Q2 2023 Vertiv Holdings Co Earnings Call
Good morning, My name is Lauren and I'll be your country operate Tonight.
At this time I would like to welcome record lunch box ships.
2023, any country, it's cool.
Oh no lines have been placed on mute to prevent any background noise.
Please note that this call is being recorded.
I would now like to turn the party commit to hoist with today's country, It's cool mid Magdalena Vice President Investor Relations.
Great. Thank you Laura and good morning, and welcome to <unk> second quarter 2023 earnings Conference call. Joining me today are verdicts executive Chairman, Dave Cody, Chief Executive Officer, Giordano advertising and Chief Financial Officer, David Fallon before we begin I would like to point out that during the course of this call we will make forward looking.
Statements regarding future events, including the future financial and operating permits converting these forward looking statements are subject to material risks and uncertainties that could cause actual results to differ materially from those in the forward looking statements. We refer you to the cautionary language included in today's earnings release, and you can learn more about these risks in our annual and quarterly reports.
And other filings made with the SEC.
Any forward looking statements that we make today are based on assumptions that we believe to be reasonable as of this date, we undertake no obligation to update these statements as a result of new information or future events.
During this call. We will also present, both GAAP and non-GAAP financial measures, our GAAP results and 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 suffered a dot com with that I'll turn the call over to executive Chairman Dave Cody.
Well these last few quarters, there's been a lot more enjoyable to report we.
We had another strong quarter of performance inverted, which positions us very well to achieve our significantly increased 2023 outlook adjusts.
Adjusted free cash flow adjusted operating profit sales and margins all performed very well and operational execution continues to improve.
We've raised our full year guidance because of our strong first half performance. We also have the very pleasant effect of a strengthening balance sheet.
The data center end market continues to look very healthy and there is an incremental tailwind from AI coming.
And that tailwind should provide additional opportunities over many years for virtus because their technology will matter.
Great market position, a great industry, where we can differentiate with technology. These attributes are what attracted me to <unk> over four years ago, and they are truer today than ever.
We're obviously pleased with the results, but there is so much more to come there's a lot of upside not just in the market and our technology, but also just continuing to fixed legacy process issues and building a high performance culture, which didn't exist.
Joe and his team are off to a great start and there is a lot of work left to be done.
But it is also.
<unk> supports more consistent execution over the long term.
So with that I'll turn the call over to Jim <unk>.
Thank you very much Dave.
We saw the positive momentum continuing into second quarter across all key financial metrics second quarter sales were up 25% organically led again by a 48% increase in Americas.
We continue to see supply chain improvements and increased resiliency.
We saw healthy market demand, which supported the shipment of substantial volume in the Americas region.
Excluding FX were down just 3% from last year's second quarter better than anticipated and book to Bill remains at one <unk>.
Despite ongoing orders normalization as well as difficult comparison the market remains healthy we have also seen an encouraging AI related activity and I'll elaborate on this when we cover slide six.
Our adjusted operating profit was $251 million and we saw benefits from our increased volume as well as price cost.
Our adjusted operating profit margin improved 860 basis points to 14, 5% as we continued to strengthen operational execution.
I am, particularly pleased to report strong adjusted free cash flow of $227 million in second quarter.
We also continue to see the leverage profile of the business improve at three one times at the end of Q2 as the balance sheet continues to strengthen these early successes and still much more opportunity ahead, we are raising fairly significantly full year guidance and are now expecting.
Sales for the full year to be up 20% organically.
At $950 million at the midpoint and adjusted free cash flow of $550 million at the midpoint.
We are executing our plan to deliver the full year one quarter at a time in our transformation continues.
We are making meaningful steps forward in our operational execution, we are demonstrating clear traction and there is tremendous value creation I had.
We're not relenting, our focus on operational execution.
That is what we intend to continue to demonstrate each and every quarter. So let's now turn to page four.
Changes on the market environment Slide first we moved cloud Hyperscale to green in EMEA globally, we have seen an acceleration of the cloud Hyperscale and Colocation market segment in the last 90 days substantiated by the large amount of incremental capacity that is being planned as well.
As by the amount of leasing capacity that was signed in the.
This past quarter gigawatts of new capacity.
Pipelines have clearly strengthened it is hard to delineate what is AI and what is not but we know the industry certainly getting ready for AI and we have orders in our books and opportunities in our pipeline to adopt unequivocally for AI infrastructure.
Conversations with cloud and Colo players are now around making sure. There is available capacity to support a healthy outlook and we are in discussions with several large and relevant customers on what these commercial arrangements can look like very encouraging.
As we move to telecom.
Area has further weakened in the last 90 days with some further clubbing us spend by the major telco carriers, we anticipate that telecom markets remaining quiet for the balance of 2023, not particularly worrisome. These patents are not atypical for this market.
We have left the APAC market yellow across the segments, the China market, specifically experienced a slower than expected start to the year not just for us but for most companies and our current view, we are not anticipating much recovery in China market in 2023, but there are.
There are some encouraging signs as we would see orders turned positive in Q2 and pipelines are healthy.
No changes in views on enterprise, SMB or commercial and industrial overall I'm more encouraged today than 90 days ago, given a clear demand signals from the cloud Hyperscale Colocation markets that support our view for second half 'twenty, three and shape, our thinking around 2000.
24.
Let's move to slide five orders performed better than anticipated, although down 3% they are coming together.
Stronger than expected and they were 13% sequentially up from Q1.
Book to Bill ratio of one preserve the healthy backlog we.
We anticipate orders flat.
More or less in Q3 and turning positive in Q4.
I know everyone is interested in what AI orders looks.
It looked like in the quarter and candidly that would be almost impossible to answer with precision we have seen AI related orders I would say in the tens of millions of dollars.
Customers are focused on AI retrofit rate infrastructure and we see evidence of this in our pipelines.
Many of our products today can be useful either regular density or high density applications, and we won't be able to report out a discrete number for example, most AIG view today is still being air cooled.
Perfectly served by the traditional vertical portfolio over time, a part of these loads will transition to liquid and here too we are uniquely positioned liquid to remove heat from the server and the rack, but removal of the heat doesn't stop outside the rack you need to remove.
The heat from the data hole and we have the portfolio of solutions to do just that.
As I say, we are seeing clear demand acceleration signals from the market and we are having conversations with very relevant market players around securing capacity and not just over the next few quarters, but well into 'twenty four and beyond.
Let his transition to supply chain, we see.
Improving the environment, but there are two parts to this story first supply chain continues to incrementally improve no doubt lead times are gradually reducing and there is more certainty and supply.
The second part is the self help part we have been vocal about our multi sourcing programs one of the most important architects of this ongoing supply chain resilience program, Paul Ryan is now live.
Leader of global procurement is not new to me over the years.
Been with us over a decade and has more than 25 years of experience in.
And a strong track record of operational execution combined with very clear strategic vision.
Supply chain resilience is key considering the demand wave that may be ahead.
Let's now, let's now talk capacity, we have been investing in capacity for a few years.
In a balanced approach.
Across the globe.
The focus is on utilizing and coordinating capacity globally, we have recently announced a new role in the organization Executive Vice President manufacturing logistics, and operational excellence with Andrews and Undoes Calgary, leading the effort over.
The last five years and has led vertical operations in Asia than EMEA and finally Americas.
In the Americas operations over the past year, specifically, we have seen significant improvement.
He is the right person to take the organization to the next level on process and operations improvement.
Well as company wide deployment of Vertigo operating system.
Our ability to navigate strong periods of growth in a complex environment continues to improve.
Let's talk about inflation.
While inflation is trending a bit more favorably lead on anticipated a couple of dynamics influence of second half of 2023.
First metal prices were at lower levels in Q3, and Q4 of the last year. So as we lap that comparison, we're experiencing year on year inflation evita higher a bit higher in the second half.
We also anticipate when the Chinese economy accelerates that increased demand could cause additional.
<unk> inflationary pressure on commodities.
Have seen a favorable tailwind from price cost with good processes in place.
Prepare us for volatility related to our input costs.
Let's go to slide six.
We believe AI will increase our overall Tam AI is a reinforcement of demand trend and AI workloads are incremental new applications. They aren't in general replacing other applications in a digital economy, we expect growth.
In both high density in general compute.
This benefits all relative technologies.
We believe liquid cooling is not a displacement risk and in fact is additive to growth for vertex before liquid cooling we would take the hit.
From outside the rack to outside the data center building with liquid cooling it's additive.
We reach out into the Iraq and get one step closer to the heat generation point, while still controlling all parts of the heat rejection.
The infrastructure transition to Adi high density environment will be complicated and likely involve hybrid approach. It's due to technology deployment. It is very likely datacenter will need both liquid and air cooling orchestrated tightly together to optimize.
As the data center environment, we do very well with AD approach with the widest portfolio of thermal technology available deepest denied domain expertise on how to orchestrate. These technologies using our advanced control systems and over 3500 field service engineers across.
The world to support the deployment and maintenance of the infrastructure, we have the scale and the ability to increase capacity.
And I hope and I believe you can sense my excitement much more to come on high density.
Our Investor Conference in November , but feel very well positioned for this opportunity with that over to David.
Perfect. Thanks, Joe.
Turning to page seven.
This slide summarizes our second quarter financial results.
As you can see strong financial performance across the board starting with <unk>.
Sent from last year, 9% of that was from pricing and 16% from volume with most of that volume benefit in the Americas, highlighting the continued supply chain and operational improvements in that region, which has been a pillar of our turnaround over the last 18 months or so.
Adjusted operating profit of 100.
Quarter, and adjusted operating margin of 14, 5% improved 860 basis points of which 610 was from higher variable contribution margin and 250 basis points.
From fixed cost leverage.
Adjusted operating profit was $61 million higher than our prior guidance.
$45 million from higher pricing $25 million from incremental volume and $15 million from lower than expected inflation with these tailwind partially offset by headwinds from foreign exchange and investment in fixed costs, primarily from restructuring and incentive compensation.
<unk>.
Higher than expected pricing was driven by higher volume favorable regional mix in some conservatism for potential pricing headwinds that did not materialize.
Inflation was not as bad as we expected as commodity cost, including metals declined from the end of the first quarter likely influenced by a slower than expected rebound in the Chinese economy.
Next on this slide and very proudly, we generated $227 million of adjusted free cash flow in the quarter, an impressive $460 million higher than last year's second quarter. While there is still a lot of work to do to optimize working capital our second.
<unk> is reflective of our focus on cash and indicative of the cash generation potential of this business. When we do control working capital, which increased just $5 million in the second quarter. Despite a $213 million increase in sales from the first quarter.
Now the second quarter number was aided by some favorable timing tailwind.
And we should not expect free cash flow to be 130% of adjusted net income each quarter, but it shows we have made significant strides towards unlocking the cash generation potential of this business while funding organic growth.
Last on this slide.
Net leverage declined to three one times at the end of the quarter and is expected to be approximately two three times by year end well within our previously communicated target leverage.
Range of two to three times.
It was only a few months ago that we were being labeled by some and likely discounted from a multiple perspective as highly levered.
We argued at the time that it was pursuant to a mechanical calculation and just a matter of timing.
I think we were proven correct as our year to date performance is now driven that mechanical calculation towards what we believe to be the practical reality.
Turning to page eight.
This slide summarizes our second quarter segment results.
The Americas region continues to show strong year over year performance with organic net sales growth of 48%, including 35% from volume and 13% from pricing.
Adjusted operating margin improved 12, three percentage points on the strength of price cost fixed cost leverage.
And notably improved operating results from Eni.
APAC top line continues to be influenced by slower than expected recovery in China.
<unk> was relatively flat or our organic growth was driven by incremental pricing adjusted.
Operating margin declined 100.
About 100 basis points from last year, and that was primarily driven by approximately $6 million of restructuring costs in the quarter.
We do anticipate sequential quarterly sales growth in APAC in the third quarter, but we have reduced our full year projection from our prior guidance now expecting full year low single digit growth.
EMEA grew organically, 9% in the second quarter almost entirely driven by pricing.
We expect third quarter sales in EMEA to be down slightly from the second quarter with a significant increase in the fourth quarter and full year growth expected to be in the upper single digits EMEA.
EMEA continues to impress from an adjusted operating margin perspective perspective, posting 26, 6% for the second quarter 870 basis points higher than last year with this increase primarily driven by price cost and fixed cost leverage.
Finally on this page corporate costs were $21 million higher than last year, driven by higher restructuring and incentive compensation costs, and an incremental $5 million loss on foreign exchange.
Based on the current guidance, we anticipate these incremental costs at our corporate entity to flow through for the full year and we expect second half corporate costs to be consistent with the first half.
Next turning to page nine.
This slide summarizes our third quarter guidance as a reminder, we have anticipated a more stable quarterly sequential sales cadence as we proceed through 2023 for this reason our third quarter guidance looks largely consistent with our second quarter in absolute terms.
We have included provision for sequential increases in both pricing and inflation in the third quarter and sequential headwinds from foreign exchange, including $15 million on sales and $5 million on adjusted operating profit.
Moving to slide 10, our full year guidance.
We are raising our projected top line by $285 million, primarily driven by higher expected sales in the Americas, partially offset by lower expected sales in APAC with EMEA consistent with prior guidance.
We are raising our 2023 adjusted operating profit guidance by $150 million.
$60 million from the second quarter, Pete and $90 million in the second half.
This increase translates into a 170 basis point increase in our expected adjusted operating margin to 14%.
While we have not explicitly provided fourth quarter guidance math suggests we exit the year at 15% edging closer to our intermediate term.
Target of 16%, which should provide good momentum transitioning into 2024.
And finally on this page we are increasing our full year adjusted free cash flow guidance by $200 million at the midpoint to $550 million.
This is an $810 million improvement over last year and demonstrates momentum not only with our drive for profitability, but also with our management of working capital.
Before I hand, it back over to Joe Let me front run some potential questions on our adjusted free cash flow guidance, which implies approximately $300 million of free cash flow in the second half, which is a $150 million lower than our second quarter number multiplied by two.
The primary driver of this variance is timing timing for both Capex and cash taxes, which are normally back half loaded in this year is no exception.
These two items explain approximately $130 million of the 150 variance.
The remainder is driven by higher use of cash from trade working capital as we prepare for strong anticipated demand in 2024.
That being partially offset by higher projected EBITDA and lower cash interest.
So with that said I turn it back over to Jim well. Thanks.
Thanks, a lot.
As Dave said earlier, great quarter, but still a lot to do in February .
Our February call I went through the focus areas for 2023, creating a high performance culture, where ownership is clear.
And we hold ourselves accountable for the results constant focus on things that matter.
And executing relentless focus on execution at the half way Mark of 2023, we have made progress.
Innovation and technology continue to be a key differentiator for <unk> and with our ongoing investment in this area.
Encouraged by our Roadmaps for R&D and technology development I believe you will see this momentum building and differentiation further distinguished relative as the partner of choice in critical infrastructure.
I continue to travel around the globe visiting customers relative locations in key industry players are more excited today than I have been in the last 25 years with this great organization I can feel the energy and momentum building in our business in our industry.
It is tangible this traction is not easy to translate in words, but you're starting to see the transformation, taking hold deepening and becoming but his DNA.
The takeaways strong first half supported by continued improvements in operational execution.
The market momentum continued and in fact, increasing with AI tailwind, we are raising our guidance across all financial metrics, and especially pleased to be raising our adjusted operating profit guidance to $950 million at the midpoint. This indicates a healthy second half.
<unk> and.
Great Foundation for 2024.
An important reminder.
The investors conference on November 2019 at the New York Stock Exchange So I.
I truly hope you can join us and make sure you Mark that in your calendars with that over to <unk>.
Operator.
Thank you.
We will now begin the question and answer session.
In order to ask a question please press <unk>.
Star and the number one on your telephone keypad.
In the interest of time, please limit yourself to one question and if you have follow up please rejoin the queue.
We will post for 90 minutes compiled Q&A.
Our first question comes from Baidu HIFU.
Nigel Please go ahead.
Yes.
Thanks, Good morning, everyone.
So the leverage finance and accounting.
Perfect.
Great.
So obviously a lot to us.
To go through.
You mentioned <unk> was the.
The AI stroke, GPU retrofit opportunity and we don't often think of retrofit activity in the data center. So just maybe just walk through sort of what you're seeing today and sort of how impactful do you think this could be the <unk> and maybe just talk about how important your service organization can be.
If we do start seeing material retrofits.
Yes, two aspects to this Nigel thank you for the question.
There is certainly.
Kind of.
Non retrofit new market, New data center and it's a place that is one where our service organization becomes absolutely critical in our ability to partner with customers everywhere in the world not all the players in specifically the liquid part of the.
Thermals spectrum have this ability to reach out everywhere.
As we are and we have demonstrated that in our numbers prove that as I was saying 35.
3500 service engineers globally, but the other is we.
We see it today.
We talk with customers today, and they say no don't be do we have to think about liquid cooling, but to think that we have to think about is is a hybrid environment probably in the initial build that has more traditional server cooling so there needs to be an ability.
To retrofit over time, because the sites.
Hebrew dies and be enabled with that and then being there with our customers to execute on that retrofit is again, it's fundamental and that retrofit is not just the rack itself or the ROE, but is the ability to interconnect and balance it with the rest of the existing.
Thermal.
Thermal system, but think about the stock of data centers that exists in the industry today.
It's really hard to believe that that part will not be hybrid in and of itself and thats. What we here. That's what we hear today today, we hear people, saying Hey, we are already today some times having AI.
Hi.
Enabling high density.
Racks, and we are cool them, but thats sounds easier said than done and then youll have to balance of course, the cooling in in the hole, but at the same time that very same retrofit can be at liquid retrofit eventually and again the same problem exists even more complicated if you will than with an <unk>.
Infrastructure was thought for future retrofit hope I answered it could be very long voyage.
Yeah Yeah.
It sounds like it could be quite a material opportunity.
Sure.
We don't have exactly.
On that.
Yes.
Okay.
We'll come back to them on the pricing.
So I think its 9% in the quarter I think 7% in the third quarter, maybe David what's in your fourth quarter.
<unk>.
<unk> won't be a reasonable outlook for pricing in 2024, I'm, assuming we're going to be down some more sort of normal range, but I'm just curious if you're still continuing to push price.
Real time.
Yes from a quarterly cadence perspective pricing, 9% first quarter, 9% second quarter, 7% in the third quarter and 5% in the fourth so full year $4 20.
About $120 million from our prior guidance and it's probably too early at this point.
Comment on 2020 for pricing.
But we should have a nice tailwind heading into next year.
Great. Thank you very much.
Thank you.
Our next question comes from Andrew.
Thank you Greg. Please go ahead.
Hey, good morning, everyone.
Good morning.
You said, it's difficult to discern AI versus non AI in your markets, but as you said your pipeline of opportunities.
Increased in the last 90 days and you turned EMEA cloud Hyperscale. The green. So is there a way to quantify how much bigger your pipeline is that is feeding into that expectation of flat bookings in Q3 and up modestly in Q4, and then just stepping back would you say contribution.
Contribution in orders is coming earlier than you expected in 2023.
Well.
Acceleration of pipeline that I referred to in my.
When we were going through the slide is specific to <unk>.
Two industry, sorry, two region.
And.
Customer are really so it varies but acceleration it is how big.
It is.
But part of a wave of demand as I as I explained this is additional demand and it is additional demand that will probably drive also the more traditional type of loads and compute.
For the further up.
Specifically the comment about EMEA is that we start to see this effect hit EMEA as well and any way you wanted to get to send the message that we see acceleration on the call a cloud across the board because because of.
How big exactly again, it's premature to say.
The market is moving I would say, it's hard to distinguish what is AI and what is not but we know that some technologies specifically for high density is specifically for Jeep GPU and.
That is a little bit earlier to to track, but we know that there are a lot of traditional technologies and lot of traditional technologies that are there to two two.
<unk> enabled.
As well and that's true for the power part of our portfolio and for the thermal part of our portfolio.
I'll stick to one question thanks, guys.
Thanks, Andy.
Thank you.
Our next question comes from Amit <unk> with Evercore.
Please go ahead.
Thanks for taking my question and congrats on a nice print.
I was hoping you could just talk a little bit more about when it comes to clothing AI clusters liquid cooling clearly becomes a more important thing, especially in higher densities, but there seems to be multiple ways that you can use liquid cooling directed chip you folks do but I think the immersion and other forms of it.
So from your perspective, do you think <unk> strategy would be to have a broader liquid cooled institution across different formats or would you want to focus more on direct to chip and then as it comes as it relates to these asset classes can you just touch on what do you think economics look like versus the corporate average.
So.
I want to reiterate a message that I had when I was going through the slides is that when we talk about.
Liquid cooling here, we really talk about how we extract heat from that.
The heat generation point Aida.
The chip to outside the outside the rack and into <unk>.
Into the data whole anywhere in an order and this is this is the novelty. This is the new part as I was saying actually there are three ways to make that extraction a continue to do it through air and we have seen.
Yeah.
Air cooled racks going all the way to north of 40, North of 40 kilowatts per rack.
<unk>.
Clearly.
So two stages.
As one of our slides was explaining at a certain stage liquid kicks in liquid clinics in form of emotion or direct to chip.
Have both in our portfolio.
Also we're partnering with people that handle both but the fact is we think we believe that the main.
The main technology going forward when it comes to liquid is is really data to cheat.
But again it is certainly a portfolio approach that we're taking.
Got it and then I guess, how do you think of the economics with these clusters versus corporate averages I imagine that's more complex with higher Asp's, but would love to know if you think that that's fair and then how does it block for operating margins and so on as well.
It's a bit.
A lot of detail and also premature for those details, but I'll go back to the point I made at the beginning we see this is Adam.
So it is it is another technology.
We did not participate in the.
And the heat sink ore extraction of the heat from the server.
Now we started to participate tools desktop.
Part of the equation, so it'd be premature, but I want to make sure we understand that if something.
In addition for us.
But that absolutely dovetail.
Two etcetera.
Thank you.
Our next question comes from Lance Vitanza from Cowen.
Cowen.
Please go ahead.
Thanks, guys for taking the question.
My question is with leverage down to around two times at the end of the year Youre about a year ahead of where we thought it would be and it seems to me that two times is low enough and that free cash flow in 2024 should be directed back to shareholders can you discuss your thoughts on that idea and would you favor increase.
<unk>, the recurring dividend or a share buyback or perhaps other other vehicles. How are you thinking about return of capital.
Yes, first let me say, it's very nice to have this conversation because.
Couldnt.
A year ago.
So.
Yes at this point, we're going to get through this year and we will.
Sure in our Investor Conference, our further thoughts on capital allocation, we certainly.
Participating in an industry, where there should be plenty of growth and there's probably plenty of opportunity to continue to reinvest.
In the business, but we do recognize that.
We will have to make some strategic decisions with what to do with some excess cash I think as we said previously we do believe there are some accretive strategic acquisitions out there.
That is probably something we would look at first but we will be able to give a lot more detail in November .
Thanks very much.
Thank you.
Our next question comes from Jeff Sprague from vertical research. Please go ahead.
Okay.
Thank you good morning, everyone.
Good morning, John Nice quarter.
Good to see.
I wanted to pick up on.
Sort of the <unk>.
<unk> right there on the margin David Thanks for doing that math for us we've done it but I'm glad you pointed it out.
And really the.
I guess the question is if we go back to that original algorithm.
The core kind of the missteps.
Months 18 months ago or so.
We were thinking about operational improvement being better on price execution of internal execution and the like.
I'm just wondering if you could update us on all of those levers really.
Particularly kind of the internal operational opportunities that you see.
And I would suspect we're in a strong enough demand environment.
You would expect to be able to remain price cost positive for the foreseeable future, but I wonder if you would agree with that or how are you thinking about kind of the price cost lever inside the margin trajectory from here.
Maybe I can start with a little bit.
Of the three points through a toolkit and we're asking about price cost and execution.
I mean this is something we've been absolutely vocal about in in the last three calls as a matter of fact this included.
Suddenly.
A lot of.
Price efforts and successful execution as David explained also our outlook.
What is most important.
As our price cost when we were talking about price I was vocal about the fact that we have now a muscle that we did not have before.
Okay.
Has helped a lot to rebalanced back to position.
And let's say pre pre big inflation position when it comes to when it comes to the cost side of the equation. We have a lot of focus on on an efficiency be that in.
Manufacturing execution, we that in in procurement.
And.
And Ah.
There are still potential to suit potential in general.
<unk> in particular is to across the organization across the organization that I can point, particularly to the execution that we have started to drive in the procurement and manufacturing and the ability to ship.
That has certainly characterize and accelerated our ability to deliver on our strong backlog we entered 2020.
Three with so.
We will have time in November to go into more details of exactly what the other.
The axis of this acceleration, but I was vocal about.
Our internal.
Promotion of pole and Anders as a further step in the direction that is testament to the fact that we are not done yet and thats.
Good news.
Yes. It is.
<unk>.
I Wonder if you could maybe give us some perspective on incremental margins. So I'm trying to kind of call that together. So we're trying to say we're not done in 'twenty, three but we've kind of pulled out of the big hole in.
Or something maybe approaching normal not quite there, but as we look into 2024 and beyond.
What would be kind of a reasonable kind of incremental margin construct for us to have our head.
Yes.
I think the easy answer is higher.
But if you look at where we were last year and we've disclosed this in the past we were probably in the low <unk> from a variable contribution margin perspective.
We're in the upper <unk> at this point in time, let's call. It the mid to upper <unk>. So if you look at the projected 600 plus basis point increase.
In operating margin this year versus last year about 400 of that is related to the variable contribution margin.
200 is related to fixed cost leverage and I definitely don't want to discount the.
The power of the fixed cost constant.
Methodology and culture that should continue to provide upward.
Momentum on the operating profit so.
As we've consistently said, 16% has been our intermediate.
Term goal.
We have high confidence of getting there for sure, but we're not celebrating our long term goal is 20% and higher but to get to that level. Geoff to your question, we're going to have to continue to.
Improve with the contribution margin, while also incorporating that fixed cost leverage philosophy.
Great. Thanks for the insight I appreciate it.
Thank you.
Our next question comes from Nicole today to Deutsche Bank Nicole. Please go ahead.
Yes, thanks, good morning, guys.
Good morning.
And can we just start with.
Enterprise demand I know you didn't change the bubble and the market outlook.
What are you seeing on that front I know this has been kind of like a watch item year to date.
But.
Nicole not much really to add to what we were saying we continue to see that.
Demand fairly fairly stable.
The technology.
Continues to be evolving for everyone.
And the industry and Thats not just Colo hyperscale.
But again not a lot to elaborate upon here we see.
We see we've seen some stability in that in that space.
Okay. Thank you and then.
<unk> margins, obviously pretty big step up this quarter.
How are you guys thinking about the sustainability of that level of margins into the second half of the year. Thank you.
Yes.
Yes.
I would say that we have done a.
A very very good job operationally.
Terms of positioning ourselves in the market.
<unk>.
With our technology and with our <unk>.
Total cost of ownership story so.
We are strongly positioned in EMEA altogether.
Thank you.
Our next question comes from Steve Tusa from JP Morgan. Please go ahead.
Hi, congrats on the free cash flow.
Thank you thank you Steve.
Okay.
Just a nitpicky one that I have a follow up but why do you guys have.
The inflation material freight and labor inflation ticking up quarter to quarter from <unk> to <unk> is that something to do with the comp from last year or something.
Yes, so there's three components to the inflation story has the material inflation, which is $110 million headwind.
<unk> for the full year yet.
I have actually a benefit and freight about $40 million in labor is about $100 million. The benefit from freight is definitely front end loaded so of that 40 <unk> 30 of it is in the first half which.
Provides the actual tailwind as you look at the second half versus the first half. In addition, we do see an uptick in labor inflation.
Partly because of the timing of.
Pay raises but also related to.
Foreign exchange dynamic in Mexico, where we have some of our labor.
So.
I would say those are probably the two most significant.
Dynamics pretty.
Pretty much just.
Front half back half dynamics in both freight and then also labor.
And then can.
Can you just help reconcile it just seems like the other guys. The other peers you compete against their orders are trending better than you guys on a year over year basis. I know there is some difference in portfolio Theres, some lumpiness or do you guys feel like youre being selective or you're kind of holding your own.
These bids for now.
So there are two elements here.
One is.
One is the normalization.
That we have been vocal about in the last.
<unk> coals and this and this will continue so that's a very normal very very healthy situation. We're in.
We certainly have.
Very strong comparisons.
This is certainly true.
And we see pipelines.
Growing so.
Yes.
I am.
Positive about the trajectory the trajectory we are on I cant speak for our four other players that base period comparison.
There is an element exactly exactly so if we if we go back to the beginning of the year, we were saying Hey, we are at <unk> 8 billion.
Dollar backlog and we are likely going to shrink that and we have gone up probably consume this backlog. So here we are halfway through the year that is that is not.
That has not been the case, so positively surprised by that we have a.
Book to Bill, one, but and if we look at our book to Bill on the 12 trailing months than we are at 1.11, so that multiple ways to look at this.
I recommend we don't just take thanks.
At their face value, but we double click on what's really behind.
Yeah, Great and then just one last one on this on this new technology around cooling and just the.
The proliferation of these AI related data centers do you feel like youre going to need to at some point.
Go in and do invest more whether it's through acquisitions or through technology.
At some stage to kind of bring more in house or.
It's more steady as she goes as far as partnerships in developing internally are there is there a certain degree or is there some sort of acquisition that you feel like Youll end up doing when you get better visibility on on what the format is.
This technology is still at a very early at a very early stage.
And as every technology at early stage.
Youre looking at.
The opportunities through multiple lenses one is.
As the organic lenses and we're certainly investing a lot, but we have partnerships as well. So there are multiple opportunities out there and we will really see NB.
A stronger balance sheet as well will be will be.
Yes.
Focusing on understanding exactly what's the best path going forward as the market matures.
Great. Thanks, a lot.
Thank you.
Our next question comes from Andrew <unk> from Bank of America, Andrew. Please go ahead.
Hey, guys good morning.
Hey, Andrew Andrew.
Hey, how are you.
Just a question I wanted typical lead times for thermal management products at this point.
If data center owners are planning to buy these GPU chips, what lead times are you quoting for the related thermal products.
Well that really depends on the on the customer with customer request of course, but in this moment, we have changed a lot from the situation in from a situation in which we were.
In 2022, as we explained during the last earnings call, where we were our top 50 60 weeks lead time to much lower levels.
To the.
30, 40 weeks and down from their further so.
Really what requested lead times, we get depends on the strategy of the various players and do not think necessarily if I. If I may suggest that it's at.
The exact concatenation of when do I get the chip the GPU and when I need the infrastructure because of two things go in parallel and very often the infrastructure comes fast. So you will see probably some earlier.
<unk> demand than when the bulk of the chips will be available for <unk> for AI, but.
It's customer specific.
For what we are concerned we have moved.
Down the path of.
Shortening lead times and now we're able to serve the market with a much shorter lead times than we did a year ago and indeed three months ago Thats exactly.
And maybe just a follow up and I'll Echo Steve's comment on cash could.
Could you give us some update just more color on internal changes that youre, making to improve cash.
Changes of how you bill payment terms downpayments, just any color about sort of nuts and bolts of moving the needle there. Thank you.
Yes, I think your words nuts, and bolts probably has a pretty good description.
Similar to what we did from an operational perspective, notably in the Americas, we are really getting into the basics.
And focusing on day to day execution, and we have a lot stronger visibility transparency with where we are.
Particular payment terms with every customer.
Get daily updates as it relates to inventory and probably most importantly, we have a plan that we're executing against.
So.
I would say there's been some early successes.
But there still is a ton of opportunity out there.
<unk>.
This is was a focus as we exited last year.
Probably started.
In force mid last year, but.
It is also a huge cultural aspect. So when we talk about drumbeat and when we talk about financial metrics. We generally start with cash at this point in time. So we're encouraged with where we are but not satisfied there is still a lot of work to do.
Great. Thanks, so much.
Thank you.
Thank you.
Question comes from Mark Delaney with Goldman Sachs Mark. Please go ahead.
Yes, congratulations on the strong results and thank you very much for taking my question. The company have an expecting backlog to get worked down.
<unk> lead times normalized book to Bill as you mentioned has come in at 1.0, approximately for both <unk> and <unk>. So given the upside in orders you've seen in the first half of the year can you share your latest views and I expect backlog to trend do you still think that comes down a bit this year and on a related topic given the better than expected demand do you think you need to put any.
More manufacturing capacity in place to support that.
Yes, well thanks, Paul for the question so when it comes to the backlog.
We have.
We have.
Plan for orders that sees our orders in.
In Q3, and Q4 sequentially sequentially increase.
And.
We will see what the backlog the backlog does exactly.
We still are in.
An unusually big backlog situation, given our historical trends and historical trends in the industry.
We were north of 70% coverage, we believe I think above 50% is a good place to be but let's see how things unfold in that respect certainly certainly the pipeline strength is something that is encouraging in that respect.
And just operationally in order to support the backlog do you need to put any more capacity.
<unk> got facilities unit.
Well.
We do have capacity as I explained we have in.
The increase can be invested in capacity in the last 12 to 18 months.
We are certainly extracting more capacity from what we have we we've been vocal many times about our vertical operating system and that certainly is a big enabler for more capacity out of our current footprint.
But.
<unk>.
Very focused and very keen on.
Building scenarios as to what exactly will happen. So we will move Ali if needed when we see that there is an imbalance between the potential demand and our available capacity.
Okay.
Understood. Thank you.
Thank you.
Thank you.
This completes our question answer session I would like to turn the culture.
Dominate all pataki for closing remarks.
Well.
Thanks, a lot again, a good first half and looking forward to two our second half and looking forward to meeting you all in November .
Okay.
The conference has now concluded. Thank you for attending today's presentation. You may now disconnect looking forward to meeting you all in November .