Vertiv Holdings Co (NYSE:VRT) Q4 2023 Earnings Call Transcript
Vertiv Holdings Co (NYSE:VRT) Q4 2023 Earnings Call Transcript February 21, 2024
Vertiv Holdings Co beats earnings expectations. Reported EPS is $0.56, expectations were $0.54. Vertiv Holdings Co isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: Good morning. My name is Brica, and I'll be your conference operator for today. At this time, I would like to welcome everyone to the Vertiv's Fourth Quarter and Full Year 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, Brica. Good morning, and welcome to Vertiv's fourth quarter and full year 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 our 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 : Well, 2023 was a great year for Vertiv and our share owners, we created tremendous value. Our stock price increased 252% in 2023, putting us well ahead of the number one performer in all of the S&P 500 and its up very well again so far this year. We announced the capital allocation strategy at our November Investor Conference and is very flexible and we believe is structured well to provide additional benefits to share owners and is a great reflection of the cash generating capability of the company. A very nice and exceptionally promising change from where we were. We finished the year strong, quite strong in fact, and we fully expect this to set us up well to continue to provide good returns for our share owners in 2024 and beyond.
So Gio and team are off to a very good start, but we still have work to do. You'll hear Gio talk about his focus areas for 2024 and what we plan to accomplish this year to deliver another good year for our investors. It's getting the important things like customer relationships, technology, VOS, organization, resiliency, working capital and capital deployment. We demonstrated our potential in 2023, but we still have a long way to run and that's all upside. So with that, I'll turn the call over to Gio.
Giordano Albertazzi : Well, thank you, Dave. Thanks a lot. As Dave mentioned our stock was up 252% last year. And as Dave said, if we were in the S&P 500, we would have been the top performing stock. We believe we meet the criteria and we believe Vertiv is a good candidate for S&P 500 inclusion. Let's go to Slide 3. We finished the year strong. Operational execution continues to improve. Q4 sales were up 12% organically. Growth continues to be led by the Americas. Orders grew 23% year-on-year and 18% sequentially, good across all regions. Additionally, book-to-bill was very strong at 1.3x, a demonstration of market strength that gives us confidence in what we believe will be a strong demand environment for ’24 and beyond. Adjusted operating profit of $330 million and adjusted operating margin of 17.7%, really a step function improvement and a demonstration of our sharpened operational execution.
Our adjusted free cash flow was $305 million for a full year at $778 million resulting in more than $ 1 billion improvement year-on-year. Our net leverage at the end of the year was 1.9x. So within our target range of 1x to 2x. And we were upgraded by both Moody's and S&P in December. In December, we announced the acquisition of CoolTera that further strengthens our technology leadership in high density and liquid cooling. More to come on that in a few slides. I'm pleased with a strong foundation. As we enter 2024, coupled with strong market demand, we feel good about our trajectory for the year and beyond. And let's move to Slide 4. We take a look at the market environment here and it's pretty consistent with what we have been seeing for a while.
Cloud/Hyperscale continues to lead the growth with tangible signs of AI deployment and very strong build plans. We continue to see encouraging signs in Enterprise with customers starting to develop AI plans for their business. Be it either on-prem or cloud, either way, it's good for Vertiv. Telecom, not a lot of news here, CapEx is tight and mainly focused on retrofit. From a regional standpoint, APAC remains soft but continues to be a story of China and the rest of Asia. The China market continues to be weak but we saw some small positive signs in terms of orders. We don't think the market is getting weaker but recovery is slow paced, if at all. In the rest of Asia, including India, we see significant investments happening across the market.
Cloud & Colocation are certainly leading the pack but Enterprise customers are also investing. We moved Commercial & Industrial to green in APAC, really driven by India. The investment and infrastructure are accelerating. The India market is quite exciting and we are well positioned. Overall, our pipeline formation is good and particularly strong in the Colo Hyperscale segment. Let's go to the next slide, Slide 5. I am pleased with the order strength we saw in Q4, 23% year-to-year and 18% sequentially. We enter ’24 influenced by a strong 2H23 booking driven by large projects reflecting also demand from AI. We continue to post record backlog which was up about $0.5 billion from the end of Q3. Good visibility for ’24 and beyond. We expect Q1 ’24 orders to continue to be strong, up in the high teens on a year-on-year basis in the first quarter across the portfolio.
We anticipate they will be down sequentially from Q4 but this is just a normal business pattern. We are working in close collaboration with our customers and suppliers to make sure we have the capacity in place to support the likely strong demand environment for the foreseeable future. We inaugurated a new thermal management plant in India. We have significant capacity expansion underway for switchgear and busbars across the thermal portfolio, including of course liquid cooling. As I mentioned at Investor Day, on a weekly basis, we look at evolving demand scenarios in a disciplined, rigorous, and focused way to make timely investment decisions. The backlog for AI orders continues to grow robustly. The acceleration of the overall order book related to AI, and it's never an exact science as I explained, matches the expected growth rate for the application, i.e. a growth uplift of 3% to 4% to the overall market, as we mentioned in November.
I continue to caution what is and what is not AI is fungible to a certain extent. What matters is that we believe that traction is consistent with the market uplift from AI, or perhaps a bit ahead, given our strong position in thermal, and thermal is a clear differentiator. Continuing to the right side of Slide 5, we believe that supply chains have largely returned to normal, but I'd say normal in a post-pandemic world. We are focused on making sure that resiliency is constantly increasing across the supply chain to weather what a quite complicated world can throw at us, so a lot of focus here. Looking at material inflation, we expect materials pricing to be relatively stable year-on-year, but we are very mindful that things can change rapidly.
And with that, over to you, David.
David Fallon : Thanks, Gio. Turning to Page 6, this slide summarizes our fourth quarter financial results. We finished the year quite strong, or our organic net sales increased 12%, 5% from volume, 7% from price, and America continues to be the growth engine which America's was up 22% in the quarter. Our sales performance was within guidance range, but slightly below midpoint, which was mainly attributable to a weaker China and some project delays in EMEA. Adjusted operating profit was $330 million, up $120 million from last year's fourth quarter, and that was mainly driven by favorable price cost and the higher volume. We beat the midpoint of our implied fourth quarter adjusted operating profit guidance based upon good commercial execution and material inflation below our modeled assumptions.
Our adjusted operating margin was 17.7% in the quarter, a 500 basis point improvement compared to last year, and that certainly was driven by our continued relentless focus on operational execution, and that clearly showed in the results. As we move to the right, our fourth quarter GAAP diluted EPS includes a $115 million non-recurring tax benefit related to the release of a valuation allowance, and we have removed that from adjusted diluted EPS. And we provide additional detail on that valuation allowance release on Page 28 in the Appendix, but otherwise, the year-over-year increase in adjusted diluted EPS was driven by higher adjusted operating profit. To the far right, another very strong quarter for adjusted free cash flow, as we generated $305 million in the quarter, more than doubling last year.
Certainly higher profitability contributed to this result, but working capital is also an important part of the story with plenty of opportunity for continued improvement. As Gio mentioned, that leverage declined to 1.9x within our target long-term leverage range of 1x to 2x and down from 5.6x at the end of 2022. This leverage level supports the capital deployment framework provided at our Investor Conference and gives us significant flexibility and optionality to deploy excess cash. Turning to Page 7, this slide summarizes our fourth quarter segment results. The Americas region, as I mentioned, continues to fuel the growth engine with organic net sales up 22% in the quarter. The improvement in adjusted operating margin in the Americas continues, up 640 basis points from last year to 26.9% with the increase primarily driven by favorable price cost and fixed cost leverage.
APAC sales increased 3% organically, but continues to be weighed down by China where sales were relatively flat year-over-year, but below expectations included in our quarterly guidance. APAC adjusted operating margin declined 220 points with unfavorable mix and the timing of fixed cost contributory factors. EMEA grew 1% organically in the fourth quarter, which was lower than anticipated, primarily due to delays on several larger projects. However, we did see an 18% sequential sales increase from the third quarter, which is encouraging. And EMEA experienced strong year-over-year fourth quarter orders growth, both which provides confidence for us to project low double digit organic growth in EMEA for full year 2024. EMEA delivered strong adjusted operating margin of 28.3% in the fourth quarter, an increase of 750 basis points from last year's fourth quarter, although they did benefit from a $6 million non-recurring gain from an asset sale in the quarter.
And as Anand Sanghi, our America's President has emphatically reminded us, without that gain the adjusted operating margin for the Americas and EMEA would have been approximately the same as those two regions continue to push each other for highest regional adjusted operating margin. Next, turning to Page 8, a summary of full year 2023. I can safely say it was a very strong year. It's always a good thing when the orange bars on this slide are significantly higher than the gray bars, and that is the case for all financial metrics for this past year. 2023 produced a step function change in financial performance from 2022 that is not often seen in a 12-month period. This significant improvement is a result of a relentless focus on operational execution, which very clearly reads directly through to our financial results.
Our full year organic sales up 21%, reflects a great position in a strong end market. Adjusted operating margin of 15.3%, an improvement of 760 basis points from last year, certainly provides a strong foundation to surpass our midterm adjusted operating margin target at 16%, which we expect to do in 2024 with about 110 basis points to spare at the midpoint. We did well in converting the improved profitability to cash with an over $1 billion improvement year-over-year. And let me repeat that, an over $1 billion improvement in adjusted free cash flow year-over-year with this improvement driven by the higher profitability and improved working capital management while continuing to invest in CapEx to support growth. Adjusted free cash flow of $778 million drove an adjusted free cash flow conversion of 114%, with this improved conversion benefiting from a significant increase in deferred revenue, primarily from advanced customer payments, which increased $280 million or 80% in the year while sales were up 21%, which we estimate contributed about 30 percentage points to that conversion.
While we expect continued growth in deferred revenue, there are many market dynamics at play and we should not expect similar growth in 2024, which is one of the primary reasons we are guiding to adjusted free cash flow conversion in the low to mid 90s for full year 2024. We have much work to do and there's plenty of opportunity for continued improvement, but 2023 certainly demonstrates our potential and helps build credibility and confidence that we can execute upon our long-term strategy and deliver the financial targets we introduced at our Investor Conference. Pivoting to 2024 and moving to Slide 9, this is a look at our first quarter guidance. We are expecting first quarter sales to be up approximately 5% organically with Americas up high-single digits, APAC up mid-single digits, and EMEA relatively flat.
Adjusted operating profit between $200 million and $220 million and adjusted operating margin of 13.1% up 160 basis points from last year's first quarter and that is driven by price cost tailwinds and productivity programs partially offset by continued growth investments. As you likely have noted in our slide deck, we have not provided the detailed split between price and cost/inflation for 2024. As we emphasized at our Investor Conference, our ambition is to cover all inflation including labor inflation with price and being price cost positive is an important lever for us to attain our long-term adjusted operating margin target of 20% plus. As you will see on the next slide, we fully expect to be price cost positive in 2024 and we expect that to be the case each year going forward.
We will continue to price our products commensurate with the increasing value we provide our customers. However, for commercial and competitive reasons, we are not disclosing the specific quantified pricing figure going forward. But rest assured, that commercial excellence actions are core tenant to our continued profit improvement program and we believe we are well positioned in a favorable market to continue to execute upon our long-term plans. Next, turning to Slide 10, our full year guidance. Higher across all metrics from the view presented at our November Investor Conference. Organic net sales growth is expected to be 9% to 11%, up from the 8% to 10% we shared in November. We are increasing the midpoint for adjusted operating profit from $1.25 billion to $1.3 billion with adjusted operating margin at 17.1%, well above the previously established mid-term target of 16%.
And as a reminder, our long-term margin target is 20% plus and we believe we will take all the necessary next steps in ’24 on our path toward that target. Our projected 2024 adjusted diluted EPS of $2.23 at the midpoint is approximately 25% higher than 2023 primarily driven by higher adjusted operating profit and partially offset by taxes and a higher share count as a higher share price drives more accounting dilution for employee stock options. We have included some estimates for share repurchases and share price in our estimated ’24 diluted share count but we are not prepared at this point to share specifics for either. But we believe the 393 million shares estimate for full year diluted share count is a reasonable and balanced guidance but certainly subject to change based upon several variables.
Moving to the right, on this Slide, we are projecting adjusted free cash flow between $800 million and $850 million representing 94% adjusted free cash flow conversion at the midpoint. As mentioned, this is lower than 2023 conversion primarily due to assumptions with deferred revenue and higher investment in CapEx. And finally, as we introduced at our Investor Conference, there will be a couple of external reporting changes in 2024 to align with how we run the business. We summarize these changes on Slide 31 in the Appendix and we have provided a historical recasting for these changes going back to 2020 in Exhibit 99.2 of our earnings release. And with that said, I turn it back over to Gio.
Giordano Albertazzi : Well, thank you. Thanks a lot. Thanks a lot, David. And we go to Slide 11. Thank you. You saw this slide at our Investor Conference. We are the market leader in thermal management for data centers. We have the most complete portfolio of thermal management solutions including liquid cooling to lead the industry as a transition to GPU accelerate. We can do this customizing at scale and we believe we have a very strong position. This slide here shows also our high-density liquid cooling portfolio. In November, the technology was both owned and partnership based. Now it's fully owned. We can go to Slide 12. On the 8th of December, we closed the acquisition of CoolTera, which has industry leading liquid cooling technology.
We have now secured that technology with full ownership. We have been close partners of CoolTera for years. Now, take CoolTera's premier technology, certified and approved by key chip manufacturers along with established customer relationships, combine that with Vertiv's reach and you can scale the technology at a pace that will support our customers' aggressive AI deployment plans. We have already started to manufacture CoolTera CDUs in one of the Vertiv plants and we expect to have capacity quadrupled by the end of Q1. We are executing on a plan to scale the production of our liquid cooling solutions more than 40 times by the end of this year. We truly want to make sure that we have capacity to cover the most aggressive GPU growth scenarios.
That is what Vertiv means by scaling technology, activating our global manufacturing and supply chain footprint. Let's go now to Slide 13. This is where we obsessively focus to deliver another very good year. It starts with the customers. We plan to continue leveraging our far-reaching and deep customer relationships and have the technology, the portfolio, the innovation and the capacity to meet their demand. We spoke about the capacity expansion underway. We have allocated additional investments to CapEx to support our customers. Our global scale matters and will continue to differentiate us. Vertiv Operating System is foundational across the organization helping us to realize productivity, improvements in general and giving us speed. We have started to make progress on trade working capital but there is more work to do.
We are not optimized. It continues to have my full attention and we are improving. Our capital deployment framework provides much flexibility driven by good cash flow generation. So a lot to do in 2024 and be sure work is fully underway to continue to execute well on all these focus areas. Now to Slide 14. We started 2024 in strong positions. Orders in Q1, backlog at the end of the year were very strong. Orders in Q4, backlog at the end of the year were very strong. End markets continue to signal strong and increasing demand for the foreseeable future, certainly driven by AI. We expect to have the capacity to support our customers, that is our commitment to them. Investments in capacity and R&D to support the growth of the business will continue.
Our foundation is stronger today than ever before. Our focus area will continue to strengthen that foundation and increase the resiliency of the organization to navigate, again, an increasingly complicated world. VOS, Vertiv Operating System is a cornerstone for that, a robust, resilient operating system deployed globally. I am pleased with the progress but I see even more opportunity than I did when I stepped into the CEO role, much more. There is work to do and we look forward to updating you on our progress and we look forward to our questions now. So over to the operator, and thank you very much.
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