Okay. For those of you that don't know me, I'm Nicole DeBlase. I cover the multi-industry and electrical equipment and machinery groups at DB. Next up on today's presentation schedule is Vertiv. Very pleased to introduce Giordano Albertazzi, CEO and President of Americas, as well as David Fallon, CFO.
So, Gio took over as CEO in January of 2023, prior to which he served as president of the EMEA region, and then president of the Americas region. He actually joined the company in its prior phase as Emerson Network Power in 1998. David has served as CFO since 2017, prior to which he was CFO of CLARCOR. I think we're going to dive right into the fireside chat. Have your questions ready.
I'm going to open it up to questions from the audience, maybe when we have about 10 minutes left or so. Don't be shy. All right. Maybe first question, Gio, what has changed or is changing at Vertiv under your leadership?
Yeah, absolutely. Well, good day, everyone. First, first of all, as I said, I've been with the company for quite some time, know the company very well. One would expect an evolution, remaining not a revolution, but certainly an evolution that is focused a lot on execution in this phase of our history. History is a bit, kind of, bumpy in the last, in the last, 24 months. I think, we started to demonstrate, back end of 2022, and certainly at the beginning of this year, that we are in execution mode. Execution mode is not just one quarter, execution mode is mindset that we are injecting in the entire organization. The organization responding very well.
We were talking about Vertiv Operating System, but the execution for us is really broad, reaching every aspect of conducting the business. Execution for us also means making sure that we deliver as we have started to do on our past cost equation, and certainly deliver on our customer expectations and our investors expectation. So far, so good. Execution is natural to me. I'm originally an ops person, so an operator by education and by experience, but again, been in a leadership role for quite some time. I understand that while execution is 80% of the success of a company, that 20% that is a strategy can be absolutely and crucially important for the long-term success of a company.
That's why a lot of my time now, especially in this moment of inflection of the industry, is on innovation and long-term, long-term strategy, something that we are all focused on. It's also an opportunity to remind everyone that we have an Investor Day coming up at the end of November, where we will be able to more extensively answer your question, what has changed, what is changing as we really crystallize our next, the view, our view of the future.
Excellent. Okay, we're going to get into this topic of AI right away. Just let's get it out of the way. It's what everyone wants to hear about, I'm sure. You know, post-NVIDIA's big earnings beat, what was that, 1.5 week ago now? There's been a lot more interest in this AI-driven transition to high-density data centers. Maybe just starting with the liquid cooling aspect, seems to me like this is the clearest way Vertiv could benefit. Is it possible for you to size for us, like, the liquid cooling business or market today, and just give us a sense of your view of the strength of Vertiv's position?
I would talk in general about the increased density of power and compute power and the transition CPU to GPU transition that the industry will undergo. Clearly, something that will be gradual, probably rapid, but gradual nonetheless, the speed of which is yet to be defined. Prior to that, we've been thinking and we've been talking about an industry that is growing, a secular trend of 6% or 7% going forward. We believe that the transition to GPU and high density will happen in stages, and there will be an initial stage in which air cooling will continue.
Also in the, in its most extreme, and future, configurations, in which you have above 300 W- 400 W per chip, type of solutions, you will have liquid cooling to the chip, but there is a lot of other heat-creating type of equipment inside the rack. Always think about the mixed environment, air and liquid will gradually start. It's now kind of a small percent, low to mid single digit, and that will gradually transition to a mid-teens, let's say, in a few years.
The fact that we have liquid cooling technology, the fact that liquid cooling never should be looked at in isolation, but also and always as part of the system, not only because the two coexist, as I briefly explained, but because, you know, you have to extract that heat from the primary or secondary, in this case, liquid cooling circuit and get it out either in the environment or sometimes even use the heat for other purposes. As always, think in a complex system that goes from a chiller, most likely, all the way to inside the rack in multiple means. And this complexity and this multi-technology is exactly our sweet spot.
We know the space like no others, been here for decades, and we have the breadth of portfolio, the scale, the global footprint to really accompany the industry in this in this transition. That is again not a binary transition, but it's a transition to higher level of complexity. We love what we see, and we know it will be, you know, the speed at which will happen, yet to be defined.
Okay, understood. I mean, some of the pushback that I've had from investors about the liquid cooling story for you guys is just when you google liquid cooling, there seems to be a lot of smaller players in that industry. Do you think that your leading position in thermal today could also echo through to liquid cooling as the market develops?
The answer is yes, let me elaborate a little bit more. Liquid cooling is a very early stage in the technology lifecycle curve. As it's normal in these cases, you have a lot of new entrants, which is actually fabulous because these new entrants serve a purpose that, you know, it's multiply the ability to experiment new technologies over and beyond what the incumbents, like ourselves, so of course, work and develop organically, liquid cooling as well, can do.
It's very normal in this kind of industries that the solution is then a combination of organic and inorganic type of portfolio expansion. In the end, you need guys like us to guarantee the scale, the service, reliability, and presence to really deliver for an industry that will be growing fast.
Right. Makes sense.
You can't be too small for that.
Right, I understand.
It doesn't happen.
The service organization has to be a huge part of it as well.
It is fundamental. It's always been fundamental in our industry. In more complex thermal world, and power, of course, let's not forget there is a power story to that equation. Having strong, incredible service, global presence is absolutely paramount.
I'm going to get to the power aspect in a second, but just one more on liquid cooling. The other concern I've had is: Are we sure that liquid cooling as an industry or as a product line for Vertiv will be margin accretive in its, you know, more complete industry state or its post-growth industry state?
New technology, new complex technology, with a lot at stake. We talk about, let's say, business critical. There's nothing more business critical than a singularly cooling a server, singularly. If anything, there is more criticality there than anywhere else. We like that. Again, it's about the orchestration. We believe that the system, and not only, but also, the individual point, liquid cooling solution will be a good margin story for us.
Right. I mean, I'm sure you wouldn't be trying to participate in this market if that wasn't the case, right?
Exactly.
Okay. Have you or.
Sorry.
That's okay, go ahead.
We do not see it as a market. It's one of the technology in the bigger market. Let me be very clear. It's like, is there a direct expansion data center thermal management market? No, there is a direct expansion technology. There will be a liquid cooling technology within the market.
Right. Okay, important distinction.
Sorry for the double-talk in that.
No, totally fine. Have you started to actually see orders come in, or is this still to come? I know it's early days, right? We've just learned about this in the past few weeks.
I go back to our earnings call where we were adamant about the fact that quite a few conversations with many customers, and the fact that we do have some high density orders in our backlog. It is happening definitely.
What is happening also is that a lot of our customers, the large customers, are sitting with us to say: "Okay, I know the high density will come. I know that it will be a mix of technologies, and we'll have a higher mix of direct-to-chip liquid cooling going forward, but I can't design our infrastructure around that yet. I need to work with you to design a liquid cooling transition-ready infrastructure so that my investment today will have a 12- 15 years' life cycle accommodating this transition." That's a very important role we play with our customers.
Absolutely. Okay, outside of liquid cooling. Couldn't the rest of the business benefit? I feel like everyone's so focused on liquid cooling, if you're increasing the power consumption of your data center by transitioning to high density, wouldn't that also spur higher demand in the rest of your business as well?
Again, that's a very logical inference in many respect. That's what we believe. Again, the speed and the intensity at which this will happen is yet to be defined. It's very logical. Again, you know, there will be an efficiency play on the compute side, and we believe that's not only normal, but also welcome, considering how much more compute power that will be needed in the future. You know, what exactly, how the two will offset is yet to be defined. We believe it will be a kind of a favorable scenario for Vertiv and for the industry as a whole.
Okay. There's been so much buzz about this whole retrofit trend, but with, you know, the implementation and deployment of AI, don't you also think that this just creates the need for more data center build-out over the next, you know, decade?
It would be indeed a combination of the two. It really depends on how fast the industry will want to transition to GPU-based, high-density based. There will be an element of retrofit if you really want to accelerate or the players will want to accelerate over and above what the speed at which new sites will be built will allow. It's natural that there will be a retrofit component.
Mind you, probably some of the retrofits or some of the initial retrofit at server level, not infrastructure level, may happen still within the envelope of the existing technologies, and that's the good news. It doesn't mean that the industry stalls necessarily until everything is retrofit, but it will be a gradual transition.
Okay. Last question on this, and then I'll check with the audience to see if there's more on AI. Do you think this is going to be focused more in the Americas region, or is this a truly global phenomenon?
I think it will be truly global. As everything in this industry, North America has what we call a 6- 12 months head start. It will not be different this time.
Okay, makes sense. Any questions from the audience on the topic of AI before I move on?
Maybe just shifting away from that into the underlying business. The comps are really tough. You know, clearly, that's why orders are down, and that's why you're expecting them to be down again, although less so in the second quarter. How do you expect backlog to kind of trend through the rest of the year? Do you expect material backlog burn, and can book-to-bill remain 1 times or better for the rest of the year?
Clearly, we've been, I think, explicit and clear about orders as you summarized in our earnings call. Also we were signaling both in February and in April that the, well, in February, that the 70% almost backlog coverage that we had in 1st of January, say, was an anomaly for us and for the industry in general. We expect that the backlog coverage will normalize and, you know, not exact science, but we would think in terms of something sub- 50% in a normal business in a normal business cycle. We, we believe we will go down that path going forward, which will be very normal and good for the industry.
You know, we like a lot, book-to-bill 1 or above, but let's see how it goes. Again, for us, is the reference point is in this normalization of order intake that we explained, it's really about having the right amount of coverage of backlog coverage that is certainly lower than the 1 we experienced so far.
Sure, makes sense. When you say you expect data center CapEx growth over the next several years, medium term, is that kind of like in the mid-single digits? Is that what you would view as a sustainable medium-term growth rate, or is there scope for that to be a bit higher with things like AI?
We've been talking about 6%, 7%, 8% growth as something that we believe will be true, you know, going forward as a really translation of this secular trend. It is very sensible to believe that AI transition and this kind of a accelerated transition, I mean, not that AI is new, but this accelerated what seems to be an accelerated transition will accelerate growth rates further. Again, that's just a sensible way of looking at things. It's early for us, it's early for us to forecast anything different than we have done so far.
Sure. Okay. Maybe on the near term, what are you hearing from the three major types of customers, hyperscale, colo, enterprise, about spending plans?
Pretty much consistent with what we have seen. We have not encountered or experienced parts of the industry that say, "Oh, hey, we have to stop. We have to digest what we have done in the past." That's specifically, of course, different players that have different cycles, build cycles. But in general, we see kind of a positive environment across across the board. We've been very transparent with what happened with our backlog and with our orders, and, you know, we feel pretty positive across the board, and we do not have a piece of the data center business that is slowing.
Okay. No slowdown. I know you had changed enterprise to yellow on your industry chart a couple of quarters ago, but still no evidence of slowdown in enterprise spend. It's more about concern about macro?
Yes, and again, you know, let's see what this AI acceleration will do. The AI acceleration will play across the board, not just for the hyperscalers or the cloud providers, will be a general impact.
Okay, got it. China. So, China's an area where we have seen a bit of a digestion phase, if you wanna call it that, over the past few years. Have you seen any evidence of recovery in demand or customer interest in that region yet?
Back to April conversations or call, China, clearly, that's true across every industry, not just our industry, but certainly true for our industry, and we're not immune. It's been slower than we originally expected, but the back end of 2022. As we said in April, we have seen an acceleration in pipeline, and that's encouraging.
Okay, great. Supply chain, what are you seeing? Does component availability continue to steadily improve? There's been a few companies on the stage this morning that have claimed that supply chain is very close to returning back to normal, so would love to hear what you think of that.
There are two elements to the supply chain story: one exogenous and one endogenous for us. The endogenous is everything we have done over the course of last 12 months or, let's say, 12 months or a little bit more, in terms of making sure that our supply chain is way more resilient than it was before. In terms of making sure that every critical component is multi-sourced, but also we're moving to the next phase of resilience in terms of what is the long-term example, geographic footprint of our supply base, so that future shocks will find us way more prepared than we were back then.
Definitely, there is a normalization of the environment when it comes to the general exogenous part of a supply chain. There are still some challenges on the power electronics, but improving.
Got it. When you talked about the changes that you're making to your own supply chain, post, you know, all of this supply chain constraint that we've seen over the past several years, what exactly are you talking about more dual sourcing? Like, what is the plan?
There is certainly a dual or multiple sourcing on existing products. There is certainly an element of nearshoring in some cases. We are much more aware, as everyone, you know, the trade-off of lead time, freight cost or freight cost risk. Freight costs, of course, are now a favorable side of the equation, but the resilience is also in a complicated geopolitical environment, making sure that that aspect is also taken into consideration.
A lot of work. Don't think, I invite everyone not to think about Vertiv as someone fixing the problem and then business as usual. We have learned a lot, and our quest for resilient will not resilience will not start. Of course, we have hit everything that was short-term, risky and problem, and now we are really scanning everything we do to create that resilience that I was talking about.
Okay. Very clear.
Thank you.
Let's move on to price cost. As we move through 2023, can you talk a little bit about how pricing phases and how the pricing effort is going versus your plan?
We are satisfied in 2023 with our price cost equation, and especially, you know, as we said during earnings call, relative to our plan and our guide. More generally speaking, we're very satisfied about the $365 million price that we delivered last year. The over time, as we move into 2024, 2025, of course, in a moderating inflationary or a less inflationary environment, in a moderating inflation type of business, everybody's ability to price for inflation, to set inflation will diminish. Marginal price gains will be diminishing, but we have learned a lot.
We have built a muscle that is way stronger than it was before in terms of how we price, how we approve project-specific price, in terms of delegation of authority, and in terms of intelligence, but also in terms of incentive to everyone in the organization. I feel very good. I will continue to be, you know, strong in pricing, even though of course, price gain margins will diminish. In the end, price is a translation of the value you provide to your customer. Hence, back to innovation, back to an ability to really enable our customer's business and optimize their total cost of ownership.
Okay. When we return to this more normal price environment, what is the new normal? Like, is this a 1%, 2%, 3% pricing business annually, just thinking about the way you approach list price with customers?
That's very specific to product lines, type of business, and think about our business, less about the list price type of business and a project-based. Again, it clearly I go back to what I would say, we'll continue to see price, favorable price. The intensity of price will depend on really the overall market conditions.
Okay, fair enough. Just going to check with the audience to see any questions? Okay, I'll keep going. Let's go ahead and shift to margins. If we rewind the clock back before COVID, you know, when Vertiv first IPO'd, I think that closing the margin gap versus peers was probably one of the more interesting aspects of the story that investors were really focused on. I think the major driver of that was holding fixed cost constant while driving top line growth. Now that we're kind of moving past this price cost period, let's hope, do we return to that whole hold fixed cost constant, grow the top line as a source of margin? Is that the plan?
That's a mantra, not only a plan for us. It's something that we give ourselves a little bit of a wiggle room to the rule, $40 million for innovation and for capacity expansion and the little wiggle room, which is small relative to the cost base, is something that we will afford ourselves most likely going forward. Other than that, we are absolutely religious about that. You know, the operational leverage that drives is fundamental to our value equation. You know, there is a lot to the value equation that has to do with the overall productivity, also on the variable cost side of the equation. The answer is yes, absolutely central. It drives the right mindset as well.
Right. Absolutely. On R&D, I think that was an aspect of I mean, it's not a fixed cost, but it's an aspect of your cost that did kind of need to increase. It's been a story for a while. Where do you stand with increasing R&D today, and how do you think about how that needs to trend over the next several years?
You know, when I say that we increase on the R&D costs, make no mistake, some of the R&D investment is also fueled by being more efficient on the rest of the fixed cost base. It's not just the extra, but, you know, so we want to have a little bit more wiggle room again, in periods like this one, in which there is a clear inflection point from a technology standpoint. We want to have the right fuel to drive innovation. Yes, again, it's not usually material in terms of our operational leverage story.
Even more importantly than that, the long-term benefit in terms of pricing, margin accretiveness of the new technology, if really, as it does, solves a customer problem, is something that, you know, it is overall good for the bottom line, and certainly for the long-term success of the company.
Definitely. Okay, I think you guys used to talk about, like, a 45%, I think you called it a variable margin or drop through on revenue growth as you hold fixed cost constant. Is that still the right number, Dave?
It is not.
Okay.
When you look at the dynamic over the last couple of years with price cost, you know, even if you recover every dollar of inflation with price, you're still gonna dilute your margin. You can do the math. We're probably in the mid-30s right now as it relates to contribution. I think that 45% was more forward-looking.
Right. Is that still appropriate, though, for the forward view, post-price cost headwind?
But, we wouldn't even limit ourselves at 45%, you know, but if you look at the margin enhancement story, certainly fixed costs as a percentage of sales, as we talked about. Even more focused with Gio entering the role, is the execution on the contribution margin side. Definitely not satisfied and pleased with the 35%, and that will be a huge lever to first get to the 16%, and then in the long term, to 20% and more.
Okay. It's hard to see where peers are from a margin perspective because, you know, data centers is embedded. It's a smaller part of what they do. When you get to 20%, do you think at that point you're kind of structurally in line with peers, or is there still more work to do beyond that?
Yeah, you're absolutely right. It's not, you know, our competitors aren't pure-play data center, so there's some guesstimates and some, you know, logical inferences on what their margins are, but that's how we derive the 16%. Maybe it's a little bit higher, maybe it's a little bit lower. That's how we first established that as a goal. You know, the 20% is just a nice round number. We believe there's certainly opportunity in the long run, and most of the levers that we need to pull are in our control, you know, from an execution perspective.
There isn't really any fundamental differences between our business and these other businesses that would create an environment where we shouldn't anticipate getting to where they are currently. Based on our execution, that we would move beyond that, and, you know, hopefully, we're talking about a 20%-25% margin here and at some point in time.
I hope so, too.
Yeah.
Okay, anything from the audience before I move on to M&A capital deployment?
Maybe just asking about E&I. Can you talk about the performance of E&I? I think that there were, you know, some hiccups in the earlier part. Actually, it was the later part of 2022, I believe. Just an update on the integration process.
Absolutely. First of all, I want to reiterate the fundamental strategic importance of the acquisition. We're discussing with some of the colleagues, and really details earlier, how complete is our portfolio right now? This complete grid to inside the server to the chip type of power portfolio serves us splendidly. Especially thinking about the complicating power distribution environment as density increases. Very happy strategically. We are accelerating the integration. Of course, in a very orderly manner. We are making sure that E&I is really part of the Vertiv fabric, and it's ready to further scale.
We're very happy, as we explained in April, about the synergies that we see over and above our expectations. Very there. We have accelerated the regional integration of the Americas part of E&I into our Vertiv Americas, so that we can leverage the strong operational capability that we have built there to address some of the issues that we were transparent about in February. In general, everything we've done, we have reorganized everything, busbars and switch gear. I go a little bit in details of these technologies.
On a line of business basis, that is exactly the same structure that we have across all our technologies, so that we are ready to leverage the global footprint, and we are expanding capacity in Mexico, Slovakia, United Arab Emirates right now. Good story. I mean, work, more work to do, of course, but we are moving forward at a good pace, and I'm happy about what I see.
Excellent. Then once we kind of get back to your leverage target, do you see, you know, significant M&A in the future, or is it more about bolt-ons?
Yeah, I would say we look in the long run at M&A as a strategic growth driver. You know, I think it's more from the perspective of complementing our current portfolio. As Gio mentioned, the E&I acquisition filled a, you know, a more significant gap we may had in that power chain. You know, we will not be looking at a balance sheet as, you know, effectively a hammer looking for a nail. Meaning we won't do a deal just like, you know, for the sole reason to say we need to do a deal.
We'd be perfectly comfortable with leverage dipping below 2 times, but just like we did with the E&I acquisition, you know, opportunities generally choose their own timing.
We'd be perfectly comfortable getting above the 2.5 times or 3 times to do the right strategic deal. You know, with that said, in the near term, it may be more bolt-on and, you know, portfolio complementary type of acquisitions.
Okay. Sure. Well, I think unless the audience has any final questions? Okay, well, I think we're out of time, so we'll go ahead and wrap it there. Thanks, Gio. Thanks, David.
Nicole, thanks a lot. Thanks, everyone.