll see that the opportunity is there. We don't necessarily sell our Full entire product set in all of the hyperscalers today. So there's room for improvement there as well, whether it's a larger Battery backup system or a larger STS or a more power distribution, there's room for growth there too.
So we're certainly not at a And have the ability to continue to grow our share there. And that's one of the reasons why we're investing in R and D so heavily.
Perfect. Thank you very much for your time.
Thank you. Your
next question comes from Lance Vitanza of Cowen.
Hi. Thanks guys for taking
the questions. First off, the revenue performance and the revenue guidance Relative to the industry growth that you discussed in the past, I guess, you're taking significant market share. So my question is, Where exactly are you seeing these gains? Is this mostly from taking business away from the smaller companies Yes, that we necessarily haven't heard of or are you also taking share from the Schneiders
and the Edens of the world?
So, great question, Lance. Thank you. This is Rob. What I'd say is a combination of both. When we look at some of the share gain that we're seeing, Certainly, there's a lot of regional players, smaller regional players that we compete against and because of our global nature And filling out some product gaps that maybe we had, we're able to take that.
But I think as it relates to Eaton and Schneider, we compete with them and it's different in every region, right? How competitive they are, they aren't. But I would say in general, we believe we're growing in both cases and taking some share. I know just looking at some of the channel statistics In the IT channel side of things, while a lot of people were down, I think our overall Decline in 2020 was much less than our competitors in some cases, therefore, showing that we took We share there as well. So it's kind of beginning in the channel and in the colocation hyperscale.
Great. Okay. And then my other question is actually with respect to Slide 13. I wanted to focus on this 26% projected increase And adjusted operating profit, and that's the metric that we're going to be looking at going forward. So I think that's where we want to focus.
And I guess the question is, what should we think the potential there is for that kind of growth to be sustained beyond 2021? Now I'm not asking for guidance, But I'd love to get your thoughts there. And if nothing else, perhaps we could talk about the 40,000,000 Dollars of COVID savings that are sort of being restored in 2021. Well, clearly that I would I think that's not going to be recurring in 'twenty two and beyond. On the other hand, it does sound like the growth in the R and D investments are going to continue to increase for the next several years.
But that being said, I mean, how should we be thinking about kind of that 26% growth, is that anomaly or just indicative of what the earnings potential is for this business?
Yes, this is David. I'll take a shot and then ask Rob to comment as well. Yes. One thing that I do want to reaffirm for everybody on the call and all investors and analysts is that We are still fully committed to the margin improvement goals that we have talked to historically. So It's because we're switching to adjusted operating profit from adjusted EBITDA.
It doesn't change the intermediate and long goals that we have for margin expansion. Now we will have to recalibrate. So I think we historically I talked about getting to 17% adjusted EBITDA and I think equivalent number for adjusted operating profit It's somewhere between 15% 16%, but we're committed to using 16% goal. And there's no reason we can't get to 20% in the long run. So I think we've used that as kind of the Long term hurdle?
With this transition to adjusted operating profit. And so I think That very much works into your question about the future expectations for adjusted operating profit growth. Certainly, we see the growth in adjusted operating profit being enhanced And growing with the top line. So as long as we continue to grow that top line in above market while expanding Margins, there's no reason mathematically that we can't continue similar growth going forward.
Thanks very much. That's nice.
Your next question comes from Andrew Obin, Bank of America.
Good Ridley Lane on for Andrew Obin. Wanted to ask about what your guidance assumes around the services revenue given that you're still having site access
I'll take a first stab at that and then David finish that off. But Yes, we will continue to deal as COVID is an issue with site access and but we expect You know that year over year we've got in the plan that we will be growing our services revenue as part of our overall growth strategy. Again, Could be overall COVID, we can't predict what that looks like, but we've been able to navigate pretty well around that. There's just Various areas and hotspots that we'll have to deal with from time to time, but we do expect to have and built into our plan is growth in the services for 2021.
Got it. And then as a follow-up, Maybe could you talk a little bit more about what you're seeing in the enterprise space? What are the areas that you're seeing the improved demand and what's still weak?
Yes. I'd say it's going to be by industry vertical, right? We're still seeing, of course, Travel and entertainment being one that hasn't recovered and not sure when that will recover. Certainly, other verticals like Tail big box stores, we've seen the spending begin there as people continue to compete for that kind of e tail Local distribution, certainly on the financial vertical, we see spending beginning to pick up there in the financial space. And then the other areas of positive signs is around education and government spending It would be the other ones that we would see from there.
So while some sectors are down, in general, those are kind of the areas that we're seeing some bright
Your next
question comes from Mark Delaney, Goldman Sachs.
Yes. Thanks very much for taking the questions. First, just hoping to dig into the demand environment a little bit more. The company reported very strong Backlog growth of, I believe, 32% and that's now at a high level. As you're thinking about the backlog into 2021,
do you think you're going to
be able to sustain Backlogs at this type of a high level or perhaps even grow it or would you think you're potentially going to work the backlog down a little bit this year?
Hi, Mark. I'll start and then I'll let David come in. We're seeing and continue to see strong demand both in Q3 and Q4. If you listen to both hyperscale and colocation, their business is going quite well and that's a big driver In driving our backlog on projects, I think our global expansion that we're seeing in China, in the telecom side of Thanks. Certainly, India now has come on the radar map for hyperscale and colocation.
So I guess what I'd say is we expect upper single digit growth in the order rates and expect to continue to see about to happen.
That's helpful. Thanks. And my follow-up question
was on the channel opportunity. And Rob, you mentioned a few times throughout the call about some strength that you're seeing in that market begin to materialize. Is that more a function of the macroeconomic environment and some of those types of customers coming back? Or would you attribute it as well to
some of the company So
the efforts that Vertiv has underway to better penetrate those channel customers?
Yes, great question, Mark. No, I attribute it to kind of the Execution and some of the programs and some of the products that we brought out. We've got some unique products in our power distribution, IT power distribution side. We've been pretty aggressive on our lithium ion offerings and making sure that that's available. So some of the programs that we've Targeted are paying off.
And we've had, as we mentioned, quarter to quarter year over year still was down, but quarter We've seen the improvement, so we feel like we're on the right trajectory with both new product intros, the programs that we're offering. We've certainly simplified Our partner portals, project registration being that hopefully easier button for our customers To come diverted for that. We're taking that same and we've kind of globalized that same strategy to Europe, which is a little bit further behind and then driving it into the rest of Asia and China. So As you know, this is a big part of our strategy. This does take time.
We've chosen to do it organically And but we believe that our current strategy and trajectory will yield the results ultimately that we're looking for. Thank
Your next question comes from Andy Kaplowitz of Citi.
Can you give us a little more color into the continued strength you're seeing specifically in EMEA? You've been talking about working on some large colocation projects for a while. Now these projects continue through 'twenty one. And I know in the past you've talked about Regional data sovereignty driving growth. So how sustainable are these trends there?
And what else is going on in the region that's leading to such good performance in EMEA specifically?
Absolutely, Andy. And great catch on the EMEA side of things. What we see typically with hyperscale and colo is typically rushing to various parts of the world. And so there will be, well, let's say, maybe not as much spending in the U. S.
Going on or growth. We have seen that In Europe, and I firmly believe the data sovereignty, people want data centers in their country. Governments want that data there. They don't want it sitting in data centers in the U. S.
Nor In China. So I think there's a lot of build out if you take just look at the number of data centers, number of cell phone users, number of broadband Access in Europe versus what you've got in the U. S, I think we have a lot of runway ahead of ourselves as it relates to Europe and the builds that Still have to happen there. The Brexit thing is driven lots of data center builds and parts that we didn't think were necessarily going to happen. So we continue to see strength, I think, over the next couple of years in the European side of things.
We have taken some share there. We've Add some new customers that we haven't traditionally done business with in the past. So the customer acquisition has been good there. But I'll tell you, if you look at globally, I'm pretty excited about Whether it's Europe or Middle East and Africa, South America, again, a lot of chatter and talk in India Around colocation hyperscale finally coming there, they're so underserved. So I think we've got a lot of runway in Other parts of the world plus what's still happening here in the U.
S, not that the U. S. Isn't going to grow, it's going to continue to grow, but I think we'll see outside Europe. Europe's leading The way now, but I think you'll begin to see some of the Asia countries and certainly India begin to pop up on the radar screen as nice areas. So All in all, yes, I look at the next several years as we've got a fairly healthy market in front of us.
Very helpful. And then actually following up on Pat, just in terms of margin, you've talked about some margin pressure there coming from product mix, timing of large projects. How should we think about the margin progression going forward? Do Do large projects start to ramp and that will help your margin there? You've talked about supply chain stresses.
Does that hurt you in Asia Any more color would be helpful.
Yes, I'll start off there and then David, if you want to come in over the top. I would say in general, we're probably weighted more towards the telecom side of things in parts of Asia Pac and that tends to be kind of lower than fleet average margin that we see. As we continue to drive innovation and invest in innovation specifically in China, we expect to be able to Paid for that innovation as we go forward. So we're certainly focused on getting that closer to the fleet average, but there is a mix difference as it relates to the types of products we're selling there today. So channel is going to be an important part of our success there.
And specifically, China, I think, It's a driver from a margin perspective as it relates to areas of focus, being more local And driving that local innovation is going to be important part of what we're doing in 2021 beyond. David, any other thoughts? No, I think you hit it pretty well, Rob. And certainly, there is Lower margin you get with certain lower larger projects, but we have tailwinds from a mix perspective From both the channel and some of the initiatives to grow services, we certainly aren't relying on mix to be a huge Margin enhancement opportunity going forward. I think we're assuming relatively flat, but there is that potential.
It could actually be a tailwind for us.
Very helpful, guys. Thanks.
Thank you.
There are no further questions at this time. This concludes our question and answer session. I'd like to turn the conference back over to Rob Johnson for any closing remarks.
Thank you, operator. And I'm going to close the call by thanking our 20,000 employees around the world for working hard every day to take care of our customers. We appreciate everyone's time today. Please stay safe and we look forward to speaking with you again soon. Thank you very much for your support.
Conference has now concluded. Thank you for attending today's presentation. You may now disconnect.