Q2 2022 Vertiv Holdings Co Earnings Call
Profile, we presented back in February .
End markets remained strong.
Inflation is starting to moderate.
We are navigating supply chain challenges in bringing additional suppliers online and price is sticking.
With the anticipated performance profile, we expect the 2023 it can be a very good year converted and our shareholders. So with that I'll turn the call over to Rob.
Thank you Dave.
Q2 was another step forward in delivering on our commitments for 2022.
Starting with some of the key messages on slide three demand continues at a pace I have not seen in the 30 years of my career in this market.
Orders were up 17% in second quarter, 11% from volume and 10% from higher prices.
With a 4% deduct for foreign exchange.
Our customers are focused on securing supply and a tight market and we see that both in our orders and backlog, which firmed up the demand outlook well into 2023.
Our adjusted operating profit exceeded the midpoint of our guidance. We continue to work through a number of key actions for improvement, but where we have fully implemented change we are seeing the benefits take hold.
Key among them is our pricing performance, we've proved to ourselves and now hopefully to you. Our investors that we are a business that can get price our pricing plan remains at $360 million for the full year.
Supply chain continues to be challenging, but we've made very good progress in securing qualified second and third sources of supply for key components and we'll start seeing the benefit from that activity in Q3 and more fully in Q4.
Our new thermal facility in Monterrey, Mexico has started production.
And we have a new fan supplier coming online that is committed to help us meet the significant demand, we're seeing across the thermal management market.
Our work qualifying new suppliers is not only limited to fans. We have also qualified new breaker manufacturers semiconductor suppliers and other suppliers. While there is still more work to do we've been very aggressive in our actions to manage the challenging supply chain environment, most notably in the.
Chronic components.
In light of the supply change conditions and in conjunction with the expected significant sales increase in the second half of the year.
We have not been able to reduce inventory as quickly or as significantly as we anticipated and communicated to you earlier in this year.
While we are expected to use cash in the second quarter. It was larger than we anticipated.
Although there should be an improvement in the next six months, we are reducing our full year expectations for free cash flow to a range of $25 million of use to $25 million of cash generation.
As Dave mentioned, we've made significant progress in our SIOP process globally, but.
But we are especially happy with the progress that we've made in Americas and believe based on these improved processes inventory reduction should be a significant source of cash flow in 2023.
While there are many moving pieces, we provided updated guidance for our adjusted operating profit, reducing the midpoint by $25 million.
We have provided a detailed bridge on the changes on these slides on slide 12 that David Fallon will cover shortly.
There is some rebalancing between third and fourth quarter, but in aggregate, we are still on pace to deliver a very strong second half with a noticeable step up across key financial metrics.
Turning to slide four.
This slide summarizes what we see in the market by region.
No change in our view across our end markets versus what we saw in April they are still quite healthy and very strong.
Cloud and co location remained robust you've.
You've seen this in the cloud growth rates reported by all major cloud providers.
WNS reported last week that their cloud business increased 33% in the second quarter and believes that we are still in the early stages of enterprise and public sector cloud adoption.
Certainly the growth in cloud market supports this view data growth is not slowing down.
Our view on the enterprise and small to medium business remained consistent from Q1, and we believe edge applications will continue to provide growth and lift for these markets.
The communication market continues to see <unk> investment and we're aligned with all the relevant players in this space.
In the commercial and industrial market vital applications continue to drive growth and opportunities for Virtu.
The market outlook remains very healthy.
It is likely our year over year order growth rate will moderate in the second half as the comparisons to prior year will be difficult.
But I want to reiterate the end markets, we play and continue to be very very good shape.
Moving on to slide five.
Customer demand remained strong our order rate and backlog are a clear demonstration of the strength.
We are delivering on our price plan and have implemented price actions needed to deliver the second half pricing plans, including that on our book and ship business.
As I said earlier supply chain continues to be challenging, especially in electronics, we do not expect this to abate in 2022, and we anticipate that we will see pressure at least through the first half of 2023.
We have incurred higher costs for electronic components. Since we had to go to the spot market to secure some of that supply.
In addition material and freight inflation was higher as absolute dollars for the second quarter, but generally in line with the adjusted for the higher volume.
We have started to see some relief in commodity and freight markets. We typically see a benefit on this on a quarter lag, but expected to provide a nice tailwind for us as we go into 2023.
We've made good progress in qualifying additional suppliers on key components and should start seeing additional supply hit our factories in late Q3 and further into Q4.
This provides support to our volume assumptions for the ramp in Q3 and Q4.
We have to add some fixed costs sooner than anticipated to support the volume lift in areas such as our new thermal plant in Monterrey, Mexico.
In summary, the market remained strong supply chain is still complex, but we're getting to the implementation phase for the new suppliers that should help alleviate sourcing pressures on the most critical components with that I'll now turn it over to David to walk us through the financials David.
Thanks, Rob turning to page six this slide summarizes our second quarter financial results.
As you can see net sales increased 11% from last year's second quarter and were up 8% organically, including 2% from volume and 6% from price.
<unk> acquisition added $114 million in net sales and was partially offset by a $60 million FX headwind more than 70% of that headwind in EMEA.
And we also had a headwind related to.
The divestiture of our industrial Etfs business in EMEA and that was a $17 million headwind.
Pricing added 80.
$80 million in the quarter, which was in line with guidance and double what we saw in the first quarter.
As we continue to burn through the lower priced backlog and recognize more sale booked after we implemented substantial price increases late last year and earlier this year.
Adjusted operating profit of $82 million exceeded the midpoint of guidance.
But was $52 million lower than last year's second quarter.
We let some of the components of this reduction at the bottom of the page but in summary.
There was $11 million or $10 million unfavorable price cost.
And $45 million headwind.
Headwind from FX, and other including a $10 million foreign exchange headwind $10 million from direct labor inflation and inefficiency in part driven by the supply chain challenges.
And approximately $20 million from cost headwinds in the Americas, primarily related to customer support costs, our sales incentive compensation program.
Several other drivers.
We expect to see continued year over year cost headwinds in the Americas in the third quarter, but we believe we have identified and addressed most of these issues.
We will enter the fourth quarter and transition into 2023.
Adjusted diluted EPS was <unk> 10 for the quarter, which was in line with guidance.
Second quarter free cash flow was negative $232 million.
While we expected a net use of cash it was certainly higher than we anticipated as well.
As Rob mentioned, we have not reduced inventory consistent with our expectations at the beginning of the year in part due to continued supply chain challenges, but also in preparation for this significant volume ramp in the second half of the year.
We are improving our SIOP processes globally, and as Dave mentioned, notably in the Americas.
Expect to receive an inventory free cash flow dividend at some point in 2023.
Turning to page seven.
This slide summarizes our second quarter segment results, we saw sequential quarterly improvement in organic sales growth adjusted operating profit and adjusted operating margin across all three regions. The Americas region grew organically six 6% or $37 million.
With most of that growth coming from price.
We do anticipate more balanced between price and volume in the Americas in the second half of 2022, including mid teen year over year volume growth as we continued to qualify new suppliers and launched the Monterrey facility.
Americas adjusted operating profit of $82 million was negatively impacted year over year by price cost higher fixed cost, including to support the volume ramp up in the second half and additional cost headwinds we referenced on the previous slide.
In APAC organic sales increased five 9%, despite the China, Covid, Lockdowns, which we estimate lowered second quarter sales by approximately $30 million not.
Notwithstanding the impact of the Lockdowns adjusted operating profit for APAC was actually higher than our expectations as we were able to drive higher sale in other APAC regions, while managing fixed costs.
Finally, we continue to see strong growth in EMEA with organic sales up 13 three.
3% with a good balance between volume and price.
While inflation accelerated in the second quarter from the first quarter. So did our pricing our second quarter net price cost in EMEA, while still a headwind was less of a headwind than what we saw in Q1, and we expect price cost to be a significant tailwind in the second half of the year.
Moving to slide eight.
We summarize our updated third quarter guidance, which is about $50 million lower at the midpoint than our previous guidance.
This slide summarizes third quarter versus last year, but likely more pertinent is an analysis of the changes from our previous guidance, which we provide.
In a couple of slides.
Despite the reduction in third quarter guidance still reflects a material sequential step up from the second quarter across all of our key financial metrics with organic sales expected to be up approximately $100 million, 70% of that volume and adjusted operating profit expected to be up almost $60 million.
At the midpoint.
Despite the reduction from our prior guidance, our third quarter expectations return us to an adjusted operating profit level from last year's third quarter and will serve as a strong bridge to a substantial improvement in the fourth quarter and transition us into a very strong 2023.
Next turning to page nine.
This slide summarizes our revised full year financial guidance, which reflects the 37 $5 million lower adjusted operating profit at the midpoint.
Versus our prior guidance.
Once again, we provide detail of this reduction on slide 10, the next page, but from a macro perspective. It is driven by a $25 million foreign exchange headwind and an additional $12 $5 million net from additional cost wins in various categories, partially offset.
By the benefit from incremental sales volume.
More on this on the next slide, but as Rob mentioned at the outset.
It relates to free cash flow, we are reducing our full year guidance to a range of positive $25 to negative 25% in part due to lower expected adjusted operating profit, but probably more significantly from changed expectations with our <unk>.
Expected inventory reduction.
We continue to improve our SIOP processes, and what is a very challenging supply chain environment.
We're encouraged that these improved processes will result in much improved inventory management of the timing of the inventory reduction benefits will likely be pushed into 2023.
Nonetheless, we are still anticipating significant improvements in free cash flow in the second half of the year and notably in the fourth quarter.
Now.
Turning to slide 10.
We provide additional detail underlying changes from our previous guidance.
As you can see on the slide foreign currency translation.
Certainly driven by the strengthening U S dollar negatively impacted net sales by approximately $160 million for the full year.
And adjusted operating profit by approximately $25 million.
We include some additional information on our foreign currency exposure on page.
<unk> 27 in the appendix a in this package, but just as a broad overview over 50% of our sales are denominated in a currency other than the U S. Dollar.
Changes in the Euro and British pound have been more acute than other currencies and as a result over 70% of our negative FX.
<unk> impact is.
Is in EMEA.
Moving on incremental volume is expected to generate an additional 200 and <unk>.
$30 million of sales of $100 million of that was in the second quarter Andy.
And these sales translate into $82 million adjusted.
Operating profit for the full year.
And there is a pronounced increase in volume in the fourth quarter as we've increased sales expectations, primarily in the Americas based upon our success in qualifying new suppliers and of course, the launch of the Monterrey facility.
Material inflation is up $20 million from our previous guidance $10 million in each Q2, and Q3, primarily driven by continued higher cost for electronic components and spot buys.
We anticipate this pressure to ease somewhat heading into the fourth quarter as we continued to bring additional suppliers into our supply chain.
We have reduced profit expectations for Eni for the full year by about $12 million.
This is mostly driven by timing of shipments have shifted to the right and into 2023.
But that business continues to improve and the demand environment continues to be strong with backlog at Eni up over 60% from year from year end, 2021, which portends significant sales and profitability improvement heading into 2023.
We have increased our fixed cost estimates for the year by approximately $30 million.
Most of this driven by timing as we anticipated, adding some of these fixed costs in early 2023, but we accelerated the timing to support the higher volume in the second half and for early 2023. Some of these higher fixed costs are also related to spending as we continue to <unk>.
Optimize our ERP system in the Americas.
And last on this chart, our other cost headwinds primarily in the Americas and as we mentioned associated with any number of underlying factors most of which we believe are transitory and addressable and should be mitigated as we enter the fourth quarter and pivot into 2023.
So in summary on this slide current full year guidance is about $37 million lower than prior guidance at the midpoint $25 million of that related to FX with.
With $50 million of $37 million reduction in the third quarter offset by an $11 million increase in the fourth quarter and of course, the $2 million beat in the second quarter.
Next turning to slide 11, we.
We provide a sequential bridge from third quarter to fourth quarter for both net sales and adjusted operating profit a $220 million increase in net sales and a $113 million increase in adjusted operating profit.
We understand that based upon our fourth quarter last year, there may be some concerns with our ability to deliver a robust fourth quarter. This year.
To help allay these potential concerns we provide this bridge, which quantify as the sources of the uplift.
First the higher volume is certainly supported by improved visibility in the sourcing.
And as <unk> and <unk>.
As we've mentioned the launch of the monitor AIT facility. In addition, it's very important to understand we normally have a seasonal volume ramp from third quarter to fourth quarter.
The $35 million sequential pricing benefit is driven by the continued burn of lower price backlog in previous quarters.
With a vast majority of our fourth quarter shipments from higher priced orders.
From late 2021.
Early 2022.
We anticipate approximately $10 million additional adjusted operating profit from Eni in the fourth quarter, primarily from incremental volume, which should flow through at higher margins pursuant to improve pricing similar dynamic for the base <unk> business.
And finally as we discussed on the prior slide other is driven by the ramp down in the Americas cost headwinds, partially offset by additional fixed costs.
So in summary, the fourth quarter adjusted operating profit guidance of $253 million at the midpoint certainly represents a substantial quarter for us, especially considering the $13 million adjusted operating profit in the first quarter.
And the $82 million in the second quarter. However, we believe we are addressing two of the most pressing issues that drove lower firsthand first half performance pricing and supply chain constraints, and we have visibility and confidence in our <unk>.
<unk> to deliver these fourth quarter protections.
Well.
On the following slides so slides 12 through 14.
Continue to be transparent with our communications.
Around our plan and provide additional details for the second half.
In February we laid out an aggressive but achievable plan through the first six months, our high level scorecard reflects $91 million higher sales $25 million higher adjusted operating profit.
$10 million higher pricing and $5 million lower inflation and likely more important our expectations for the fourth quarter have not significantly changed from the beginning of the year.
On page 12.
This illustrates our current quarterly sales guidance at the top of the slide and our prior April guidance at the bottom.
Theres certainly a lot of numbers on this slide I won't go through each and every one of them but of note on the right.
Is the increased volume growth from our previous guidance higher across all three regions, but most certainly.
Most significant in the Americas as we have referenced.
Turning to page 13.
This slide summarizes.
Our updated quarterly adjusted.
Operating profit.
And margin guidance, a similar construct to the previous slide with current guidance at the top in the April guidance at the bottom we've already discussed changes in guidance and the step up from the third quarter to a fourth quarter that would be a record high and by a wide margin for sales adjusted operating profit.
And adjusted operating margin between 14 and 15%.
Finally for me.
For our prepared remarks on slide 14.
We show the expected quarterly 2022 progression of our regional adjusted operating margins we.
We are primarily focused externally on the recovery plan for the Americas, but as reflected on this slide there is expected sequential quarterly adjusted operating margin improvement across all three regions and even though not depicted on this slide.
The same is true for Eni.
The scale of the improvement is more significant in the American economy.
They were more impacted by inflation in APAC.
These charts illustrate that the entire <unk> of global team is driving improved execution clear.
Clearly we are focused on unlocking value on a global basis, and we know you are watching closely and we will continue to be very transparent with the status of our progress.
With that said I turn it back over to Rob.
Yes.
Thanks, David.
Turning to slide 15, we provide our expectations for market conditions over the next 18 months or so.
And we share many of the drivers of optimism for 2023 that pretends to be a very strong year first you've heard us comment on several times on the strength of the market we serve.
All major cloud companies are growing strongly and continue to invest co location utilization rate continued to be high.
<unk> demand in <unk> Rollouts will continue and.
And we are very well positioned to win on both of those fronts.
While we are certainly mindful of the possibilities of a recession, we don't think that plus the growth of data certainly not in the near term or intermediate term and.
In fact business could likely utilize more data in ways to enrich their business models and gain productivity productivity across their operations in the face of recessionary conditions.
In summary, our demand remains strong.
We are currently filling filling our backlog for the second half of the neck up for next year and we expect these favorable conditions to continue.
On the right hand side of this slide we provide a quick list of reasons to be optimistic about 2023.
Our fourth quarter is shaping up consistent with our beginning of the year expectations with pricing actions not only returning profitability to where we were prior to the challenging supply chain an inflationary environment.
But to a higher level in fact, we believe we are in a much much stronger company today and will be much stronger company tomorrow.
Because of these events over the last 12 months.
And the results we are very encouraged with that we see for 2023.
Although we are not prepared to provide a lot of detail into 2023 expectations, we still need to execute and deliver Q3, and Q4 and there is plenty of uncertainty with supply chain and inflation.
Yeah.
To give everyone something to work with for next year, we Directionally expect that our adjusted operating profit to be 50% higher in 2023, then in 2022.
Of course, there is still a lot of moving pieces and we will know more and we'll update this expectation after our third and fourth quarters. So please view this as a preliminary guidepost as we look forward to a strong 2023.
Finally on slide 16, and again, the summary of our key messages for today.
Sitting here one quarter further into 2022, I feel more strongly than ever that the process improvements we've made in implementing throughout the year.
Give us the ability and the consistency to get price.
Coupled with the corrective actions, we've taken and the Americas are going to result in a very very successful future for virtu.
Without a doubt the proof will be in the back half of 2022.
I pledge to you that we are committed to executing well and transparently communicating our progress.
With that said I want to thank our employees our board members for your continued support in our organization as we continue to make significant strides forward.
I'll now turn the call over to the operator, who will open up the lines for questions.
Thank you we will now begin the question and answer session in order to ask a question. Please press star followed by the number one your telephone keypad.
Also just to name it to compile the Q&A.
Yeah.
And our first question today comes from Nigel Coe of Wolfe Research. Please go ahead. Your line is open.
Thanks, Good morning, Thanks for all the detail.
A lot to chew through here that's for sure.
So just wanted to run through.
You mentioned some of the cost headwinds in Q Q2, leaking through to Q3, and then improvement in Q4 I thought maybe we could just dive a little bit deeper on that you mentioned some of the cost headwinds in the Americas, We got the Monterrey facility et cetera. So maybe if you can just run through that quickly that would be awesome.
Yeah. Thanks, Thanks, Nigel this is David so.
There's really two categories.
And we try to break those out on slide 10, but first categories related to to fixed costs and these are certainly tight although not completely tied to additional cost to support.
The second half ramp up in volume and some of these costs, we anticipated at the beginning of 2023.
But we brought them forward.
Most of these are plant related costs, but also includes.
Some engineering costs.
Related to the qualifying a new vendors and parks.
But.
I think there is probably a question is these would create a tail or a headwind.
For 2023, I think that $15 million, we're expecting in Q4, you annualize that.
$60 million versus the $30 million for this year would imply a $30 million headwind.
Some of these costs certainly are one time related to support either hard ramp in a plant like Monterrey or a soft ramp in many of the other plants or youre seeing high volume. So I would not anticipate to see a significant year over year headwind related to fixed costs.
2023.
The other cost headwinds bucket.
We estimate.
Estimate at about 18 million in Q2.
$50 million in Q3.
Truly believes these are transitory. These are very specific issues, we mentioned a couple of them in the slide deck customer support costs.
Also higher costs related to the sales incentive plan. These are.
And there's a host of other issues that.
<unk> and his team have been identifying and addressing over the last.
Two quarters or so and we believe we have identified.
They will continue to present a headwind in Q3, but we believe these.
It should be fully resolved in the Q Q4 <unk>.
And from a year over year basis actually provide a nice year over year tailwind for 2023.
Okay, Great and I just wanted to just curious on the material inflation.
We got a $10 million.
Both Q2 Q3, and then the neutral in Q4 is that just.
And have a more normalized purchasing pattern.
Combined with.
Some of these new suppliers on chips I mean any color.
No Youre, absolutely right I think we've seen a little bit of stability, although there continues to be.
Variability as it relates to electronic components.
Inflation, there certainly is higher.
Than we anticipated heading into the quarter.
I think the light at the end of the tunnel is.
Related to the new supplier qualifications that were seeing that should come in line online in.
The fourth quarter.
So I think if you look at the ramp up of new inflation I think we saw $15 million in.
Q1 that ramp to $40 million in Q2, we anticipate that $40 million of new inflation.
Remained consistent in Q3, and we actually have implied in our guidance.
A $5 million dip in Q4, but.
Subject to change there is still a lot of uncertainty and challenges.
With the electronic components.
Still relying to a certain extent on spot buys, but we believe we've taken some really proactive.
Steps and initiatives to address that those higher costs, we're paying and primarily through qualifying new suppliers.
Thanks, David My final one is the free cash flow in the second half of the year, you mentioned psyops improving in 2023 I'm just wondering the degree of confidence in executing on the second half free cash plan and then perhaps more importantly going into 2023, you mentioned an inventory free dividend in 'twenty three.
Suggests that youre confident in converting 100% in 'twenty three.
Probably not prepared to commit on a free cash flow conversion for next year, but we certainly are optimistic.
Our beginning of the year guidance for inventory actually.
Assumed a $50 million redact reduction from end of year.
2021.
And Thats a 2021.
Year end number that was actually up fairly significantly from the end of 2020.
Yes.
In reality, we'll probably build inventory by about $100 million again.
In two.
2022.
Thats, a $150 million Delta and there's other moving pieces, but that effectively explains the takedown in the full for the full year number from 150 to about zero at midpoint.
There is.
There is definitely opportunity as it relates to optimizing our inventory levels.
We are very confident that we are executing.
<unk> that opportunity through our SIOP processes.
And I would be very.
Optimistic that we should have a reduction.
A real reduction in inventory are certainly from a <unk> perspective.
In 2023, so we referred to that.
Internally as a dividend and it should not only create a very nice one time benefit from that reduction in 2023, but certainly.
On an ongoing basis as we look at are reduced.
Thanks, David that helps Jeff.
Yes, yes.
Thank you and our next question comes from Scott Davis of Melius Research Scott. Please go ahead. Your line is open.
Thank you operator, good morning, everybody.
Good morning, Scott.
So I wanted to talk a little bit about the Monterrey facility. If you will because this is a new thing.
Perhaps but.
As the Monterrey facility, replacing some higher cost capacity in addition to creating new capacity and.
Can you just give us a little bit of color on <unk>.
Why it's needed.
Yes, Scott sure we've seen a large uptick in our thermal business, especially with some of the innovative.
Solutions that we've delivered so it's really complementing we're not we're not shutting down any other capacity, it's really additional capacity for the additional volume that we're seeing so we're.
This is something we've been planning for awhile, and we think Monterrey is a great place to be from a cost perspective, but it is really to help the ramp and the demand we see in the backlog that we have.
Normal business.
Okay, just to back up a little bit there was diverted story was always pitched as holding fixed cost study, which as Dave Cody Playbook, you wrote a book on it.
And now I think we've had multiple quarters in a row of not holding fixed costs, so I'm going to be back on that in 2023.
Where do you guys stand.
Yes, Thanks Scott.
Oh, no it's a great question.
And Scott.
Can assure you that's not the first time that <unk>.
That question was asked it's certainly been a focus here internally.
We are still absolutely committed to.
Holding fixed cost constant on a year over year basis going forward.
The added fixed costs that we're seeing here in.
2022.
That is.
More from a timing perspective. These are fixed costs that we had anticipated adding.
Adding in the first half of 2023.
Just to put the fixed cost and perspective and the need for the timing our second quarter.
Sales at a annual run rate, we're about $5 6 billion.
Thats ramping up to $6 8 billion in the fourth quarter.
And.
So.
Sure.
We continue to focus on fixed costs I think.
We have seen increases over the last couple of years, but most of those increases are pursuant to.
Operations and higher capacity and also E. R&D I can tell you our administrative functions are absolutely.
Constant from a fixed cost.
Basis in 2023 versus our in 2022 versus 2021 and will continue to be but we're.
Our selective with fixed costs and to the extent that it creates a future return including.
R&D and from operational perspective.
We will choose from a timing perspective to sometimes to accelerate those.
Okay. That's helpful. Thank you and good luck guys pass it on thanks, Scott Thanks, Scott.
Thank you and our next question comes from Jeff Sprague of that could Lisa Jeff. Please go ahead. Your line is open.
Thank you good morning, everyone.
Good morning, I also wanted to touch on Greg grocery getting your name right.
Yes, it's amazing Mr. Cotai really crushed it now.
Im doing well.
Yeah.
[laughter].
Just wondering on Monterey.
How critical this capacity as the meeting the topline.
Forecast here for the year is that.
And.
As the plant actually up and running and delivering commercial product yet so.
The second part to the first question is.
Sure.
Are we on a ramp where we got visibility of getting the revenues, we need out of that plant in the back half.
Yeah, Hey, Jeff Hi, this is Rob.
Monterey first of all is up and operating it delivered even in Q2 some products to our customers. So we are shipping.
We're in the middle of a middle of a ramp.
With that going into Q3, and then a steeper ramp going into Q4.
As long as we get the supply we feel confident with the way that plants operating.
And it is needed to provide the necessary volume increase more so in Q4 for us, but we feel confident with the team.
They've spent a lot of time down there and so far so good with the with the product coming out of the plant right now.
Great and then also just on the cost side.
What exactly is the customer support cost that youre talking about is this expedited freight.
Ounces.
What actually is going on there and what's the visibility of that moderating.
Yes, Jeff This is David so it's a combination of things.
Yes.
One example, we had to rent a crane to facilitate the installation of product.
Into our customer site.
So we continue to focus on our customers and in some cases, we'll actually.
Put the bill as it relates to hit.
Hitting hitting timing.
Some of those customer support costs are also pursuant to.
Late deliveries and in some cases our contracts include penalties if we don't.
Deliver product.
In the.
Amount of time so.
A lot of these things are certainly tied into the supply chain.
We're still.
What kind of day to day as it relates to supply, which creates a lot of uncertainty with delivery.
And some points, we just have to catch up and.
Spend some of our own money to hit some promise customer delivery dates.
So the reason this is tied into the new supply is a lot of those pressures should go away as we continue to qualify new investors and when you can spread that risk over three.
Three or four vendors as opposed to one or two.
It really helps planning out a plant and a delivery schedule and we think a significant amount of these costs should go away.
Yeah.
And sort of on that front, one last one for me and I'll pass. It just also kind of the internal.
Operations of the company as it relates to systems and ERP.
Mentioned still working on that.
Maybe just an update on what needs to be accomplished and to what degree if any is it.
It's still somewhat of a restraint on orders delivery operations what happier.
Yes, I would say.
We are over the scenario the significant launch hurdle that you get with with a lot of Erp's. That's certainly created noise in the fourth quarter early first quarter, we have a fully functioning system. It's.
It's not perfect.
Not many ERP are.
A year after launch.
But.
Sure.
In conjunction with some of the issues that we have identified in the Americas over the first six months.
We're still identifying we've actually.
<unk> seen the system as a very useful tool versus the system. We've previously previously had to actually address those issues and we continue to.
Yeah.
<unk>.
Identify ways the system can help and I would say we have a fully functioning system.
But we'll continue to invest in that system to optimize the usage and to address issues as they come forward.
Great. Thanks for the color and thanks, Dave quoted.
Yes.
Here to serve Jeff here to serve.
Okay.
Thank you and our next question comes from Andy Kaplowitz Citi Great. Andy. Please go ahead. Your line is open.
Good morning, everyone.
Good morning, Randy could you talk good morning could you talk about the progress you've made in getting the company more focused on pricing and why pricing Hasnt gone up at least a little with volume and inflation with the understanding that a lot of pricing was locked into backlog at the beginning of the year, you, obviously youre seeing significantly more volume than your previous.
As expected you did raise your inflation forecast a little bit so why can't you get a little bit more price as revenue and inflation goes up.
Yes, Andy I'll address the first part just on our pricing.
We feel from where we've been in the past as you know we feel really good about the.
360 that we've talked about this year.
<unk> said pricing is now built into our DNA, how we go get it.
Our process on a global basis, the approvals when we raise price and we continue to look at that pricing was not just a one and done for US we'll continue to evaluate where we have innovative solutions, making sure that we're getting the appropriate price we have for the market. So as we go through this year into next year. We don't we don't expect this to be something we.
Wanted to an inflationary thing and we're done we will continue to refine.
The way we go about driving price. So I would expect as part of our thesis has been create great products.
That solve real customer problems that are innovative and get paid for that so we will continue to work that as we go through it David can speak a little bit to why some of the inflationary stuff as the price as we drive it we're getting too right now as we talked about into Q4, a lot of that old backlog fallen away and a new price will begin to see in that end.
It gives us gives us a nice uplift in Q4, but David.
Yes, Thanks, Rob and Andy we were fully anticipating that question from someone so.
Youre absolutely right as is volume assumptions go up so should the pricing we've.
Made the decision because a lot of that additional volume is in the Q4.
We made the decision just to keep the pricing targeted at $3 60.
Maybe so as to not over complicate things, but it is absolutely fair to look at this as an opportunity for additional pricing based on that volume over and above the 360, but we also have not added in to this external model.
Potential additional inflation that would also be associated.
With that higher volume so on a net net basis, it's probably a an opportunity.
But there would be an offset with additional pricing and additional inflation just mathematically.
From that higher volume, but when we looked at it we felt like we just wanted to kind of keep the messaging simple quarter to quarter and we've included that as a net opportunity.
In our bucket of net risks and opportunities that we see for the second half of the year.
Sure sure. That's helpful. And then maybe if I could take that conversation into 2023, you. Obviously stated that you expect a 50% improvement in adjusted operating profit could you talk about as we sit here today or maybe forecast forward how much backlog coverage you have.
That improvement I think you said, you expect supply chain and <unk> electronic component headwinds to last well into 'twenty, three so what kind of price versus cost or supply chain assumptions are you baking into that initial 23 expectation.
Yes, I can address that Andy so.
Up.
Probably answer with a non answer is so we're not really prepared to provide a whole lot of color at this point, it's still very early.
Rob mentioned on the call we thought that deliver on Q3 Q4.
But I certainly would include on the list of potential opportunity for next year pricing and you can look at that just from.
The.
Increased sequential pricing that we're seeing here.
On a quarterly basis in 2022, theres going to be probably $150 million to $200 million carryover pricing benefit just by doing the calculus right. So.
As it relates to some of the other elements.
Sure.
Notably.
Backlog coverage, we're certainly.
We certainly have a robust backlog today.
To a certain extent we're filling.
Backlogs for the second backlog for the second half of next year and with some of our products. So we're feeling really good from a demand perspective, but there are certainly we would place more uncertainty.
As it relates to inflation and the supply chain as we have seen.
Those are somewhat material as it relates to a month to month quarter to quarter, but we believe we are doing everything we can within our power and being proactive to address it but it's hard at this point to give any type of quantitative detail on what we expect for next year.
I appreciate the color though.
Yes.
Thank you and our next question comes from Mark Delaney of Goldman Sachs. Please go ahead. Your line is open.
Yes.
Good morning, and thank you very much for taking the questions and I appreciate all the detail in the presentation.
First question is on the implied for Q outlook, maybe you can better contextualize, how much turns or book and ship business, you're anticipating in that guide and how that compares to typical fourth quarters.
Okay.
Yes, I would say we have.
Really good visibility certainly into Q3.
And if you look at the.
Backlog versus book and ship for Q4.
It's.
Likely higher than what we would see in other quarters.
So.
And including for a fourth quarter, so a fairly significant ramp in Q4 at least from prior guide was not related to filling out of backlog.
Very directly related to have the capacity and the.
The supply of components to ship that backlog.
No.
Every every quarter and even into every month, there is a certain amount of book and ship business.
I would say, we have really good confidence in fourth quarter as it relates to.
The backlog coverage and.
For us and as Rob mentioned, a bigger risk would be the execution of the ramp of the Monterrey facility.
And also the additional fan supply.
So we don't think demand.
We will be an issue certainly.
For Q3 or Q4.
That's helpful for a second question was on pricing in particular pricing for 2020 through maybe you can remind us how much of your negotiations are done towards the end of the calendar year.
For the following year.
Yes.
And kind of related to that to the extent of input cost ste.
Kind of where they are or do you think you'll be able to hold on to all the pricing you've been able to achieve as you do go into 2023 or are some of the customer's going to say Oh, we will input cost to start going off.
Looking for a reduction next year. Thanks.
Hey, Mark this is Rob.
Actions have been done and been implemented for what we need to do but as I mentioned earlier, we continue to look at additional opportunities for price, where we have innovative products and solutions. So I feel I feel confident that we've executed on those those have been put in place a while ago.
From that perspective as it relates to customers asking are looking to take the price down it's kind of a similar phenomenon, we didn't get a lot of <unk>.
Pricing on the backlog that we had it was part of our problem. We had burned through that so expecting kind of the same thing to happen that the hard purchase orders that we have today that people wanted the price that we.
That we set forth and those as we go forward. So I don't expect that to deteriorate either as we go into 2023 if inflationary.
Conditions go we bought inventory at higher prices they understand that so it's something that wouldn't keep me up at night that were going to see that activity, but we will continue even in a deflation.
On pricing goes away environment as I mentioned earlier, we will continue.
With this pricing muscle that we have now to get price, where it makes sense and where we're providing more value to the market and that was a valuable lesson learned from us as we went through this.
Whole activity is that.
People do value the services and the products that the bird a minute.
Thank you.
Thanks Mark.
Thanks.
Thank you and our next question comes from Lance Vitanza of Cowen.
Please go ahead your line is open.
Thanks, guys and congratulations on the strong quarter.
I wanted to ask you about Eni looked a little bit weaker than expected in the guidance as well you mentioned during the prepared remarks, some timing related issues and I think you said that the asset continues to improve but maybe you could clarify if I'm getting that right and in any case, if you could elaborate a bit on exactly what the issues are there at <unk>.
Hi.
Yeah sure Hi, Lance Thanks for the question appreciate the comments as well.
With Eni, what we've seen I think David kind of talk about it when he was speaking as we're seeing some of that some of their stock push push out of this year pushing into next year with some of the some of the projects that they have.
I haven't experienced kind of a little bit later than <unk> did the inflationary impact and then.
Lack of supply on Breakers, and then we're not just like us slower to get price. We feel that's correct. It. We really are excited David mentioned the backlog of for Eni is up over 60% I believe since we bought them.
So the activity is good.
We've got the price now being built in the back in the backlog and the orders that are coming forth. So I'm really still very excited and probably more excited about the asset now than when I was when we acquired it yes, we had a depth and unfortunately will go through this year with that but we see we see eni pulling out of this next year.
With the with the additional pricing.
We have seen some projects chip, which happens in their business because they are heavily on the construction side of it we have seen some of that shift in some of that will shift into next year I know Gary any other thoughts.
Yes, I think thats exactly right Rob Lynch.
The amount of.
Quote activity pipeline the joint development between the various sellers eni's sellers. The embracement of the customer base has had has been phenomenal and the only thing to Rob's point is some of that switch gear some of the modular.
Just give it power units if they sell shifted out to the right some of it because of the supply some of it because a customer site readiness, but overall, it's actually coming up online just like just like we had planned earlier in the year.
So youre not seeing just to be clear youre not seeing any issues with how the integration has gone or.
Anything that would make you feel less.
Cited about what you acquired.
No absolutely the opposite I think.
Integration has gone really well they had a couple of stumbles that they had was really pricing and getting components and they were kind of later on both of those.
A lot of people are talking about breaker availability breakers drive a lot of content in our products and we still see that as something thats.
No.
Readily available we have looked at additional breaker sources and have been qualified them overall integration has gone well and what I can tell you as Gary mentioned on the back.
On the actual funnel the activity and the synergy with <unk> as we thought it would be.
It is really there so we never baked in any kind of sales synergy upside to our model, but just what we thought would happen as our sellers would pick this up we would take it out to a wider audience to the enterprise.
And to a broader base of customers that we reach and touch so happy with the very happy with the asset happy with the management team there and what what they've done and I think this is.
Going to smooth as it possibly could except for the getting prices quicker than.
And we did and getting supply turned around but overall this fits in our portfolio very well.
Okay. Thanks, very much guys.
Yeah.
Thank you. Our next question comes from Steve Tusa of Jpmorgan. Steve. Please go ahead. Your line is open.
Hi, guys.
How's it going.
Good.
<unk>.
Good.
So just on the on the backlog.
I guess trying to read the tea leaves a little bit here with the big revenue ramp in the fourth quarter do you expect book to Bill in the second half to be above one in total.
Obviously, it'll kind of modulate because of the big fourth quarter, but in total do you.
Book to Bill can be above one.
Yeah.
Yes, we're still putting together our projections for.
Orders for the fourth quarter.
Can look at the.
The second half.
Sales number.
I would say we would expect continued orders growth in Q3, Q4 poses a pretty good year over year.
Tailwind, but I would say it would be plus or minus close to that.
One time book to Bill.
Okay, and then just more philosophically, maybe a question for Dave but how.
How are we defining success at this stage is it kind of a hard line on this fourth quarter and the 50% increase.
For 2023 or is it if we continue to have these costs that pop up.
Like they have in the third quarter, where the guidance is below it kind of things keep getting pushed to keep getting pushed forward.
Come to the fourth quarter and things quote unquote slip into 'twenty three is that a is that an acceptable outcome for you at this stage or.
Is there more of a kind of like a hard line here now.
Given what we've seen the last few quarters acknowledging the sequential improvement is steady.
Steve I assume that that's a question for Dave Cody, Yes, Dave Cody, Yes, yes, that's right.
Alright.
Yes.
I would say, it's not so much the number itself.
For the fourth quarter.
It is a lead in to 2023.
As you know this whole year has been one of.
Having to transition through a backlog be a hell of a lot more aggressive on.
Price than we were and be a lot more aggressive.
Alright.
Alright, great.
Great.
Okay.
So this was a transition year for us so the whole point.
Was to get price to get America fixed them up so that it was in a position where it could perform.
And to lead us into what I think is going to be a very good 2023.
And that's going to be that's the game that we're playing here is to <unk>.
Work, our way into a position where for 'twenty three onward.
They're in the kind of position to perform that we thought we were before this has been out.
Tactical year that we've had you run into the strategy of the company is still right still good it's a great position in a good industry technology is good we're still doing all the.
New product intros still increasing R&D spending.
Rick here has been to get Americas clicks.
And to get price.
Running ahead of total inflation not just inflation.
'twenty two.
That's the way it looks like it's coming together at this point as I said I feel good about the profile.
And.
Feeling good about 'twenty three.
But that's the that's the game for us.
And anything lumpy seasonally about 23 like if you do push out of <unk> into <unk> I would assume that price cost that kind of stuff shouldnt be that lumpy. So that you should start 2023 on a pretty strong footing. If that's the case it would kind of reinforce what do you see for 'twenty three or is 23 are more backend.
Justin backend loaded because of seasonality.
Now with the kind of alluded we should get.
From <unk>.
<unk>, we would expect <unk> to be markedly different from what it was this year, Dave I assume you agree with that.
It's totally agree and.
<unk>.
Yes. The key there is the additional demand supply we're getting in the fourth quarter will certainly lead into Q1 Q2. So there is always seasonality, but probably a little bit less pronounced next year.
Okay, great. Thanks for the color guys I appreciate it.
Sure.
Thank you. Our next question comes from Andrew <unk> of Bank of America. Please go ahead. Your line is open.
Thank you this is David Ridley Lane on for Andrew.
Hyperscale and Colocation Capex, maybe more cyclical sorry, more secular than cyclical, but historically enterprise and SMB Capex has been.
Tied to the broader economy.
Im wondering what youre hearing from the field and sales about enterprise pipelines have you heard anything about two.
2023 Capex plans.
David This is Rob I'll start with that Gary you can kind of chime in there.
What I'd say is the activity in enterprise has been kind of stifled by by the Covid and people still not fully going back to the office. So what we're seeing is a phenomenon as people go back to the office to refresh their edge their closets that type of thing. So that activity has been fairly strong the projects in that space are fairly strong.
<unk>.
From what we're seeing from the field on the enterprise side of things.
Some of our larger enterprise data center customers continue to build.
And continue to have demand demand on us.
So.
I'm pretty bullish on what we're seeing just what's necessary to update the enterprises and then expand the enterprises as we mentioned data is not slowing down by any stretch and people are using data to drive more efficiency in there and in order to do that they're going to have to have the compute and ore.
The infrastructure to make that happen and I'll Gary.
You're going to say something.
I think thats exactly right Rob.
So David you are right the cloud and Colo that Capex is always hard to peg it at any given quarter. So we look at more the trajectory in the run rate of that that all looks very healthy and the enterprise there would not be a light capex number that gets published anywhere. So we do we take a lot of that from voice of the customer from our pipeline and what we're hearing directly from the individuals.
<unk> point, we have not heard any conversations or anywhere around hey, we're going to slow down here. We're doing they were planned or this in 2023 will that looks very different than what we thought over the last couple of quarters. So we still think the enterprise edge channel all of that market is pretty healthy we only one exception was.
China had a little bit of a step back and enterprise just because of the Covid lockdowns that occurred in late Q1, and Q2, but theyre coming out of that now so we're seeing that pipeline start to ramp up in enterprise, but everything we see in that area.
<unk> channel edge enterprise sort of loop it altogether looks still looks pretty good and robust to us.
Got it that's helpful and then.
In the Americas region, that's really the.
Key for you to have meaningful margin recovery.
Could you just give us a little bit more color on the internal initiatives that you have.
Have.
Beyond the Monterrey facility.
That could drive margin expansion go forward.
Yes, David This is this is David so.
Certainly if you look at the second quarter end.
Some of the headwinds versus last year set a kind of compare it prior to this higher inflation supply chain challenged environment.
Price cost certainly played a role.
The Americas was actually still.
Negative price cost.
In Q2, I think it was about $10 million.
We certainly feel like we will address that with the additional pricing we expect to get in the second half of the year, but pricing will continue to be a leather and.
We've never been Super aggressive with pricing and what we've realized is that we've left a lot of money on the table, we could've been pricing much more aggressively.
For a long while here and based on the strength of our products and notably external thermal products will continue to be aggressive with pricing so that will continue.
To be a lever next year, even beyond offsetting inflation, whether from a dollar perspective or a.
Percentage perspective, but.
A lot of the other things.
Don't want to discount them by by calling them blocking and tackling but there are a lot of elements of <unk>.
Operations.
We have identified over the last six months or so that can be significantly improve we talked a lot about.
The SIOP process.
That's not only going to improve our ability to manage inventory it will improve our ability to drive margin.
Capacity planning is another.
Organizational structure continue to get benefits from.
ERP and driving process and putting additional tools in place so.
Going back to the very beginning this Americas region was built through a series of acquisitions that never really integrated.
We've done some of that over the last four or five years.
And there's still a ton of benefit out there just by putting in place some improved processes.
We're already starting to see that benefit in.
We would expect an acceleration of those things in 2023 and beyond.
Thank you very much.
Thank you there are no further questions at this time. This concludes our question and answer session I would like to turn the conference back over to Bob Jones for any closing remarks.
Okay. Thank you and thank you to everybody participating today and for your support our second quarters. Another step forward in delivering on our plan that we detailed out last February .
<unk> to be a dynamic time in a macro environment, but we remain firmly focused on executing a strong second half, which will provide a strong setup for 2023.
Again appreciate everyone's support.
Thank everyone for joining the call today.
Yeah.
Thank you. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect your lines.
Okay.