Q2 2021 Vertiv Holdings Co Earnings Call
I would like to welcome everyone to Virtu second quarter 2021 earnings Conference call.
All lines have been placed on mute to prevent any background noise. Please.
Please note. This event is being recorded on.
I'll now turn the program over to your host for today's conference.
Matt <unk>, Vice President of Investor Relations.
Yeah.
Great. Thank you Betsy and good morning, and welcome to <unk> second quarter 2021 earnings Conference call. Joining me today are Virtus Executive Chairman, Dave Cody Chief Executive Officer, Rob Johnson, Chief Financial Officer, David Fallon, and Chief strategy and development Officer, Gary needle from.
Before we.
We begin I point out that during the course of the call. We will make forward looking statements regarding future events, including the future financial and operating performance. The verdict. 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 commentary which 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.
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.
During this call.
Also present both GAAP.
GAAP financial measures, our GAAP results and GAAP to non-GAAP reconciliations can be found in our earnings press release and in the Investor Slide deck found on our website at investors Dot <unk> Dot com.
With that I'll turn the call over to executive Chairman, Dave Cote.
More on the NIM.
Good morning, everyone.
So there's many times, but I truly believe it so I guess I'm Gonna continued interest burden is a great company.
Really good industry.
Company know industry is ever perfect, but from what I've seen over the last day.
Im very pleased with the company the management team.
We want this group.
Total continues to make all the right investments and product development.
Average user experience.
On the operating system and many more readers, which are all areas that will pay off more in the future that you can have to date.
Julie is personified winning now.
And the launch of it you all know is so important to me.
The focus on today and tomorrow at the same time is especially true as Rob and his team focus on taking care of customers.
It's an age old concept, but it sure has been proven to be true.
But if you do a great job of taking care of our customers that is 1 of the best long term strategies you can have.
So it is costing us something to do as you can see from the numbers with the block buys that Rob and his team have had to do.
All of US are absolutely convinced it's the right thing to do taking care of customers today.
Day, and Tomorrow every way you can.
Clearly a winning strategy so with that I'll turn the call over to Rob.
Thanks, Dave and thanks for your guidance that you provide both to me and to my executive team and supporting voted on all the ways that you do.
We're better and a stronger company having U S.
Our executive Chairman.
To all of you on today's call. Thank you for being here.
Im eager to share with you our performance for the 2021 second quarter our outlook on the market.
And information about a few of our growth initiatives that we're driving is relative.
There are 5 key messages I want to convey.
Okay, and David Brown, our CFO will take you into a deeper dive on the financials in just a few minutes.
First of all demand for <unk> products and services is strong during our last earnings call. We reported first quarter sales that were up more than 22% and orders that were up 21%.
Compared to the first quarter of last year.
I am pleased to report that the sales and orders are up again in Q2.
Sales were up 25% and orders were up over 24%.
Having sales and orders growth in excess of 20% and the back to back quarters demonstrates our.
Late September 1st approach.
That is paying off in addition, our Q2 backlog rose to $2.3 billion the highest its ever been.
Secondly, profitability is up this quarter, our adjusted operating profit was $134 million, which is up $31 million or 30.
Percentage from last year's second quarter. This resulted in adjusted operating margin expansion of 40 basis points.
Third year to day free cash flow is greater today than it was this time last year.
Free cash flow for Q2 was $41 million and year to date $84 million.
From a year to date perspective, this represents an improvement of over $225 million versus the first half of 2020.
Fourth we are dealing with supply chain issues and inflation issues, we encountered supply chain challenges in Q2 and experienced commodity and freight inflation.
As Dave mentioned, we made spot buys so that we can meet the delivery commitments to serve our customers and we've implemented strategies to recapture cost.
Pricing always lags caused by a quarter or 2 and that's exactly what we're seeing now.
I have a slide coming up with more details on this.
And.
Finally, the key message, we're raising our 2021 guidance by $100 million in sales and $5 million and adjusted Op profit.
This action demonstrates the confidence we have on our end markets and also reflects the priority we are placing on customer pursuit and capture and.
In addition, we are balancing the timing of incremental.
Incremental pricing coming into the P&L.
Sure.
Sure.
We've been using this slide each quarter to illustrate what we are seeing in each of our world regions and each of our end markets.
As we said before revenue bucket red button indicate sluggish performance.
Button indicate strong performance in.
And a yellow button indicate somewhere in between for.
For the second quarter in a row there are no rent.
Let's take each market cloud and Hyperscale.
And our co location markets remained strong on the demand for digital applications continue to fuel.
Agree industry and is driving strong and a growing need for vertical products and services.
And our enterprise small and medium business market, we continued to see signs of progress.
As it works to recover from the pandemic.
We are experiencing an increase in pipeline and orders.
Our current pace of activity.
We will begin this upward trajectory, we will be able to upgrade a few of the markets that are yellow to green on our next call.
The communication networks stayed constant in all regions.
<unk> deployments and trials are continuing as are the starts and stops of customer deployments.
These will provide tailwind for.
For us over the next few years.
In the commercial and industrial market things remain constant.
While this is a smaller slice of our business the variety of products and services. We sell here continues to strengthen.
All in all the end markets, we serve have remained steady.
Moving on to slide 5.
I want to provide a little bit of color around demand as we're seeing it and give you a glimpse.
2 of growth investments.
As mentioned earlier overall market demand is strong as indicated by our order rates and record backlog.
This scenario led us to raise our guidance.
Each of our regions.
<unk> saw revenue growth in the second quarter led by continued strength in the cloud and co location markets are.
Our cloud on co location customers continue to build data centers, and an aggressive but balance fashion and we continue to partner with them to meet the strong and growing demand. We are receiving every opportunity to capture long.
Term customer commitments and investing in spot buys as Dave mentioned to procure our central product components to take care of the delivery for our customers.
Moving to the column on the right.
And to our growth investments I want to talk about 2 specific investments.
Our channel business and second.
Product development initiatives.
For the channel our channel is growing and as part of our strategy and our growth strategy for our business.
We have spent time in listening to our partners, we fine tuned our strategy, we built a new partner portal developed augmented reality sales.
Our votes added configure a configuration <unk> increased sales support and ramped up our digital presence in our quest to make vertical easy for our partners to do business with.
These efforts are definitely paying dividends existing partnerships are being strengthened new partnerships are being farmed and all partners.
Our promoting burden.
By the numbers, we had a 50% increase in the number of resellers that are actively buying our products. Since this time last year.
Customer base is up over 400% from Q2 of last year.
A second example of how 1 of our growth.
Initiatives is performing can be illustrated with this customer success story.
Green Mountain is a Europe and Colocation provider.
Green Mountain recently selected vertical as a supplier far as they call it our cutting edge technology.
A key executive from Green Mountain has gone on to say the sustainability.
Product and the suppliers is a key factor when purchasing new equipment.
<unk> technologies are the most efficient I've seen and this will further improve our overall sustainability.
The investments we are making in our various product development.
Both initiatives are helping us develop more cutting edge and energy.
Efficiency technologies for.
Innovation sustainability and expanding on our list of customers.
These are just 2 examples.
It demonstrates the progress we are making as we drive focus resources on growth and investment areas.
Moving on to slide 6.
The pricing is never easy task, but this market has required it we are estimating having $65 million of pricing actions for the full year versus 2020.
As you can see though by the time, we get to Q4, we will have pricing that fully offset inflationary cost.
Moving to the second column inflation is being felt by us and material freight costs and spot buys.
Approximately $60 million in materials.
<unk> million dollars in freight and 35 million and spot buys.
We expect the cost impacts to ramp down in 2022, driving net tailwind.
David will provide additional commentary.
The third column depicts how we expect our contribution margin to evolve over the next 2 quarters.
Timing of pricing versus inflation caused on the dip in Q2, the pricing actions will accelerate in Q3 driving margin recovery, we anticipate full recovery.
Poor as headwinds stabilize and the pricing plan is fully implemented and as mentioned we are expecting to net tailwind in 2022 for this activity.
So while we've experienced some short term cost impacts pricing is coming and customer investments, we're making in on.
<unk> and <unk>.
Short term and will over the long term continue to drive shareholder value.
With that I'll turn it over to David David for a closer look at our Q2 numbers and we'll come back at the end with some final comments.
David.
Great. Thanks, Rob turning to page 7 this slide summarizes our second.
<unk> financial results versus last year, net sales were up $254 million or 25%.
And 20% when adjusted for our $50 million foreign exchange tailwind.
We continued our strong momentum with second quarter orders as Rob mentioned, which were up 24%.
After increasing over 20% in the first quarter.
Adjusted operating profit increased $31 million or 30%, primarily driven by the profit flow through from higher sales.
However, as discussed on our contribution margin in the second quarter was negatively influenced by material.
And freight inflation, which impacted our second quarter P&L in advance of much of the favorable pricing expect it to materially benefit the second half of the year the.
The negative impact of net inflation on contribution margin in the second quarter was approximately $25 million with another $10 million.
Okay.
Contribution margin driven by the plant inefficiencies driven by the supply chain environment.
Fixed costs were up $20 million from last year's second quarter, including $30 million from last year's onetime COVID-19 cost actions and $20 million from incremental.
<unk> and R&D investment.
Both partially offset by continued fixed cost reduction initiatives.
And an impairment of capitalized software recognized in last year's second quarter.
Our adjusted earnings per share increased 15% to 31.
Primarily on the strength of higher adjusted operating profit.
Net and lower interest and income tax expense.
Free cash flow was down $20 million from last year's second quarter, but <unk>.
As we discussed in our first quarter conference call free cash flow in the first quarter was positively impacted by $25 million due to the delay of the cash disbursement at the end of the.
First quarter as a result of our systems implementation and of course. This timing also negatively impacted second quarter free cash flow by the same $25 million otherwise free cash flow would have been in line with last year's second quarter.
Turning to page 8 this slide summarizes our second quarter segment results.
Net sales in the Americas were up $80 million or 16, 5% driven.
Driven by strong double digit growth across all 3 product segments.
Net sales in APAC were up $75 million or 23% with growth across most of the APAC subregions product segments and market verticals.
Net sales in EMEA.
We're up $99 million or an impressive 50%.
41% or GAAP.
Predominantly in the critical infrastructure and solutions product segment, driven by several larger co location projects.
From a profitability.
As adjusted operating margin declined in both the Americas and APAC with both regions negatively impacted by material and freight inflation.
With Americas disproportionately impacted due to regional differences in commodity markets and higher electronic spot buys to support a larger channel.
Perfect.
Adjusted operating profit improved in EMEA, despite inflation challenges due to the leverage benefit of lower fixed cost on a significantly higher net sales base. Once again this demonstrates the margin benefit of maintaining a reducing fixed costs, while growing the top.
Net.
You may have heard the philosophy of keeping fixed cost constant. So this is once again a real.
Political.
Example of that.
Next.
Turning to slide 9.
This chart bridge second quarter free cash flow from last year.
Applying a year over year benefit from higher adjusted operating profit and lower cash interest payments was more than offset by several unfavorable variances, including $20 million from cash taxes, driven by lower estimated payments in last year's second quarters.
Primarily to due to COVID-19 uncertainty.
And we also had an additional $18 million outflow from inventory as we have proactively invested in inventory to satisfy customer demand in this challenging supply chain environment.
Despite the unfavorable quarterly year over year comparison year to date free cash flow is still 220.
$1 higher than the same period last year.
Last on this slide.
We ended the second quarter.
With the record high liquidity of $1.1 billion and a record low net leverage net.
Net debt leverage ratio of 2.2 times.
Next turning to slide 10.
This slide summarizes.
Our third quarter financial guidance, we expect.
First half top line momentum to continue into the third quarter with net net sales up 10% at the midpoint.
Including double digit growth in EMEA.
A number of single digit growth in Americas, and APAC. So we expect the growth momentum to continue across all 3 regions.
Net sales guidance.
<unk> $25 million year over year benefit from pricing.
And that's probably a little bit more proportionately.
<unk>.
Directed at the Americas versus the other.
2 regions.
We guide towards adjusted operating profit of $160 million at the midpoint up $92 million from last year, but as a reminder, we recognized an $80 million combined charge than last.
And third quarter.
Restructuring and in assets.
This adjusted operating profit guidance assume that the third quarter benefit from pricing does not quite offset.
The negative impact from inflation.
However, we do anticipate a full offset.
<unk>.
Last year inflation in the fourth quarter.
Finally, adjusted EPS is expected to increase approximately 23 at the midpoint.
Primarily driven by the $8 million restructuring and asset impairment charge in last year's third quarter as the EPS benefits from incremental volume or offset.
Offset by headwinds from net price inflation and last year's Covid actions, which were still $10 million in the third quarter of 2020.
Next turning to slide 11, we summarize our revised full year 2021 financial guidance.
Including.
Versus net sales of $5 billion up 14% from 2020 and $100 million higher than our prior guidance.
We are increasing our adjusted operating profit guidance of $600 million up $5 million from private prior guidance.
And we will provide.
From detailed as dollar increase on the next slide.
We are taking down our full year estimate for adjusted operating margin by approximately 10 basis points at the midpoint.
There are several moving pieces to our updated operating profit guidance, which certainly impact operating.
Yeah.
Margin.
Some of these are favorable some are unfavorable as illustrated on the next slide.
In the macro the reduction is driven by the additional net inflation and related costs.
Offset by fixed cost actions, we have initiated including controlling discretionary spending.
For the avoidance of any doubt we are reaffirming our.
<unk> operating margin.
<unk> targets of 16% in the intermediate term.
And 20% in the long term.
We believe the net inflation headwind has been an unfortunate 2021 dynamic.
<unk>.
To constrained supply chain coming out of Covid and we believe the pricing actions we are implementing today.
We will generate a nice tailwind for 2022, and we are certainly incurring cost today to satisfy customer needs currently.
Referring to the spot buys.
EBITDA at freight.
That we consider a long term index.
In our customer relationships, which can be referenced as winning later.
Even though it is hypothetical at least on paper without with $45 million net inflation headwinds, we could be discussing adjusted operating profit.
And in the $645 million range for 2020.
As growth remains robust with net sales now expected to be $225 million at the midpoint.
Here than our beginning of the year estimates.
Our full year adjusted EPS is expected to be $1.15.
<unk> <unk> higher than our full year guidance.
Driven by the $5 million increase in adjusted operating profit about 1.
And $11 million lower full year tax expense contributing about <unk> <unk> and that was primarily the result of a discrete tax benefit.
<unk> that we recognized in the second quarter.
Finally, we're maintaining our full year projected free cash flow.
Guidance of $300 million.
Which is up almost a $140 million from full year 2020.
We discussed internally, whether we should increase our full year free cash flow guidance.
Guidance, but we are holding flat due to on.
Uncertainty in the supply chain, we generally realize a really nice cash inflow in the fourth quarter from the reduction of inventory.
We want to wait another quarter to see how that plays out for this year with.
With that debt and we do like the upper.
Our end of the range of our $290 million to $310 million of free cash flow.
Full year guidance.
Next turning to slide 12.
This chart bridges, our full year adjusted operating profit from prior guidance of $5 million increase.
On the prior slide we noted a $100 million net sales increase the components of this increase include $40 million of pricing, mostly in the second half.
<unk> million dollars of foreign exchange translation almost entirely in the second quarter.
And $45 million of volume with.
$5 million of that in the second quarter and $10 million in the second half.
The $40 million of pricing as depicted in the first green bar.
The second Green bar reflects the benefits of various fixed cost reduction actions, we implemented in the second quarter, including controlling.
Discretionary spending and this should benefit the remainder of 2021.
The third Green bar reflects the expected flow through from the 40% to $45 million incremental or cash organic volume.
The 2 largest red bars on this page reflect our updated views on the impact of.
Supply chain challenges in 2021.
This represents combined about $65 million of higher cost compared.
Compared to our previous guidance.
With a net incremental $20 million realized from the second quarter.
And $45 million added to the circa.
Half.
Finally on this slide the last Red bar on the right reflects expected headwinds from our prior guidance related to timing delays in productivity, both in purchasing and in the plants.
As a result of the current supply chain environment.
With that said I turn it back over to.
Thanks, David turning to slide 13, which is our last slide to recap the key messages for the quarter.
As I close I want you to know how proud I am of the verdict team and what we're doing together.
As a <unk> company.
We've accomplished a great first.
<unk> of the year the results we've shared today reflect the hard work and commitment of the 20000 employees.
On the factories and some of the field and some in offices and some still working remotely and over 130 countries around the world.
As I look at the remaining months of 2021 and as we continue.
First half best strategically I'm confident that we'll see above market top line growth.
An increase in profitability and a strengthening balance sheet.
When I look down the road at 2022 and beyond my confidence is bolstered by the conversations I've had personally with partners in key customers about the demand.
Pricing and pipeline.
To all employees I am grateful for the part you played in the past 3 months and have allowed me to provide today's earnings report. Thank.
Thank you for your dedication and your tireless effort to take care of our customers.
To our investors. Thank you for being on the call today and for your trust and support.
Inverted it is truly my pleasure to be leading burden.
I will now turn the call over to the operator, who will open up the line for questions.
We will now begin the question answer session.
Ask a question you May press Star then 1 on your Touchtone phone.
If youre using a speakerphone please pick up your handset before pressing.
On the keys.
Is it any time your question has been addressed and you would like to withdraw your question. Please press Star then 2.
At this time, we will pause momentarily to assemble our roster.
The first question comes from Nigel Coe with Wolfe Research. Please go ahead.
Thanks.
Good morning, Thanks for the question.
So suffice price.
A question on price.
The $65 million how do we.
Terrific.
<unk> action already made 2.
Customers.
Yes.
You guys had assumptions.
How much thanks.
And how much is given the way in I don't know zone.
Et cetera.
Is this $65 million sort of like what's being actions what we hope to get to is this is a conservative view on sort of how much of this price decks.
Then maybe just talk about the Americas APAC and EMEA.
Okay, Hi, Nigel Thanks for your question. This is Rob I'll start off and then let Gary.
David weigh on pricing actions will actually underway at the beginning of Q2 as.
As we began to see this inflationary environment.
As you know we feed a lot off of our backlog.
Some of those things on our backup.
Log.
We can look at price, we can look at freight but for the most part as we've indicated on the call Youll see that really kind of.
Come to life in Q3 and Q4, so we know orders that we got in Q2.
That will ship in Q3 Q4 Q1.
We know we got price on those.
Why we feel confident.
The net debt, we will get the price and we are getting the price. So that's the first thing the second thing we've done which has been talked about widely with industrials as the ability to get price in the channel and distribution.
Much faster lever from that perspective, but for us as a company compared to other industrials were.
Smaller player on that but that's an area that we are growing fast. So we have taking pricing actions in some cases 3 times within that space that we've seen stick and we've seen our order growth rates as you can see in our channels beginning to grow it.
<unk> that we've talked about in the past we expect to.
True to take share in that space, while we continue to raise price and drive that I don't think net.
<unk> carrier data.
Hey, Nigel.
Rob hit the.
Now how do you want it to.
2 other parts I would add to your question are we do think most of the price and that we're going to get right now is sticky.
It continues it's not going to be 100%, but the majority of that pricing should be sticky as we head into 2022 and as Rob mentioned in his opening comments that should provide some tailwind for us throughout that next year.
And then secondly regional breakdown I think youre on the part of your question was.
There's a good chunk of this price during the majority of it that sits in America. So we're taking actions on all.
3 reasons, but just to your regional mix question. There certainly is.
As a majority of the price and that's going to happen in the Americas as well.
That's great. Thanks for color on a quick.
A quick 1 on your comments on trying to frame, obviously with a little bit early to start from a freight train.
But this is a tailwind that you alluded to is it moving more cases.
Bulk purchases.
Frank.
Going away, so we get that $35 million tailwind.
Or do you see on the benefits next year.
I think we see that as well as we see continued the pricing that we're getting now for stuff that's going to be rolling out in.
And in 2022.
And you know my comments earlier, Nigel as well.
Fairly bullish on 2022, just based on pipeline.
Just on what we're seeing.
A lot of time with our customers understanding and we get a question asked very frequently is this typically a build until build and fill in what we're all seeing right now.
How is the continued build and build responsibly the fill rates are quite high. So it gives us great confidence that we would expect to have a really good 2022.
Okay.
Okay.
The next question comes from Jeff Sprague with vertical research. Please go ahead.
Alright, Thank you and good morning, everyone.
And just to just to pick up a little bit more on on price.
On a fully understand kind of the carryover impact would be expecting based.
Just on how you think you'll exit the year just wondering what the behavior is though.
We get some deflation is that.
Has it been your experience that you can.
On the whole pricing.
Modest deflationary period of time, I would assume price from Thomas with lag.
So you probably get some benefit from there, but just wondering about kind of the overall stickiness and has reached kind of a new higher level on pricing.
Okay.
Yes.
Good question, Jeff Hey, it's Gary again.
I would say that just like Youre right on the way up on inflationary it takes a couple of quarters.
Theres, a deflationary environment. It would certainly take a couple of quarters to lag on the way down but with that said most of the actions. We have implemented we do believe we're going to be pretty sticky I mean, there's a couple of.
1 time type things or.
Things that probably arent going to carry earned in 2022, but for the most part the actions.
So we're taking a really around list prices and multipliers and discounts on those things in our environment tend to stick around more often than not.
And the other reason we feel pretty good about that is just going back to what we were able to do in 19 and 20 with pricing both in the $20 million ish range.
Actions, we should be sort of the the lowest watermark as we think about anything in a normalized state. So overall feel pretty good about where we sit for pricing as we go into 'twenty 2.
And then.
Just on the fixed cost effort the $30 million, so you've shown us here in the bridge.
Would this represent.
I guess from me for a lack of a better place kind of at a celebration of.
What you were doing on this journey to debt to 16% or is there some temporary actions here that ethics.
Okay.
Maybe you could just give us a little bit more context on.
The self help levers that you use.
<unk> tried to combat inflation and be on well I guess, the higher margin range.
Yes, I think it's a combination of the 2 GAAP, meaning summit.
2 an acceleration.
Some of the cost actions that we planned at the beginning of the year.
On the others, it's hard to call them temporary because.
They are related to.
On assumption.
<unk>.
With Covid opening up so.
In our beginning of year guidance, we anticipated debt the world that can help on up in Q2 with travel and other discretionary costs thats, probably getting pushed out.
For the third or fourth quarter. So we're certainly.
Moving to benefit from lower discretionary cost there, but we've been able to accelerate some of the other.
Fixed cost reduction, it's hard to quantify how much of that $30 million is going on than a carryover.
If I would have if I were to.
On.
Take the proportionate is probably 50.50, there's probably 50 temporary and letting them, there's probably 50% debt as an acceleration of permanent things that we had in the hopper anyhow.
Great. Thanks, I'll pass the baton.
Yeah.
Yeah.
Yes.
Okay.
The next question comes from Andrew <unk> with Bank of America. Please go ahead.
Hi, Good morning. This is David Ridley Lane on for Andrew.
What's the size of shipments you couldn't make in the second quarter due to the supply chain issue is are so different.
Differently, what portion of that sequential growth you had on your backlog its due to supply chain issues.
Yes.
Okay.
Thank you.
You know very clearly the costs are much easier to quantify then.
Hypothetical lost sales.
With that said it certainly is greater than zero the way I think is.
Best way.
Yes. Your stand it is if you look at the second half of the year, what we have built into our guidance.
Is probably.
On somewhat conservative based on what we're anticipating and continued supply chain constraints.
And that could amount to anywhere between 200 to 3.
Way to on basis points of growth in the back half of the year debt, we believe could be constrained because of the availability of parts. So if you were to dollar is that that's in the tens of millions of dollars. So it certainly isn't.
Isn't insignificant.
I think we've gotten some feedback that there's a belief that our topline guide in the second half as somewhat conservative then it could be built.
Built in provision for what we think is.
A realistic.
Scenario as it relates to.
Yeah.
Being able to obtain parts.
Got it.
Are you hearing that competitors are having sort of similar issues with.
As of on time delivery and parts availability.
Yeah, David Hi, Rob Johnson here, absolutely in it and it's not just our equipment its across the board.
Or whether it's steel plastics for the construction of the building, it's really hit everybody. So I would say in general we're seeing lead times are for.
For example on things like generators and stuff that we don't sell but go on moving out and it's happening pretty much everybody we're trying to.
I'll get after some of the same parts, whether its fans are lithium ion or discrete electrical components.
Yes, it's pretty much across the board.
Hello, everyone.
Got it.
And then.
This might be a little tough to answer but sort of what's the stat.
Status quo price.
I don't think you would receive in 2022, if you just assumed.
Fourth quarter pricing actions hold for that year and material and freight costs totaled.
Hold for the year at fourth quarter levels.
Yes, I think a fairly rudimentary memory way to look at.
Costs do you look at slide 6.
You see the pricing bars on.
On the left and the material freight inflation on the right.
Effectively the white space above each of the quarterly bars would be the opportunity.
On the upside opportunity from pricing.
And.
The down.
Potential detriment from material and freight inflation predominantly the white space in that first quarter chart. So definitely there is.
A tailwind from pricing.
Don't necessarily want to quantify it for other reasons.
As we discussed we're not 100% sure that it will all staff.
The 1 thing that is clear from that chart is yes.
What we're seeing in the Q4 for both price and inflation continues into next year.
Certainly should see it net.
Tailwind.
Yeah.
Part of it because of the overlap of timing the cost certainly hit us sooner.
This year, then the benefit of pricing.
Got it alright, thank you very much.
Thank you.
The next question.
<unk> comes from Scott Davis Melius Research. Please go ahead.
Okay.
Good morning, guys.
Morning, Scott.
At risk of asking a stupid question can you give us a sense of kind of the.
The spot buys are most where you guys are most aggressive.
But what kind of bill of materials.
It's it's kind of a combination certainly electronic components.
When we can get those in the past that's been things like <unk>.
Certainly lithium ion batteries have driven that and kind of kind of a combination of areas around really focus their fans I guess I would say I'd go into that category as well so yes.
And then there's.
Included in some of the spot buys as for example, the channel we know that.
We don't have the product we lose the order it goes to somebody else. So we've had to do some expediting and spot buys in there for certain components for our channel products are single phase Ups's on a rack Mount <unk> those types.
Types of things.
Yes that makes sense.
In that context, when you think about some of the I mean, obviously your main markets are fairly consolidated but you do have some peripheral players here and there I mean.
I would think some of those guys might be suffering.
Right now on perhaps on lower down on the list of being able to get materials.
What that is is there an opportunity right now on on the M&A side to kind of participate in kind of another level of consolidation for some of the smaller suppliers around the peripheral just that may be suffering a bit right now.
That makes sense.
Yeah, Hey, Scott Gary.
Doug I think you.
I also think flow is very just add logical I would say that we're being pretty measured still in the M&A philosophy to say, we want to anything we do to go back to the 4 key tenants that we've talked about why we would want to acquire a company or there are some people that have reached out to us and said there's been a difficult time.
Logic would want to partner with you, yes, theres been a few more boldly inbound calls, but I think from our standpoint, we're really still stick to the 4 key strategic tenants, while we want to acquire a company. If 1 of those companies have to be struggling great certainly an opportunity there, but we're going to stay pretty tried and true to the types of companies, we want to buy not just because they may be struggling.
<unk> environment.
Makes sense, okay. Thank you good luck with everything.
Thanks Scott.
Our next question comes from Nicole Day, Blase with Deutsche Bank. Please go ahead.
Yeah. Thanks, good morning, guys.
Good morning, Nicole.
I just wanted to ask from my first 1.
On the spot on my question earlier, so understanding that the majority of the pricing actions are benefiting the America I assume is that also the case for the inflation predominantly impacting Americas, then maybe as part of the answers that question. If you want to give any color around what you're thinking from margin trajectory.
Following guidance that'd be helpful.
So Nicole this is David.
The 1 thing that we certainly have learned through.
The 2021 environment is debt the supply chains or regional so the impact of 1 region.
And that would be different than the impact in other other regions.
And we certainly.
You can probably have a conversation on the drivers of that dynamic but.
At the end of the day, what we're seeing is if you look at both the.
Cost impact from inflation.
Certainly and spot buy and also the.
Our response for pricing about 60% of what we're seeing is.
As in the Americas.
And the remainder fairly equally split between the other 2 regions, but just to understand the disproportionality there.
<unk> is about 45%.
Company, but it has seen 60% of the impact.
Of inflation and of course.
Our pricing response there.
<unk> as well.
Okay got it on anything on.
<unk> margins.
America is in the back half or in the third quarter by segment or is it just the Americas.
Probably looking the worse than in EMEA, and APAC, a little bit better on a year on year basis.
That's certainly the case the Americas.
It depends on if you look at it versus prior year versus.
Prior.
On guidance, but.
The incremental costs that we.
Included in the back half of the year.
Definitely proportionate to the Americas.
If I were modeling I would certainly.
On model the Americas down.
Prior guidance, but with that said.
For avoidance of doubt the net inflation certainly impacts all 3 regions when you get down to.
The adjusted operating.
Profit.
Line item.
Yeah.
There are 2 regions, notably EMEA.
Probably is relatively flat in part because.
Some of the volume increase that.
We included in the guidance.
Probably disproportionate to EMEA as well so that certainly helps from a fixed cost leverage but on.
All other things being equal it certainly is disproportionate to to the Americas.
Okay got it that's really helpful and then I guess on.
Next I mean, obviously price cost is kind of overshadowing other impacts on margins right now, but is there anything on the mix that we should be thinking about in the second half with maybe service ramps or other dynamics.
Yeah.
We have a little bit of a mix dynamic for the full year.
Related to higher growth in critical infrastructure and solutions segments.
You can see that certainly on a on a year to date basis.
We don't think there is anything significantly different that we will.
In the second half debt, we have not seen in the first half.
From a mix perspective, but.
Certainly.
The growth in net CNS is expected to be a little bit higher than 2 product segments.
From a regional perspective.
Okay.
Yes.
Because.
The growth.
The sales growth we're seeing is in.
Disproportionate to EMEA.
In EMEA contribution margins are fairly close to the to the Americas. So we're not necessarily seeing a negative regional mix.
So what we would see from index perspective, certainly would be from a product perspective.
Got it thanks, David I'll pass it on.
Yes.
The next question comes from Mark Delaney with Goldman Sachs. Please go ahead.
Yes, thanks, very much for taking the questions.
So I was hoping that you could.
Ill talk more about your expectation on supply chain costs and component availability going forward and any outlook you may have as to when the cost pressures and supply tightness may begin to alleviate and related to that if cost does go up again in the fourth quarter or do you think your outlook that you can offset this cost inflation.
With pricing would that still holds based on pricing and continue to go up in <unk>.
So mark I'll start off and then David any comments, there, but I would say in general we think things have.
<unk> leveled out as it relates to the cost, but again, it's always a supply and demand thing and.
Patients will continue to continue to watch that and if they continue to creep up then we're going to have to crank prices up and continue to do that so we use that lever.
To be fair to our customers though.
We're looking to cover to cover our costs in this environment.
As far as the easing of supply.
It's going to be a combination of things that are happening certainly chip fabs. We are in touch with some of the largest ones that we use to understand when they get additional capacity come on and then at the end of this year. There is some capacity and then towards the middle of 2022. So once that capacity comes online we will feel better about the overall.
Overall components chip level anyway, we do know that whether its fans or even lithium ion.
Actual capacity is being.
Our comfort in the future that.
We will be able to see some of those constraints ease as well that being said our <unk>.
Fly chain team.
A very proactive in and negotiating longer term supply agreements, making commitments for supply longer than we normally would to be able to assure supply as we get into 2022.
That's helpful. Thanks, and for my second question I was hoping to better understand.
The order growth on some of the components behind that.
I believe the company has had more than 20% order growth for 2 quarters in a row now maybe you could help break that down a little bit further in terms of how much is coming from.
Growth in demand how much is perhaps share gain and then is there potentially a piece of this debt.
On the customers, placing orders sooner than they normally would given some of the global supply chain challenges. Thank you.
Mark This is Rob again, I'll start and then Gary will come on over the top a couple of things.
That we we believe the dynamics are happening here. Our plan is working and our plan was to gain share in the Colo and Hyperscale.
It is.
Traditionally against debt.
Local companies that you wouldn't be aware of.
In various parts of the region and we've been executing quite well there and seen those orders slip in our direction. So part of part of our growth is just hey, we're taking.
Some share in the smaller.
Space.
More regional based companies that you would recognize.
I would say that again kind of similar thing in the channel we've posted up some nice growth.
With our various new innovative products finding that moving to.
To take some share there as well and we get day.
And on a on a monthly basis on how we're doing so we feel we feel good about that.
What we will see I think.
And saw a little bit of going forward as people wanting to get their slotting for 2022 to assure supply.
<unk> is experiencing the lack of supply customer wise so.
On that we will see an acceleration of people, putting just like we have on our supply base longer term.
Orders in place fixed and firm.
In order to be able to assure that they can get.
Get their product when they need it I don't know what are the thoughts Gary.
Yes, no I think I think Mark I think Rob.
I think on nailed it spot on and we definitely continue to see that.
I would say that 20% on the first half growth there is probably a pretty good chance that the market hasn't grown anywhere near that and so I think with the latest updated guide even for the full year, we're at what close to 30%, 40% organic and I think our best estimates right now as the market is probably growing.
On maybe upper single digits still a little fuzzy to tell exactly but I think clearly there is there is great momentum.
Mentum not only theres good market theres good market.
Demand right now and there is also a really good penetration happening by our sales and marketing and product development teams and Hey, Mark 1 other thing to add there that I'm Super excited.
David kind of mentioned that our investments are paying off and our VP DS and an example of that is our 1 of our large.
Cooling units it doesn't use water innovative technology.
Area, we've been displacing other traditional technologies, maybe water cooled system in that space. So we're.
About the investment on the R&D the ramp on that and the products now coming out the door are truly innovative and allow for us to take share from that perspective. So we're very excited.
More to come there I know, we talked about in the last call some of those products, but I continue to be excited in both per channel.
4.
For Colo Hyperscale, even on the enterprise customers, an edge customers the stuff that we've got in the pipeline and the stuff that's already hit the ground debt that is really aiding us in getting above market growth rate.
Thank you.
The next question comes from Steve Tusa with Jpmorgan. Please go ahead.
Ed.
Hey, guys good morning or on.
Good afternoon.
Good morning afternoon already.
The.
And I'm not sure. If you guys have talked about it this way in the past, but what was your book to Bill on the quarter.
Okay.
Hello, Yes.
Sorry, I think we're having audio difficulties.
Can you hear me, Okay, Yes, yes, yes.
Yes, sorry about that I think I'm not sure if some of the management are having audio difficulties, but I think you're right I mean book to Bill is traditionally.
Not a statistic on a ratio.
I'll speak about externally, but I think if you look at just the order on both that we've seen over the past couple of quarters moving fast.
20%.
Which.
It has been we've also posted really strong sales come from our soldiers to the momentum on the order because we have been very strong.
But that wasn't something that move.
It's currently per month.
Okay, and then just on on kind of the second half.
<unk> forecast.
You are kind of calling it flat year over year I think there are other companies out there they are definitely calling for it to kind of step up in.
I have a little bit more.
Is there something about how you guys.
Hedge these costs or.
Your assumptions around <unk>.
Price movements that would would impact that or maybe you were just having different volume trends and these other guys, where you grew better last year I don't know is there any.
What's kind of the underlying assumption for that flat guidance for the second half on the commodity.
Yes.
On what we're seeing in each of the regions.
As I mentioned Theres definitely regional differences.
I would say we feel pretty good.
With where were locked in.
<unk>.
As it relate in the forecast as it relates to APAC and EMEA.
The price increases from a steel perspective as an example, certainly were more pronounced in the Americas than the other 2 regions.
So I would say if we do have uncertainty is.
<unk>.
Related to what we're seeing in the Americas.
With that said I think what we have assumed in that.
Forecast for Q3 and Q4.
Is actually slightly higher than what we're seeing currently so even though it's bill.
Hello Q2.
It is slightly lower than what we're seeing currently and we've seen some stabilization in some of our input cost over the last 30 to 45 days.
At the end of the day.
Yeah.
We don't 100% know what's going to happen but.
But we believe we have enough.
Of conservatism from.
Cost perspective built in and.
The other dynamic for that is.
Related to the spot side.
And as we mentioned and Thats primarily related to electronic components.
We're certainly not.
Unique in having that issue that.
On a dynamic debt.
We certainly believe can extend into 2022.
But what we've included.
In the back half of the year.
It's a combination of what we're seeing.
On the market and also managed so we.
We certainly have an election, whether to do a spot buy or not to do a spot price and we're making that decision based on.
Yeah.
A profitability out revenue, meaning we're not going on.
Execute spot price for every.
And single order, but we certainly will prioritize.
What we're seeing.
In the on the demand side in the short run.
Great Alright, thanks, a lot.
Thanks, Steve.
The next question comes from Lance.
Lance Vitanza with Cowen. Please go ahead.
Hi, Thanks, guys. Thanks for squeezing me in on slide 9 with respect to cash taxes, and the inventory impact there the inventory $18 million on incremental inventory build over what I guess, what you did in <unk> 'twenty.
When should we expect to see the reversal of that back into cash flow as at some point you begin to work off.
The inventory build and where we expect to see should we expect to see additional inventory building before we get to that point.
Yes.
Yes.
Thanks for the question so.
If you look back at our historical cash flow generation from a quarterly perspective.
Certainly have a pronounced uptick in the fourth quarter part of that is because of the higher volume that we see.
And we generally build inventory.
During the year, and then bleed it down in the fourth quarter.
So I would say normally that dynamic happen in the fourth quarter.
And as I mentioned the reason, we did not take our free cash flow full year guidance up.
In the current guidance is.
Little bit.
The dynamic of what's your question on so.
It may make strategic sense for us to continue to build inventory.
Notably with electronic parts.
As it relates to adding some insurance heading into next year, So all other things being equal.
The standard answer is generally we would see that cash flow impact from the fourth quarter.
This year.
We're going to wait probably until sometime at the end of the third quarter early fourth quarter to see if it makes sense to continue that inventory investment.
Perfect and then on the ACH swing.
<unk>.
You mentioned that part of it is timing part of it is just higher adjusted operating profit can.
Can you help us sort of 50.50 in terms of those.
Sure.
How would you say.
Yes, yes from a from a cash tax perspective that clearly related.
2.
Last year so.
Yeah the <unk>.
Our estimated cash tax payments in the second quarter.
2020, we're probably artificially low based on our.
Actual profit we were seeing on a year to date basis.
Timing or expectations.
Full year.
So that's just a timing issue.
I'll, probably take this opportunity to maybe talk a little bit about the.
The tax impact on the P&L. So we did take our full year.
Income tax expense down.
Awesome.
About.
$10 million to $11 million for the full year. If you look at our tax expense in Q2, we guided closer to 2021 on our expense was actually about $1 million.
So that's a $20 million P&L.
P&L benefit that's not.
Not necessarily tied to this $20 million.
On.
Cash.
Varian is just for.
Clarity, there, but half of the $20 million P&L benefit was related to some legal.
Entity restructuring we did in.
Outside the U S. That's a permanent benefit the other 10 million was related to.
The ASC 740 accounting so it's purely.
Tiny base than a lot of that was unfortunately driven by.
Yeah.
The accounting.
Accounting, we have to do for warrants, which pushed a lot.
Net $10 million expense into Q3, and probably more significantly in Q4, so probably more than what you are asking for from a tax perspective.
But there may be a question out there on that.
I appreciate it.
Like 2 times net leverage that you call out on this slide.
I would imagine on the gross leverage is closer to 3 <unk>, but could you just remind us.
Where should we think that leverage whether it's better of course, where do you think that's going to shape up a year from now 2 years from now and what other.
Last part of things should we be expecting you to use your cash.
From my understanding of liquidity that you have.
Yes, I think so.
Youre right on a gross basis.
<unk>.
Gross leverage is probably 3.3 times and we had about $700 million of cash on on our balance sheet.
<unk> takes on.
That's what takes you down to the 2 point too, but we don't see that $700 million is burning a hole in our pocket. So as we kind of mentioned if you look at our priorities.
We will continue to pay down debt, but we certainly would like to use.
Our balance.
Okay.
On to look at from strategic acquisitions and.
When we started this.
Journey about 18 months ago.
Our net leverage was.
Net fixed assets 6.5 times.
We were 4 times.
When we'd be when we track these back.
Sitting at 2.2 times.
Got better we have always talked about.
Probably a comfortable long term range is in that 2 to 3 times, but with that said we would certainly.
We'd be comfortable getting above 3 times.
For the right deal.
And we also would feel comfortable getting below 2 times, if that right deal was not available.
But from a priority prioritization perspective, we'll continue to pay down debt.
With.
Certainly look at accretive strategic acquisitions and.
If we're in a position we have to do something from a dividend perspective.
Or a share repurchase perspective, we'll look at that when the time comes.
Alright, thanks, guys nice quarter.
Thanks, Brian.
Okay.
Your next question comes from Andy Kaplowitz with Citigroup. Please go ahead.
Hey, good afternoon, guys. It is afternoon how're you.
Good afternoon Andy.
So you've mentioned that your pipeline and orders were continuing to improve and enterprise. Obviously, you didn't change any of your enterprise bubbles, yet, but you did.
I think you can change the next quarter if current trends persist. So is it possible to quantify in some way what the recovery is looking like for you exiting Q2 on enterprise and then ultimately where have you seen the improved orders within enterprise and we're continuing trends are you looking on to turn on enterprise from you on the Green.
Yes.
Did sandy I'll start with that and what I'd say is we began to see kind of in a June timeframe that enterprise began to pick up by evidence of some of the channel movements right typically refreshes as people go back to the office.
And net.
Closets and things like that need that need to.
Hiccup and refresh since they've been sitting there for a while so it gives us.
Some excitement about where it's going we want to see that continue through Q3, and if we do then youll see that trend.
Green shows that they're buying it is back on.
I would say as we think.
About some of the debt.
<unk> verticals right now.
Enterprise area, it's certainly.
Health care spending education spending.
Some areas still kind of travel, we certainly see financial institutions spending.
So beginning.
Post Covid, but we've got this thing still going on.
We had talked about in previous calls that we had seen a lot of quote activity.
A lot of engineering activity.
And that is now being turned in placing the orders.
For us in the enterprise space.
So.
I'm confident if it continues at the trajectory we saw in June that will be seen in between there and will be upwards.
In that enterprise space.
And to be clear you havent seen any falloff on that trajectory with delta being around here, it's still pretty good in July.
Yes.
I would say without kind of go on yes, we continue to see.
The trajectory in the right direction for that that enterprise business throughout July now again, it's early lots of places are locking down with mask again, we'll see what happens on what that does but prior to all that.
We are optimistic.
Mystic that we'd be going green in Q3.
Great and then it's great that you reiterated your medium term adjusted operating margin target that 16%, reaching 20% I know you mentioned debt net tailwind from pricing in 'twenty 2 happens, but does the current operating environment lead you to question on all of the timing of the improvement in.
And then we know 1 on the main longer term initiatives for <unk> is to improve its pricing ability. So how would you assess share increased focus on dynamic pricing and how it's been working in the current environment.
I'll start off and then David you can you can chime in on Gary, but obviously, we're getting more and more sophisticated.
With our ways, we get price we've talked about in the past, where we've instituted some AI and really.
Pricing tools that allow our salespeople to understand when we lose at what price and when we win we're expanding those tools as we've talked in the past throughout Europe, and then Asia. So.
<unk> will continue to be a muscle that will flex and grow and get more and more mature and use us more data analytics to drive. It. So we continue to believe that pricing will be 1 of those levers that we will continue to drive for years to come but I feel good about where we're at I feel good about.
The methodologies that we have.
And the ability to get that and really stem from a couple of years ago. When we first started it and we just continue to drive that David any thoughts there.
100% agree Rob So I think what.
This year it does not impact our.
Plant.
The continued to increase.
Operating margins net.
And at 16% and the long term to 20% range and if anything what we.
We have seen this year has actually allowed us to develop some muscle from a pricing perspective, so that's always.
Then.
Sure.
The equation to improve margins and.
I think what we've seen this year gives us even more confidence debt.
We can use that as a lever to.
Our path to <unk>, 20%.
Appreciate it guys.
Thank you very much and good day.
The next question comes from Amit <unk> with Evercore. Please go ahead.
Thanks, I guess I have 2 questions as well.
I just wanted to understand given the decision to ensure you have supply on product availability versus near term profit is that resulting in new.
Customer acquisitions, we wins or are you really trying to satisfy your existing customers and distributors around new customers. Then should we think about you structurally beyond 'twenty, 1 being able to accelerate the share gains is there can you talk about 1.5 times industry broke historically.
Yes, so I would say.
First of all thanks for the question.
Rob I would say absolutely its all customers right, whether it's new or existing we we prioritize them as the orders come in and take care of them.
And we've been very fair in our process certainly with some of the new products that we've talked about.
On the thermal management.
This is from even some of the power management stuff on certainly channel.
We feel like we have sustainable gained share there happening and.
And we will continue to see that momentum and Thats all part of our whole story is innovation and driving innovation and using that to take market share from a lot of the what I call more local companies.
We've we globalize some of these products through our various product development process and we see this being very sticky for us going into the next years.
Part of our strategy to grow faster than market.
Got it.
I guess, David when I look at your back half.
Cital guide, you're implying 7% growth from 5% growth could you maybe contrast that with the full stack, that's going to grow 24% and your backlog there is up 20% compared to Bob but why did <unk> sell in back half on your backlog is so strong.
Yes, I think there's 2 dynamics that are driving.
Net.
<unk>.
Companies are often referenced.
Challenging comps and at the end of the day we.
Target growth, regardless of what those comps are but.
We do because of the dynamics of what we saw with Covid in the first half of last year, notably.
In Q2.
Some of those sales were pushed in the back half of the year end.
Notably the fourth quarter of last year creates a challenging comp.
So that's number 1.
Number 2 is as we mentioned there is probably a little bit of.
<unk>.
Cushion or buffer.
Buffer conservatism. However, you want to describe it built into what we're seeing.
As it relate to our expectations of.
Sales that we won't necessarily.
To be able to deliver because of the.
Some of the supply chain constraints.
And.
I think if you look at the.
From a quarterly perspective, I think it's 8% organic growth in Q3, 4%.
In Q4.
We believe.
What we're guiding to certainly.
Is that.
A very doable number and we.
We hope there's some some upside.
Perfect. Thank you.
The Union.
This concludes our question and answer session I would like to turn the conference back over to Rob Johnson for any closing remarks.
Okay to all of you listening today and for your support. Thank you again for the participation and the questions.
As you can tell I'm very excited about the demand for <unk> products going forward for the rest of this year and well into 2022.
So again appreciate the support and this concludes the call for today.
The conference has now concluded. Thank you for attending today's presentation you may now disconnect.
Okay.